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A transatlantic free trade area?

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In Brief

It is perhaps time to revive the idea of a transatlantic free trade area (TAFTA). This is the gist of two papers, one by ECIPE’s Fredrik Erixon and Gernot Pehnelt, the other by GEM-Sciences Po’s Patrick Messerlin and Erik van der Marel. A TAFTA initiative was floated in the 1990s, only to sink; and the Transatlantic Economic Council (TEC), established at the initiative of Chancellor Merkel to tackle regulatory barriers, has become bogged down in micro-detail and hardly made progress. Sure, political obstacles are great, but it is worth stepping back to coolly assess costs and benefits, and then decide whether to go ahead with a new initiative.

First, consider the context of US and EU trade policy, especially in light of the global economic crisis.

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Trade policy has deteriorated in the United States since the Obama administration took over. The Bush administration, for all its faults, did not do a bad job on this front. Its major achievement was to contain protectionism at home, especially against China. President Obama, on the other hand, while no clear-cut protectionist, has ambivalent views on the subject and is not an instinctive free-trader. He has powerful protectionist forces inside his tent – among Congressional Democrats, the AFL-CIO, and at his Cabinet table (notably the Labour Secretary, Hilda Solis). His record to date shows a delicate balancing act, giving way to domestic protectionist forces at one moment, but cushioning their impact and maintaining open markets the next moment. But his overall approach is defensive; and trade policy is crowded out by his domestic priorities. That leaves sweet-sounding multilateralist rhetoric, but without substance. It is soft-serve ice-cream multilateralism, worthy of a Norwegian peace prize.

Above all, the United States is not leading with open-market initiatives, and is not likely to do so under this administration. That is no surprise: a left-liberal administration given to domestic intervention left, right and centre is not the sort of administration to take the fight to protectionists at home and lead international cooperation to open markets worldwide. In this sense the United States is abrogating its traditional role in world trade. But there is no substitute leader – not the EU, not China, not anyone else.

The EU is also in defensive mode. Generally, when the Single Market is opening up and integrating, EU trade policy is more outward-looking and proactive. When the Single Market is under stress from internal protectionism, EU trade policy turns to navel-gazing and gives way to protectionism against outsiders. That is roughly the situation today. National crisis responses within the EU, especially on subsidies, restrict competition from other member-states. That in turn threatens to spill over to protectionism against third countries. True, there has been no marked increase in traditional protectionism (such as tariffs and simple non-tariff barriers), but there are worrying signs of regulatory protectionism, especially on product standards (some of it to do with the EU’s climate-change agenda). Also, the EU’s ‘offensive’ initiatives, in the Doha Round and in FTAs, have, with few exceptions, gone nowhere. Finally, the Lisbon Treaty could make EU trade policy even more defensive. That will happen if market sceptics in the European Parliament gain more influence in EU trade-policy making.

There is also a geopolitical context. The United States may be diminished in the wake of the crisis and in the face of rising powers, notably China. But it is still the fulcrum of international relations. No rising power is in a position to exercise the kind of global leadership the United States has exercised since 1945. The idea that the EU can exercise such power is risible. EU ‘soft power’ on the global stage is mostly postmodern hot air. As Les Gelb quips, it is like foreplay – not the real thing. And the EU is constantly undermined by the zero-sum competition of its Big Three (UK, France and Germany) in international relations. Overall, the EU stands to be the big loser in shifting geopolitical sands. Collectively, it is taken less seriously. That leaves the UK, France and Germany as declining middle-powers sandwiched between the United States and emerging powers outside the West.

Deepening transatlantic economic relations should be important for the EU to stay relevant globally; and it should be important for both the EU and the United States to counter their current trade-policy defensiveness. Would TAFTA be the right shot in the arm?

The most obvious argument in favour of TAFTA is that neither the EU nor the United States can rely on multilateral liberalisation. The Doha Round remains stalled, and even if eventually concluded will hardly liberalise trade, least of all on non-tariff and regulatory barriers. Given the parlous state of the WTO, no one should expect substantial multilateral liberalisation or rule-strengthening for the foreseeable future.

