• Heritage Action
  • More
Backgrounder #1441 on Trade and Economic Freedom

May 16, 2001

The Global Free Trade Association: A New Trade Agenda

By and

The expansion of free trade around the world, long a pillar of U.S. foreign policy, is once again becoming a cornerstone of U.S. policy. After the end of World War II, the United States employed trade policy as a tool to promote economic freedom and stimulate economic growth both at home and abroad. Because of its leadership on trade, more people in more countries experienced greater improvements in their living standards than at any previous time in U.S. history. In fact, world exports in dollars are 18 times higher and world gross domestic product (GDP) is now six times greater than they were in 1948 when the major economic countries signed on to the market-opening General Agreement on Tariffs and Trade (GATT), which laid the groundwork for today's World Trade Organization (WTO).1

Over the past seven years, however, the United States neglected its much-needed leadership role on trade, thereby slowing efforts to craft comprehensive international trade agreements. President Bill Clinton, for example, failed to secure fast-track negotiating authority, thereby discouraging countries from concluding trade agreements because they could not be sure that Congress would pass them on a quick up-or-down vote. And the Clinton Administration's missteps at the Seattle ministerial meeting of the WTO in late 1999 contributed to the inability of member countries to reach agreement on further reducing trade barriers.

Reclaiming U.S. leadership on free trade is now a priority. President George W. Bush has already indicated that he will ask Congress to grant him fast-track authority to conclude trade agreements, and U.S. Trade Representative Robert Zoellick has made it clear that the Bush Administration will promote "free trade globally, regionally, and bilaterally," and that its policy will be to "reward good performers."2

In this era of globalization, trade issues meld foreign policy and economic policy as never before. The Bush Administration must shape a new agenda for promoting free trade that brings the world's open economies together and demonstrates the immense benefits that economic freedom brings to their people. It is an optimum time to initiate a Global Free Trade Association (GFTA) of countries that are committed to free trade and free movement of capital. Such an association would enable these countries to accelerate the removal of any trade barriers and investment restrictions they now have and would encourage other countries to open their economies unilaterally to trade in order to join.

The GFTA must be a voluntary and inclusive association, with membership based solely on a country's demonstrated commitment to a liberal trading order. This means that its members share similar beliefs and market institutions. By agreeing to further reduction or elimination of their trade barriers, they minimize the need for lengthy negotiations that often hamper bilateral or multilateral trade deals. The GFTA, by its very nature, will advance free trade around the world, promote economic freedom and economic growth among its members, secure the benefits of free trade for more people, and provide an incentive for other countries to liberalize their economies in order to join.

Rather than being seen as a substitute for other mechanisms that further free trade, such as the WTO or bilateral trade deals, the GFTA should be seen as the basis of a larger trade agenda--to promote free trade by any means. It is a creative alternative to current approaches that is more suitable for an era in which the advance of global free trade has stalled.

THE FOUR CRITERIA FOR GFTA MEMBERSHIP
As part of the effort to create a Global Free Trade Association, each country's commitment to free trade must be measured by objective standards. Each prospective member country must have demonstrated its ability and willingness to meet specific criteria of openness to trade, such as those employed in The Heritage Foundation/Wall Street Journal Index of Economic Freedom, which annually evaluates over 160 countries on 10 specific factors.3 Four of these Index factors, taken together, constitute a sound measure of the openness of a country's markets:

  1. Trade policy,
  2. Capital flows and foreign investment,
  3. Property rights, and
  4. Regulation.

To qualify for the GFTA, a country would need to score well on each of these factors.4 Doing so would indicate that the country is open to trade and investment and that it maintains a secure rule of law with low levels of regulation.

Trade Policy
According to these Index factors, then, countries must have an average tariff rate of no more than 9 percent and must maintain minimum non-tariff barriers. Such barriers include anything that prohibits trade, including import licenses, administrative controls, and quotas. Countries with low tariff rates and low non-tariff barriers to trade enable foreign goods to enter without requiring them to overcome major obstacles.

Hong Kong, which received the best Index score for economic freedom in 2001, provides a good example of a country with low trade barriers. Hong Kong levies virtually no import tariffs and maintains few, if any, non-tariff barriers. Foreign firms have competitive access to Hong Kong's vibrant market.

