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Say No To This Free Trade Deal

Authors: Ross Garnaut, and Jagdish N. Bhagwati
July 11, 2003
The Australian

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Leading US and Australian free-traders Jagdish Bhagwati and Ross Garnaut warn that bilateral deals will hurt the global trade system and promote protectionism

AUSTRALIA presents an international image of some bad and a lot of good. Many in New York as much as Sydney have heard of its great contributions to tennis, opera, films -- oh, (says the American), who can sport a trinity of talent such as Russell Crowe, Mel Gibson and Nicole Kidman? -- literature, and some even to cricket.

Australians may be surprised to hear that one more jewel in this crown is their country's contribution to the making of an admirable architecture of the world trading system. Unfortunately, this is the jewel that the Howard Government is consigning to the dustbin as it responds enthusiastically to the US initiative to pursue free trade agreements with any willing and politically agreeable partner.

Australia turned away from huge protectionism over the past two decades. Its world-class international economists, among them Max Corden, now back home in Melbourne, and the late Richard Snape, provided the intellectual starting points. A generation of visionary bureaucrats, political leaders and public policy analysts sustained the effort.

Australians, through these efforts, did more than take away the gun that they had been firing at Australia's foot. These Australians also provided support for a world trading system, into which Australia's openness would fit snugly, which was relatively free from preferences, genuinely devoted to even-handed or most favoured nation treatment of all trading partners. In particular, countries in Australia's western Pacific neighbourhood liberalised trade on a most favoured nation basis, which was important to the world trading system as east Asia's relative importance increased rapidly.

Regionalism in the Asia-Pacific region, through APEC, acted as a facilitator for MFN or non-discriminatory reductions in trade barriers at the GATT (absorbed into the World Trade Organisation in 1994) rather than as a free trade area which would free trade among its members but not for non-members. This approach, embraced by western Pacific APEC members, was called "concerted unilateral liberalisation" such that APEC members would agree in concert to reductions of trade barriers on an MFN basis.

Was this policy, and the vision it reflected, wrong? Hardly.

As the great US economist Jacob Viner pointed out in 1950, free trade areas are not free trade. Although they remove tariffs for member countries, they also increase the handicap that non-members suffer vis-a-vis non-member producers in the markets of the member countries, implying therefore protection against them. So FTAs are two-faced: they free trade and they retreat into protection, simultaneously.

Like any protection, the discriminatory elements in an FTA create concentrations of benefits among particular producers. The beneficiaries have a powerful interest in resisting movement to genuine free trade. This is one reason it is generally naive to see free trade areas as building rather than stumbling blocs to free trade.

The protectionist trade discrimination would be a feature even of a perfectly clean FTA, that completely removed all trade barriers between partner countries. In practice, FTAs are rarely anything like clean. The Australia-New Zealand Closer Economic Relations agreement is one of a tiny number of exceptions. Trade barriers are most likely to be removed if their removal would divert imports from the rest of the world to partner suppliers -- emphasising precisely the protectionist rather than the free trade elements of the arrangements.

Countries tend to seek as partners in an FTA economies that do not have highly competitive industries from which large amounts of imports would force reduction in domestic production. So Japanese and South Korean steel producers, but not farmers, would like a free trade agreement with the US. American farmers but not steel producers would like an FTA with Japan and with South Korea. The potential free trade agreements that would have the largest free trade elements don't happen. Or if they happen, they make exceptions for threatened industries -- note exclusion of limitations on US subsidies to agriculture from the proposed FTA with Australia.

The discrimination among trading partners creates the need for rules of origin to limit privileges to intended beneficiaries. In the best of circumstances, these are highly intrusive -- requiring international bureaucratic supervision of management decisions in companies that take advantage of preferential privileges within the FTA.

The rules of origin can provide very high effective rates of protection for suppliers of inputs from within the FTA.

Normal practice is worse than this. The protectionists get to work on the detail. There are variations in the proportion of third country inputs allowed across different FTAs, and across different products within FTAs. The rules of origin in the North America Free Trade Agreement run to hundreds of pages, creating a bureaucrat's delight, a lobbyist's heaven and a good businessman's nightmare.

When there are many free trade areas the result is what one of us (Bhagwati) has described as a "spaghetti bowl" of preferential arrangements. With different rules of origin applied to different sectors in different countries in different bilateral trading relationships, with the same commodity on different schedule of tariff abolition, the name of the game becomes defining which product comes from where.

But, then, one might argue: even GATT's architects allowed for Article24, which permits the most favoured nation or even-handed principle to be waived in favour of FTAs. But that misses the point. There is no evidence that they had in mind an epidemic of FTAs that would spread far more effectively than severe acute respiratory syndrome.

Today, the problem has turned systemic, with multiplying preferences smothering us in diverse rules of origin and differentiated tariff rates. Already, hundreds more possible FTAs have been the subject of discussions since Australia first responded to the Bush team's new approach to FTAs in late 2000.

While the European Union played the principal role in initiating this epidemic, the enthusiastic entry of the US in this race to the bottom has given the systemic problem an added twist. The US has been actively using FTAs, where they bargain with smaller powers such as Mexico, Chile and Jordan, to introduce templates on non-trade issues such as intellectual property protection, restrictions on the use of capital controls even in times of crisis, labour standards and diverse environmental issues of peripheral relevance to trade. The US has turned the bilaterals into a game of pursuing agendas that reflect the agendas of their trade-unrelated lobbies and increasingly the ideology of the present administration.

In short, we have a situation where the MFN principles that are critical to an efficient world trading system are being increasingly sacrificed to bilaterals that are far better suited to pursuit of other policy objectives.

Does this systemic decline make a case for Australia, in its own self-interest, joining the rush?

There is a substantial cost to the multilateral trading system if Australia chooses this course, given its significant Asia-Pacific and global leadership roles during the past two decades. An FTA with Australia would be the most significant of the group being considered by the Bush administration in its first term, so it would help to entrench the new American views on discriminatory trade.

The downside for Australia would be large if an Australia-US FTA was followed by FTAs in East Asia that excluded Australia. And the small direct advantages that might come from preferential access to the US market may vanish as Australia's rivals start playing the same game, as Mexico has discovered. Both self-interest and altruistic leadership argue for Australia rethinking its trade policy today.


Jagdish Bhagwati is professor of economics at Columbia University and a senior fellow in international economics at the Council on Foreign Relations in New York.

Ross Garnaut is professor of economics at the Australian National University in Canberra.

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