“Free Trade” Agreements – The Debate at a Glance

April 21, 2007

A few weeks ago, South Korea and the United States signed a free trade agreement which sparked lots of debate. FT Economics Commentator Martin Wolf made objections to this agreement in a column published on the 3rd of April, and opened it to comments from leading economists on his online “economist’s” forum. Comments came in until a few days ago, and I warmly invite you to have a look at it – if you are a geek enough. The forum, but not Martin Wolf’s column, is open to non-FT subscribers. Have participated such eminent figures as: Robert Wade, André Sapir, Fred Bergsten, Jagdish Baghwati, a former USTR Carla Hills, David Vines, Joseph Francois.

In this column entitled “A Korean-American strand enters trade’s spaghetti bowl” Martin Wolf objects mainly for “systemic” reasons. The South Korea US Free Trade agreement is according to Wolf one of those many “discriminatory trade agreements” that currently undermine the world trading system:

“The number of preferential trade agreements has exploded upwards in recent years (see chart). An agreement between the US and South Korea is itself a quantum leap in this progression. The US was the world’s largest importer of merchandise products and South Korea the sixth largest in 2005 (if the European Union’s internal trade and Hong Kong’s re-exports are excluded). The US is also the world’s largest importer of commercial services, while South Korea is the 12th largest (this time with EU internal trade included). Other countries will be desperate to avoid the adverse effects upon them. This makes probable yet another jump in the prevalence of such agreements.

This economist’s forum offers a handy synopsis of the current debate on so-called free trade agreements. For those who have not enough time to read through this very dense debate, here a few highlights:

Robert Wade:

“As Kenneth Shadlen shows in an important article (“Exchanging development for market access? Deep integration and industrial policy under multilateral and regional-bilateral trade agreements”, Rev. Int. Pol. Econ. 12 (5), 2005, 750-75), preferential trade agreements involve the southern partner receiving better market access for existing exports, in return for “reforms” deep within its borders (in tariffs, foreign direct investment, intellectual property, capital mobility, government procurement, etc). “Reforms” mean putting the government under new constraints not to use industrial policy instruments to accelerate production diversification and upgrading – instruments of the kind that most of the now developed countries used during their rapid development phase. Hence the risk of freezing the existing division of labour between the trade partners.

On the other hand the WTO’s multilateral rules do continue to give more “space” (than the bilateral-regional ones) for policy instruments aimed at changing comparative advantage. In the WTO the powerful northern countries are a bit less able to close down this policy space and neutralize the competition from southern producers than they are in bilateral or regional agreements. This is one very good reason for supporting the WTO and discouraging the proliferation of PTAs. Though Martin may disagree with my rationale, we agree on the bottom line: the WTO deserves support, PTAs should in general be discouraged.”

André Sapir:

“A few years ago economists feared that the proliferation of free trade agreements would lead to a fragmentation of the world trading system into three blocs: a European bloc built around the European Union, an American bloc around the United States and an Asian bloc around China and Japan. It turns out that this scenario was wrong. Instead we are witnessing an even worse scenario: the development of bilateral free trade areas around three or four hegemons: the United States, the European Union, China and Japan. Why do I say that it is worse than the other scenario? Because within each regional bloc there would at least have been non-discrimination for all participating countries. Clearly a second-best compared to multilateral non-discrimination as envisaged by the GATT but certainly far better than a system of hub-and-spoke built around the three or four largest trading partners in the world (…)

One of the rationales for the principle of non-discrimination is that it protects the small nations from abuses by the big powers. Unfortunately developing countries have been slow to grasp this simple idea and have preferred to cling to ‘special-and-differential’ (S&D) treatment, which was meant to provide discrimination in their favour. The result is that no-one anymore champions non-discrimination: neither the developing countries who should but still dream of S&D, nor the big powers who draw competitive advantages from their ability to open their large markets to emerging countries such as South Korea and Mexico.”

Fred Bergsten and his “competitive liberalisation” views:

“This last point is in fact decisive in countering Martin’s concern that such a bilateral agreement will have negative systemic effects. Japan and several other countries have already indicated their interest in emulating the US-Korea deal. This will produce a further substantial reduction of trade and other barriers, perhaps including between the two largest national economies in the world. US deals with Korea and Japan would then almost certainly compel other Asian countries, including China, to seek similar compacts. The most promising way to pursue them would be a Free Trade Area of the Asia Pacific, as already adopted for “serious consideration” by the APEC leaders at their latest summit last November and currently being studied in that organization. Serious movement toward such an Asia Pacific agreement would naturally galvanize deep anxiety in Europe and other parts of the world, and thus probably represents the best prospect for reviving the Doha Round and achieving the new installment of global liberalization for which I share Martin’s great enthusiasm (…)

(…) Martin’s final concern, that bilateral deals like US-Korea and regional initiatives like the European Union and the Free Trade Area of the Asia Pacific will undermine multilateral efforts like the Doha Round, is simply incorrect. As noted above, they are much more likely to promote Doha than to divert attention from it.”

Carla Hills:

“This agreement is a good agreement. As Martin acknowledges “95 percent of bilateral trade in consumer and industrial products is to become duty free within three years with most remaining tariffs abolished within 10; South Korea is to liberalize access for many U.S. farm exports. . . U.S. service sector will be liberalized. . .intellectual property is to receive greater protection; government procurement is to be substantially opened up. . . .” And, Martin acknowledges that trade diversion is minimal (…).

