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MUTUAL RECOGNITION OF REGULATORY REGIMES SOME LESSONS AND PROSPECTS.rtf

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					    Mutual Recognition of Regulatory Regimes: Some Lessons
                         and Prospects

                                          by Kalypso Nicolaodis



     I. Introductory remarks
1.        Mutual recognition agreements (MRAs) will likely be at the heart of trade diplomacy in the
coming decade. 1 Not only do they represent a most effective approach to addressing the impact of
differences in national regulatory systems as barriers to trade, but they also constitute a powerful impetus
for improving such systems through regulatory co-operation.2 Since the mid-1980s, the principle of mutual
recognition (MR) has been widely hailed as the hallmark of "Europe 1992" and has served to ensure the
successful completion of the European single market in a wide array of sectors, ranging from toys,
machine tools, telecommunication equipment and pharmaceuticals to banks, insurance, professionals, or
broadcasting. At the global level, the signatories of the Uruguay Round called for the bilateral or
plurilateral negotiation of MRAs both in the agreement on Technical Barriers to Trade (TBT) and in the
General Agreement on Trade in Services (GATS). A decade after its rise to fame in the European context,
and notwithstanding fundamental differences in its scope of application, mutual recognition has proven
contagious. MRAs are being negotiated or considered bilaterally (e.g. between the United States and the
European Union, Australia and New Zealand), plurilaterally (the Quad countries) and regionally (within
APEC, ASEAN, NAFTA and the FTAA). The results of the current US-EU negotiations in particular are
awaited by many as a possible model in this regard.

2.        But the negotiation and implementation of these agreements are bound to be a source of tension
and even conflict between states as differences of view arise on their desirable characteristics and
boundaries and on the best ways in which they can accommodate disparate regulatory traditions. This
paper asks how can we best capture joint gains from trade through MRAs, what are the preconditions for
negotiating MRAs and how MRAs can most effectively be designed to minimise such potential conflicts.
In particular, it stresses the importance of taking into account MRAs -even if not yet negotiated- while
implementing regulatory reform and the potential synergies that can be exploited between the two
processes.

3.         Mutual recognition can be defined as a contractual norm between governments whereby they
agree to the transfer of regulatory authority from the host country (or jurisdiction) where a transaction
takes place, to the home country (or jurisdiction) from which a product, a person, a service or a firm
originate (jurisdictions are generally sovereign states but they can also be sub-national units in federal
entities). This in turn embodies the general principle that if a product can be sold lawfully in one


1
      MRAs will be used in this paper to refer to any inter-state agreement involving mutual recognition
      although the current common use of the term is more narrow.
2
      Throughout this paper I will use the terms national regulatory system or regime to refer to the
      overall range of national requirements for the sale of goods and services. While recognizing the
      technical use of the terms regulation to refer to mandatory requirements and standards to voluntary
      ones, I will sometimes use standards to mean mandatory requirements as is often done in the
      litterature on standards and international trade.

                                                     1
jurisdiction, it can be sold freely in any other participating jurisdiction, without having to comply with the
regulations of these other jurisdictions. 3 The "recognition" involved here is of the "equivalence",
"compatibility" or at least "acceptability" of the counterpart's regulatory system; the "mutual" part indicates
that the reallocation of authority is reciprocal and simultaneous. Finally, mutual recognition agreements
are specific instances of application of this general principle, between specific parties, applying to specific
goods and services and including more or less restrictive constraints and caveats.

4.        Assessing the basis for MRAs constitutes a variation on the broader question of how to reconcile
trade and regulatory objectives, that is how to reduce or eliminate the trade impact of differences in
national regulation without sacrificing legitimate regulatory objectives. As highlighted by the OECD's
current review of regulatory reform in its member states, cross-border providers of goods and services face
two core trends. On one hand, an ever growing range of products need to comply with different
regulatory requirements or be certified to different national standards, from cars to machinery, drugs,
chemicals, telecommunication equipment or data transfers. This trend is not only due to the rise of living
standards in the last two decades but also to a growing awareness of the need for regulations to protect
human health and safety, the environment and other concerns. At the same time, regulatory reform -a more
appropriate term than deregulation- has been under way in many sectors to remedy the more cumbersome
and sub-optimal aspects of regulatory intervention, and decrease its complexity, opaqueness and rent
seeking nature.

5.         It is in this context that new methods are currently being devised to ensure effective market
access, or -in current OECD parlance- international openness of markets, that focus on the impact of
disparities of regulations on actual and potential competition rather than only on their discriminatory
character. To be sure, technical barriers to trade have been the focus of attention under bilateral, regional
and multilateral agreements since the 1970s through the refinement of the principle of national treatment to
include various forms of latent discrimination. But there is a growing recognition of the need to address the
"hard cases" of regulatory barriers that reflect "legitimate differences" between countries in taste, income
distribution, market culture, geography, risk aversion and more generally, prevailing patterns of
state-society relationships. At a first level of analysis, we need to ask whether the costs of regulatory
heterogeneity are so substantial as to outweigh its benefits. 4 But given both the practical limits to
harmonization and the political imperative of subsidiarity at a world level, the fundamental choice is not
between regulatory heterogeneity and regulatory homogeneity across states. The central question ought to
be: given regulatory heterogeneity to what extent should mutual recognition be introduced? In other
words, to what extent should a decentralised approach to regulation be accompanied by a reallocation of
jurisdictional authority?

6.        MR-based laws in the EU or currently negotiated bilateral MRAs do not generally apply mutual
recognition in its "pure" form: full unhindered rights of access reflecting full reallocation of authority from
the host to the home jurisdiction. Instead they vary in their regulatory scope and usually leave residual
powers to the host state; they involve mutual monitoring between regulatory authorities as well as
enhanced co-operation; and they require stringent ex-ante and ex-post conditions. In short, what I will
refer to here as "managed mutual recognition."




3
      The formula was originally stated by the European Court of Justice in its Cassis de Dijon ruling of
      1979. It is usually used to descibe mutual recognition. See for instance "A proposal for the
      Trans-Tasman mutual recognition of standards for goods and occupation," 1995.
4
      For a recent overview of these issues see Alan O. Sykes (1995), and comments by NicolaÔdis and
      Pelkmans therein.

                                                      2
7.        This paper is organised as follows. First, I will argue that the world of commercial diplomacy is
changing faster than our conceptual lenses to apprehend it: we need to move from a view of mutual
recognition as a "residual" alternative to national treatment and harmonization to a central paradigm. I will
then suggest how the basic arguments for and against the adoption of mutual recognition need to be used in
this light and in doing so present the case for managed mutual recognition. Section III turns from a
normative to a positive approach and draws on the current US-EU MRA negotiations to show how
managed mutual recognition is being designed in practice. Section IV suggests ways of anticipating
future implementation problems and magnifying liberalisation dynamics. Finally, section V explores the
prospect for world-wide mutual recognition of regulatory regimes.

     II.  Mutual recognition and its alternatives: residual,
     hybrid or core paradigm?
          II.1. Lessons from the EU experience:                        policed national treatment,
          harmonization and mutual recognition
8.        Conceptually, policed national treatment, harmonization and mutual recognition can be
considered as the three alternative approaches to trade liberalisation. Historically, however, mutual
recognition has come about as a "residual" alternative to either of the other two, as is best illustrated by the
history of its progressive emergence in the EU. 5 To illustrate this point, it is useful to draw on the
traditional distinction between negative and positive economic integration. 6 Classical analysis of
customs unions and traditional commercial law or GATT law consider trade liberalisation as an exercise in
negative integration, e.g."the removal of discrimination in national economic rules and policies under joint
and authoritative surveillance." Positive integration -e.g. "the transfer of public market-rule-making and
policy-making powers from the participating polities to the union level"- concerns macro-economic or
monetary integration and the "approximation of laws," as called for by Articles 2 and 100 of the Treaty of
Rome. Trade liberalisation in Europe rather quickly came to be seen as requiring a mix between national
treatment and harmonization as the operative norms corresponding to negative and positive integration
respectively. For a long time, under the so called "old approach," approximation of laws was seen as
requiring detailed harmonization and, "pending" such harmonization, national treatment was policed by the
Commission and the European Court of Justice in an increasingly constraining manner.

9.         Mutual recognition is often presented as a form of negative integration in that it consists of an
obligation which restricts the freedom of member states and does not involve the transfer of power to a
supranational level. In this sense, it constitutes an extreme form of national treatment if non discrimination
is taken to mean that foreign and domestic actors ought to be granted the same rights of access, or equality
of opportunity, even if this implied that national regulations would be applied in a discriminatory manner
to the latter. By the same token, the ECJ, responsible for upholding liberalisation commitments embodied
in the Treaty of Rome, came to enforce mutual recognition. The key to this development was a subtle
matter of degree, a shift from a negative to a positive test applied to domestic regulations. Policed national
treatment implied a negative test: should the conditions required for market entry of nationals and
foreigners, be considered as restrictions or barriers to trade ("equivalent" to that of tariffs and quotas) and
therefore be removed unilaterally under existing liberalisation commitments? Mutual recognition



5
      For a history of mutual recognition in the EU contrasting the three approaches, see for instance
      NicolaÔdis (1993) or Pelkmans (1995).
6
      The distinction was introduced by Tinbergen (1954) and developed by Pinder (1968)

                                                       3
appeared by judicial fiat when the Court turned to a positive test: should home country standards be
recognised as "equivalent" to those of the host country, and therefore replace them. In Cassis de Dijon, and
the ensuing case law, authoritative judicial review led to the notion of "recognition of equivalence" as an
extreme interpretation of negative integration requirements (while directed at one party, a judicial
injunction of "recognition of equivalence" is "mutual" through jurisprudencial generalisation).

