June 17, 1987

June 17, 1987 | Backgrounder on Trade, Economic Freedom

Free Trade Areas: Removing Trade Obstacles and Bucking Protection


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587 June 17,1987 FREE TRADE AREAS REMOVING TRADE OBSTACLES AND BUCKING PROTECTION INTRODU(STION As calls for trade protection grow louder, a key argume nt made by its advocates is that he there indeed is considerable truth to the claim that trade barriers have been increasing, the antidote to such barriers is not protection, it is a policy that iiberal&es trade An innovative way of doing this that now is being explored is the creation of Free Trade Areas, known as RAs. With an FI'A, two countries that wish the benefits of opened markets remove all tariffs and quota restrictions against one another, as well as other non-tariff barriers. Although this is do n e in a relatively short period of time, in contrast to the years taken to negotiatemultinational trade accords, FTAs are phased in to allow industries to adjust to the new opened market environment. FTAs allow countries to maintain their separate trade po licies toward non-FTA countries.

The U.S. would realize many economic benefits from the expanded use of AS.

Among them 1) unrestricted access for U.S. businesses to foreign markets 2) future trade certainty for American entrepreneurs 3) lower prices for American consumers; and rotection is needed to retaliate against nations that mpede the import of U.S. goods 4) more competitive American industries.

FTAs also could further the multilateral General Agreement on Tariffs and Trade process by working out solutions to such roblems as trade in services, with which the giving developing countries access to U.S. goods and markets and by creating the economic condihons in which developing countries would funnel labor and ca ita1 into reasons non-FTA members. This is because goods from such countries entering markets linked to the U.S. in FI'As would face many trade barr iers from which U.S. goods would be exempt.

This would lace the non-FTA countries at a com etitive disadvantage. These countries with the FTA countries. Since each FTA country still wodld maintain ultimate control over its own trade policy, there is little chance that FTAs would degenerate into trading blocs that act to restrict trade against others GATT is only now beginning to deal. Ff As would spur Third World economic growth by productive industries and away from those money losing industries supported r or political then would lg ave an incentive to lower their trade 1 arriers to achieve market liberalization an FTA with its largest trading partner, Cana B a. Countries expressing interest in FTAs An I A with the six ASEAN nations--Brunei, Indonesia, Ma l aysia, the Philippines FTAs would give the U.S. leverage for opening markets of more protectionist Israel and Canada. The U.S. currently is hasing in an FTA with Israel and negotiating with the U.S. include Singapore, Thailand, the Republic of China on Ta i wan, and Urn ay. Prominent congressional free trade advocates suggest a North American FTA Singapore, and Thailand--is being considered by Administration officials other things, would include The Reagan Administration needs a coherent policy and strategy f or FTAs that, among Administration "fast track" authority from Con ress to negotiate FTAs and have A decision to pursue FI'As with any friendly country that desires completely free such agreements voted on by Congress without amen J ments trade anded staf f for the U.S. Trade Representative's Office to handle the many details K of A negotiations are "graduated" out of the Generalized System of 3 references An offer of FTAs to countries whose per ca ita income has grown so much that they A declaration that s e rious requests for FTAs are to be a litmus test of a country's intentions to open its market FREE TRADE AND ECONOMIC DEVELOPMENT Free trade has played an indispensable role in the economic growth of the West for more than six centuries. During the Middle A ges, the merchants of the Italian city-states 2the Low Countries, and Northern Germany helped break down the feudal system that had kept Euro e in abysmal overty. The American Declaration of Inde endence denounced American patriots fought for the right to trade with whomever they leased. A major goal of the U.S. Constitution was to create a complete and unrestricted ee market between what had been thirteen separate states, each with restrictions against each other Prolonging Depression. Trade protectionism in the late 1920s and early 1930s probably tri ered, and certainly deepened and prolonged, the Great Depression. After World War II, 9 e Western allies established the General Agreement on Tariffs and Trade (GATT) to ensure multilateral trade liberalizati o n. Their premise, which has been confirmed, was that free trade leads to peace and prosperity principles that lead to prosperity within a country. Private property, free exchange between mdividuals, and demand-determined wages, prices, and roduction allow individuals and The overall wealth and standards of living of everyone within the country increase. The same principles apply to individuals and companies trading across national boundaries. All parties to such transactions gain. Both countries "win neith e r "loses Bntain's ng George 11 P "For cutting off our trade with all parts oft IJl e world." The The benefits of free trade between countries derive from the same fiee market businesses to specialize in economic activities in which t E ey have a comparati v e advantage FREE TRADE AREAS DEFINED Thoup various "rounds" of GATT negotiations have reduced tariffs significantly, tariffs still persist and other trade barriers are pawing. For exam le, quotas, or uantitative the U.S. is a prime offender. Meantime, tra de in such services as accounting, advertising data processing, banking, and construction are barely dealt with by GATT provisions.