Also this agreement stands as a model for how other nations could open their markets to goods, services, procurement, and protect intellectual property just as the North American Free Trade Agreement did when the Uruguay Round faltered in 1992. Then the NAFTA not only stimulated more growth throughout the North American region, it also (1) encouraged the nations of the Asia Pacific to agree to a gradual opening of their economies; (2) persuaded the 34 democratically elected leaders of the Western Hemisphere to agree to negotiate a free trade agreement of the hemisphere, and (3) breathed new life into then stalled global trade talks. My hope is that the Korea-U.S. FTA will serve as a similar example.”

David Vines, an Australian scholar based at Oxford, argues that those agreements signed by a “hegemon” such as the US in the current emerging hub-and-spoke model is done to the detriment of the smaller partner, taking an example from the US-Australia free trade agreement signed a few years ago:

“I should say that many Australians noticed long ago that sugar was left out of the Australian FTA with the US, and that beef has a long transition time (eighteen years, which is subject to snapback). In addition a number of Australians have looked over the 1200 pages of non-transparent rules of origin, and it seems to them that these rules were tailor-made for a particular purpose. These rules effectively prevent the agreement being relevant for many exports from Australia to US, particularly exports of those manufactures on which Australia has come to specialise, which are integrated into the beneficial ‘fragmentation’ of production in the Asia Pacific region, through which goods are increasingly assembled out of components coming from many countries. It is an empirical question, as yet unresolved, as to whether the US-Australia FTA is leading, in Fred’s words, to ‘an explosion of new trade flows…far greater than estimated by even the most optimistic analysts’. My Australian colleagues think that the opposite is happening. They have noticed, too, the significant upward pressure on drug prices which is now evident in Australia, as a result of the agreement. And they are aware of the economically indefensible extension of US monopoly power over intellectual property which has occurred in the film and publishing industries, again as a result of the agreement.”

Joseph Francois over in Rotterdam, makes an interesting historical reminder, and proposes free trade solutions for OECD countries:

“I would also worry about bilateral deals leading to competing trade networks (I vaguely, and somewhat uneasily, remember old history lectures on colonial trading systems as an incubator for global military conflict). How does an emerging economic and military powerhouse (China) fit into a world of FTAs it does not belong to? (Imperial Japan felt justified in embarking on its military adventures in part because it felt a need to build its own trade block, as Europeans would not let Japan play in their own economic sandboxes.) (…)

If Bergsten is right, and we will soon start work on a Japan-US FTA, along with the likely EU-Korea FTA (and rumors of EU-U.S. discussions) then we have all major OECD economies linked up at least partially in a spider web of FTAs, right? Maybe it is time to talk about leveraging the intra-OECD FTAs through Geneva into some kind of OECD-based zero-tariff plurilateral for manufactured goods. I recognize this would be impossible for agriculture. Even so, at least it would force some of the current round of FTAs onto a path toward multilateral liberalization. (Though I can hear the trade lawyers from here: “But then we would not need rules of origin anymore, would we!?”) This could be MFN from the outset, or an open-membership side-agreement with easier conditions for the least developed countries. A model is the Information Technology Agreement. It would bypass the problem of finding a formula suitable for North and South economies in the current Doha Round negotiations, and if extended on an MFN basis to developing countries would give full access and eliminate the trade-cost aspects of rules-of-origin haunting preferential tariff schemes that, in theory, should be providing better access for developing countries. Just a passing thought…”

Jagdish Baghwati – a classic reaction, and personal book promotion…:

“First, the current administration has never understood that PTAs can, and often do, undermine the multilateral freeing of trade. Under the influence of USTR Zoellick, who must be credited with launching the Doha Round, and of Fred Bergsten, the US has embraced the notion that the US can successfully walk on two legs: multilateral and bilateral, ignoring altogether the possibility that the US would wind up walking on all fours! The US has embraced the Zoellick doctrine of “competitive liberalization” which asserts that PTAs which exclude them threaten laggards (which, of course, are others and not the US) on multilateral trade negotiations into compliance. But the only alleged instance that Mr. Zoellick, and Mr. Bergsten, cite is the EU agreeing to close the Uruguay Round because the US activated APEC as a threat. But I have to meet a single important EU official who buys into this assertion. After all, the Europeans are not nitwits: APEC has not even now, after twenty years, become an FTA!

Second, the bilaterals have now been captured by non-trade interests like IP lobbies, financial lobbies that do not want others to use financial controls during even financial crises, labour and environmental lobbies who wish to advance their agendas. All this can be done in the context of bilaterals where the US has a huge advantage vis-à-vis the other nation, usually weak and pliant towards making any concessions that the US demands for preferential access (which, in nay case, erodes over time while the non-trade obligations stay with you for ever). Bilaterals turn a trade game into a non-trade, a shell game. This cannot be done in multilateral negotiations: so you can well imagine which way trade liberalization will get biased once bilaterals are available.

“These, and several other, criticisms of PTAs have been developed at some length by me in a forthcoming Oxford University Press book titled Termites in the Trading System: How Preferential Trade Agreements are undermining Multilateral Free Trade.

The debate is never ending. Now that the conclusion of the Doha round is again postponed, we probably need more than an extra book on the matter.

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