10.        Judicial and political MR must be distinguished both semantically and in their effects. Both
judicial an political MR apply the general principle enunciated in the introduction: lawful in one
jurisdiction, lawful everywhere. But, by definition, only political MR constitutes a contractual norm. The
job of Courts or dispute resolution panels is to decide when the general principle can be enforced legally
and when it needs to be the result of a contractual norm. In doing so the ECJ refined a set of criteria which
led it to extend judicial MR to most non-health and safety matters and some other matters. 7
Nevertheless, even the ECJ has exercised considerable caution in enforcing mutual recognition by fiat,
from the beginning with services regulations and increasingly for goods regulations(Mitouard case law).
Lessons need to be drawn here for the multilateral level.

11.        More generally, political MR casts a wider net for liberalisation for four main reasons. First a
political deal introduces greater certainty and immediacy for exporters -even if the Court was to eventually
cover their products. Second, political fiat can afford to be bolder than judicial fiat. Regulatory differences
that may be considered "legitimate" by the ECJ and therefore not amenable to MR by judicial fiat, can
nevertheless be considered as "acceptable" as the basis for mutual recognition agreements: government
representatives can decide to take a leap of faith. Third, political MR does not have to be an up or down
decision: it usually sets in place a process involving the progressive expansion of the scope of mutual
recognition, whereby each step prepares the ground for the next. Differences become acceptable with time.
Finally, and to the extent that both judges and government representatives would consider existing
differences as an unacceptable, the latter have the option of resorting to prior minimal harmonization that
the former do not have.

12.       This leads to the remark that confining mutual recognition to an extreme case of negative
integration does not capture its essence, whereby states do not only agree to abstain from a given
behaviour, but do so on the condition that the control they give up will be replaced by an "equivalent
control" on the part of home countries. As a matter of fact, mutual recognition has indeed traditionally been
referred to as part of the so-called "harmonization process." As states engage in a collective assessment of
the extent of harmonization necessary as a prerequisite for free movement, mutual recognition can be seen
as the residual of harmonization. National regulations are hence mutually recognised to the extent that they
have not been harmonized, or to the extent that they differ in the "ways in which essential requirements are
applied." To view mutual recognition as a form of positive integration, as a transfer rather than a giving up
of regulatory authority, implies taking into account the high level of regulatory co-operation involved in its
adoption rather than equating it with a form of deregulation.

13.      In sum, mutual recognition has come to be seen as the "residual" of either one of two processes:
assessing the legitimacy of an individual host country's regulations in light of the equivalence of a home
country regulations (negative integration); and assessing the degree of necessary harmonization beyond


7
      In Gebhar, 1995, for instance, the ECJ states: "national measures liable to hinder or make less
      attractive the exercise of fundamental freedoms guaranteed by the Treaty must fulfill four
      conditions: they must be applied in a non discriminatory manner [classic national treatment]; they
      must be justified by imperative requirements in the national interest; they must be suitable for the
      attainment of the objective which they pursue [least restrictive means], and they must not go beyond
      what is necessary order to attain it [proportionality]."

                                                      4
which member states' rules ought to be considered as mutually equivalent (positive integration). Mutual
recognition must be adopted to the extent that policed national treatment is insufficient to ensure effective
market access and to the extent that harmonization is undesirable or unfeasible. The negative/positive
integration dichotomy is reductionist, mutual recognition is in fact a hybrid at the intersection of both
processes.


14.       If mutual recognition like policed national treatment does indeed pertain to both realms of
integration, it is precisely its place at their intersection which makes for its unusual properties. It amounts
to creating transitional jurisdictions, which cut across national jurisdictions but do not result in the
introduction of a supranational jurisdictional layer. Mutual recognition constitutes a powerful instrument to
enhance the contestability of markets precisely because it consists in retaining regulatory heterogeneity
across polities -like policed national treatment - while introducing a single rule or standard across
boundaries from the point of view of producers -like harmonization. At the same time, this instrument is a
controversial one because, contrary to both these options it leads to the competition between regulatory
systems -- rather than a single rule --within each national jurisdiction. Both the rational for and the
resistance to the adoption of mutual recognition is grounded in the properties of such transnational
application of laws and regulations and jurisdictional control, as summarised in the table below.

Trade norm: Single Rule?...
                                           National Treatment        Harmonization        Mutual recognition

...from economic actors’ viewpoint                 No                     Yes                     Yes

...from a symmetric viewpoint                      No                     Yes                     No

...within systemic jurisdiction                    Yes                    Yes                     No

15.       Finally, and in order to properly assess the specific function of mutual recognition, we need to
refer back to the fundamental distinction between recognition of actual substantive regulations and the
recognition of regulatory control.8 In addition to mandating substantive regulations, governments require
that exporters comply with certification (e.g. goods), licensing (e.g. professionals), control (e.g.
manufacturing processes) or supervision (e.g. banks) by the regulatory authorities of the host country or
increasingly by quasi-public or private entities operating on their behalf.     This second dimension of
regulatory regimes underscore the centrality of mutual recognition as a mechanism for liberalisation. First,
unless we envisage the creation of supranational agencies responsible for the enforcement of rules, mutual
recognition of home country conformity assessment (for products) or control (for services) is the only
alternative to host country control. Moreover, even in cases where countries adopt the same rules or both
rely on international rules, such mutual recognition of conformity assessment is generally not extended as
a matter of course.9 As a result, when we say that harmonization provides a single rule from the economic
actors' viewpoint, it does not necessarily follow that it provides a single point of control. Mutual
recognition is thus the only path to market access.




8
      For goods we refer to standards versus conformity assessment, for services to regulation vs home
      country control.
9
      This point is often overlooked by those who present harmonization as a complete alternative to
      mutual recognition. See for instance Sykes, op cit, 1996

                                                      5
            II.2. MR as the core paradigm
16.        The developments sketched call for a reversal of perspective about mutual recognition both from
a policy and from a conceptual standpoint. Contrary to the traditional view that MR should be turned to as
a “residual” option if policed national treatment is not enough and full harmonization not feasible,
commercial diplomacy should adopt mutual recognition as the core paradigm for dealing with regulatory
barriers to trade. The creation of transnational jurisdictions is the only way to provide transnational actors
with a single authority of control or conformity assessment. Liberalisation exercises need to adopt mutual
recognition as their starting assumption, even while some degree of residual host country control or prior
harmonization may be deemed necessary. Such a reversal of perspective implies that it is policed
national treatment and harmonization that ought to be considered as deviations from the core MR
paradigm.

17.       Both the EU approach to completing the Single Market and the Trans-Tasman MRA between
New-Zealand and Canada reflect such as a reversal of perspective. The process adopted in these contexts
suggests a pattern that can be followed elsewhere, even if in less ambitious fashion 10∑ To simplify, both
exercises follow a similar sequence:

     a) Visible public commitment to full trade liberalisation on the part of politicians with explicit reference
        to mutual recognition as the central mechanism to attain it. At this point, MR is adopted as a core
        paradigm rather than an operational norm.

     b) Announcement that mutual recognition will enter into force by a given deadline, although the
        deadline is likely not to be completely compulsory. In Europe, 31 December 1992 did not create
        automatic legal effect for MR in areas that had not been addressed yet but was to be considered an
        “expression of political will”. The Trans-Tasman agreement is more constraining since exemptions
        must be notified before the deadline.

     c) Negotiations between regulators over the precise terms of agreement, including residual power to the
        host state and/or minimal harmonization prior to mutual recognition. In short, regulators attempt to
        abide by the new mandate created by politicians while at the same time doing it “their” way through
        “managed mutual recognition”.

     d) MR-based directives or MRAs enter into force, with given sectors, products or services falling under
        one of the four categories described below:


            Category 1: MR is an end in itself.
      This applies to areas where differences are acceptable -e.g. where they are modest, where they are
       considered to have no serious implications or where regulators on all sides agree that the benefits of
       MR are worth the regulatory risks. It may later fall into Category 3 if differences widen at a later
       stage.



10
        Despite their difference in scope, the European approach and Trans-Tasman agreement reflect the
        same basic philosophy. See “Council of Australian Governments and the Goverments of
        New-Zealand”. A proposal for the Trans-Tasman mutual recognition of standards for goods and
        occupation. Australian Government publishing office, April 1995. The Trans-Tasman MRA has
        been finalised in June 1996 and covers all products except exemptions as well as professional
        services referred to as “occupation”.

