There are more than 430 free trade agreements in the world today, some 300 of which have been struck in the last eight years. Now more than half of all world trade runs through special trading routes carved out between two or more trading partners, and every country in Asia save Mongolia participates in at least one of these FTAs.
For two decades, renowned economist Jagdish Bhagwati has taken the lead in warning that these deals are dangerous, famously likening the proliferating crisscrossing strands of bilateral trade routes to a messy spaghetti bowl. Now Mr. Bhagwati has a new metaphor. Termites in the Trading System likens FTAs to nasty little insects that eat at the very foundations of world trade. While the politicians who espouse FTAs may think they have been promoting free trade, says the professor, they have unwittingly been creating “systemic havoc in the world trading system.”
Mr. Bhagwati—an economics professor at Columbia University and a senior fellow at the Council of Foreign Relations—has written his share of weighty academic tomes aimed at technicians. But in his newest book, the professor aims at a broader audience. Termites is a slim volume, but there is a lifetime of economic learning in it, expressed in clear, often witty, language that is accessible to interested lay readers. Termites reminds this reviewer of Mr. Bhagwati’s influential Protectionism, first published in 1988, which thoroughly analyzed the virtues of free trade in 147 pages. His newest work is also likely to be widely read.
For openers, the economist says the political supporters of FTAs have gotten the acronym wrong. Instead of calling them FTAs, economists call the bilateral and regional trade deals PTAs—the “p” stands for preferential. PTAs give advantages to certain trading partners, while withholding them from others. PTAs are thus “inherently discriminatory.”
Special trade favors exchanged, say, between Japan and Singapore, disadvantage South Korea. The current proposed United States-Korea deal cuts out Japan, and on and on, as each country jockeys for special privileges in deals that are withheld from others. The U.S. and Australia are willing to give themselves mutual trade preferences in the U.S.-Australia FTA—excuse me, PTA—that the Yanks and Aussies withhold from their Kiwi cousins in New Zealand. “So FTAs are two-faced: they free trade among members, but they increase protection against nonmembers,” writes Mr. Bhagwati. “This means they are fundamentally different from free trade.”
Mr. Bhagwati also knows a thing or two about history. He recalls how free trade was “buried under the bilateral rubble” of competing, hostile trading blocs during the pre-World War II era, with disastrous consequences. “The 1930s experience, and reflection on the descent of the world economy into bilateralism under policies of competitive tariff escalations and currency depreciations, provided the backdrop against which the architects of the postwar trading system” created in 1948 what became the multilateral General Agreement on Tariffs and Trade, he observes.
At the heart of the GATT—which morphed into the World Trade Organization in 1995—was the core multilateral principle that members of the global trading system must not favor selected trading partners. Instead, all WTO members must apply their tariffs equally to all other WTO members; it’s called the MFN treatment, where all countries are most-favored-nations.
But at the same time, the GATT opened the door—at first, just a crack—for special preferential bilateral deals, thanks to a small loophole called Article 24. “It seems from the historical record that few thought this exception would be used except under rare circumstances,” Mr. Bhagwati laments. Fast forward to the present, and whatever one says about preferential trade deals, they are no longer rare. For their political supporters, temPTAtions to cut special deals have simply proven too great for politicians to resist. The problem is not just that the European Union, the U.S., and Japan have turned away from the wto’s multilateralism. The loose Article 24 restraints don’t even apply to “developing country” members, whose numbers include broad spans of Asia, Latin America and Africa. Thus, a “pandemic” has been spread, as Mr. Bhagwati puts it.
Switching from termites back to his metaphorical pasta, Mr. Bhagwati explains that the “complexity that the spaghetti bowls create for international trade causes distortions in trade and investment.” He adds: “Much energy and many resources must be expended to discover the optimal sourcing of large numbers of components with a view to minimizing the cost of manufacture plus transportation and the differential tariffs and charges levied by origin.” Singapore’s PTA with the U.S. has 284 pages of “product-specific” rules of origin. The costs of establishing where component parts came from—so that they can qualify for special lower duties that PTAs allow—can be very high. So costly that some manufacturers simply opt out of the preferential process altogether. Sometimes it is easier just to pay the higher tariffs that are applied to all WTO members, than pay hordes of accountants, lawyers, and computer geeks to try to get around them.
Mr. Bhagwati also points to how poor countries can be pressured to give in to the lobbyist-driven demands of larger “hegemonic powers.” For instance, the U.S. refuses to open up its protected sugar market when striking preferential deals with smaller economies, who have little choice but to give in. Moreover, when opposition to the Central America Free Trade Agreement turned up in little Costa Rica, Washington threatened to withhold other, already existing, trade preferences that Costa Rica had been enjoying. “So instead of Costa Rica’s main motivation for joining CAFTA being better market access, losing market access to the [U.S.] if it did not join became the issue,” a still incredulous Mr. Bhagwati reports.
To the professor, today’s unequal preferential trade treaties recall the colonial dependencies once associated with the British Empire’s imperial preference schemes that bound its overseas subjects to the mother country’s economy.
So what is the answer? Mr. Bhagwati believes that “halting the formation of new PTAs and eliminating the preferences in existing” discriminatory trade deals isn’t politically realistic. Likewise, the political difficulties associated with trying to harmonize all the rules of origins in hundreds of complex PTAs are daunting. But happily, there is a simpler solution, he concludes.
“Preferences are relative to the MFN tariff,” Mr. Bhagwati rightly notes. So while the PTAs themselves cannot be removed directly, “we can virtually eliminate” them by cutting MFN tariffs to zero. If there are no tariffs to get around, no discriminatory rules of origin and no discriminatory preferences would be necessary.
This is why the WTO’s current round of multilateral tariff cutting in the Doha Round is so important. “We cannot afford to have the Doha Round fail,” he says, lest those termites destroy the foundation of the multilateral global trading system.