The GATT round which convened in Uruguay in September 1986 seeks to deal with both old and new forms of market restrictions. Yet as important as the results will be much rotection will remain. Thefe can be addressed by Free Trade Areas, which limits on imports, which are technically illegal under GATf are increasing 3 y used. Here spec4 K cally are allowed by GATT with export s ubsidies and even wi tg subsidies to domestic industries. An FTA could be new open trade arrangement. FTAs also allow limited exceptions P or particularly sensitive Completely Fair. Removal of all tariffs and quotas is the basic goal of an FTA. Other goal s could include elimination of restrictions on trade in services or at least the establishment of standardized treatment of such services by the FTA countries. An l3A also might liberalize the flow of ca ital and investment funds. Finally, an FTA might dea l phased in over a period of years, allowing producers in each count time to adjust to the products. An FTA is a completely fair arrangement, since both parties remove their tariffs and quotas An FTA differs from a customs union, such as the European Econo m ic Community EEC In a customs union, all countries involved maintain a common trade policy toward other countries. For example, tariffs on imports will be the same no matter which customs union country receives the imported goods. In an FTA, each country s till maintains its own 1. According to Article XXIV of the GATT, an FTA requires that "the duties and other restrictive regulations on commerce b e] eliminated on substantially all trade" between two countries 3trade relations with other countries. Contro l s could prevent "trans-shippin ,I' that is straight into the other FTA country to circumvent the latter's more restricted policies imports entering the FTA country with the more liberal trade policy, and t i! en being sent takes effect gradually over a de c ade. Under the agreement, al Y tariffs between the U.S Eliminating All Tariffs. In 1985 the U.S. signed an mA a eement with Israel, which and Israel wll be eliminated, as will quotas on all goods except certain sensitive a 'cultural products. Israel has a g reed to cease subsidizing exports to the U.S. Protection o intellectual roperty ri ts, such as patents andcopyri ts, has been reaffiimed. ILiberal investment PO cies have een maintained. In addition, t e two countries are exploring ways to liberalize subs tantially trade in services. Any solutions to the service trade problem can later be incorporated into the FTA agreement.

The U.S. currently is negotiatin an FTA with Canada. It and the U.S. are each other's I! P f B r artners. Their tot af two-way trade i s ap roximately $120 billion, the ilateral trade relationship. Since Cana a, with 25 million inhabitants and a gross national product, is larger and richer than Israel, the provisions of this FTA are likely to be more extensive than those of the FTA with I srael ECONOMIC ADVANTAGES OF FTAs The U.S. would gain a number of domestic economic benefits from FTAs. Among the most noteworthy are 1) Unrestricted Access of U.S. Businesses To Foreign Markets. Tariffs, quotas, and other restrictions that currently hind e r America's ability to sell in foreign markets would be lifted 2) Future Trade Certainty for American Entrepreneurs. Investors commit ca ital and other resources well ahead of the time when the goods to be produced will be so P d in the the chances that a foreign market for his goods would be closed to him in the rficantly ture by market place. Investments in plants and equipment are paid off only over many years.