                                                        6
         Category 2: MR is an end in itself but requires pre-conditions.

   This option is especially relevant to recognition of conformity assessment or home country control
    where there is no alternative to MR as a mechanism for liberalisation. This applies to areas where
    some degree of enhanced mutual familiarity with each other's regulatory system needs to develop
    before mutual recognition can be enforced. Preconditions can include exchange of information or
    regulatory co-operation or regulatory convergence, but contrary to Category 3, such convergence is
    not an end in itself and needs not necessarily be permanent.


         Category 3: MR is a means to an end, to reach agreement on "essential requirements."

   MR can be used to give a sense of urgency to harmonization, in areas that are considered too critical
    for outright mutual recognition. As opposed to the classic harmonization or standardization process,
    however, discussions occur against the backdrop of MR. In some cases, MR is actually adopted but
    performs a stop-gap function pending the adoption of regional or global regulations (similar to
    Category 1 in effect if not intent). In most cases, it is the prospect of eventual MR (backed up by
    public commitments) and the injunction to minimise the degree of harmonization to essential
    requirements which provide the impetus. In order to maximise such impetus, the Trans-Tasman MRA
    set in place a temporary exemption mechanism, covering 12 months. Part of the difficulty is to decide
    which cases may warrant an extended timetable.


         Category 4: temporary or permanent exemptions from MR.

   These are cases too sensitive for mutual recognition and where harmonization is not feasible, if for
    instance regulations reflect unique local conditions or where the control over operations can only be
    done from the host state. Under a generalised MR assumption, these cases need to be explicitly
    excluded.

18.      In the context of a generalised application of mutual recognition as in Europe, governments need
to make decisions over the product scope falling under each one of these categories. Under more limited
agreements, they may concentrate on one of these categories. The scope covered by category 1 as
opposed to the other three categories, as well as the approach taken within categories 2 and 3, will
determine the extent to which MR is being managed to take into account regulatory imperatives.

    III. Balancing benefits and costs: the case for "managed
    mutual recognition"
19.       In light of the above, there are two ways of weighing the benefits against the potential costs of
MR. We can ask whether and when mutual recognition is desirable in contrast with its alternatives. We can
also ask to what extent mutual recognition, if adopted, needs to be "managed" to take account of its costs
and offer safeguards for signatories. Even if for trade purposes the case in favour of mutual recognition
can be made forcefully, positions need to be more nuanced when we turn to regulatory and political
implications of MR.

         III.1 The trade rationale: market demand for mutual recognition
20.     The trade facilitation benefits of MR are obvious and have often been repeated. By only having
to comply with one national standard or regulation, exporters avoid adaptation costs and may reap


                                                    7
previously unrealized economies of scale; by doing away with repetitive testing and certification in
importing countries, exporters avoid not only the associated expenses, but also delays that can be
especially costly to short life-cycle products. Moreover, MR provides certainty to the producer in a context
where host country conformity assessment leaves the door open to arbitrary decisions due to outright
protectionism. The exporter also avoids the risk of an importing country carrying out reverse engineering,
infringing on intellectual property rights or engaging in unauthorised technology transfer through the
process of evaluating the performance of imports.11

21.       Obviously, these potential benefits vary with the actual compliance costs, themselves a function
of differences in applicable regulations and extent of potential economies of scale. It is important to take
such variation into account since a judgement on the judicial enforceability or the political desirability of
MR involves weighing regulatory costs against trade benefits. To take the case of professional services,
adapting to local training and certification requirements may require a significant proportion of one's life
(the need for mutual recognition of diploma was the only instance of MR foreseen by the Treaty of Rome)
whereas local conduct rules are not so costly to comply with. Permanent establishment may justify a
greater adaptation effort than sporadic cross border provision of services. For banks, compliance costs
linked to structural adaptation such as specialisation requirements (commercial Vs investment banking) are
likely to be so high as to prohibit trade altogether (there MR was introduced in the EU by the second
banking directive adopted in 1989 but does not exist between the US and the EU).

22.       There also exist differentiated market incentives to seek mutual recognition. Consumers may
want to import a product banned in the host country (pharmaceuticals, food products, types of financial
products, professional practices, temporary employment agencies). In this case, mutual recognition is
synonymous with market access. Conversely, market incentives may require that adaptation costs be
incurred anyway, where local regulations have strongly shaped the local demand for specific
product-types; or where adaptation is an integral part of the product offered (providing advice on local
law). Even in the latter cases, voluntary adaptation may be less cumbersome and as effective as having to
provide the proofs of such adaptation.

23.       Specifically in the realm of services, lack of MR can simply preclude certain types of
international transactions entirely, at least through the means of cross-border trade as opposed to
permanent local establishment since local control requires local presence. It has become a clichÈ to point
out that through communication networks a firm engaged in long-distance data processing services or
provision of financial information, or a bank offering portfolio management services, can operate entirely
from their home base. Mutual recognition is a prerequisite to network-based service delivery which
amounts to a right of non-establishment. Even for services which need to be customised through
interaction with the customer (e.g. investigative capacity of insurance), local presence could be reduced to
simple offices, which is impossible without mutual recognition of supervisory functions.

24.      It is clearly difficult to assess the extent to which regulatory requirements as opposed to
technological and demand requirements influence actors' export and location strategies. Mutual recognition
may translate into a small market share in the short run yet may have a significant influence on the
competitive environment of the importing country.

          III.2. The regulatory rationale: costs and benefits of regulatory
          competition and co-operation


11
      Clarke (1996) emphasizes this point especially with regards to newly industrialized East Asia
      countries.

                                                     8
25.       Three broad categories of regulatory rationale can be invoked in favour of MR. First, MR
introduces freedom of choice for the consumer, extending the traditional argument in favour of free
trade to the freedom to chose among rules. Some consumers will derive greater benefit from stringent
regulations even at higher cost while others will favour lower price/lesser quality packages. Second,
regulatory competition introduced by mutual recognition is likely to increase the efficiency of regulations
by acting as a "means of discovery" and even lead to convergence towards some "optimal" through the
arbitrage of consumers and firms rather than bureaucracies. 12 Third, mutual recognition can improve
regulatory practices directly through better division of labour and enhanced co-operation between
regulators or private regulatory bodies. Regulators can reallocate the resources previously devoted to
redundant control of foreigners and increase their capacity to operate domestically and to collaborate with
their counterparts. The negotiation of MRAs externally can even constitute the impetus for streamlining
domestic regulatory systems, including to address problems of redundancy in federal systems (for instance
in the United States). These arguments are all-the-more powerful that they suggest a synergy rather than
tension between trade and regulatory objectives.

26.       Nevertheless, it would be difficult to deny that pure mutual recognition does have regulatory
costs. At a minimum, the primary rationale for domestic regulation -e.g. to correct market failures which
include externalities, market power, and asymmetric information- is put into question.13 First, because
states hold very different notions of what market failures are and how they should be corrected. Second,
market failures may actually be magnified under MR: information asymmetries may be greater between
consumers and suppliers from different countries. Third, home state regulatory or conformity assessment
bodies alone may not have the capacity to effectively enforce their counterpart's regulation or their own
across jurisdiction. Fourth, mutual recognition risks introducing a new basis for "unfair competition." Fifth,
mutual recognition may create incentives for deregulatory competition and a race-to-the-bottom between
regulators.

27.        Such arguments do not all have the same force. The extent to which they justify limiting the
adoption of MR has been extensively debated, in particular in European circles. The temporary outcome of
these debates and deals between regulators or bodies with delegated authority have formed the basis for the
"managed" character of mutual recognition in the EU context, including various degrees of prior
harmonization, reduction in regulatory scope and progressive expansion of such scope, safeguard clauses
for the host state and provisions for mutual oversight between regulatory bodies. A few general points
illustrate these considerations. In order of importance:

28.       The existence of negative externalities usually justifies levels of prior harmonization close to
those of countries with the most stringent regulation, although with disagreement over how to define
stringency. This includes cases where safeguarding systemic integrity across jurisdiction is concerned
(capital adequacy or "no harm to network" requirements) or where externalities are confined to the specific
territory where a good is consumed (auto emission) or a service provided (security norms in road
transport).




12
      An extreme -but not necessarily dominant- version of this argument is that mutual recognition serves
      as a means of diffusing deregulation across national lines.
13
      Although economists have argued extensively over what should qualify as market failures, whether
      regulatory methods are properly targeted on the market failure they seek to address, what is the
      appropriate tradeoff between the benefits of regulation and the benefits of competition, and whether
      the regulatory or government failures inherent in regulatory intervention do not ultimately render
      such intervention inefficient, irrespective of the worthiness of its primary goal.

