The AFR’s Alan Mitchell has written a good piece today questioning the merits of bilateral “free trade agreements” (FTAs), which he claims miss the bigger picture that the biggest gains from trade reform comes from dropping one’s own barriers:
Almost two-thirds of the potential lift in Australia’s national income would come from the increase in Japanese exports to Australia. It would come as a result of the investment and productivity gains generated by more import competition…
They will…force Australian producers to innovate and lift productivity to survive…
Tariff-free imports are a key strength of the FTA with Japan, but they also expose the fundamental weakness of all bilateral FTAs. Australia can have all the cheap manufactured goods it wants, just as Japan can get all the cheap food it likes, by unilaterally tearing down the remaining barriers to trade.
Yet both nations deny their economies the bulk of the benefits of genuine trade reform while they spoon out market access to one trading partner after another, in stupid, long drawn-out negotiations.
I tend to agree with Mitchell’s view.
As argued previously, the first best option in trade policy is to seek trade liberalisation at the multilateral level, whereby all parties agree to drop trade barriers all at once.
However, such liberalisation has proved time and again next to impossible, with successive multilateral trade negotiations collapsing during the 2000s.
With multilateral liberalisation off the agenda, this leaves bilateral or regional liberalisation (via FTAs) or unilateral liberalisation.
For mine, unilateral liberalisation is the second best option.
Most people wrongly view trade barriers, like tariffs, as merely a negotiating coin that can be traded-off in exchange for other nations dropping their trade barriers. However, such a view is misplaced – trade barriers impose real costs on the domestic economy, both to consumers in the form of higher prices and to productivity overall by reducing competitive pressures.
Reducing one’s own trade barriers, therefore, not only improves outcomes for consumers via lower prices, but also increases competitive pressures on domestic industry, helping to spur greater innovation and productivity in order to survive.
In my view, Australian trade policy and trade liberalisation needs to be viewed more in this light – as a form of domestic competition policy, rather than something that can be traded away for a bunch of questionable bilateral deals with spurious efficiency impacts.
It should also be kept in mind that liberalisation through bilateral FTAs also imposes costs that undermine their efficacy.
FTAs typically include complex ‘rules of origin’ (ROO) that raise administrative costs for businesses (including complying with paperwork requirements) and custom services in administering and auditing the ROO, thereby undermining the benefits from such deals. Costs associated with ROOs tend to also be larger where there are a large number of FTAs each with different requirements, resulting in a ‘spaghetti bowl effect’ of increasing complexity.
Indeed, the Australian Chamber of Commerce and Industry (ACCI) has recently raised similar concerns, claiming that the recently signed Korean FTA was so poorly drafted that it was next to useless in a commercial sense. Moreover, technical problems inherent in most recent FTAs precluded Australian exporters from taking advantage of the deals, according to the ACCI, whereas in a different ACCI survey, fewer than 30% of the firms responding used the concessions available to them under FTAs.
And then there is the “trade diversion” caused by FTAs themselves – effectively a situation whereby the importing country shifts its buying from a more efficient, lower cost country whose goods are subject to a tariff towards the less efficient and higher cost FTA partner whose goods are not subject to a tariff.
In such circumstances, the importing country loses the tariff revenue, whilst its consumers do not fully benefit from a price reduction, potentially making them worse-off (see here for a stylised example of trade diversion).
Finally, some FTAs include costly non-trade provisions, which can harm domestic consumers and governments.
For example, the Australia-US FTA included extensions to both patent and copyright terms, which has raised the cost of pharmaceuticals and copyrighted materials. According to Peter Martin, the extension of pharmaceutical patents under the Australia-US FTA, from 14 years to 20 years, has “suppressed the development of a generic drugs industry and cost the government $200 million per year by slowing the entry of cheap generic drugs into the pharmaceutical benefits scheme”. Moreover, “generic manufacturers have missed out on an estimated $2 billion over eight years” whereas “70 per cent of drug patents expire later in Australia than in other countries”.
Similarly, the inclusion of Investor-State Dispute Settlement (ISDS) mechanisms in some FTAs has given authority to multinational corporations to challenge laws made by a domestic country’s government in the national interest in international courts of arbitration, and potentially sue taxpayers in the process.
Again, Peter Martin provides some nice context on recent ISDS developments:
Originally designed to allow foreign investors to sue governments for compensation if their investments were expropriated, so-called investor state dispute settlement clauses are now also used to challenge decisions ”equivalent to such deprivation”.
In Canada, Eli Lilly is suing the government over a court decision to refuse it a medicine patent; in Peru a lead mining corporation is suing the government over a court decision that it was responsible for pollution from its mine; and in El Salvador a mining corporation is suing the government over a ban on mining to protect the nation’s groundwater.
[And in Australia] …we are currently being sued by a foreign tobacco company using them over our plain packaging legislation.
The above concerns also help to explain why the Productivity Commission is generally against bilateral FTAs, noting in a 2010 report that:
…the Commission found little evidence that Australia’s recent bilateral agreements had provided substantial commercial benefits. The main factors that influence decisions to do business in other countries are likely to lie outside the scope of such agreements. The study concluded that while preferential trade agreements could increase national income, the net effect is likely to be modest.
The study also found that some provisions included in Australia’s recent preferential trade agreements — including investor-state dispute settlement mechanisms, government procurement requirements, intellectual property protections and provisions affecting areas traditionally the province of domestic policy, such as culture — potentially entail significant costs or risks.
Enough said.
