Deep Dive

Nothing Free About It

The supposedly free trade deals miss the real barriers to global exchange.

Free trade agreements, or FTAs to the cognoscenti, are popping up like daffodils in April. The European Union and South Korea just recently inked a bilateral agreement. U.S. President Barack Obama has promised to push ratification of a U.S.-Korea deal through Congress and is also rushing to complete and submit to Congress similar deals with Colombia and Panama. Washington is also in the midst of negotiating the so-called Trans-Pacific Partnership, a proposed FTA between Australia, Brunei, Chile, Malaysia, New Zealand, Peru, The Philippines, Singapore, Vietnam, and the United States.

Free trade always sounds like a good thing, especially for Americans, for whom the word "free" has very positive connotations. In this highly globalized world, however, the truth is that "free trade" agreements are actually anything but. They are a return to the ad hoc commerce of the early 20th century. And like their predecessors, they often close as many doors as they open and avoid the real issues that are tipping the trade balance from free and open to unbalanced and opaque. While the world has grown more interconnected, our trade policies have grown ever more fractious.

As an illustration, take discussions I had recently in Singapore about various "free trade" arrangements being negotiated in the Asia-Pacific region. During our conversation, one of the Singaporean negotiators warned that the United States would find itself locked out of key Asian markets if it didn't join in all the free trade deals. The implication, of course, is that the parties to an FTA will have different and more favorable trading conditions among themselves than with outsiders. In a word, they will have a preferential trade deal. That's all that FTAs really are; we should call them preferential trade agreements, or PTAs. And they are very similar to the kinds of arrangements that prevailed prior to World War II.

Over the last half of the 20th century, the world's trade negotiators did everything they could to simplify the complicated, inefficient web of bilateral compacts that were weighing global trade down. The motivation was to get all trading countries onto the same playing field. Indeed, it was to forever avoid the evils of preferential trading that the General Agreement on Tariffs and Trade (GATT) was concluded in the wake of World War II and its successor, the World Trade Organization (WTO), was formed in 1995.

Now, however, quite the opposite is happening, and the PTAs are back in force. It is quite possible, for example, that a new FTA between players A, B, and C will nullify or impair the "free trade" results of an earlier FTA between players A,Y, and Z. Consider the Caribbean Basin Trade Partnership (CBTP) of 2000 between the United States and most of the countries around the Caribbean Sea. Part of that deal gives Caribbean countries such as Honduras lower-than-average tariffs on imports of their apparel into the U.S. market on the condition that they use U.S.-made yarn or fabric for making the clothes. Because it is conditioned on use of U.S. yarn, this deal is far from true free trade. Still, it has stimulated a huge amount of trade between the United States and the Caribbean countries and has provided jobs and a way out of poverty for hundreds of thousands of Latin Americans. The proposed Trans-Pacific Partnership (TPP) could undermine this success by extending tariff reduction on apparel to the Pacific countries as well as the Caribbean countries. But this time, producers likely wouldn't have to use U.S. yarn; they could use cheaper, locally sourced raw materials. That would likely disrupt or even destroy the Caribbean industry, which still relies on more expensive American thread.

Let's also be honest about the motive of these agreements, which is not free trade per se. The Caribbean deal was about boosting jobs in that region, so as to reduce the incentives for drug smuggling and illegal immigration. Unless it is negotiated and amended with extreme care, the emerging TPP could wholly undermine whatever effect the CBTP has had in that regard. And even if carefully negotiated, every new FTA undermines a little bit more the credibility and authority of the WTO -- which really is about free trade. Although the WTO's rules allow for FTAs -- under the condition that they don't raise tariffs or other protectionist measures above levels committed to in the WTO -- their very essence contradicts what the organization is about: that each trading country should treat every other WTO member in the same way.

But dueling FTAs is the least of the problems. Far more significant is the question of whether any of our free trade negotiations, be they in pursuit of FTAs or in pursuit of new global arrangements under the auspices of the WTO, have any relevance to the actual problems in the global economy.