FTAs would eliminate considerable uncertainty for the investor by reducing si restrictive tra de measures 3) Lower Prices for American Consumers. U.S. restrictions on imports currently cost American consumers tens of billions of dollars in higher prices for such products as automobiles, clothing, shoes, and sugar. Elimination of restrictions on co u ntries wishing mutual free trade with the U.S. would lower prices for imports and give greater purchasing power to the American consumer 4) More Competitive American Industries. The challenge of foreign competition gives U.S. producers incentives to incre a se their efficiency. Protectionism, on the other hand allows businesses to grow lax and less competitive. FTAs give U.S. businesses incentive to improve. Further, the access to less costly sources of raw materials and semi-finished products provided by FT A s would allow U.S. businesses to cut costs, producing more goods or services for less 4FI'b AND THE GATI Some Critics su est that GATT negotiations, involving over 90 countries, are a better vehicle for trade li f! eralization than FTAs, which involve oql y a few nations at best. There is no conflict, however, between GATT reforms and FTAs. If two countries recognize the economic benefits of open markets, it makes no sense for them to forgo those benefits simply because other countries %e not as wise FTAs i n fact could help the GAlT rocess. For one thing, the current Uruguay Round in services and subsidies. Solutions to such problems worked out in an FTA could provide precedents and formulae for GATT negotiations. For another thing, with the U.S negotiatin F T 'As, other countries will conclude that Washington wll not be pressured into is dealing with a number of trade prob P ems barely touched in earlier rounds, such as trade accepting L 'ted and half-hearted GATT reforms FX'h AND THE THIRD WORLD Third World e c onomic development would be boosted b FTAs with the U.S. by giving developing countries assured access to a developed market r or their products. This access to acquire such goods at less cost, further enhancing its economc CK evelopment in the original F T A agreement. Open access to t e U.S. market for goods that the pro f! table alternatives are available would give competitive industries incentives to expand their operations, rewarding developing countries with faster economic growth. The U.S. would gain greater market access for its higher valued manufactured goods and the developin country would be able Finally, an FTA between the U.S. and a developing country would help discourage that nation from using subsidies meant to enhance e orts, even if this i s sue were not dealt with developing country could produce most efficiently could draw labor and capital to such industries. Third World governments would find it very costly to funnel public funds into less rofitable or even money losing sectors for the pu r pose of export promotion when FTAs AND MARKET OPENING LEVERAGE Beyond their immediate economic benefits, FTAs would create incentives for countries that were not parties to FTAs to join them. Even the o ponents of FTAs acknowledge this fact. Testifying be fore Congress against the FTA with P srael, Stephen Koplan of the AFL-CIO said If agreement can be reached, and Congress approves, it would be the first such free trade arrangement in U.S. history.

Its establishment would make future requests from other co untries for free-trade areas much more difficult to refuse. The economic rationale given by the Administration for a free-trade area with Israel will be cited as many other countries in the world. Is this initiative the start of the process where similar n egotiations 2. While GAn reforms involve more countries than do FTAS, the reforms will not be as extensive as with a bilateral RA 5will soon commence with South Korea, the Philippines, or the European Economic Community The economic dynamics set in motion by the first few FTAs could lead to more FTAs and give the U.S. levera e against countries that insist on keeping their markets closed to U.S. entered FTA negotiations, Israel had ne otiated substantial trade liberalization with the European Community. Wi t hout an FI'A, b.S. products entering Israel subject to tariffs would have competed at a disadvantage against the Euro ean goods subject to lower retaliation but rather to open Israel's market further to U.S. goods, in this case through an FrA U.S. exports . The U.S f srael FTA illustrates this point. Shortly before Israel and the tariffs. Thus, the incentive for the U.S. was not to close its mar K ets to Israeli goods in Pressure on Japan. The FTAs' potential dynamics were evident during Ja anese Prime Mini s ter Yasuhiro Nakasone's January 1986 visit to Canada, shortly after the b.S. and Canada announced intentions to negotiate an ITA Publicly, Nakasone said he saw no problems for Japan from such an arrangement. Privately, Japanese officials indicated concern about how the FTA would effect Japanese sales in the U.S. and Canadian markets. This is the sort of FI'A pressure that the U.S. should exploit.

Example: If a country maintains a 10 ercent tariff on a particular U.S. product, the U.S could unpose the same tariff agiinst $e same product from that count This, however, is treatment. Under this principle, if the U.S. maintans a 5 percent tariff on certain products from one country, it must mantain a 5 ercent tariff on the same products from all other completel y unworkable To some, reciprocity would seem the most effective way to open other markets prohibited by the GATS most fundamental principle: Most Favored 3 ation (MFN GATT countries. In a world of over 1 P 0 nations, therefore, bilateral reciprocity in tra d e is country, t lg e U.S. could negotiate mutual tariff and uota elimination through an FI'A in FTAs rovide an alternative. Rather than raising tariffs against a more protectionist the major markets of that country. This would give t e offending country a n incentive to open its own market in return for market openings in the FTA countries x THE DANGER OF TRADING BLOCS A critic of FI'As may warn that such arrangements could degenerate into trading blocs that actually would raise trade barriers against non-m e mbers. This is unlikely. First, in FTAs, unlike customs unions, each country maintains control over its own imports from non-member nations. It is unlikely that all the interests of both FTA members will coincide and lead to collective action to close bot h of their markets to imports.

