Wednesday, April 24, 2013

Why "Free Trade Agreement" Is a Misnomer: Some Thoughts on Trade Liberalization

I am someone who believes that words have value and meaning, and we should therefore use them with care. This would explain why I get annoyed when people inaccurately apply words and labels to ideas and concepts, and also why I enjoying the idea of calling a spade a spade. In the spirit of "calling it like it is," I can't help but direct that sentiment to the notion of a free trade agreement (FTA). But how can someone such as myself, being libertarian and capitalist, question the notion of an FTA? Isn't free trade a good thing? Of course it is! The more liberalized trade is, the greater the economic wellbeing. What I question is whether FTAs actually engender adequate free trade.

So what are FTAs? Free trade agreements are deals between two or more countries in which they agree  to eliminate trade barriers on most, if not all, goods amongst themselves. So where is the issue? More countries are removing trade barriers. This should be a good thing. Without getting into related topics such as the sweatshops in Mexico [also known as maquiladoras] or outsourcing, I still have to wonder where exactly in these FTAs free trade exists.

Free trade does not require a treaty because all a government has to do is voluntarily remove the trade barriers. At best, free trade should require a memorandum of understanding (MOU) or a free trade organization like the World Trade Organization (WTO) to confirm a commitment to free trade. In terms of procedure, the process is least in theory.

If free trade is a simple process, then why are there so many stipulations and exemptions in FTAs? Take a look at the North American Free Trade Agreement (NAFTA): the sheer amount of exceptions and clarifications illustrates that free trade agreements are nothing more than a form of protectionism under the guise of free trade.

If we want to give these trade agreements a more accurate label, we would call them preferential trade agreements (PTAs), instead of free trade agreements. Those nations within the trade bloc remove the trade barriers amongst themselves, but the tariffs and other trade barriers on countries not in the trade bloc still exist.

This is not to say that PTAs are without benefit. More trade creation exists prior to the creation of the PTA, but there is also more trade diversion. What takes place in trade diversion is that the composition of trade changes: production from low-cost nations who are not part of the agreement gets diverted to nations with higher production costs (e.g., NAFTA shifted some production from China to Mexico). The net effect of economic wellbeing is the gains from trade creation minus the losses from trade diversion. Typically, the trade creation exceeds the trade diversion, as can been seen with Mercosur or with agriculture under NAFTA. However, this net positive welfare takes place relative to a previous situation with even higher levels of trade barriers. Advocating for PTAs with this comparison presents a false dilemma that neglects a third option: multilateral free trade. Removing all trade barriers with all countries is better than using PTAs because trade liberalization means greater economic freedom, which improves overall wellbeing. The idea that free trade creates a net positive welfare and improves overall wellbeing is one of general consensus amongst economists.

Does this mean that I think we should remove all PTAs? Not necessarily. If it is between autarky (i.e., no free trade) and using preferential trade agreements, I opt for the latter. Nevertheless, the discrimination induced by PTAs is not optimal. Using PTAs diverts goods and services from being produced and allocated in the most efficient way possible. Even though I believe the best option is a multilateral agreement in which trade barriers are [next to] non-existent, there is a political reality with which I have to contend: preferential trade agreements are here to stay. The implementation of PTAs has increased substantially over the past twenty years. It also makes for good politics. Certain interest groups, such as labor or environmental groups or even domestic producers (e.g., sugar tariffs), further complicate the process. All of this complication creates the spaghetti bowl effect, in which the complex, intertwined network of PTAs creates paradoxes and inefficiencies. PTAs might pull developing countries from economic stagnation in the short run, but in the long run, it diverts from the ultimate goal of economic liberalization. The only good free trade agreement is one that promotes actual free trade.

1 comment:

  1. Very well balanced analysis of the issue.

    An additional factor is this:bilateral trade agreements generally do open up trade, even if they include new restrictions. Multi-lateral trade agreements - including NAFTA and EEC - introduce all the bad elements of politics into the situation, and often result in strengthening existing national limits on trade in order to get countries to participate in them at all.