Take the question of exchange rates. FTAs, as well as all the WTO negotiations, including the Doha round, focus on tariff reduction and protection of intellectual property. Yet manipulated exchange rates can have a far greater effect on imports and exports than the tariffs that are so laboriously negotiated. Brazil, China, Japan, Malaysia, South Korea, and Switzerland all intervene in international currency markets to keep their currencies undervalued as a kind of indirect subsidy for their export-led economic growth strategies. Currencies can swing by 20 to 30 percent in the course of a few months, easily wiping out tariff reductions that might be equal to 2 to 5 percent of the cost of a product. Cordoned off as the domain of banks and finance ministries, one of the single most important determinants of trade is thus left out of discussions altogether.

Investment incentives play a similarly important (and ignored) role in trade. Countries as diverse as China, France, Ireland, Israel, and Singapore aggressively use offers of free land, zero or very low taxes, capital grants, utilities at half price, and other perks to lure investment and production to their territory -- and away from locations where low operating costs would normally draw corporations to set up shop. Intel recently opened a facility in China for making advanced semiconductors, for example. A major consideration in the company's decision was the huge tax breaks and capital grants offered by China, which succeeded in luring the investment away from a U.S. location that would have had lower operating costs and better initial quality. Because the United States has a trade surplus with China in semiconductors, largely as a result of Intel's exports, the location of the new factory could well turn this surplus into another trade deficit. Yet again, these kinds of incentives are never the subject of free trade negotiations.

Even in cases where topics are nominally covered by the FTAs, the truth is that the FTAs may be largely meaningless. This is especially true for intellectual property and market opening. The proposed FTA between South Korea and the United States is a good example of both issues. It contains very strong language with regard to increasing protection of intellectual property. But the Korean legal system has demonstrated that it may rule otherwise. Over the past 15 years, for example, patents granted by the Korean patent office to FormFactor, an American company, for its probe cards (a device for testing semiconductor wafer circuits), were nullified by the Korean courts. This was not particularly surprising; Korean courts rarely rule in favor of non-Korean companies. Obviously the language of an FTA is pretty meaningless if a nationalistic legal system refuses to uphold it. In these circumstances, it does not make any difference what kind of FTA a country concludes; it will not achieve anything close to free trade.

FTAs are also meant to open markets, meaning that in any particular market, domestic and foreign producers are able to operate under the same conditions. Indeed, these deals are supposed to grant a sort of local treatment to nonlocal entrants into the market. Clearly, to sell a product in a given country, a producer must be able to get its products in front of the customer. Yet these FTAs never guarantee that. Take autos, for example: To sell them, an automaker must find dealers who will put the cars in their showrooms, service them, and market them. But in most countries, auto dealers don't sell multiple brands. So even if auto tariffs are slashed to zero, in many countries imports of foreign cars won't rise much because there are no or few dealers who will actually put the cars on their lots.

Of course, Ford, for example, may try to open dealerships in, say, South Korea. But opening a nationwide network of dealers takes a lot of time and a lot of money. Foreign companies entering the U.S. market, by contrast, don't have to spend that time and money because American auto dealers sell all manner of cars, no matter their affiliation to automakers. An FTA with South Korea would not create equal sales potential for U.S. and Korean automakers. Let me emphasize that this is not a matter of unfairness. It is a matter of trade policies needing to catch up to the real world.

FTAs and other trade deals are always presented as win-win propositions that will increase trade and jobs for everyone. They don't. And because they don't, they give rise to cynicism about the benefits of free trade and globalization and to increasing resistance to further such agreements. For the WTO to continue to succeed and for trade deals to produce real benefits for all players, we will have to recognize that the current drivers of globalization are not tariff reductions and import-export rates. We live in a world in which the real issues are anti-trust policies, investment rules, and capital flows. It's time that the negotiators caught up with the reality.


Deep Dive

On the Road to Doha

How the WTO has liberalized agricultural trade.