                                                      9
29.      The extent to which consumer protection considerations justify managed MR depends less on
whether regulatory objectives among signatories are shared (they always seem to be) than on whether:

  a) Regulators can justify changing the risk tolerance reflected in their practice. Some of the greatest
     tensions in implementing MR arise from differences in risk threshold demanded by the public (in
     pharmaceuticals tolerance of type I errors -harmful drugs- Vs type II errors-forgoing the benefits of a
     new drug) or level of confidence in respective methods to verify compliance (types of test conducted
     for auto safety). An extended preliminary phase of confidence building is key in these instances.

  b) Reputation effects exist and can be magnified through information requirements. For those who
     believe that caveat emptor ought to be the core organising principle of capitalist societies,
     reputation is how markets deal with information asymmetries between consumers and suppliers:
     under MR different regulatory systems will find different market niches with different groups of
     consumers across countries. They may concede that the information provided by the market left to
     itself may be sub-optimal. Adoption of MR may require that regulatory reallocation be made explicit
     in the eyes of consumers through labelling requirement (such as "this product has been tested
     abroad") or signalling requirements (such as the use of the appropriate professional title or the
     requirement that the consumer sign a declaration acknowledging foreign jurisdiction as with the EU
     second insurance directive). It may require more when reputation effects are not applicable (costs of
     learning about foreign "labels"; small probability of a very high cost -e.g. insurance bankruptcy,
     unqualified physician; unawareness that technical product features may vary with applicable
     regulation -- e.g. coverage of insurance contracts). An especially great need for prior convergence
     arises when one party tends to rely on liability rules rather than direct government intervention
     (arguably plagued by the same information asymmetry problem as consumers) and may thus extend
     less protection to foreign consumers.

  c) Whether it is possible to exclude from MRAs certain classes of consumers (insufficiently informed,
     trained to use a product or supported by a "use" system) or certain sub-sectors or products where the
     protection afforded likely depends on consumer characteristics (in insurance; machine tools; food).
     The safety of powdered milk depends on the quality of water locally available. Where health and
     safety is concerned, consumers need to be able to include underlying regulations in their
     investigation.


30.       The third rationale for limiting MR, namely that regulatory differentials introduce competitive
distortions or unfair competition is grounded in the belief that a more "level" playing field needs to be
part of deeper integration, just as social contracts were part of nation-building. The adoption of MR in spite
of remaining differences in both input and output regulations can lead to reverse discrimination of
nationals (Inl‰nderdiskrimminierung ) -banned from practices or markets opened to their competitors
from other member states or facing higher costs through more stringent quality, security, soundness or
social standards. The argument is greatly mitigated by countervailing factors. In addition to the
aforementioned reputation effects, "costly" regulations are often correlated with counterbalancing
comparative advantages, such as human capital, productivity, or reliable infrastructures so that the
competitive impact of MR is a wash. One of the "hard cases" is whether MR should extend to the social
conditions of workers employed under low social protection by foreign firms (e.g. construction) operating
temporarily in the importing country. It is hard to make the case that local firms do not have countervailing
sources of comparative advantage although there may be an externality case for host country jurisdiction
(disruption of local social contract).

31.     Finally, although the question is extensively debated there is little concrete evidence for the
argument that regulatory competition may lead to a race to the bottom (as opposed to more efficient


                                                     10
regulations). The diagnosis rests on two assumptions which often do not hold. First that regulatory bodies
do find themselves in a so-called prisoner's dilemma, whereby if their counterparts defect (relax or scrap
their regulations) they will have an incentive to follow suit. In fact, they may value their regulatory
objectives more than the marginal loss of competitiveness or such losses may be deemed unlikely
(reputation effects and mitigating factors mentioned above). Second, that even if such incentives do
operate, regulators will act on them and relax their regulation. Regulators usually assume that they are in
a "repeated game" and that their behaviour is observable so that gains from following suit would be short
lived. In practice, managed mutual recognition serves to limit the potential for deregulatory competition.
Adequate safeguard clauses in particular can play a key role. I will come back to this point in section V of
this paper.

          III.3. The political             rationale:        sovereignty,         subsidiarity         and
          accountability
32.        Beyond the debates over matters of degree (acceptable impediment to trade, level of necessary
consumer protection, desirability of deregulation) the ultimate argument in favour of mutual recognition is
political. This is a way to ensure subsidiarity at the world level in an era when citizens feel increasingly
alienated by the economic forces of globalisation and homogenisation. Subsidiarity -the European term for
the obligation to act at the lowest level possible- is synonymous here with the protection of state
sovereignty and the diversity of local and national traditions. During the ratification campaign for the
Maastricht Treaty, Jacques Delors never tired to point out how Brussels had practice subsidiarity avant la
lettre by promoting mutual recognition as a means to complete the single market. While the argument is
obviously valid, it is important to stress its limits.

33.       Indeed, if mutual recognition falls short of a supranational transfer of power it constitutes a
transnational transfer of power that may with time come to be seen as much of an infringement on
sovereignty. For one, governments forego their traditional monopoly of territorial control through the
creation of islands of extraterritorial laws on their soil, on which their own citizens may unknowingly loose
the protection of the state. Second, while MR is supposed to at least leave state powers intact with regards
to its own national products and actors, its implementation may end up constraining states in their
regulatory practices in more radical ways than participation in supranational processes (obviously a
potentially beneficial effect as discussed above, but certainly a constraint on sovereignty).

34.        Furthermore, horizontal rather than vertical transfer affords less control over the delegated
authority : states are usually part of, indeed often sole constituents of, supranational decision making
process but do not participate formally in each other's regulatory fora. In turn, mutual recognition puts
into question democratic models of representation since it will not necessarily be perceived as a instance of
"nearness" (the popular term for subsidiarity) by the citizens. For national lobbies, NGOs and consumer
groups, supranational regulatory fora are likely to be more accessible and transparent than those of other
states. If a citizen is harmed by a drug or a machine approved by a foreign regulatory authority recognised
as competent by his state, who is ultimately accountable? To be sure, and by the same token mutual
recognition may strengthen the state apparatus by providing ammunition against regulatory capture. But
political accountability may be better guaranteed by overlapping jurisdiction through harmonization than
by extraterritorial jurisdiction. Hence the paradox that mutual recognition can be both introduced and
contested in the name of subsidiarity.

35.      Finally, in terms of corresponding political vision, mutual recognition is vulnerable to criticism
by both advocates of diversity and unity. Diversity of choice under MR may hinder diversity tout court
by submitting "diversity of polity' to market forces and thus for instance, threatening local traditions as
long-standing but fragile social constructs, which need to be protected from what may be termed "cultural
dumping." European citizens may have applauded the abandonment of the "Euro-breads" plans of the

                                                     11
1970s, but under MR, Italians no more have a say in how to define "pasta", Germans "beer" and the
French "dairy products." At the other end of the spectrum, some will argue that an increasingly integrated
economic space (Europe today, the world tomorrow) should aim towards common rules irrespective of the
market-based rationale for doing so. The flanking policies accompanying the Europe 1992 program -be it
in the field of environment, social policies, or for that matter in the design of common consumer protection
guidelines- were not only geared at smoothing the functioning of the single market but maybe more
importantly at raising the general standards of living for citizens across Europe. But while such policies
were certainly considered by many as crucial elements of the European project, they were pursued in
parallel with, rather than as prerequisite to, the implementation of mutual recognition. The balance to be
struck between unity and diversity among polity needs to be the object of an explicit political debate and
not only emerge as a by product of technical bargains over mutual recognition.

    IV. Negotiation dynamics: Lessons from the US-EU
    bilateral MRA
36.       The MRAs under discussion between the US and the EU are limited in coverage but do include
highly sensitive sectors such as pharmaceuticals, medical devices and telecommunication equipment where
the regulatory issues that arise can be most contentious. Moreover, they will likely set a precedent for
future action both between these two parties and their other trading partners and for the negotiation of
MRAs elsewhere. Although the negotiations are not yet concluded, some important lessons can already be
drawn that illustrate some of the general points discussed in the previous sections.

         IV.1. The scope of MRAs : Standards vs conformity assessment
37.       Up to now, I have discussed MR of regulations and of regulatory control indiscriminately. It is
important to stress that the current MRA negotiations between the US and the EU, as well as most others
referred to as such around the world, are limited to recognition of conformity assessment in the field of
goods (that is the set of procedures by which products and processes are evaluated and determined to
conform to particular standards or regulations). As illustrated in exhibit 1 (see separate annex) in the
separate annex, the mutual recognition of home country conformity assessment can occur in three
circumstances:

   Where there has already been a process of (partial) MR of underlying regulations and standards and
    where home country conformity assessment follows. This was the cases in the EU with the sequence
    "new approach"(1984)--"global approach" (1989). The issue here is whether parties trust each other
    to enforce their own regulations and/or delegate this capacity to the "right" bodies. Note that the
    same issue arises with agreements based on implicit MR of standards (NAFTA o the environment)
    where the debate is shifted to whether the home standards are actually enforced.

   Where there already exist international standards (e.g. ISO) or where the parties to the agreements
    have already harmonised their standards and regulations. In these cases, the conformity assessment
    procedures themselves have often also been harmonised. Parties still need to assess whether they
    trust each other's capacity to apply these guidelines.

   Where standards and regulations have not been harmonised nor mutually recognised and therefore
    where policed national treatment applies with regards to the regulations themselves. This is the case
    for US-EU MRAs which consist in recognising the authority of bodies accredited in the country of
    origin to certify to rules of the country of destination. To be sure, some degree of harmonization or
    autonomous convergence of underlying standards may be a likely consequence of MRAs. These
    negotiations therefore involve a judgement regarding the competence of one side to correctly assess


                                                    12
      conformity against regulations of the other side. Contrary to what is sometimes said this is not a
      trivial matter since agreement requires confidence both in each other's assessment procedures and in
      each other' understanding of unfamiliar standards and regulations.


