The Case for TAFTA

Why Obama's call for a free trade agreement between the United States and Europe could be a game-changer.

As U.S. President Barack Obama opens his second term, America's trade policy is showing signs of life. The United States is negotiating the Trans-Pacific Partnership (TPP) agreement with 11 countries in Asia, and at Tuesday's State of the Union, Obama announced the launch of negotiations with the European Union for a transatlantic free trade agreement -- call it TAFTA -- to connect the world's largest markets. European leaders greenlighted the talks last Friday, hoping a deal could jumpstart export-led growth -- German Chancellor Angela Merkel says she wishes "nothing more." But the forthcoming battles with protectionist agricultural lobbies and entrenched regulatory differences from autos to pharmaceuticals risk giving the two sides cold feet and diluting the deal to a TAFTA-lite negotiated "on one tank." A deal without substance would be an epic lost opportunity: Much like the North American Free Trade Agreement (NAFTA) launched in 1994, TAFTA represents a game-changer in the global trading system that is in a deep crisis after 12 years of fruitless Doha Round talks.

In 1994, the world trading system looked very different. The United States, Canada and Mexico launched NAFTA in January, pressuring Europeans to ink the 123-country Uruguay Round, which made extensive cuts to tariffs and non-tariff barriers and established the crown jewel of the global trading system, the World Trade Organization (WTO). The mantra of free trade was spreading on the back of the so-called Washington Consensus across the emerging world and post-communist bloc. America's export wars of the 1980s with Japan had drawn to a close, and Eastern European countries were joining the EU, forming a giant single market for trade, investment, and production. The world economy blossomed, with trade and investment growth rivaling 20-year highs. America's Internet-fueled growth would eliminate unemployment and help balance the budget in 1998 for the first time in three decades.

As the world's first serious free trade agreement, NAFTA consolidated U.S. export lobbies that would press for further deals in the Americas and Asia, inspired a wave of FTAs around the world, and created a template for a comprehensive, gold-standard deal that would be copied in subsequent U.S. FTAs and in countless of FTAs signed by Latin American countries.

Today, the setting is different. The multilateral trading system is flailing, as the United States, EU, India, and Brazil remain at loggerheads over liberalization in agriculture and manufactures, and developing countries fear opening their markets would only cause a surge in imports from China, WTO member since 2001. With Doha on a deathbed, trade negotiators focus on smaller free trade deals. Since NAFTA, well over 200 FTAs have been struck, connecting such couples as Chile and China, Japan and Mexico, Korea and the EU, and the United States and Singapore. The result of the FTA frenzy is more liberalization, but also more complexity. The labyrinth of distinct rules and regulations in the FTA "spaghetti bowl" is a daily headache to multinationals, small exporters, and customs the world over.

The world economy too is a gloomy place. Unlike the economic renaissance of the 1990s, the hallmark of today's global marketplace is profound uncertainty and fierce competition for the marginal dollar -- and the foul practices it can spawn. Countries are manufacturing competitiveness in the quick, easy, and dirty way -- currency devaluations and quantitative easings that risk widening global imbalances and the U.S. trade deficit, the familiar precursor of protectionism. Insidious non-tariff trade barriers, such as the "indigenous innovation" policies employed by China, are proliferating as countries privilege domestic producers at the expense of domestic consumers and free trade pledges made by world leaders.

The troubled world economy needs a circuit-breaker. TAFTA could be is just that.

First, a substantive TAFTA will help jumpstart economic growth in the U.S. and Europe, which in turn will drive emerging markets' trade and growth. Erasing non-tariff barriers would add 0.7 percentage points to the EU economy and 0.3 percentage points to the U.S. economy, according to the Dutch consultancy Ecorys -- not bad for economies forecast to grow at 0.2 percent and 1.8 percent, respectively, this year. And when the global economic pie expands, the siren calls of currency manipulation and protectionism are held at bay.