After Republican Mike Huckabee and Democrat Barack Obama won the Jan 3 Iowa presidential caucuses, the respected Reuters news service reported that as the primary election season unfolds, “anxiety about the state of the U.S. economy…is likely to influence voters’ view of the U.S. role in the global economy, say experts on trade and manufacturing.” The first expert Reuters reporter Nick Zieminski cited was Scott Paul, who asserted that “trade and globalization and anxiety about the future are top of mind for a lot of people.” Mr. Paul was identified as director of “the nonpartisan Alliance for American Manufacturing.”
Just a moment. The Alliance for American Manufacturing is not even close to being a neutral observer of the international trade scene. It’s a well-heeled Washington lobby group that is at the heart and soul of the American steel lobby, where bashing imports is a blood sport. The alliance’s main financial backers include Leo Gerard’s United Steelworkers of America, and the U.S. Steel Corporation. Scott Paul is a former trade lobbyist for the AFL-CIO, and was also the chief trade adviser to David Bonior, a former Michigan Democratic Congressman. Mr. Bonior was one of the most ardent advocates of trade protection in the House, and is now a top strategist in John Edwards’ presidential campaign. The USW has endorsed Mr. Edwards for president. The steelworkers’ political action committee has given 100 percent of the $199,000 it has donated to political candidates for this year’s elections to Democrats. U.S. Steel has given $94,628 to congressional candidates so far this year, according to the Center for Responsive Politics, 69 percent of which has gone to Democrats. In short, Mr. Paul’s alliance is “nonpartisan” much in the sense that Rush Limbaugh is nonpartisan. Mark another public relations accomplishment for the steel lobby at the expense of a gullible press.
Whether the steel lobby will accomplish its main policy policy goal of exploiting American anxiety about jobs to obtain a firm commitment from this year’s eventual winning presidential candidate to make a serious effort to roll back “unfair” import competition is another story. The last time that happened — eight years ago in the 2000 presidential race, when then vice-presidential candidate Richard Cheney won votes in the Ohio Valley by promising that, if elected, George W. Bush would adopt a protectionist agenda for steel — it didn’t work as promised. While President Bush did slap on 30% tariffs on imported steel in 2002, his steel plan ultimately collapsed in the face of protests from outraged American steel-consuming businesses, whose costs of importing essential raw materials shot up. Bush subsequently dropped the tariffs after they failed to withstand a legal challenge before a World Trade Organization dispute panel. So far this year, there has been a lot of protectionist rhetoric hurled around — but every candidate, with the exception of John Edwards, has also positioned himself or herself to move back to the mainstream center, if elected.
To understand why, take a closer look at the evolving economic fundamentals in the next two key primary states that turn out to be something less than the hotbeds of protectionism they are usually thought to be. In Michigan, where Republicans vote tomorrow, global sourcing, not protectionism, is the evolving Michigan economic model. On Saturday, Jan. 19 — when Republicans vote in South Carolina — five Chinese auto makers will be displaying their wares to Motown audiences at the North American Auto Show, along with the likes of Toyota, Hyundai, Honda, and BMW (which builds its sporty X6 Coupe in Spartanburg, S.C., where auto production is on the rise). And even South Carolina textile magnate Roger Milliken, one of the last true American economic nationalists left standing, hasn’t been able to escape becoming ensnared in global sourcing realities. When Americans buy tennis balls from major manufacturers like Wilson Sporting Goods, those balls may well have been made in China, with fabric supplied from a Milliken subsidiary in the United Kingdom. While the grassroots politics hasn’t yet caught up with the economics, a closer look at what’s going on suggests that that day is coming. To alter Bill Clinton’s famous slogan from the 1992 presidential race, It’s the economics, stupid!
Nowhere do the true economic fundamentals stand out more starkly than in Michigan, a state that has been bleeding jobs. Ironically, the job-loss problem that Republican Mitt Romney is now talking about originated more than four decades ago, thanks in part to weak executive leadership by his father, George Romney, who was president of American Motors Corp. from 1954 to 1962, before he was elected Michigan’s governor. Romney has boasted that if he is elected president, he would get Michigan “on the move again,” as his father had done. The historical record suggests that George Romney did help get Michigan moving — backwards.
What should the United States do about Russia’s longstanding application to become a member of the World Trade Organization, after the crude Aug. 7 Russian invasion of Georgia? The next US president will have to decide whether to use the proverbial carrot or stick. The carrot approach would seek to bring Russia into the WTO’s rules-based multilateral trading system, as an inducement to settle economic differences peacefully. But current emotions in Washington, D.C. are strongly in favor of using the stick: continue blocking Russia’s WTO accession as punishment for its bad behavior in Georgia. How long will the punishment last? Well, China didn’t get into the WTO until December 2001, twelve years after the 1989 massacre in Tiananmen Square.
The bottom line question that isn’t presently being asked in Washington, D.C. is: who stands to benefit, the longer the world’s 10th largest economy is excluded from the WTO? So far, thoughtful answers aren’t coming from either of the two American presidential candidates. When Russian tanks roll across the borders of small neighboring democracies, American voters don’t look for nuanced responses — they mainly want to know how tough the next commander in chief would be prepared to be. The candidate who promises to pick up the stick today will always beat down any candidate who would dare to suggest that the carrot approach might be wiser tomorrow or the next day. And on the 2008 campaign trail, the only difference between Republican John McCain and Democrat Barack Obama is over who would pick up the bigger anti-Russian stick.
Does continuing to frustrate Russia’s hopes to join the WTO help encourage the bear to behave more responsibly? There is a history here that suggests otherwise. Let’s take a look, both from the perspective of the American eagle and the Russian bear.