38.       The second distinction that needs to be made here is that between accreditation and
certification both part of conformity assessment systems. Certification is the formal verification by an
unbiased third party that a product conforms to specific standard or that a manufacturing process itself
does. It results in a formal statement of conformity. Third party testing is usually an integral component
of such certification, with testing and certification usually but not always carried out by the same body.
Accreditation is the evaluation of the competence of certification bodies by an independent party. In the
case of mandatory requirements, the ultimate power of control resides with the locus of accreditation.
Systems of accreditation are therefore the ultimate targets of MRAs.

39.        An intermediary step towards mutual recognition of conformity assessment systems (labelled
here pre-MRA) is the recognition of competence of foreign certification/testing bodies which can as a
result apply for accreditation or approval by the host country. The issue of access of these bodies to the
host country accreditation system has been cited as a primary goal in APEC, ASEAN and in the FTAA
contexts. Such access was actually called for under the US-Canada FTA and later NAFTA, but both
Canada up to 1995 and Mexico to this day have been dragging their feet to implement this clause.
Lobbies in both countries fear competition from the highly competitive US testing labs industry. By the
same token, the United States accreditation programs often do not discriminate between domestic and local
applicants, thus practising a limited form of unilateral recognition. It must be noted however that such
recognition does not usually extend to the full power of certification but is often limited to the recognition
of test data and reports, leaving the final market approval to host country bodies. 14 In any case, labs and
certification bodies are still subject to redundant accreditation. As a result, the great majority of
manufacturers even in the sectors covered are still dealing with certifies accredited in only one jurisdiction.
Effective market access requires MRA of accreditation.

40.       Exhibit 2 (see separate annex) summarises the range of trade agreements under consideration
according to the scope of MR. It is interesting to note how the expansion of the scope of MR creates two
overlapping cycles in the market for products and in the market for product testing/certification. Under a
protectionist regime, exporters of products demand access to markets, including to certification bodies.
With national treatment, producers fight redundant certification while the demand for access shift from
producers to testers/certifiers who demand access to accreditation in the country of import. As this access
is granted to the latter, redundancy also becomes an issue for certifiers/testers who now demand MR of
accreditation. As the scope of MR expands, so does the type of competition, from a competition between
products, to testing labs and certifiers to accreditation systems and finally to regulatory regimes as a whole.

          IV.2. US vs EU conformity assessment systems in the early 1990s
41.      In most developed countries, conformity assessment systems are the result of idiosyncratic
national developments and a product of prevailing relationships between the state and the market. The
United States has an extensive and increasingly complex conformity assessment system which evolved in a




14
      The most limited form of such "pre-MRAs" has existed for some time through bilateral arrangemets
      in industries such a machinery or consumer electronic where regultors of one country recognize the
      test data produced by foreign labs, without extending to the power to certify theproduct in question.

                                                      13
decentralised and uncoordinated manner over time. This is not the place for a detailed description.15 In
short, manufacturers in the US can resort to four types of mechanisms for ensuring that products conform
to standards, whether these standards are voluntary or mandatory. They can issue their own
manufacturer's declaration of conformity; they can register their own quality assurance system with a
quality system registrar; they can resort to product testing by independent laboratories as is often required
by buyers; or they can resort to the certification, itself involving preliminary testing of products or
inspection of production site. It is this latest category that is most relevant for mandatory standards. Third
party assessment (the last three categories) has grown over the years with the growing demand for health
and safety as well as environmental impact assessment. Private certification programs have also emerged
to forestall government regulatory intervention. 16 Haphazard growth has led to a high degree of
redundancy in the system, both across states who often require separate accreditation or even certification,
and between the state and federal level where agencies like the FCC does not necessarily recognise
accreditation by other bodies.

42.       In its drive to complete the single market, the European Union introduced in 1989 the "global
approach to testing and certification," a co-ordinated system for MR of conformity assessment within
Europe. This complements the new approach, whereby manufacturers must meet "essential requirements"
spelled out in EU directives and it is up to private bodies to develop specific standards (while conformity
to the more specific standards developed by private action bodies is not required, it is often the easiest way
to prove that a product meets the relevant essential requirements). In turn, under the global approach, if
third party assessment of conformity to EU directives approval is required by law (e.g. "regulated"),
product approval (and the "CE mark") can only be granted by entities "notified" to the EU Commission as
technically competent by the governments in which they operate (a form of co-ordinated accreditation).
The European Organisation for Testing and Certification has been created to provide a framework for
co-operation MRAs between these notified bodies as well as all entities involved in conformity assessment.
EOTC partners are involved in on-going negotiations within sectoral committees (e.g. on information
technology) which involve a great degree of harmonization of conformity assessment procedures and
parameters. A web of multilateral agreements are thus negotiated among conformity assessment bodies in
Europe to ensure that products tested and certified once in the EU accepted everywhere.

43.       Although MRAs inside Europe eliminate the need for redundant testing within Europe for
European producers and US exporters alike, the fact that EU approval can only be performed by
"notified" bodies located in Europe (although sub-contractors located in the US can participate in assessing
conformity to EU regulations) indisputably puts foreign producers at a disadvantage, sometimes even
reducing previous levels of market access.17 While it is clear that this new situation in Europe provided the
reason for the current US-EU negotiations, US and Europeans officials differ in their description of the


15
      For an overview, see National Research Council (1995) Standards, Conformity Assessment, and
      Trade, National Academy Press, Washington, 1995
16
      There are more than 110 private-sector certifiers in the US where certification was an estimated
      12 billion industry by the end of 1995. The UL label (underwriters laboratory product safety
      certification) is one of the most known. There are also 84 certification programs run by federal
      agencies, including: USDA which certifies to meat and poultry; the Federal Aviation Administation;
      FDA for phamaceuticals; the Occupational Safety and Health Administration (OSHA). There are
      also more than 100 public and private acceditation bodies
17
      In addition, approval is now required for entry into all member states where no approval may
      have been the norm before and pre-existing bilateral agreements will need to be renegotiated at the
      EU level.

                                                     14
impetus behind the negotiations. US officials naturally have sought to fulfil their mission to enhance
market access for US firms. But as readily admitted by one of them, "MRAs are a European invention
unlike anything before."18 From a European viewpoint, the announcement of the EU's intention to allow
third country conformity assessment bodies to participate in the new European system on the same basis as
European bodies -which dates back to 1989- was "a small conceptual step." Indeed, MRAs can be seen as a
typical instance of proselytising on the part of EU regulators and Commission officials. In addition, there is
little doubt that Europeans were keen on deflecting criticism of fortress Europe and obtaining reciprocal
benefits. If it took until 1994 for the EU to initiate formal negotiations with the US and others it is both
because an informal phase of familiarisation with the EU system was needed and because this system itself
was still in the making.

          IV.3. The negotiations: Obstacles to agreement and bargains
44.        The envisaged MRAs cover $40 billion of US exports to the EU across eleven sectors, six of
which are currently actively under negotiation (pharmaceuticals, electromagnetic compatibility, electrical
safety, medical devices, telecommunications equipment and recreational craft).19 Sectors were originally
selected according to whether the EU had itself an MRA in the sector, potential trade benefits of
liberalisation for both sides and the assessed feasibility of reaching agreement. Yet, participants concur that
the process turned out to be much more complex than imagined and that devising adequate MRAs requires
an extended learning period to exchange background information and sector-specific data. The high
political visibility granted to MRAs in "The New Transatlantic Agenda" agreed to in Madrid in the fall of
1995 has increased the pressure on all parties to achieve results in a timely fashion. This should not,
however, lead to the temptation to sign face-saving agreements that do not provide the increase in market
access hoped for by the industry or does so at the expense of the guarantees demanded by regulators.
Negotiators have had to overcome major obstacles, and confront asymmetries not only in regulatory
practices but also in assessment of market access benefits and in the degree of penetration of the trade
culture inside regulatory circles.

45.     To simplify, three core sets of issues have created major obstacles to the completion of the
US-EU negotiations while pointing to the type of bargains that must be struck in order to reach agreements
on mutual recognition.

46.       First, in the face of US demand for access the EU has clearly announced its main condition:
convergence to the EU system. If US bodies are to be granted the status of notified bodies, the US
government must get involved in guaranteeing the competence of its conformity assessment bodies
and thus provide formal assurances to its partner that US bodies can perform essential services and certify
to EU standards. While US conformity assessment bodies may have simply demanded to be
accredited/notified by EU governments, the EU offered more in response (accreditation in the US) but at a
higher price.

47.      In a most interesting development, the Department of Commerce asked the National Institute of
Standards & Technology to create the National Voluntary Conformity Assessment Program ( NVCASE)
as a mechanism for addressing this European demand. NVCASE will officially recognise the competence
of US accreditors to check the capacity of certifiers to work with EU requirements and may temporarily


18
      For a presentation of the issues from both sides' viewpoint one can contrast Charles Ludolph (1994;
      1995) and John Clarke (1996).
19
      The National Export Strategy: Annual Report to the United States Congress, (Washington: Trade
      Promotion Coordinating Committee) October, 1994, p. 140.