Second, just like NAFTA did with Europe in the Uruguay Round, a deep and comprehensive TAFTA can force a return to the Doha table of cantankerous emerging markets -- Brazil, China, and India, which torpedoed the deal in 2008, and set the tone and template for global trade rulemaking.

Third, TAFTA promises to recreate the global trading system. Much like the United States, the EU has deals with Mexico, Canada, Colombia, Peru, Korea, Australia, and Chile, and it is currently completing bilaterals with Singapore, Malaysia, Vietnam, and Japan -- all likely future TPP members. Once wedded to each other, the United States and EU could next weave all these common deals into one mammoth FTA. Outside this giant TPP-TAFTA trade zone would remain India, Brazil, and China -- which as a result should have every incentive to join. In this scenario, the agonized multilateral rounds are moot: Rather than pie-in-the-sky, big-bang deals at the WTO, world trading powers will have arrived at a multilateral deal from bottom-up, through knitting together the various FTAs -- and along the way also sorted out the FTA spaghetti bowl that NAFTA helped inspire.

Fourth, a deep TAFTA is miracle water for the U.S.-EU relationship, which turned antagonistic last year as the United States failed to offer aid to Europeans at the IMF, Obama and Merkel locked horns on fiscal policies in the eurozone, and America's attention kept shifting to Asia. TAFTA is a remedy like no other: Economically, it allows the United States and Europe to help each other grow and recover without spending a single stimulus dollar; strategically, it enables Washington and Brussels to reassert leadership in the world economy they have built together, and it undercuts Beijing's divide-and-conquer tactics.

After a tiring slog of four years through insipid growth, sky-high unemployment, and soaring debts, the United States and Europe will have a chance to reignite growth and remake the world trading system they have championed for seven decades. As in 1994, special interests are drawing policymakers' eyes off the ball. TAFTA offers President Obama a chance to make history. He's laid out an ambitious goal. Now it is time to make it happen.


Democracy Lab

Free Trade or Penalty-Free Crime?

Free Trade Zones are meant to promote trade and improve economies. But they often end up being a cover for crime.

Economists love free trade, but it draws a decidedly mixed reception elsewhere. Since the Uruguay Round paved the way for the WTO in 1995, there's been no significant multilateral movement towards removing the remaining barriers to global commerce. And while new regional trade pacts have been inked all over the place, much of the political focus has been on more limited unilateral fixes -- notably the creation of free trade zones to smooth the multi-stage, multi-country supply chains that have come to dominate commerce in industrial goods.

There are roughly 3,500 free trade zones worldwide in which most national regulation is suspended -- more than 2,000 of them in developing and transition economies. And while policymakers typically promote FTZs as a means of job creation, more often than not the real purpose is to liberalize markets hindered by interest group conflict, local government corruption, or ideological rigidity.

Usually, these zones are established in the poorest parts of countries that would otherwise languish for lack of infrastructure or business-friendly governance. They often become home to multinational manufacturers of middle- and low-tech goods, such as clothing and consumer electronics, or to firms repackaging products like cigarettes and pharmaceuticals for re-export. Thus FTZs may speed local development, as well as signaling the advantages of free markets to other localities within the country. Think of the "special economic zones" in which Deng Xiaoping introduced capitalism to post-Maoist China.

All is not roses, though. FTZs sometimes make it possible for autocratic regimes to perpetuate illiberal societies -- for example, North Korea -- using them to generate desperately needed foreign exchange. More commonly, FTZs become havens for smugglers, money launderers, and terrorists in search of hard currency. And these problems can discredit both open trade and regulatory reform by equating the free-for-all of cowboy capitalism with free markets.

A few FTZs in rich countries, such as the St Regis-Mohawk Reservation in New York State that serves as a major transit point for smuggled cigarettes, illustrate the downside. But for the most part, highly industrialized countries manage to maintain civil institutions and the rule of law in FTZs without undermining their attraction to investors. The same can't be said for developing countries, particularly those with weak political and economic institutions.

