Book Review: Termites in the Trading System: How Preferential Agreements Undermine Free Trade by Jagdish Bhagwati Oxford University Press, 125 pages, $24.95
Published in: Far Eastern Economic Reviewposted by Greg Rushford on October 1, 2008
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.