It has long been established that FTAs, ceteris paribus, can be welfare enhancing for the parties to them but not as welfare enhancing as multilateral liberalization. It depends on their specific character.
However, one must also take into account the effect of the DTAs on achieving further multilateral liberalization. It may well be that the fact of having the DTA but not having multilateral liberalization may result in less economic welfare for the parties to the DTA, as compared to not having the DTA but having multilateral liberalization.
Similarly, it has long been established that DTAs may or may not be welfare enhancing for the world as a whole, depending on whether trade creation effects exceed the trade diversion effects.
We do know that trade diversion effects will be small if MFN tariffs between the DTA parties are small. We also know that if DTAs are followed by multilateral liberalization that applies to all countries and all products then to the extent that DTAs have caused trade diversion, then those trade diversion losses will be reduced (particularly if the multilateral liberalization reduced dispersion between rates of protection across different products). Therefore, DTAs are least likely to diminish world welfare where the DTA parties have low MFN tariffs and when the DTAs are followed by multilateral liberalization of trade by all of the DTA parties.
Therefore, in considering whether DTAs are welfare enhancing for the parties and for the world, it is relevant to consider whether the DTA diminishes the likelihood of comprehensive multilateral trade liberalization.
In every nation faced with the possibility of entering into a multilateral liberalization agreement, there will be import competing industries who will lobby against the proposed multilateral deal. The only way that governments are politically able to go ahead with multilateral liberalization in the face of this political opposition is if the agreement also delivers export access to other markets in a way that provides an incentive to exporting producers to provide political support for the government that enters into the multilateral trade liberalization agreement.
One of the determinants of that political support from exporting producers is the incremental market access that would flow from the multilateral agreement. If exporters have already gained market access to particular countries though DTAs, then their incentive to provide political support for a multilateral trade deal is diminished.
Therefore, Korean exporters (like LG or Hyundai) who would gain access to Australia on a zero customs duty basis would have, to some extent, lost interest in providing support to the Korean government for entering into a multilateral trade agreement. The same would be true, though on a larger scale, of the effects of a Korea–USA DTA. Similarly, Australian exporters (e.g. of beef) who would gain access to Korea on a zero customs duty basis would have, to some extent, a diminished interest in providing political support to the Australian government for entering into a multilateral trade agreement.
The occurrence of multilateral liberalization is important to diminish the trade diversion effects of all existing and future DTAs. It is important that Australia tries to play a role in achieving multilateral liberalization, and it is important to realize that the benefits of multilateral liberalization lie both in the reduction of the level of protection and in the reduction of discrimination.
Indeed, Australia has attempted to play such a role by supporting Doha Round proposals for comprehensive trade liberalization across all products for all countries. In contrast, the Republic of Korea has supported proposals in the Doha Round which would diminish the ability of the WTO negotiation to reduce the effects of trade diversion arising from DTAs.
Korea has sought to create significant exceptions from the harmonizing tariff reductions for sensitive products and special products in agriculture and for similar carve-outs for non-agricultural tariff reductions. In doing so, Korea has positioned itself in one group of protectionist developed country members (the G10) and in one group of protectionist developing country members (the G33).
In summary, as DTAs have proliferated, it has become even more important that the WTO process be able to achieve multilateral liberalization which diminishes the extent that the DTAs have caused trade diversion losses through their discriminatory rules.
Australia has supported comprehensive trade liberalization in the Doha Round, but Korea has not. The proposed Korea-Australia DTA would make it even less likely for Korea to support a broad liberalizing outcome from the Doha Round.
Australia and Korea would both benefit from forging a partnership in promoting a multilateral trading system instead of negotiating a Discriminatory Trade Agreement.
Australia should be asking Korea to begin by ceasing to claim developing country status in the WTO and by supporting a comprehensive harmonizing approach to trade liberalization across all products and all countries in the Doha Round.
As if it was not known, that FTAs are only a second best solution. And what about a potential domino effect in Asia-Pacific (such as seen with the agreements btw China and ASEAN followed by Japan doing the same?
The issue is particularly acute in an era of GFC and a meltdown now in the global real economy, with worldwide GDP is expected to decline 9 percent. (Even second-best solutions are more acceptable when economies are growing anyway.) Hence Andrew Elek reporting on this Forum recently about calls for a multilateral ‘crisis Round’. And in today’s Sydney Morning Herald (18-19 April, business p4, ‘Free trade deals bind for better and worse’), Clancy Yeates points out that ‘Today there are 350 preferential trade agreements and [Prof Jagdish] Bagwati notes a resemblance to the outbreak of protectionism between the two world wars, which also coincided with a monumental financial collapse’.
But a way forward may be foreshadowed by the Comment above about the China-ASEAN agreement and other deals with ASEAN. Are such regional FTAs in fact less discriminatory in the short term, by diffusing trade diversion throughout the region? And more conducive to connecting up the regions and their constituent states into a new multilateral system?
In theory, I guess so. In practice, it depends on what goes into the texts of the regional agreements. And I have heard that they tend to ‘least common denominator’, ie they extend basic liberalisations found among existing bilateral partners to the other partners brought into the regional agreement, but the better liberalisations found between bilateral partners remain for their benefit but not those of other partners.
Something similar apparently has happened with investment arbitration in the new ASEAN-Australia-NZ FTA (trying saying the acronym: “AANZFTA”). This protection for investors arises between say ASEAN investors and Australia, but it won’t apply between NZ investors and Australia (and vice versa) due to a governmental side agreement – because Australia and NZ are still negotiating a new Investment Chapter for their longstanding bilateral CER agreement.
That last example suggests, however, that the solution is unlikely simply to be regional agreements that just comprehensively ‘trade up’ to the best investor protections or liberalisations that happen to exist between existing bilateral partners. Policymakers and citizens are more conscious nowadays about the non-economic as well as economic issues involved, especially given the massive market failures that have poisoned world markets at vast expense to current and future generations of taxpayers. It is not enough for economists to just assume or even say: “those are completely different markets and regulatory issues, there’s still nothing wrong with prioritising self-interested exchange for overall mutual gain”. We should be more realistic about the parameters and assumptions embedded in economic models, and so be more prepared to build in – even with ‘free’ trade agreements – additional safeguards to excessively self-interested behaviour.
So, as I’ve suggested before on this blog, at least allow foreign investors to ‘do the right thing’ and choose investor-state arbitration rules tailored to address greater public interests (compared to rules nowadays used for arbitration purely between commercial entities), which are included in bilateral or regional FTAs. Or we allow ministers or officials from FTA partners to generate joint standards on food safety (as already in Australia/NZ) or consumer product safety generally, and indeed ‘trade up’ to better consumer protection in each country (eg by Australia joining Japan, China, the EU, the US and soon Canada in requiring manufacturers and importers to notify regulators of serious product-related injuries).
Sometimes this will be mean acting even if economists are unsure about quantifiable net benefits from introducing such measures. But it may be the only way to a sustainable new world trade order, balancing legitimacy and free markets forces.