                                                      15
fill in the gap and accredit certifiers where accreditation programs are still lacking. One of the early
success of the negotiation was the EU indication that recognition by NVCASE would prove sufficient to
grants US entities the status of EU notified body.

48.        Nevertheless, there may be reasons to doubt that NVCASE will actually work to the EU
satisfaction while many in the US would still prefer a direct understanding between accreditation bodies.
US officials recognise that such a system is utterly new to the United States. It is not an easy proposition to
implement in a country, where, except for automobile emission, drug certification, and a few other
instances, there has traditionally been less reliance than in Europe on third party assessment and greater
reliance on manufacturer's declaration, voluntary standard and ex-post liability constraints. At the same
time, third party assessment has been less privatised in the US than in the EU. In addition NVCASE must
turn around an accreditation system that is highly fragmented and with no prior experience in accreditation
to meet foreign requirements.

49.      US negotiators also acknowledge that the required overhaul will allow to streamline the US
system and eliminate unnecessary government accreditation and certification programs. Adding a layer of
government recognition to the domestic conformity assessment system is a prerequisite for a
government-to-government MRAs while it provides an impetus for the devolution of conformity
assessment function on the part of governments. The lesson: As government-to-government agreement,
MRAs require government involvement in conformity assessment systems as the ultimate authority
accountable for compliance.

50.       The second set of controversial issues has to do with EU access to the US markets and the EU
demand for a balanced agreement with regard to the advantages derived by either party. In terms of
sectoral coverage, the EU has refuse to set aside a problematic sector like pharmaceutical where the
commercial benefits derived could compensate for losses elsewhere (e.g. telecommunication). It has been
harder, however, to obtain that balance be measured in terms of relative gains from mutual recognition
based on prior and posterior costs of regulatory compliance. Given the prevalence of US liability laws for
instance, EU laboratories may find that such an unfamiliar operating environment after MR may not be a
great gain. More generally, while recognising that the US does not impose discriminatory trade barriers,
EU negotiators have pointed to the complexity of the US system -with overlapping layers of jurisdiction at
the national, state and local levels, and a complex web of public and private bodies- as hindering effective
and complete access for EU exporters. To be sure, the lack of a single US Mark -like the EC Mark- across
the 50 states is also an hindrance for US producers. But on the grounds of reciprocity, Europeans want the
US to deliver the whole US market in the same way that they are committing to deliver theirs.

51.       In order to oblige, the US would need to put in place a full fledged domestic MRA system with
pre-emption by federal accreditation program and ensure that all relevant bodies are part of the domestic
MRA and involved in the external one. But while the US commerce department may be envious of the
relative simplicity of the EU global approach and may even be suspected to try to import the global
approach in the US though MRAs, there is little chance that even general commitments towards this goal
could be credibly issued in the current negotiation time frame. The lesson here is that MRA are not simply
about technical requirements but about the comparability of ensuing market access broadly defined and
that moves towards such comparability may need to predate the negotiations.

52.       A third set of obstacles calling for special mention here relate to the tension between an
incremental or building block approach promoted by the US and the EU demand for full MRAs. The
tension arises especially for the sectors under discussion directly controlled in the US by regulatory
agencies that usually centralise all conformity assessment function under one roof (FDA, FCC; EPA).
Contrary to the EU where most authority has been delegated to quasi-public bodies that are prone to MR in
order to expand their network, these US regulatory agencies remain all powerful and have not warmed up


                                                      16
to the MR culture. Having not been exposed to trade-related constraints in the past and enjoying a great
degree of autonomy, these agencies would have preferred to develop direct and informal co-operation with
European accreditors instead of being directed by governments. They have increasingly resisted significant
loss of regulatory sovereignty as they progressively realised what was involved in the negotiations. Against
the position of both EU and US negotiators they demand -and are likely to obtain- limitations on the
MRAs in three directions:

  a) Scope:
     Agencies like the FDA want to reduce the scope of MR to recognition of test data or inspection
     reports (the first three steps in the conformity assessment procedure), thus ensuring that they retain
     the ultimate authority of approval. For the EU, such a truncated agreement would leave intact
     arbitrary decision power in the host country. Europeans may have to settle for an incremental
     approach where full MR is attained at a later stage through progressive scope expansion (ironically,
     US manufacturers are currently complaining that their unique MRA with Mexico on tires only
     recognises test data and not yet final approval).

  b) Prior harmonization of procedures:
  While both parties require confidence in the other's technical competence as a pre-condition to
    negotiations, they disagree on how to determine such competence. The US side wants prior
    harmonization of the detailed conformity assessment procedures rather than merely accepting the
    results of such assessment as demanded by the EU. The FDA and EPA are actually working with
    some of their foreign counterparts to reach agreement on equivalency of assessment standards as a
    precondition for the MRAs. If they succeed in an acceptable time frame, the EU can still object to
    similar pre-conditions across the board but will be in a weaker position.

  c) Length of transition:
     Finally, parties disagree on the extent of prior co-operation required before implementing MRAs. US
     negotiators want long transition period during which to implement confidence building measures as
     well as flexibility as to the timing of implementation of actual recognition. Europeans have long
     insisted on a short term deadline for implementing MRAs along with a firm commitment, if not
     automaticity, of such a deadline. Here again, the EU needs to move toward compromise and
     recognise that its own strategy of setting quasi-automatic deadlines for completion of the single
     market was predicated on two decades of prior discussions and familiarisation between regulators,
     something that is not true across the Atlantic.

53.        This last set of issues has proven to be the most contentious in the last phase of negotiations. The
European question the ability of the Department of Commerce to force significant change on regulatory
agencies especially when its authority and even existence is put into question by the US Congress. At the
same time, the US side asks why the EU Commission is not ready to settle for what it can get, suspecting it
to revert to old protectionist temptations. Instead of questioning each other's ability to deliver, the US and
EU must seek an acceptable bargain. The EU can accept most of the elements of the US incremental
approach while insisting that significant progress be made to deliver a single US market. Progress in the
second dimension will actually accelerate progress on the path of incremental liberalisation. If this core
underlying bargain is struck, almost any result achieved by December 1996 should be considered a
success. Exhibits 4 and 5 (See separate annex) provide a graphic illustration of the MRAs under
discussion.

     V. Implementing MRAs: The design of sustainable
     contracts

                                                      17
54.       The specific case of EU-US MRA negotiations combined with the general lessons drawn from
other instances of adoption of mutual recognition suggest a number of recommendations for the design of
MRAs. We need to ask what are the possible problems connected to the implementation of MRAs and
how can they be pre-empted. In other words, how to design more effective and sustainable MRAs. In the
discussion, I distinguish between core elements that need to be present in any MRA and areas where
choices must be made between alternative options.

          V.1. Core elements
55.       We can gain some analytical leverage by analysing MRAs as "insecure" contracts as defined in
economic theory. Mutual recognition agreements are typical contracts under conditions of uncertainty and
ambiguity negotiated between national governments. These are incomplete contracts in that they cannot
spelled out all the situations that may emerge during their implementations. The contracts are signed
between countries that act simultaneously as home and host countries. Under MR contracts, host countries
commit to granting some pre-defined degree of market access. In turn, home countries commit to adequate
supervision of economic actors in exchange for such market access. The mutual commitments form an
'insecure contracts' since these are just promises or expectation of effective access in the host state and
sound regulatory supervision in the home state. This conceptual framework puts in sharper light four main
mechanisms by which mutual recognition contracts can be made more sustainable.

56.       First, contracts are obviously more sustainable when all parties are confident that the others
abide by the letter and spirit of the contract. In the case of MRAs, such confidence is based on the initial
familiarisation and continue involvement with the foreign system, including through: obligations of
transparency of regulatory systems, decision making process, and change in such system through the
continued exchange of information between regulators; mutual monitoring that allows for the continued
assessment of technical competence, capabilities, and efficiency as well as the foreign industries overall
state of the art in its capability to comply with the importing country's requirements (host country
"accreditation inspectors must have a permanent right of access in the exporting country); and finally, since
there will always remain some information asymmetry, there needs to be trust that the foreign authorities
will continue to have adequate regard for public health, safety and environmental concern.

57.        A second way in which mutual recognition contracts can be made more sustainable is to have
parties commit to help each other abide by the terms and spirit of the contract. In this sense, MRAs
should be seen more as framework for mutual technical assistance than for regulatory competition. Host
countries can help home country enforce compliance, by readily transferring to the country of origin
information about regulated actors obtained in the territory of sale (e.g.. financial sector). More generally,
parties can think of MRAs as a means of reallocating rights of control to ensure an optimal division of
labour between regulators across jurisdiction. Ceteris paribus, quality control is better done by local
authorities/inspectors who can come more often, know local conditions better, etc. A common culture of
certification quality needs to be created through co-operation between labs. MRAs between private actors
to supplement government to government MRAs and conditional on mutual confidence help increase
incentives for the quality reputation of individual registration, licensing, certification or testing bodies.
Collective guarantees of quality control backed up by peer enforcement in turn increase the confidence of
the buyers in the soundness of control.