Second, trade bloc practices are more likely to result from the protectionist measures not from attem ts to liberalize trade. For example, in reaction to the Draconian supports to their farmers to provide im ort substitutes. They then gave pre erential trade British" policy within their Empire. This, of course, further contracted world trade and deepened the Depression. This all was in reaction to protectionist U.S. policies. It is hard to imagine such a response to FTAs or o t her trade liberalizing measures f Smoot-Hawley ariff of 1929, the British introduced tariffs on imports and ave price treatment to imports from the British I! mpire and the Commonwealth and instituted a "Buy 6AMERICA'S POSSIBLE FI'A PARTNERS A number of c ountries have approached Washington concerning FTAs. Priority ,should be given to countries friendly to the U.S. and particularly those of political or security importance.

Among .the lTA c~didates are North America Senator Phil Grm, the Texas Re ublican, and Representative Jack Kemp, the New would include the U.S., Canada, Mexico, the Caribbean, and Central America. Current negotiations for a U.S.-Canada FI'A are a fundamental step in this direction. Reagan's Caribbean Basin Initiative (CBI) of 1984 was m e ant to promote economic growth in that region through o e markets, thus preparing some groundwork for inte ation of this in large part for its current economic difficulties. Moving Mexico away from its self-destructive protectionist policies will be diffi cult. Yet the recent entry of Mexico into the GATT as well as other small market opening efforts, offers some hope, if the U.S would press the issue.

A North American FTA commands riority for both economic and security reasons York Republican, recently int roduced Y egislation calling for a North American FTA. It region into an Mexico traditionally has had a very restricted mar f et, which accounts Such an arrangement would surround t K e U.S. with a ring of prosperous countries better E promote PO Y itical security in Mexico, Central America, and the Cari bean able to purchase American oods and give U.S. businesses access to markets of some 140 million peo le, with nearly 600 billion in GNP. By promoting pros erity, an FTA would 8 Singapore The ci -state of Singapore, with a population of 2.6 million and a GNP of $18 billion is a small t ut prosperous country. Singapore has long been interested in an FTA with the U.S.. Singapore has a more completely open market than the U.S Thailand A country of 52 million p eople and a GNP of around $40 billion, Thailand has begun adopting market-oriented economic policies. The result has been impressive economic owth. Thailand has expressed interest in an FTA with the U.S. This would help the ais and would give the U.S. ear l y entry into a very promising and expanding market Republic of China on Taiwan The Re ublic of China on Taiwan--or ROC--is one of the developing world's most economica P ly successful nations. The ROC still maintains substantial trade barriers to U.S oods , which partially is responsible for its $15 billion trade deficit with the U.S. last year ft would serve the ROC'S long-term interests to open its markets completely to U.S. goods and, in turn, gain full access to the U.S. market 3. U.S. exclusion from th e CBI of that region's major commodity, sugar, as well as other products, has dampened CB t's benefiaal effects 7- I Trade protectionism is an economic illness especially widespread in Latin America.

Most Latin American countries have ke t their markets ti ghtly closed to both foreign goods of the world needs trade liberalization, it is Latin America and direct foreign investments. This in P arge part has caused the debt crisis. If any region Uru a has expressed interest. in an?FI'A.with the,U.S A country.o f .3 lmillion people 88 ap roachin $7 billion, Uruguay is a particularly good candidate for such an arrangement Prf rupay ong has been one of the most prosperous countries of Latin with a Amenca. Its traditional open market for foreign currencies has won i t the reputation as the Switzerland of Latin America. Uruguay therefore has not been as hostile as other Latin countries to economic ties with its neighbors. Latin America sorely needs a local example of a country practicing the open market alternative to p rotectionism. If Uruguay seeks an FTA with the US negotiations should begin as soon as possible Association of South East Asian Nations (ASEAN Some Administration officials have privately considered the idea of an FI'A with ASEAN, an organization for econ o mic coo eration that includes Brunei, Indonesia Malaysia, the Phili pines, Singa ore, and &ailand, with a total population of 300 million Sin apore and Thailand individually have expressed strong interest in an FI'A. The PhAppines at times has expressed m i ld interest. Indonesia and Malaysia general1 have resisted the idea. To gain complete access to America's market, Sin apore and 'dailand free trade and a total GNP o P over $200 bi E 'on. The strategy of an FI'A wth ASEAN is promising would have a strong i ncentive to convince their fellow ASEAN mem ers of the wisdom of An FTA with ASEAN would o en to U.S. products a market now dominated by the competition with U.S. products. This in turn would give the. U.S. leverage to further pry open Japan's domestic ma r ket to U.S. goods Japanese. With a U.S.-ASEAN K A, the Japanese would be at a distinct disadvantage in RECOMMENDATIONS The Reagan Administration has acted wisely in negotiating FTAs with Israel and Canada. But those countries are just a start if FTAs are t o be a major component in a bold and imaginative policy of trade liberalization. Among the key elements of such a policy would be 1 Fast track' authority to negotiate FI'As If an FTA is to gain the approval of Congress, the agreement should be voted eithe r up or down, with no amendments. Because of the many interest groups with clout in Congress amendments would turn into a lon list of goods to which the FTA would not apply. This would gut the FTA. Reco 'zing t is, Congress gave the Administration "fast tr ack authonty for the Israel an r Canada FTA negotiations. This runs out at the end of the year.

