Game of zones

Regional trade deals aren’t as good as global ones but they are still beneficial

AFTER years of missed deadlines, the coming months will be decisive for international trade talks. Much hinges on whether Congress gives the president “trade promotion authority” by waiving its right to reopen trade deals that have already been approved by America’s negotiators. This would help clear the path to an agreement among Pacific countries and to an American-European pact. Completion of these deals, in turn, would be evidence that regional trade negotiations are capable of success where global talks have foundered. With that, an old debate will begin anew: do regional deals lead to freer trade globally, or do they obstruct it by Balkanising the world?

In classical economic theory, free trade boosts prosperity by encouraging nations to focus on their relative strengths. The reality of regional deals is messier. Jacob Viner, a Canadian economist, showed more than 60 years ago that customs unions sometimes divert rather than create trade by inducing consumers to buy from inefficient producers. A hypothetical example: Thailand makes widgets more cheaply than Mexico, but Americans buy them from Mexico due to lower tariffs on Mexican goods. Such a diversion hurts the global economy, keeping resources from the places where they would be used most productively. Jagdish Bhagwati of Columbia University expanded on this with his observation that regional deals might be stumbling, not building, blocks towards freer trade worldwide. Many had hoped that regional agreements in the early 1990s would lead to global pacts. But Mr Bhagwati argued that less efficient producers would lobby for regional accords, seeking protection inside them.

At first glance, the past 20 years bear out his warnings. Since 1994 there have been more than ten regional deals a year on average but only one global deal: the World Trade Organisation’s underwhelming “Bali package” of 2013. Moreover, forecasts about the regional deals now under negotiation highlight the dangers of trade diversion. According to a controversial study by Germany’s Ifo Institute, the Transatlantic Trade and Investment Partnership (TTIP), a mooted deal between America and the European Union, would boost America’s GDP by 13.4%. But it would leave the economy of Canada, which is not part of the pact, 9.5% smaller than it would otherwise have been. Other studies reach similar, if less dramatic, conclusions about the Transpacific Partnership (TPP), which links 12 countries in Asia and the Americas.

On closer scrutiny, though, regional deals do not look so bad. One indication that the stumbling-block claim was true would have been a proliferation of preferential tariffs following the explosion of regional agreements in recent years, as trading partners lowered barriers for each other exclusively. There has not been one. As of 2008 less than 17% of global trade flows were subject to any preferential treatment. Instead, there has been a spectacular decline in tariffs in general. The average rate applied by Latin American countries fell from 13.1% in 1996 to 4.8% in 2012, according to the World Bank. Developing countries in Africa, Asia and Europe have also slashed tariffs.

The trade-diversion argument is also wanting. Despite the gloomy forecasts for countries excluded from TPP and TTIP, regional deals have a good record in practice. Almost all have boosted trade for non-members, albeit not by as much as for members. The reason is that trade deals nowadays have relatively little to do with tariffs; they focus instead on deeper regulatory issues such as rules governing capital flows and competition policy.

Richard Baldwin, a trade economist, explains their benign external impact by way of two examples. First, America and Peru, in their free-trade deal, promised that one another’s firms would get just as good access to telecoms services as local companies. That may sound like a non-tariff preference for American firms in Peru, since, say, Japanese companies do not get the same guarantee. But the nationality of firms is malleable: Toyota USA qualifies since it is incorporated in America. Second, aligning regulations is more like a public good than a preference, since countries outside the deal also benefit. The European Union’s shared standards on mobile telecoms, for instance, make life easier for all firms doing business in Europe, wherever they are headquartered.

In predicting trouble for those outside TTIP, the Ifo study did not consider the positive spillovers from harmonised regulation. The Centre for Economic Policy Research, which did, forecast small income gains for non-members. To be clear, truly global deals would deliver even greater gains. But this research suggests that regional agreements, especially big ones, should be welcomed as productive alternatives.

Block and tackle

The European example reveals another dimension to regional deals. Although third parties may benefit from a common mobile standard, it is Europe that sets the standard, with the interests of its companies in mind. Those inside trade zones get to draft rules that outsiders must adhere to.

This helps to explain America’s decision to exclude China from TPP at the outset, Shintaro Hamanaka of the Asian Development Bank argues in a new paper. America is pushing, among other things, for severe restrictions on state-owned firms, which are central to China’s economy. If TPP is completed, America could then invite China to join, presenting the limiting provisions as a fait accompli. China, meanwhile, is trying to craft an Asian free-trade pact, with America on the outside. Describing regional deals as stumbling or building blocks often misses their real importance. They are also power bases. Countries use them to project their vision of free markets on to the global economy. –http://www.economist.com/news/finance-and-economics/21646772-regional-trade-deals-arent-good-global-ones-they-are-still?fsrc=scn/tw/te/pe/ed/gameofzones