Investment
The second factor to consider in determining a country's eligibility for GFTA membership is the openness of its investment regime. The Index defines an open investment regime as one that maintains a transparent and open foreign investment code, treats foreign investments impartially, and approves foreign investments efficiently.

A good example of a country with an open investment regime is Ireland. Foreign businesses locate in Ireland to gain access to the European market, but also because Ireland maintains an efficient and transparent foreign investment code and welcomes foreign investment in virtually all sectors of the economy. Today, over 1,200 foreign companies have chosen to locate in Ireland because of its openness to foreign investment and its competitive environment.5

Property Rights
The third factor to consider is whether a country maintains a secure property rights regime. According to the Index, a secure property rights regime is one in which an established rule of law protects private property and provides an environment in which business transactions take place with a high degree of certainty.

The United States is a good example of a country with well-protected property rights. When property rights are secure, entrepreneurs--both domestic and foreign--are more likely to take risks with their income. They know that if they do invest in a new business venture, they will be able to keep the profits. Entrepreneurs in the United States do not have to worry about third parties stealing their products or ideas, and are thus more likely to engage in this economic activity.

Regulation
The fourth factor to consider is regulation. Scoring well on the Index on this factor would indicate that a country's government regulations do not deter entrepreneurs from opening a business and do not overly burden new businesses with regulation. Businesses are less likely to invest in branching out to countries with excessive bureaucratic hurdles to opening a business or where regulations significantly raise the cost of doing business.

Singapore, which has continually ranked among the top Index countries in overall economic freedom, is an example of a country that maintains very few obstacles to opening businesses. Entrepreneurs wishing to open a new business in Singapore encounter a very simple licensing system and often get their businesses up and running in a matter of days. Moreover, once a business is established in Singapore, the government imposes very few regulations.

Taken together, these four characteristics of countries with open markets create an attractive environment in which to do business.

Aside from securing the benefits of free trade for its member countries, the GFTA also gives countries committed to open markets an opportunity to form an alliance with like-minded countries. For instance, in Europe, a number of smaller "periphery" countries such as Denmark, Estonia, and Ireland have exhibited a commitment to free and open markets and are often at odds with European Union (EU) regulations.

Current and future EU member countries such as these will be forced to accept EU regulations, which would undo much of the good that they have accomplished by liberalizing their economies. For example, EU member countries are greatly restricted by a regulation requiring that they negotiate trade treaties through the EU instead of making individual sovereign choices regarding their trading arrangements. For nations that want to form alliances with open countries and avoid being linked with organizations that adhere to market-unfriendly policies, the logical alternative is to join the GFTA.

Countries that Would Qualify
The advantage of the GFTA over current mechanisms for promoting free trade is that qualifying countries would secure the benefits of increased trade and investment among the members without having to undergo any new major policy reforms. In other words, membership is based on current policies, not future promises.

Because the nature of the GFTA is voluntary and inclusive, it embraces state sovereignty. Membership is based solely on a country's commitment to a liberal trading order as demonstrated by its economic policies. Numerical targets that determine membership allow for self-selection, based on a country's economic policy decisions; membership is solely under the control of each country.

Using the Index factors listed above, 11 countries would qualify for the GFTA immediately because they already have very open markets. These countries are Chile, the Czech Republic, Denmark, Estonia, Hong Kong, Ireland, Luxembourg, New Zealand, Singapore, the United Kingdom, and the United States. (See Chart 1.) Next in line are the 26 countries that miss qualifying by falling short on just one of the four factors.

As Chart 1 shows, the 11 countries represent major regions of the world. The periphery countries in Europe and the Asia-Pacific region are also represented. Chile secures a foothold for Latin America, and the United States anchors North America. Policies, not geography, are what define the GFTA.

The success of the GFTA for the first 11 members would attract other countries to reform in order to join. Without any American finger-pointing about the merits of liberalization, they would have an incentive to open their markets further to qualify for the GFTA. Reform would be in their best interest. A system based on rewarding markets that have already opened will change the way countries think about trade. No longer will open economies need to wrangle over winning concessions from closed countries to further free trade. Instead, free trade will be seen for what it is--a policy that gives countries that embrace it a massive economic advantage.