Panama's Colón Free Trade Zone, with its proximity to the Canal, is one of the busiest FTZs in the world -- and a beehive of illicit activity. The Panamanian military has been known to collude with importers seeking to evade regulation, getting a cut of the savings on goods otherwise subject to stiff tariffs. More ominously, it has cooperated with smugglers to transport weapons and illicit goods to private militias across South America that mix radical politics with crime.

Perhaps not surprisingly, organized crime often fills the power vacuum left by the absence of regulation: The environment of "no rules" becomes one of rule by the most brutal. For example, laissez-faire and corruption allowed Aruba to become a haven for the Sicilian-based Caruana-Cuntrera family, which controlled 60 percent of all property on the island in the early 1990s. 

Aruba's nearness to Colombia and anything-goes ethos within its FTA made the country an ideal waypoint in the American-European narcotics trade. By the mid-1990s, Aruba's reputation had also made it a no-go zone for legitimate foreign investors wishing to avoid guilt by association. And under pressure from multinational corporations (and foreign governments), the Aruban government finally grew the backbone to overhaul its laws.

Evidence of counterfeit goods passing through FTZs has led business trade groups to call for greater regulation of free trade zones elsewhere. The Jebel Ali FTZ in Dubai is one of Europe's largest sources of counterfeit goods. In 2008, the year I visited the zone to investigate the fake-pharmaceutical supply chain, 15 percent of incidents of seized counterfeits at EU borders were in transit from United Arab Emirates.

FTZs also facilitate the packaging/rebranding of pharmaceuticals not licensed by the patent holder, leading to uncertain provenance and hence concerns about quality. A public health inspector found label-modification activities in the FTZs of the Netherlands Antilles; zones in China, Panama, and the UAE are also regularly implicated. When my research group bought pharmaceuticals from bogus Canadian websites, the drugs would often come from China via Dubai, with payment going to accounts held in Panama.

The FTZ-terrorism connection is especially disturbing. There's evidence that a Colombian cartel used FTZs to funnel cocaine revenues to Hezbollah in exchange for protected access to Mideast drug consumers. Lax banking laws in one Asian country allowed the traffickers to launder the funds through what's called a "black market peso exchange." Colombian traffickers would deposit money in an Asian bank account and then buy the currency back with pesos, using the currency to move the drug shipments in and out of Panama (including the Colon FTZ). The network utilized a peso exchange system in Miami as well.

An FTZ in the Ciudad del Este, located at the juncture of Brazil, Paraguay, and Argentina, has also been a source of concern for security experts. The "Tri-Border Area" (TBA) became infamous for the trafficking of illicit goods due to lax border security, thanks to a mix of corruption and a desire to attract tourists with hassle-free entry. After 9/11, Paraguayan police responded to U.S. pressure by arresting a Lebanese immigrant whose electronics store fronted for a massive money-laundering and DVD piracy scheme that funded Hezbollah.

Some economists have argued that the kinds of corruption we see in FTZs do more good than harm by giving investors a way to duck costly, inefficient government bureaucracies. But, more typically, the cowboy-capitalist FTZs offer nothing positive. While the better-managed FTZs provide millions worldwide with employment and trade benefits, the worst encourage cronyism, corruption, and illegal trafficking, discrediting a concept that can be immensely beneficial.

Moreover, the problem is not beyond solution: As noted above, Aruba eventually stood up to entrenched interests, implementing comprehensive background checks, tightening oversight of incoming and outgoing shipments, and maintaining better inventory controls. In fact, as Aruba's FTZ went legitimate, it became more prosperous; it is now the preferred venue for Venezuelan investors seeking relief from their country's corrupt, regulation-bound government.

Aruba still has problems with inventory management, and it does not have the oversight of American FTZs. But the turnaround shows that developing country FTZs are not beyond the influence of western interests, both authorities and multinational corporations -- and can actually make a bigger buck by treading the straight and narrow.    

Photo by Jesus Alcazar/AFP/Getty Images