What should be in TAFTA? Erixon and Pehnelt call for a ‘shallow-integration’ agreement on tariff elimination. This should not be difficult. Typically, EU and US industrial tariffs are low (around 1-4 per cent). There are a few tariff peaks, such as on agriculture and textiles, but they do not affect that much bilateral trade. In fact there is little bilateral trade in labour-intensive products, which are overwhelmingly imported from developing countries. Eliminating tariffs would not deliver a huge gain, but it would not be insignificant given the high trade volumes involved. The authors estimate a gain of EUR 7-18 billion (depending on price elasticities for imports), which would increase bilateral trade in goods by 1.5-4.5 per cent. Electrical and machinery goods, steel, chemicals and minerals would be the biggest beneficiaries, as would Germany and other large industrial exporting countries. These are estimated static (short-term) effects. Dynamic (longer-term) gains from productivity improvements could be much higher, especially given the prevalence of intra-industry trade across the Atlantic. Trade diversion from third countries would be modest. An EU-US tariff-free agreement could be open to other interested countries. And it could lead to a plurilateral agreement in the WTO.

But what to do with agricultural tariffs? Lobbies on both sides of the pond would likely resist tariff elimination. Bilateral agricultural trade is minuscule compared with bilateral manufacturing trade; and carving agriculture out of the agreement would hardly make a difference to the overall result. But doing that would probably not be compatible with WTO rules. An alternative could be to include agriculture without specific exemptions, but with longer transition periods.

Nevertheless, tariff elimination on its own might not be worth the candle. Large political capital would be needed to deliver quite modest gains, while sidelining the WTO and perhaps undermining multilateral rules. Rather a shallow-integration agreement should be seen as a stepping-stone to a much bigger prize, a ‘deep-integration’ TAFTA that would tackle non-tariff barriers and seriously liberalise trade in goods, services and investment. Gains from regulatory liberalisation would be much, much larger, especially in services. But this is precisely where the major technical and political obstacles lie, as the TEC record shows. The advantage of doing a deal on tariffs is that it might, finally, generate momentum to tackle regulatory barriers.

Messerlin and van der Marel indicate how big the gains could be in services. Some big-ticket services sectors – electricity, transport, distribution and business services — suffer from particularly high levels of protection in both the EU and the United States. They amount to about 20 per cent of EU and United States combined GDP – about the same share as for industrial and agricultural production combined. Removing barriers in these sectors would be equivalent to fifty years’ worth of GATT and WTO liberalisation of goods trade (assuming a successful Doha Round). Furthermore, an EU-US initiative or agreement on services could be ‘plurilateralised’. Typically, about ten countries (counting the EU as one) account for about 80 per cent of trade in most services sectors. They include China, Brazil, India, Russia, Canada, South Korea and Mexico. This group, plus perhaps up to nine other countries that figure in trade in some services sectors, would constitute a ‘critical mass’ for negotiating the kind of services liberalisation that has eluded GATS negotiations to date.

To conclude: This is not a good time for EU and US trade policy. Both are defensive in a global economic climate that has gone from benign to turbulent. That also poses a threat to bilateral economic relations. TAFTA is worth another look, this time as a two-stage initiative: first to eliminate tariffs, and then to tackle the harder stuff.

Razeen Sally is Director of the European Centre for International Political Economy (ECIPE).

This article also appeared here at the ECIPE blog ‘Trade Matters.

One response to “A transatlantic free trade area?”

  1. Dear Razeen Sally,

    Thank you for your valuable post.

    There are, indeed, potential mutual benefits from closer economic integration across the Pacific. But there are far more imaginative ways to achieve that than yet another trading block, whose costs would fall largely on the poorest economies of the rest of the world.

    There is no prospect of genuine liberalisation of agriculture except in the WTO.
    And getting rid of nuisance low tariffs does not need an FTA in goods.

    An FTA in services can seem more useful at first sight. But a closer examination of the issues will soon reveal that the problems are ones of market regulation, not simple border barriers.

    As noted in the post, it is more important to move on new issues. That was recognised by Sir Leon Brittan and others more than a decade ago. Instead of recommending an FTA across the Atlantic, they perceived that there is a far smarter way to deal with the mostly regulatory problems limiting the already remarkably deep economic integration across the Atlantic.

    That led to the Transatlantic Economic Partnership (TEP) which is analysed in my 1998 paper:
    “Open regionalism going global: APEC and the new Transatlantic Economic Partnership”, Pacific Economic Papers, No 296, Australia-Japan Research Centre, December 1998.

    The TEP initiative,was not followed up, but forgotten, leading to attempts to reinvent the wheel or to turn to the shop-worn idea of yet another so-called FTA.

    It would be far better to revive the TEP. I would be happy to collaborate in an effort to do so.

    Best wishes,

    Andrew Elek

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