Iran has decided to suspend all trade and economic ties with Denmark in the wake of the ongoing flap over the caricatures of the prophet Muhammad that appeared first in Danish newspapers. Existing contracts will be suspended, imports of Danish goods will cease and Danish firms using Iran's ports will be taxed more heavily than others.
This action is intended to please a domestic audience within the Middle East. The Iranian regime seems to be betting that no one will respond and that the lost imports from tiny Denmark can be replaced easily on the world market. The European Union's response to Iran's threat should be to double the wager. The EU should cut off all trade with Iran until the Islamic Republic removes its economic threat and until it comes into full compliance with its prior commitments to nuclear nonproliferation.
Iran is not a member of the World Trade Organization, though it has applied for membership. Since Iran is not bound by the rules that govern members, it can do what it pleases. But the world community can be equally uninhibited toward Iran.
The two primary rules that govern the world trading system are nondiscrimination and national treatment.
Nondiscrimination requires member nations to treat the goods from all other members equally. This means the United States cannot use foreign policy differences with France, for instance, as a pretext to tax French wines more heavily than wine imports from Australia.
National treatment means that all firms operating within a country's borders must be treated the same. Thus, a German firm operating in Alabama can't be socked with rules and regulations (or taxes) that don't also affect an American firm in Detroit.
These two rules are the foundation of the world trading system. They civilize behavior among nations by offering protection for each nation from capricious trade policy actions by their neighbors. These rules also protect us from ourselves by depoliticizing trade policy. Each nation agrees not to discriminate, but only because all other nations legally commit to the same rules.
Iran's actions violate both tenets.
If it were in the WTO, the legal machinery of the world organization would slowly gear up. Because Iran is an outsider, those deliberative processes that protect honest disputants from a rush to judgment do not apply. Iran can receive whatever retaliation the EU cares to mete out, and the punishment can be implemented immediately. The EU also is free to link trade sanctions with foreign policy goals such as nuclear nonproliferation.
The EU is in the best position to influence the situation within Iran.
Since the EU began its "critical engagement" policy in the 1990s, EU trade with Iran has doubled. Excluding the energy sector, EU nations export more than $14 billion worth of manufactured goods, transport equipment and chemicals to the Islamic Republic. The EU also sells over $1 billion in services. This is 40 percent of Iran's total imports, and many of these goods cannot be replaced with identical imports from elsewhere at the same cost.
Europe need not fear any Iranian retaliation through the oil market. Like money, oil is fungible. If Iran diverts all oil sales to China, the EU would buy from other sources and the shell game would leave world prices largely unaffected.
If Iran pulls its oil off the market, the cost to Tehran would dwarf any consequences for the EU. Oil revenues fuel the Islamic regime. Spare capacity in other nations of the Organization of Oil Exporting Countries could make up for most Iranian exports, so after some initial tremors, the world market would settle down. And if world prices did rise, the damage would fall on Iran's friends - such as oil-guzzling China - as well as its foes.
The EU attempt to draw Iran into the international community has proved to be in vain. Along with high oil prices, the economic breathing space this engagement helped provide has witnessed the eclipse of "reformist" politics in Iran and the reactivation of Iran's nuclear ambitions.
Moreover, with its commercial assault on Denmark, Iran now directly threatens European political and economic institutions by singling out individual members of the EU for discriminatory trade sanctions.
The problem, of course, is that any retaliatory sanctions the EU might impose are a double-edged sword. They would hurt profits for some companies and cost jobs in Europe.
The EU has stated that a boycott of Danish goods is a boycott of European goods. What remains to be seen is whether Europe can pull together to defend its collective interests or whether the commercial interests of individual European firms will exert the larger influence.
David H. Feldman, whose specialty is international trade and trade policy, is a professor of economics at the College of William and Mary in Virginia. His e-mail is email@example.com.