‘What do trade agreements really do?’. This is the question Dani Rodrik asks in an essay published in the Journal of Economic Perspectives last year. He begins by citing a survey of leading economics professors in the US showing near-consensus support amongst them for both the concept of free trade in general and the North American Free Trade Agreement specifically.
Why do economists support free trade?
It’s one of the first clear results in economic theory, outlined by David Ricardo back in 1817. He deduced, in his book Principles of Political Economy and Taxation, that a country would be strictly better off if it got rid of tariffs on imports. Increasing trade, increases efficiency – the economic pie gets larger, to use an aging metaphor. Though it’s true that some industries will be worse off having to compete with cheaper imports.
Why do economists support free trade agreements?
Proponents of trade agreements say that governments are under constant lobbying pressure from local industries that compete with imports. They benefit from protections like tariffs which keep the price of their products high. But, while people in these industries benefit from higher prices, consumers more generally lose out. Trade agreements are supposed to be long-term commitments that help governments resist this pressure towards protectionism, to the general benefit of the economy.
Do they work?
Rodrik distinguishes between two periods of trade agreements.
The first phase was the General Agreement on Tariffs and Trade (GATT) signed by 23 countries in 1947. Tariffs were generally high in the postwar years, suggesting that protectionist interests had been dominant up until then. And with the early trade agreements tariffs seemed to come down.
But the second phase began with the creation of the World Trade Organization (WTO) in 1995. With the negotiations leading up to its creation and ever since, trade agreements have focused more and more on behind-the-border issues like: trade-related intellectual property, cross-border capital flows, investor-state dispute resolution and regulatory harmonisation.
As evidence of this change in focus, Rodrik compares the US-Israel FTA, signed in 1985, with the US-Singapore FTA signed in 2004; the former consisted of less than eight thousand words, while the latter inflated to more than seventy thousand.
Trade-related intellectual property
Intellectual property (IP) is a government-granted monopoly that certain industries need to recoup their initial investments in a product. The ongoing manufacture of the product is very cheap – producing drugs, or copies of a Disney film – while the initial cost of making the product might be hundreds of millions of dollars. Some IP protection is necessary for firms to make this initial investment, but where exactly to draw the line is difficult to tell. Firms in these industries have a financial incentive in as much IP protection as possible. The purpose of including these rules in trade agreements is to push developing countries to accept the more stringent IP protections of the advanced countries. Longer patent lengths means more money for the company, but from the public’s point of view, we only want to guarantee the firm just enough of these IP rents to keep them researching and developing, and realise the rest of the value in lower prices for consumers.
In the case of trade-related IP rules we can see that more stringent IP standards in developing countries means higher prices for consumers in those countries and this amounts to a transfer of wealth from those consumers to the exporting firms in wealthy countries. Whether this is justified by more innovation by those firms is deeply unclear and Rodrik cites empirical evidence suggesting that it is indeed not justified.
Cross-border capital flows
Rodrik notes that it has become standard in trade agreements to enforce open capital accounts, that is to say, that financial capital can be moved into and out of a country without restriction, even in times of crisis. This is meant to encourage efficient investment, but there are concerns that this flexibility actually makes crises more likely, since if capital flees a country at the first sign of trouble it can deepen the crisis for the human beings who cannot flee so easily. He also notes that the pendulum of academic opinion has swung back against such enforced openness, citing the IMF’s revised position on capital controls that they can be a complementary, second-best measure in times of financial stress. Yet they remain a feature of modern trade agreements because it suits international financiers to have the option to cut and run when they spot trouble.
Investor-state dispute settlement
Trade agreements increasingly contain provisions for specialist tribunals that exist outside of established legal systems, to decide on questions relating to trade. The starting assumption is that wealthy countries have a strong legal system which protects businesses from governments in a way which is good for business and by extension the public. These protections include things like not appropriating the assets of a business without compensation. Where developing countries are seen to lack these protections, potential investors might fear they will lose their investments. Developing countries then have an interest in signing up to these tribunals to guarantee and hence encourage foreign investment.
However in practice issues taken to these courts have gone beyond the usual protections. The tobacco company Philip Morris attempted to sue the Australian government over plain-packaging laws under our trade agreement with Hong Kong, something they could not pursue within Australia’s legal system. The legal costs to Australia, at least some of which Philip Morris were ordered to pay, were found to have totalled almost $40 million. It seems hard to argue that Australia’s legal system provides insufficient protection to businesses when it is the same kind of system seen as a model to be shared with developing countries.
Regulatory ‘harmonisation’
Proponents argue that differences in domestic regulations impose a cost on trade, and governments have the option to introduce regulations which favour their own domestic producers over imports as a backdoor form of protection. But how to tell the difference between regulations which reflect the consumer preferences of a democratic public and which are unhelpful barriers to trade?
‘Harmonisation’ in the regulatory context always means bringing down higher standards in line with lower standards. It is in the interest of multinational companies to face less regulation wherever they do business. Trade agreements are never made to increase worker safety requirements or environmental protections.
The problem with behind-the-border interventions is there is no objective way to evaluate, for example, the level of worker or environmental protections. We suppose that a democratic society gets to decide on those levels for themselves. Yet trade agreements empower multinational companies in other countries to impose regulatory regimes domestically.
Given the very different levels of development between different countries it is not clear that the way they do things in say, America is necessarily the best way to do things in Vietnam.
Economic analysis can offer no objective assessment of the validity of people’s preferences – that is a matter left to moral and political philosophy. But economists cannot then defend the imposition of one set of preferences over another.
So whose interests do modern trade agreements serve?
Despite the many varied interests with a stake in trade agreement outcomes, negotiations are conducted largely in secret, but with significant input from business lobbyists. Given the complexity of the rules being negotiated, governments rely on the expertise of businesses at the cost of their access to the process. Rodrik reports that business representatives made up 80 per cent of the advisory committee for the Trans-Pacific Partnership negotiations.
Rodrik also draws our attention to issues that have not been the subject of trade agreements even though they fit into the expanded remit of modern negotiations. One example is the US Merchant Marine Act of 1920 which prevents foreign ships from servicing domestic US shipping lanes. The purpose of the law is unambiguously protectionist and yet it has never been up for negotiation. Rodrik also suggests it would be in the public interest to prevent a harmful race to the bottom for corporate taxes and subsidies, but again this has never seriously come up. In neither case are there powerful multinationals pushing for these issues to be put on the agenda.
Free Trade Agreements have political causes and effects, at least as much as they have economic ones. If we only cared about economic reasons, and were going solely off Ricardian theory, we could unilaterally eliminate trade barriers, without the need for any agreements. Increasingly ‘free’ has come to be a propagandistic label. For some agents freedom is increased, like the freedom of pharmaceutical companies to charge monopoly prices for decades longer. While others have their freedoms curtailed, like the freedom of a democratic public to ban substances harmful to health and the environment.
Trade agreements now focus on issues where their economic and social consequences are ambiguous, and where we have good reason to think that exporting special interests have more of a say in their creation than other stakeholders. The conclusion Rodrik reaches is that we cannot be so sure modern trade agreements serve the public good.