GATT, preferantial trade and liberalisation

A Korean-American strand enters trade’s spaghetti bowl

Martin Wolf, Financial Times, London (UK)
Apr 4, 2007. pg. 15

"I will never falter in my belief that enduring peace and the welfare of nations are indissolubly connected with friendliness, fairness, equality, and the maximum practicable degree of freedom in international trade." Cordell Hull, US secretary of state 1933-44.

This month marks the 60th anniversary of the General Agreement on Tariffs and Trade, of which Cordell Hull was a founding father. It also sees the announcement of a "free trade agreement" between his country and South Korea. The core of the Gatt was non- discrimination. The core of the new agreement is its opposite. Thus has the US taken the betrayal of its erstwhile principles even closer to its logical conclusion.
At a first glance, the new FTA does deliver a substantial opening between the world's largest economy and its 11th largest: nearly 95 per cent of bilateral trade in consumer and industrial products is to become duty free within three years, with most remaining tariffs abolished within 10; South Korea is to liberalise access for many US farm exports, though not rice; US investors are to receive greater protection; access for the US service sector will be liberalised, including for legal, accounting and audiovisual services; intellectual property is to receive greater protection; government procurement is to be substantially opened up; new commitments are made on customs administration and rules of origin; and, not least, a new dispute settlements body is to be established.
Why do I object? Is such trade liberalisation not precisely what most economists interested in trade believe in? The answer to this question is "yes and no": yes, because liberal trade is desirable, but no, because this form of liberalisation is not necessarily a move towards liberal trade. As Jagdish Bhagwati of Columbia University has argued, "free trade agreements" should, instead, be called "preferential trade agreements". I would prefer "discriminatory trade agreements".
In this case, the US and South Korea agree to discriminate in favour of exporters or investors based in each other's territory. The obvious potential economic cost of such an agreement is what Jacob Viner, the great inter-war trade economist, called "trade diversion". In other words, the partners might shift from more competitive to less competitive suppliers. In this case, however, trade diversion may be modest, since these two countries are among the world's most competitive suppliers of a wide range of goods and services.
A more significant economic cost, however, is systemic. The number of preferential trade agreements has exploded upwards in recent years (see chart). An agreement between the US and South Korea is itself a quantum leap in this progression. The US was the world's largest importer of merchandise products and South Korea the sixth largest in 2005 (if the European Union's internal trade and Hong Kong's re-exports are excluded). The US is also the world's largest importer of commercial services, while South Korea is the 12th largest (this time with EU internal trade included). Other countries will be desperate to avoid the adverse effects upon them. This makes probable yet another jump in the prevalence of such agreements.
That will have at least two further economic consequences. First, an increasing proportion of the world's trade is sure to be governed by the diverse rules of origins and special procedures of a host of discriminatory bilateral and plurilateral agreements. That guarantees an explosion in administrative complexity. Second, every further bilateral agreement will alter the degree of preference enjoyed by existing suppliers. That guarantees an explosion of business uncertainty. These are indeed inevitable results of what Prof Bhagwati has called the "spaghetti bowl" of preferences.
The political consequences of this development are, however, at least as important. First, a company's market access will depend increasingly on the power of its own government to lever open other markets rather than its competitiveness. Second, big powers will compete with one another to wrest more favourable terms for their own producers. The emergence of such power-driven trading blocs is a world away from the hopes of the founding fathers of the Gatt system.
Political and diplomatic capacity is also limited. While the US is focusing on preferential agreements, the Doha round of negotiations is incomplete. The EU is at least as culpable as the US for the failure to complete a round that would bring far greater benefits to world trade than any conceivable bilateral agreements. But if the attention of the US is diverted from multilateral to bilateral trade agreements, the Doha round is even less likely to be completed.
I am not totally opposed to the idea of preferential trade agreements. Regional agreements at least have a natural political and economic logic. More imaginatively, a free trade agreement open to the world could be the best route to global liberalisation, after the Doha round. Liberally minded countries could agree to a single free trade agreement open to any country prepared to sign up. Such an agreement could then ultimately be a template for global free trade.
As it is, however, it is far more likely that the move to discriminatory trade will end up fragmenting the world economy rather than integrating it in this imaginative way. If they were so minded, the members of the World Trade Organisation could sign some 10,000 different bilateral agreements among themselves. Does anybody think that this would be sensible? If not, at what point would the Gadarene rush cease? If the US, as the dominant economic player, makes discrimination a central principle of its own policy, how can it fail to become a global model, with predictable and disturbing results?
John Maynard Keynes stated the fundamental issues clearly just before his death in 1946: "The separate blocs and loss of friendship they must bring with them are expedients to which one may be driven in a hostile world where trade has ceased over wide areas to be co- operative and peaceful and where are forgotten the healthy rules of mutual advantage and equal treatment. But it is surely crazy to prefer that."Let us hope that we do not have to re-learn just how crazy it would be. I am a long-run optimist on this. As the number of agreements explodes upwards some wise policymaker will surely ask why his or her country conducts trade policy through a hundred or more bilateral agreements. Why, he will ask, do we not have a single multilateral agreement, instead? He may even want a name for this new agreement. I know. Why not call it the "World Trade Organisation"?