58.       Third, there may be cases when even these two types of mechanisms are not sufficient to ensure
compliance on the part of home regulators. The theory points out that the sustainability of contracts are
highly affected by whether parties can convincingly threaten to "walk out" of an agreement if contractual
terms cease to be respected. The advice is : when contracts are insecure, make contingency explicit and
specify walk away conditions. This is why mutual recognition agreements must be designed more
explicitly as contingent agreements that can be terminated should the situation change in a country that


                                                     18
fails to produce the required regulatory results. At one extreme, MRAs could even include trial periods.
Such overall reversibility of MRAs depends both on the rights --safeguard clauses- and capacities of
parties to do so. Conditions for adequate reversibility include: 1) the possibility to observe "the state of
the world" that is the soundness of home regulation, e.g. transparency clauses as well as a format to
interpret data on foreign regulations. 2) the existence of fair arbitration mechanisms available in cases of
alleged non compliance. These may be instances of temporary regulatory dumping. Safeguards act like
anti-regulatory dumping measures and must be applied under commonly agreed circumstances. 3) the
capacity of parties to reverse their initial concession in case of non-compliance. This last point is the most
tricky since information asymmetries may develop to such an extent between host country regulators and
foreign producers that reasserting control may become almost problematic. Technology may also make it
increasingly impossible to cut off imports in such instances where such imports are beamed through
satellite or carried by communication networks. Thus, reversibility itself must be the object of co-operation
between regulators including under conditions of crisis.

59.        Fourth, and as a quid pro quo for their safeguard clause, host countries must refrain from
arbitrary behaviour or compensation mechanisms as well as commit to dealing with external factors that
might emerge that would unduly nullify contract. For example, there is a real tension in the use of labelling
in mutual recognition contexts. While labels can be thought of as mechanisms to minimise government
intervention and      make acceptable mutual recognition, officially sanctioned labelling (such as
eco-labelling) can itself turn out to be a means to protect in more sophisticated ways against mutually
recognised products. In terms of contestability, labels with a "local connotation" imply that importers do
not have access to same input. More generally, the access provided by mutual recognition may be
incomplete as private anti-competitive behaviour replaces previous requirements.                Professional
registration bodies may refuse to abide, distribution centres may refuse to distribute a product without a
given mark of conformity or insurances may refuse to insure it. In the spirit of MRAs, co-operation in
competition law must act as a supplementary lever on market openness where market forces would not
take care of these problems alone. Finally, if the host country is granted the right to make acceptance of
products conditional on additional requirements in light of additional knowledge, any amendment to
market access awarded must be proportional to the need. In order to make such commitment acceptable to
public opinion, political and regulatory accountability must be explicitly and publicly shared between
home and host countries.

          V.2. Making options and trade-offs explicit
60.       Beyond these general prescriptions, the characteristics of MRAs are bound to vary with the
requirements of each negotiation context. On a number of fundamental choices there can be no general
prescription, except for the fact that there exists alternative available options as well as trade-offs that can
be exploited among the features of an MRA. A fundamental tension is that between judicial and political
mutual recognition. The fact that even in the EU judicial activism has created resistance and that WTO's
dispute settlement mechanism is a main target for the political exploitation of the "sovereignty argument
against trade liberalisation ought to suggest caution. It would seem to be wiser to specify criteria for non
compliance to the greatest extent possible in the MRAs themselves and even to resolve emerging dispute
through renewed political negotiations. This point also suggests that obligation of unilateral recognition
that may emerge from policed national treatment should not be carried too far. Mutual recognition needs to
remain a political contract.

61.       Second, some parties may prefer to pursue a path to MR through unilateral regulatory reform
rather than regulatory co-operation. Unilateral recognition can be far reaching if conducted in a broader
context of domestic regulatory reform where recognition is seen as a lever. Moreover, it can be more
acceptable to certain regulatory cultures. Countries can also pre-empt the need for mutual recognition when
they develop regulatory systems from scratch by systematically incorporating foreign and international


                                                      19
standards and including direct provisions for recognition of foreign accreditors. The unilateral approach
can also be seen as a first step to latter negotiations of MRAs that will minimise the need for mutual
adaptation.

62.      Third, parties must decide whether the regulatory co-operation that must necessarily accompany
mutual recognition needs to bare fruits before the agreement is actually implemented. The resort to a shift
from mandatory and extensive ex-ante co-operation to on-going ex-post co-operation (with reference to the
implementation of MR) is one of the central "twists" that allowed Europeans to respect (more or less) their
1993 deadline for the internal market. This does not mean that the scheme ought be reproduced
everywhere, especially where there exist no prior culture of regulatory co-operation.

63.       A fourth area of tension -also an illustration of the need to chose between regulatory assurances
before or after liberalisation- is that between the negotiation of an immediate full scope MR and the
incremental extension of regulatory scope of MR conditional on increased confidence. To some extent,
greater initial regulatory scope of MR can be achieved in exchange of more liberal rights of ad-hoc
reversibility (e.g. the 1989 mutual recognition of diplomas in the EU). But the progressive extension of
regulatory scope is certainly a less conflict prone approach adopted by the EU itself in a number of sectors.
Exhibit 6 (see separate annex) provides a summary of some of these recommendations for a model MRA.

     VI. Towards world-wide mutual recognition?
          VI.1 The de facto contagion effect of MRAs
64.       There is no denying the contagious effect of MRAs.20 First, these effects stem directly from the
"natural" extension of intra-EU MRAs to extra-EU MRAs with selected trade partners. The EU has already
initiated bilateral talks not only with the US but also with Australia, New Zealand, Canada, and in 1995
with Switzerland and Japan. We are entering a second phase -after an initial phase where the EU has
served as the hub of MRAs- where the spokes of the hub are starting to connect. As they negotiate MRAs
with the EU, countries with otherwise important bilateral trade begin to talk directly. This is the case for
the US and Canada who are starting to discuss MRAs in particular in the area of road transport. In any
case, transitivity of rights of access might logically dictate such developments if MRAs are not to be
encumbered by rules of origin. By the same token, the US and Canada have proposed to plurilateralize
the negotiation of MRAs under the Quad framework to integrate bilateral initiatives. And the EU is now
calling for negotiation of MRAs under an EU-NAFTA.21

65.      There are also parallel MRA dynamics excluding the EU even if inspired by its experience. In
keeping with their pioneering history in the field of trade diplomacy Australia and New Zealand are
currently concluding a broad MRA covering all goods as well as professional services. By 1994,
discussions on market access between the US and its partners in NAFTA, APEC, ASEAN and East
European countries were also all "occupied with the merits and demerits of the EU proposal for MRAs."22
APEC members set up a framework for exploring MRAs in their 1994 ministerial, followed in 1995 by




20
      For an early discussion, see NicolaÔdis (1989)
21
      See speech by Leon Brittan on "EU-US Relationship",The Reuter European Community Report,
      April 27, 1995
22
      See Ludolph, op cit, p2.

                                                     20
participants in the FTAA project.23 While these agreements are far for being concluded and are much less
ambitious than intra-EU MRAs, their likely existence must be taken into account in thinking about the
multilateral context. It must be note that such contagion effects is greatly magnified by the multiplication
of MRAs between private bodies themselves. Thus, the example set by the Committees of EOTC operating
in the EU is being taken up in other regions of the world and the long term aim is to a create a body for
world-wide mutual recognition. Exhibit 7 (see separate annex) lists some the current MRA negotiations.

         VI.2. The WTO framework: MFN vs MRAs

66.       As the practice and legal basis for MRAs is progressively incorporated in the WTO framework,
MRAs will become increasingly independent from their European origin. What is the prospect for
world-wide mutual recognition, given the contagious effects alluded to above? If this prospect is to be
enhanced, the mission of the WTO should be seen as threefold: ensuring the transparency and openness of
individual bilateral agreements, helping to maximise the geographical reach of plurilateral MRAs, and
providing an umbrella for the eventual integration of these disparate agreements under a global and
decentralised framework.

67.        Both unilateral and mutual recognition is encouraged in the WTO for services and goods.
Article 7 of GATS encourages signatories to adopt measures, by way of bilateral agreements or
“autonomously”, in order “to recognise the education or experience obtained, requirements met, or licences
or certification obtained in a particular country”. Recognition under the TBT agreement for products is
not as far reaching as it does not include recognition of substantive regulations: “Members are
encouraged, at the request of other members, to be willing to enter into negotiations for the conclusion of
agreements for the mutual recognition of results of each other’s conformity assessment
procedures...(article 6.3).” This clause serves as the legal basis for the span of MRAs currently negotiated
around the world. The TBT also includes a stronger obligation regarding unilateral recognition of
equivalence: “6.1. Members shall ensure , whenever possible, that results of conformity assessment in
other Members are accepted, even when those procedures differ from their own ... (article 6.1).”

