There are many ways of controlling and promoting international trade today. The methods range from agreements among governments—whether bilateral or multilateral—to more ambitious attempts at economic integration through supranational organizations, such as the European Union (EU).

The term trade agreement or commercial agreement can be used to describe any contractual arrangement between states concerning their trade relationships. Trade agreements may be bilateral or multilateral—that is, between two states or between more than two states.

A bilateral trade agreement usually includes a broad range of provisions regulating the conditions of trade between the contracting parties. These include stipulations governing customs duties and other levies on imports and exports, commercial and fiscal regulations, transit arrangements for merchandise, customs valuation bases, administrative formalities, quotas, and various legal provisions. Most bilateral trade agreements, either explicitly or implicitly, provide for (1) reciprocity, (2) most-favoured-nation treatment, and (3) “national treatment” of nontariff restrictions on trade.

In a trade agreement, the parties make reciprocal concessions to put their trade relationships on a basis deemed equitable by each. The principle of reciprocity is extremely old, and in one form or another it is to be found, implicitly at least, in all trade agreements. The concessions may, however, be in different areas. In the Anglo-French Agreement of 1860, for example, France pledged itself to reduce its duties to 20 percent by 1864. In return, Britain granted duty-free imports of all French products except wines and spirits. The principle of reciprocity implies only that the gains arising out of foreign trade are distributed fairly.

The most-favoured-nation (MFN) clause binds a country to apply to its partner country any lower rate of import duties that it may later grant to imports from some other country. The clause may cover a list of specified products only, or specific concessions yielded to certain foreign countries. Alternatively, it may cover all advantages, privileges, immunities, or other favourable treatment granted to any third country whatever. The clause is intended to provide each signatory with the assurance that the advantages obtained will not be attenuated or wiped out by a subsequent agreement concluded between one of the partners and a third country. It guarantees the parties against discriminatory treatment in favour of a competitor.

The effect of the MFN clause on customs duties is to amalgamate the successive trade agreements concluded by a state. If the rates in different agreements are fixed at varying levels, the clause reduces them to the lowest rate specified in any agreement. Thus, goods imported from a country benefiting from MFN treatment are charged the rate of duty applicable to imports from another country which, in a subsequent trade agreement, has negotiated a lower rate of duty.

The coverage of the MFN clause can be considerably reduced by a minute definition of a particular item so that a concession, while general in form, applies in practice to only one country. A historical illustration of this technique can be found in the German Tariff of 1902, which admitted at a special rate

large dappled mountain cattle, reared at a spot at least 300 metres above sea level, and which have at least one month’s grazing each year at a spot at least 800 metres above sea level.

The advantages granted under the MFN clause may be conditional or unconditional. If unconditional, the clause operates automatically whenever appropriate circumstances arise. The country drawing benefit from it is not called on to make any fresh concession. By contrast, the partner invoking a conditional MFN clause must make concessions equivalent to those extended by the third country. A typical wording was that of the 1911 treaty between the United States and Japan, which stated that

in all that concerns commerce and navigation, any privilege, favour or immunity…to the citizens or subjects of any other State shall be extended to the citizens or subjects of the other Contracting Party gratuitously, if the concession in favour of that other State shall have been gratuitous, and on the same or equivalent conditions, if the concession shall have been conditional.

The conditional form of the clause may at first sight seem more equitable. But it has the major drawback of being liable to raise a dispute each time it is invoked, for it is by no means easy for a country to evaluate the compensation it is being offered as in fact being equivalent to the concession made by the third country.

The effect of the unconditional form of the MFN clause is, finally, to wipe out any relevance that the principle of reciprocity may have had to the purely bilateral preoccupations of the negotiating parties, since the results of the bargaining process, instead of being limited to the participants, influence their relationships with other states. In practice, therefore, a country negotiating a trade agreement must measure the advantages it is willing to concede in terms of the benefits these concessions will provide collaterally to that third country which is the most competitive. In other words, the concessions that may be granted are determined by the minimum protection that the negotiating state deems indispensable to protect its home producers. This sets a major limitation on the scope of bilateral negotiations.

Proponents of free trade consider that the unconditional MFN clause is the only practical way by which to obtain the progressive reduction of customs duties. Those who favour protectionism are resolutely against it, preferring the conditional form of the clause or some equivalent mechanism.

The conditional MFN clause was generally in use in Europe until 1860, when the so-called Cobden-Chevalier Treaty between Great Britain and France established the unconditional form as the pattern for most European treaties (see Richard Cobden). The United States used the conditional MFN clause from its first trade agreement, signed with France in 1778, until the passage of the Tariff Act of 1922, which terminated the practice. (The Trade Reform Bill of 1974, however, in effect restored to the U.S. president the authority to designate preferential tariff treatment, subject to approval by Congress.)

The Conference of Genoa, Italy, in May 1922 and the World Economic Conference in May 1927 both recommended that trade agreements include the MFN clause whenever possible. But the Great Depression of the 1930s led instead to a rise of restrictions in world trade. Imperial or regional systems of preference came into being: the Ottawa Agreements of 1932 for the British Commonwealth, similar arrangements for the French empire, and a series of tariff and preference agreements negotiated in eastern and central Europe from 1931 on.