Jagdish Bhagwati's Spaghetti bowl effect. Wikipedia.
"There may be a way to cut through this red tape if there is a will."
In his State of the Union address, President Obama revived a long mooted idea: a Transatlantic Trade and Investment Partnership (TAFTA). The aim of this initiative is to abolish or drastically reduce barriers to trade in goods and services between the United States and the European Union and turn the North Atlantic into a huge single market. The prize is alluring, but the hurdles are high. The Partnership will not be easy to set up, given the complicated regulatory barriers that fence off trade and services and the use that numerous and powerful interest groups make of them. Also, TAFTA may be against international law. The essence of the Treaty establishing the Word Trade Organisation (WTO) is the "most favored nation" principle, so that any advantages granted by the parties in a trade zone stopping short of a full customs union must be extended to all countries having a previous agreement with them. True, this rule is more honored in its breach than in its observance. Witness what Jagdish Bhagwati has called the 'spaghetti bowl' of bilateral trade agreements, shamelessly adopted by advanced countries in thrall of special interests.1 The parlous state of the Doha Round, whose aim is to extend the benefits of trade by an agreed application of the most favored nation rule, is another evidence of general prevarication.
But there is another, more serious obstacle to making a North Atlantic Partnership area a success; TAFTA may go against the laws of economics. Jacob Viner warned that mutually trading concessions within a free market agreement may be trade-diverting rather than trade-creating, and hence to some degree self-defeating. Defenders of free trade zones such as the European Common Market and TAFTA argue that the larger the area, the smaller the negative trade diverting effects on its members—but what about those left out in the cold? Mexico and Canada, who share a trilateral trade agreement with the United States and have signed bilateral agreements with the European Union, have no other way out but to join unconditionally, if they are accepted. They must be content to feed on reheated spaghetti.
The gains from TAFTA
Even before any Partnership, the U.S. economic relationship with the EU is the largest and most complex in the world. According to the Office of the United States Trade Representative, it generates flows of goods and services of some $2.7 billion a day.2 Transatlantic investment is responsible for roughly 6.8 million jobs. A total of 15 million American and European jobs are directly or indirectly linked to transatlantic commercial activity. The stock of U.S. foreign direct investment (FDI) in the EU totaled $2.1 trillion in 2011, and the stock of European FDI in the United States amounted to $1.6 trillion. These figures may be put in perspective by comparing them with the GDP of the areas concerned, to wit, some $15 trillion each.
The Office of the U.S. Trade Representative reports very large figures for trade across the North Atlantic (latest figures). U.S. exports to the EU accounted for 21 percent of overall U.S. goods and services exports. U.S. imports from the EU amounted to 19 percent of overall U.S. goods and services imports. Within this total, service figures loom larger; the U.S. purchased 25 percent and supplied 31 percent of all EU private services exports. Especially revealing of the ongoing integration of the area is the fact that majority U.S-owned affiliates sold some $499 billion worth of services in the EU in 2010, while sales of services in the United States by majority EU-owned firms were $382 billion. Intrafirm trading—trade that takes place within the same company—accounts for more than half of total U.S. trade with the EU.
Given the large figures involved, TAFTA liberalization should result in annual gains of at least 1-2 percent of the GDP of the whole area, accruing in perpetuity, some $600 billion per year to both partners. If the liberalization could be extended to the whole world, the gains would larger for all concerned.
Despite these hoped for gains, I am skeptical. Creating an Atlantic Partnership implies much more than lowering tariffs. That is the easy bit. And as the weighted average tariff on goods in the United States and the European Union is below 3 percent, the gains from lowering them might not be that large. The sensitive area is agriculture; in the United States, the simple average tariff imposed on agricultural imports is around 9 percent, and the comparable figure for the European Union is no less than 18 percent. A zero tariff could be within reach if the United States forgot about sugar and corn quotas and the European Union gave up its Common Agricultural Policy and its hostility to genetically modified foodstuffs. Easier said than done.
The real obstacles are non-tariff barriers. They would loom large even if all concerned were true friends of free trade. There are genuine differences in property rights protection between the United States and the European Union, especially as regards intellectual property and patents, since the procedures are judge-based in America administrative in Europe. And agreement about accounting standards is still not within reach despite the many years of negotiation. Technical standards differ widely and not all are hidden forms of trade protectionism: examples include differences in data and consumer protection norms, the procedure for the approval of drugs for human use, financial regulations, corporate governance rules, and telecommunications standards, re-export and trade facilitation among many others.
There may be a way to cut through this red tape if there is a will.3 This way is mutual rule recognition, whereby what is cleared through the proper bodies in America would be automatically accepted in Europe and vice versa. This is what Europeans tried with the Bolkenstein Directive and it has not worked very well among EU States. Is it realistic to expect a better outcome in a future TAFTA?
Jeremy Bentham, the utilitarian philosopher, used to call pressure groups "sinister" that were always out to defend their privileges under cover of darkness. These groups will use technical hurdles to keep barriers down. And failing that, they will appeal to feelings of fairness and altruism to put genuine reformers in the wrong. Free trade in food will harm the environment. The cinema or education cannot perform their much needed and indispensable role without public subsidy. Public procurement needs to be fair to local firms. National airlines and airports cannot be left in the hands of foreigners for reasons of defense. Complex regulations must govern the medical and legal professions for fear of a fall in quality. There will be a race to the bottom as free trade forces national workers to compete with the underfed and exploited foreign masses whose products unfairly compete away the social conquests of national workers. And failing all that, we can ask our central banks to wage a little currency war.
In the end, our hope for free trade lies with the Internet, with anonymous money, with offshore financial centers. The freedom to trade cannot be put in the hands of governments.
Office of the United States Trade Representative, Executive Office of the President. European Union.
For more discussion of the possibilities of freer trade between the United States and the European Union, see Cabrillo, Schwartz, and Garcia-Legaz. (2006) New approaches to free trade: in favour of an open atlantic prosperity area. Fudación para el Análisis y los Estudios Sociales.
* Pedro Schwartz is Professor Extraordinary in the Department of Economics at the University San Pablo CEU in Madrid, where he teaches the History of Economic Thought and directs the Centre for Political Economy and Regulation. A member of the Royal Academy of Moral and Political Sciences of Spain, Schwartz is a frequent contributor to European press and radio on the current financial and corporate scene. Schwartz is the author of two previous books, La economía explicada a Zapatero y a sus sucesores and En Busca de Montesquieu: la democracia en peligro, and he has a book forthcoming in English, Democratic Capitalism: Progress and Paradox.