68.        Such recognition clauses are very much at odds with the core tenants of the multilateral trading
system -- unconditional most-favoured-nation treatment and diffuse reciprocity. These imply that broadly
equivalent concessions are expected of all WTO signatories but not on a quid pro quo basis. But bilateral
or plurilateral mutual recognition deals cannot be “multilateralised” automatically as provided by MFN,
simply because concessions based on assessing current and future equivalence of regulatory systems are
not fungible. Hence, under MR, MFN treatment is indeed conditional, not on some symmetrical lowering
of trade barriers, but on actual compatibility of rules or equivalence of procedures. This fundamental
contradiction between mutual recognition and MFN raises a number of questions that have not yet been
fully clarified.

69.       First, how can the broad notion of non-discrimination be salvaged while MRAs are exempt from
MFN? While the signatories of the Uruguay Round have sought to ensure procedural if not actual
non-discrimination in the wording of their recognition clauses, these attempts may be viewed at best as
insufficient to ensure that customised rights of access granted through recognition do not become a means



23
      In March 1995 the Summit of the Americas in Cartaghena, Colombia, trade ministers included in the
      preparatory work to conclude a Free Trade Area of the Americas by the year 2005 a commitment to
      develop proposals for the mtual accreditation of testing facilities as a fist immediate action prior to
      more extensive negotiations of MRAs on testing and certification.

                                                    21
of discrimination between countries based on non-regulatory criteria. Three types of guarantees have been
introduced but need to be reinforced:

  a) Transparency
     Under GATS, the Council must be informed “as far in advance as possible” of recognition
     negotiations before they enter a substantive phase. In addition and to the extent possible, the criteria
     for recognition should be multilaterally agreed upon and based on co-operation with relevant
     intergovernmental and non-governmental organisations. In practice, however, the degree of
     transparency of MRA discussions is hard to ensure when involving highly sensitive sectors, where
     multilateral criteria do not pre-exist and when there is great asymmetry between regulatory practices
     and cultures involved. In such cases, the best that might be hoped is greater post-hoc transparency.

  b) Openness:
     Under GATS, members who grant recognition must “afford adequate opportunity” for other
     interested members “to negotiate their accession” to existing or future bilateral or plurilateral MRAs;
     or, if recognition is granted unilaterally, “to demonstrate that education, experience, licenses, or
     certification obtained in their territories should also be recognised.” The TBT simply “encourages”
     members to permit participation of conformity assessment bodies of other members on their own
     territory under conditions “no less favourable” than those accorded to their own bodies or those of
     other members (a voluntary recognition and a voluntary MFN clause in one). It is still unclear
     whether such obligations are formal or substantive. Will signatories simply be asked to show that
     the “opportunity” was indeed given (when? how?); or will they be obliged to give substantive
     reasons for refusing to consider incorporation of an applicant in a pre-existing MRA or an MRA
     negotiation. Most ambitiously, “adequate” might be progressively interpreted to involve more
     proactive obligations (see below).

  c) Equitable treatment:
     Finally, if outside parties have been given the opportunity but do not pass the test, the GATS
     specifies that a Member must not use recognition as a means of discrimination between countries in
     the application of its standards or criteria, or as a “disguised restriction on trade in services.” This
     will be the hardest provision to enforce, since, by definition, host country requirements will be
     applied in a discriminatory manner.

70.       The second question raised by the contradiction between MR ad MFN is that of the conditions
that parties to an MRA ought to be allowed to demand in addition to assurances regarding regulatory
equivalence. In other words, what can such agreements be conditional on? Since they are voluntary, the
answer could simply be that this is up to the parties themselves. But such open-endedness might leave
MRAs vulnerable to the bargaining leverage of the strongest parties and the imposition of lopsided deals.
Thus, the TBT specifies that Members may require that such agreements, “give mutual satisfaction
regarding their potential for facilitating trade in the products concerned.” This is in part what the EU has
been demanding through its requirement of “balanced agreements” with the US, whereby actual gains in
market access need to be considered in addition to the symmetrical lifting of regulatory requirements.
While the intent is legitimate, such broadening of conditionality to encompass actual market access does
increase the closed nature of MRAs and their potential trade distorting effects. “Mutual recognition areas”
become closer to article 24 exemptions and might need to be submitted to compensatory constraints.
71.       This raises a third question which its whether there should be a presumption of transitivity
across MRAs: if the US negotiates an MRA with the EU and with some APEC countries, to what extent
are the EU and the concerned APEC countries obliged to recognise each other’s regulations? As
mentioned, transitivity would preclude the need for “rules of origin” in mutual recognition zones and
increase the consistency between such zones. Parties may be allowed to object to transitivity because the


                                                    22
actual trade benefits may not be balanced (point above) or the compounded regulatory differentials through
chain recognition may surpass their threshold of “acceptable” differences. But in this case, asymmetries
in trade benefits and regulations must be significant and the burden of proof should be born by opponents
of transitivity. This should not preclude the use of safeguards as outlined in the previous section and the




                                                    23
granting of generous confidence-building periods to allow regulators to set up networks for mutual
monitoring. By enforcing such transitivity the WTO could help decrease the closed nature of MRAs,
“plurilateralise” bilateral agreements, and thus prepare the grounds for eventual world-wide mutual
recognition.

72.        A fourth question is what should be the legal obligations of countries short of mutual
recognition? The answer to this question obviously changes the incentives for negotiating over MR in the
first place. There are arguments on both sides. On one hand, a broad interpretation and strict enforcement
of policed national treatment (even to the point of enforcing unilateral recognition) ensures a minimal level
of liberalisation and may constitute an incentive for MRAs. Given their purely voluntary nature (WTO
simply “encourages”), countries may simply refuse to negotiate MRAs with countries that approach them
for fear that their product or services will not be competitive once mutual recognition is in place. It is not
even clear that signatories are obliged to give reason for refusing to respond to demands for MRA
negotiations. In such cases, the stringency of alternative obligations must make it clear that the country
cannot simply get away with it. This is obviously the goal of the TBT embellishments on national
treatment that are also included in GATS’ article 6 regarding non-discriminatory regulations. They
include familiar obligations to use least restrictive means, proportionality criteria, etc. But the question of
whether given domestic standards and regulations conform to these obligations is extremely difficult to
answer, especially for services where they are more vague and less tested. The current task of “article 6.4”
working groups to establish disciplines on standards and regulations for services needs to be pursued even
while some members already resort to the more ambitious MRA approach.

73.       But such attempts at strengthening unilateral obligations should not overlook the fact that
recognition is above all a process of mutual adaptation. Granting too much ground for imposing
recognition by judicial fiat at the multilateral level endangers the legitimacy of the system as a whole and
foregoes the benefits of regulatory co-operation that go along with MR. Even when unilateral recognition
is voluntary, the prospect of falling under MFN obligations enforceable by dispute settlement bodies may
discourage parties to extend unilateral recognition in the first place. This is true for GATS where the
granting of national treatment is voluntary but could theoretically result in unilateral recognition. The very
fact that MFN was not made conditional on the compatibility between regulatory regimes for concessions
made in national schedules has greatly decreased their utility as mechanisms for addressing regulatory
barriers to trade.

74.        Finally, we may ask what fora are best suited for the negotiation of MRAs. For the moment, the
plethora of bilateral agreements conducted on an ad-hoc basis serve as laboratories for future efforts. The
EU is the only regional arrangement that can engineer mutual recognition on the same basis for all its
members. Other fora (APEC, FTAA and even NAFTA) are more likely to serve as umbrella for a series of
bilateral or plurilateral agreements -at least until some convergence of regulatory procedure is attained. The
OECD could play an intermediary role by helping to develop guidelines for sustainable MRAs among its
members and by exploring means of maximising the involvement of developing countries in these
agreements. The WTO may preside over the multilateralisation of recognition obligations when agreement
over essential requirements have been reached at the multilateral level, including by private bodies as in
the field of professional services.

          VI.3. Pro-active non-discrimination

75.       In the meanwhile, the WTO must first and foremost set constraints on the discriminatory nature
of MRAs, but it also needs to encourage a more proactive approach to non-discrimination. This can be
done, for instance, through the support of plurilateral programs for regulatory assistance, and "regulatory
upgrading" in developing countries in order to increase their acceptability as members in mutual


                                                      24
recognition regimes. The WTO can also encourage the development of regulatory databases, of a world
wide system for accreditation of laboratories or the co-ordination of a global system for the accreditation or
recognition of accreditors themselves.

76.       In conclusion, a future world-wide reach of mutual recognition is likely to magnify both the
potential conflicts inherent in the adoption of mutual recognition and the regulatory benefits that can be
reaped. If mutual recognition is well managed at the world level, trade liberalisation and regulatory goals
need not be seen as two conflicting objectives that need to be somehow weighted against one another.
Mutual recognition agreements can serve as instruments to improve regulatory quality, by allowing for a
better division of labour between overburdened regulators around the world, by allowing for more effective
control at the source in the country of origin, by giving impetus to transfer of "regulatory technology," and
by fostering regulatory co-operation as well as competition between regulators, quasi-public and private
bodies as well as governments around the world.

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