In the decades-old debate over the global role of the World Trade Organization, agriculture is a constant point of reference -- particularly for those who question the organization's ability to make progress in leveling the playing field. Developing countries, many of them reliant on agriculture, have long wanted rich countries to stop subsidizing their farmers' production and lower tariffs. In exchange, wealthy countries are arguing against a proposal for a safety-net tariff mechanisms for developing countries; when prices fall or when imports rise too high, poor countries could charge substantially more at the ports to make sure local producers are protected. For more than three decades, during seven rounds of multilateral talks that finished with the Tokyo round in 1979, attempts to reach a deal on agricultural trade liberalization failed. The Uruguay round of discussions, concluded in 1994, at last brought agriculture under the purview of the organization. But it's widely agreed that Uruguay did little to open agricultural markets.

In the ongoing Doha Development Agenda round of talks, agriculture has again taken center stage. Initiated in 2001, the negotiations had stalled by December 2008 as members became deadlocked, once again, over farming sector subsidies, tariffs, and other protections. WTO member countries have vowed to rev up talks in an effort to conclude the round in 2011, but so far this year there seems to have been little concrete progress. After 10 years of Doha negotiations, there is increasing concern that if the talks are not completed this year, then the round may be abandoned. And developing countries reliant on agriculture may well begin to question the value of their membership in the organization. Indeed, given the lack of progress on agricultural-sector liberalization through the WTO negotiations, one might reasonably wonder whether the WTO is an effective body to facilitate agricultural trade.

We recently decided to test this notion, to find out what benefits the WTO actually offers to agricultural countries. Surprisingly, despite all the rancor and roadblocks on reforming agricultural trade, we found that WTO membership still yields big rewards. Importantly, this is true for both developed and developing countries' agricultural markets.

Our research provides some intriguing answers about how WTO membership affects market access for developing countries. Our data set covered over 200 countries and territories, two sectors (agriculture and manufacturing), reflected 25 years of international trade flows, and controlled for a host of economic, political, and geographical factors known to either promote or impede trade. We found that participation in the WTO and its predecessor, GATT, increased members' agricultural trade by a remarkable 68 percent on average. In 2004 alone, this translated into an increase of $167 billion worth of additional agricultural imports, compared to a world without the WTO.

Expanding this analysis, we tested whether membership improved market access for developing and least-developed countries' exports into the developed world. Again we found that the WTO was hugely beneficial. In fact, developing-country exporters actually gained relatively more access to rich markets than the other way around. We estimate that the average developing country exported 2.4 times more and the average least-developed country exported 1.9 times more to the average developed country than their non-WTO member counterparts. Clearly, when it comes to agricultural trade, participation in the WTO has its perks.

How is it that even as the WTO can't agree on liberalizing agricultural trade it still provides such tantalizing benefits to its members? Several possible explanations exist. First, since the 1980s many developing countries have progressively reduced their own agricultural export taxes. Although this domestic policy change was not a function of WTO membership, it is possible that membership made countries more disposed, in general, to undertake trade reform. Second, the WTO offers more than just a forum to negotiate trade policy reductions; it establishes procedures that reduce uncertainty in international transactions, makes rules that exemplify transparency among members about their trade policies, and provides legal means to circumvent discriminatory action. More fundamentally, however, the WTO facilitates coordination among members, incentivizing countries to invest in trading relationships that may not exist between non-members.

The implication is clear: Regardless of their development status, countries that wish to expand their agricultural trade can do so by joining the WTO. Accession generates sizable trade flow gains and establishes an atmosphere conducive to commercial exchange. Not only does membership inhibit backsliding on trade liberalization commitments, but it also sets the stage for future negotiations that promise further reforms and more trade. Countries considering joining, or existing members reconsidering the benefits of membership, given the protracted Doha round negotiations, would do well to reflect on the positive externalities embodied in WTO participation.

But the other, perhaps more profound conclusion is that in the WTO, participation in the negotiations to a final agreement may be at least as valuable as the agreement itself. By being a part of the negotiating structure, countries form relationships and put their policies and priorities transparently on the table. In a word, they build trust, which is fundamental to long-term bilateral ties. If Doha concludes with a solid agreement on agriculture, the benefits to trade will be undoubtedly worthwhile. But in the meantime, countries will find that some good can come during the wait.