Will a TAFTA make any difference at all?

In his State of the Union address in February, US President Barack Obama announced the start of negotiations on a comprehensive Transatlantic Trade and Investment Partnership with the European Union. The stated intention of this Trans-Atlantic Free Trade Area (TAFTA), as well as that of the other ongoing US trade negotiation – the Trans-Pacific Partnership (TPP) – is to create jobs. 

The politician’s logic is simple. By negotiating for reduced barriers to trade from our trade partners, in the form of lower tariffs and changes in regulatory policies for services and investment, our exporting firms can expand into new markets and reach new customers, creating new job opportunities for domestic workers. The regrettable cost of a free trade agreement – again, from the politician’s perspective – are the concessions that must be offered. These include reductions in home trade barriers and regulatory changes that open up market access to foreign companies and generate a loss of jobs in the import-competing sectors. 

The economic case for free trade is a bit different. Economists focus on the well being of consumers and ask what will achieve the highest overall standard of living. To the economist, free trade reduces discriminatory taxes and regulations and opens up markets to greater competition. Competition forces firms to continually reduce costs and innovate to improve the quality of their products in order to remain in business. As a result consumers can buy better products at lower prices, and one’s income generates a rising standard of living.

One key difference in these two rationales is that the economics case for free trade does not depend on the other country’s decisions. Increased competition from lower tariffs generates benefits for domestic consumers whether the counterpart liberalizes or not. Unilateral free trade is a winning scenario. In contrast, to the politician unilateral free trade offers concessions without providing job-creating benefits. It is a losing scenario. 

Nevertheless, since the Great Depression of the 1930s, trade liberalizing efforts have progressed, in the GATT, the WTO, and in the formation of free trade areas – under the politician’s logic.  Economists have gone along with this process because it has offered a politically viable method to achieve the goal of trade liberalization.  And via this method, tariffs did come down substantially around the world and international trade has grown phenomenally since the 1930s, which has surely contributed to the improvement of living standards around the world.

However, now that negotiations in the Doha round of the WTO have stalled for over 10 years and multilateral trade liberalization has ground to a halt; now that free trade areas around the world have grown to more than 200 in the past few decades; and now that discrimination in trade has become more the norm than the exception, it is unclear whether the continuing expansion of free trade with an agreement like the TAFTA is still satisfying the economic objective of spurring competition, raising economic efficiencies, and improving standards of living.

First, consider trade in manufacturing goods. The average weighted US tariff on imports from the EU is at 1.1%, while the average weighted EU tariff on imports from the US is at 1.5%. Reductions of these tariffs to zero will have an almost imperceptible effect. In agriculture the tariffs are only slightly higher. For example, the average weighted US tariff on agricultural imports from the EU is just 2.1%. Thus, even trade liberalization in agriculture, which is much more heavily protected, is unlikely to have much effect for either bloc. Of course, there are some regulatory issues that could be settled, such as the future rules regarding hormone–treated beef and genetically modified organisms, but they have been under constant discussion and it seems likely that the US will continue to demand greater access while the Europeans will continue to resist.  

An ambitious negotiating agenda would put the larger issue of domestic agricultural support policies in play, with the hope of implementing major reforms to reduce the distortions that continue to affect agricultural goods like cotton, grains, and sugar. However, it is largely the intractability of this issue, caused by the unwillingness of all sides to compromise, which has led to successive failures of the multilateral negotiations in the Doha Round. Even a relatively minor problem, like trade in bananas, took over 15 years of continual wrangling between affected countries to reach an agreeable resolution last fall. Thus, it seems unlikely that much progress will be made on this front.

Another hidden problem that arises as new free trade areas are formed is the set of special restrictions that go into place to prevent third countries from receiving the same preferences offered to the free trade partner. These “rules of origin” specify what portion of a product must originate in the FTA member country to be granted duty-free entry under the FTA. The rules vary from product to product and necessitate a careful, and economically costly, accounting of a product’s production pedigree. This exercise is becoming increasingly difficult, and pointless too, because, as Pascal Lamy, the Director-General of the WTO, recently said, products are no longer Made in the UK or Made in Switzerland, rather they are Made in the World. Supply chains stretch across multiple continents making national origin an increasingly arcane concept. Nonetheless, national origin becomes increasingly embedded in these regional trade agreements. 

One final suspicion I have about the new TAFTA is that it is really intended to do two things that have little to do with improving living standards in the affected regions. First, it is meant to offer easy talking points to support the notion that governments are trying to do something to get their countries out of the economic quagmire that they remain stuck in. Because a TAFTA will have few large economic impacts, it is a tepid response that sounds bold but will not upset very many constituents. Secondly, a TAFTA may be inspired by a continuing desire to isolate China and ward off the competitive pressures that emanate from Asia. Perhaps it is not a coincidence that the only FTAs the US is actively discussing comprise Trans-Pacific and Trans-Atlantic partnerships that exclude the one country whose trade has been growing the fastest. No wonder China feels like they are being treated as an economic enemy rather than a friend and partner. 

Overall, it quite possible that a TAFTA will not have much of an economic impact, will not tackle the persistent distortions in agriculture, will introduce even more trading costs in a world with increasingly discriminatory trade policies, and may even irritate other important countries that feel they are being left out of yet another trade liberalizing deal. Thus I wonder if TAFTA is worth the effort, especially if it is just being done to score a few political points. On the other hand, it is encouraging that in these troubled economic times politicians still think it prudent to support some kind of free trade deal.