Reagan should seek from Congress special "fast track authority for FI'A negotiations with any interested parties. Under such provisions, the Administration woul d have to give 8notice of its negotiatin4 intentions to the House Ways and Means Committee and the Senate Finance Comttee, which oversee trade issues. The Administration would be re uired to solicit the opinions of Congress and interested private groups o n each proposed dA Yet rior approval to negotiate with a given country would not be required. The completed hA agreement would then be submitted to the trade committees of Congress for a yes or "no" vote and then to the full houses, again for a vote withou t amendments 2) Pursue FTAs with any friendly .I country I. seeking complete free trade Because the FTA concept is new, the Administration has proceeded relative1 slowly.

Though the FTA agreement with Israel was completed in 1985, talks with Cana B a will be quic h y to begin preliminary talks with these countries concluded at the earliest by the end of this year. This pace is too slow to deal with the man countries expres s ing interest in FTAs. The Administration should move more 3) Provide extra staff for the U.S. Trade Representative's Omce to negotiate the FI'A The office of the U.S. Trade Representative (USTR which handles most trade negotiations, is small and therefore efficient. Yet if market-opening FTAs are to be extended to many other countries, more staff may be necessary, especially for the extensive background work necessary for successful negotiations. For example, extra staff will be needed to work through the m ost effective use of FTAs as leverage to o en the markets of agenaes, while some may have to be hired new 9 more protectionist countries. Some manpower could be shifted from ot rY er federal 4) Offer FTAs to countries graduated out of the Generalized Syst e m of Preferences Under the Generalized S stem of Preferences (GSP many developing countries enjoy s ecial market access to the L.S. This is designed to promote worldwde economic Zvelopment. Yet as these nations become more prosperous, they face graduation out of some or all of the GSP privileges. One of Israel's major motivations for seekine an FTA with the U.S., for example, was fear of losing its GSP status. This surely also wll motivate other developin states on the threshold of GSP graduation. The U.S. should use this situation to esta lish FTAs. The developing states will Fain access to U.S. markets. For its part, the U.S. will have a much better chance of exporting American goods to such countries, which by definition are growing and prosperous and in a good position to purchase more American products. FTAs should be offered as a matter of course to any country facing graduation from the GSP markets. I 5) View serious requests for Fl'As as a litmus test of a country's intentions to open its Even in the best of circumstances, expanded use of =As will take time to negotiate and time to phase in. In the interim, the Administration will face pressure from Congress to get tough" with U.S. trading partners. The Administration should resist taking rash action a gainst countries that truly seek more open markets country's commitment to an open world market, and avoid especially congressional pressure for protectionist actions against such countries The Administration should consider serious requests for FTAs as a litmus test of a 9Japan, for example, claims to want more open trade with the U.S. The American Ambassador to Japan, Mike Mansfield has suggested a U.S.-Ja an FTA. If Japan takes their protectionist ways serious steps to consider this suggestion, it would indicate that tlg ey truly wish to reform CONCLUSION To deal with America's trade problems by closing American markets will only make economic problems worse, and probably lead to a destructive trade war. A better solution is to open markets to U.S. expor t s as quickly as possible. The Free Trade Area approach is an important means toward this end. Not only would FTAS mean more markets opened to U.S. goods, they would give incentives to countries not party to such agreements to seek trade liberalization as well.

Free trade has layed a crucial art in the economic development of the West. Trade protectionism and closed markets but offer an opportunity to utilize new and creative ways to o en markets further. FTAS serve just this purpose and should be employed vigorously and economic di ff! culties in the U. E and around the world not only pose the danger of by tg e Administration.

Edward L Hudgins, Ph.D.

Walker Senior Policy Analyst 10-

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