Table 1 lists the 26 countries that just miss eligibility for GFTA membership by one factor. If these countries were to remove the obstacle to eligibility listed in the table, they too would qualify for the GFTA to gain greater access to the markets of the United States and the other 10 countries. Such a "carrot" would do far more than diplomatic "sticks" to advance free trade.

PROMOTING ECONOMIC GROWTH AND ECONOMIC FREEDOM
To demonstrate the economic benefits that come from maintaining market-friendly institutions, consider the following comparison: how Index countries score on the four GFTA criteria and their per capita GDP.6 Once a country's scores in trade policy, capital flows and foreign investment, property rights, and regulation are averaged, its openness to trade can be numerically graded and a new "trade openness index" can be created. Based on their grade, countries can be ranked as "open," "mostly open," mostly closed," and "closed."7

As Chart 2 illustrates, open countries accumulate more wealth than less open countries do: The "open" countries realize over twice the GDP as do "mostly open" countries, while "mostly open" countries have well over twice (2.5) the GDP of "mostly closed" countries.

Because the GFTA is likely to encourage member countries to develop internal incentives to stimulate faster economic growth, their GDPs will expand. Such incentives could well include freer movement of capital within the association, setting numerically the lowest rates of subsidies between members, and diminishing hidden tariffs. As GFTA countries' GDPs improve, other countries will find themselves subject to increasing internal pressure to increase their own economic freedom in order to compete. This is a win-win scenario for global prosperity.

CONCLUSION
Trade promotes economic growth in countries with vastly different government structures, primarily because it fosters market competition and innovation. These in turn bring consumers more choices and better opportunities to improve their standard of living. This spurs companies to develop even better products and to bring more of those goods and services to market, which in turn helps to keep prices low and quality high. The winners are the people themselves.

The time is right to initiate the Global Free Trade Association and enable more people to prosper. The GFTA promises to promote economic growth and economic freedom around the world by securing the benefits of free trade for member countries while giving non-member countries an incentive to make market-friendly reforms in order to qualify for membership.

John C. Hulsman, Ph.D., is Research Fellow for European Affairs in the Kathryn and Shelby Cullom Davis Institute for International Studies, and Aaron Schavey is a Policy Analyst in the Center for International Trade and Economics (CITE), at The Heritage Foundation.


1.
Lenore Sek, Vladimir Pregelj, and Arlene Wilson, "The World Trade Organization: The Debate in the United States," Congressional Research Service CRS Report No. RL30521, April 12, 2000, at http://www.cnie.org/nle/inter-42.html

2. Testimony of Robert Zoellick, U.S. Trade Representative, before the Subcommittee on Trade, Committee on Ways and Means, U.S. House of Representatives, 107th Cong., 1st Sess., May 8, 2001.

3. Gerald P. O'Driscoll, Jr., Kim R. Holmes, and Melanie Kirkpatrick, 2001 Index of Economic Freedom (Washington, D.C.: The Heritage Foundation and Dow Jones & Company, Inc., 2001).

4. Using the Index methodology, countries must receive a score of either 1 or 2 on trade policy, capital flows and foreign investment, property rights, and regulation to qualify for the GFTA. The Index ranks countries on a scale of 1 to 5 (1 being the highest score).

5. Industrial Development Agency, Ireland, at http://www.ida.ie/index.htm

6. Based on factor scores in O'Driscoll et al., 2001 Index of Economic Freedom, and on GDP information from World Bank, World Development Indicators on CD-ROM 2000, and Economist Intelligence Unit Limited, EIU Country Reports, London, 1999-2000.

7. See note 4, supra.

Heritage's daily Morning Bell e-mail keeps you updated on the ongoing policy battles in Washington and around the country.


The subscription is free and delivers you the latest conservative policy perspectives on the news each weekday--straight from Heritage experts.


The Morning Bell is your daily wake-up call offering a fresh, conservative analysis of the news.


More than 450,000 Americans rely on Heritage's Morning Bell to stay up to date on the policy battles that affect them.


Rush Limbaugh says "The Heritage Foundation's Morning Bell is just terrific!"


Rep. Peter Roskam (R-IL) says it's "a great way to start the day for any conservative who wants to get America back on track."


Sign up to start your free subscription today!