Deep Dive

Nothing Free About It

Nothing Free About It

Free trade agreements, or FTAs to the cognoscenti, are popping up like daffodils in April. The European Union and South Korea just recently inked a bilateral agreement. U.S. President Barack Obama has promised to push ratification of a U.S.-Korea deal through Congress and is also rushing to complete and submit to Congress similar deals with Colombia and Panama. Washington is also in the midst of negotiating the so-called Trans-Pacific Partnership, a proposed FTA between Australia, Brunei, Chile, Malaysia, New Zealand, Peru, The Philippines, Singapore, Vietnam, and the United States.

Free trade always sounds like a good thing, especially for Americans, for whom the word "free" has very positive connotations. In this highly globalized world, however, the truth is that "free trade" agreements are actually anything but. They are a return to the ad hoc commerce of the early 20th century. And like their predecessors, they often close as many doors as they open and avoid the real issues that are tipping the trade balance from free and open to unbalanced and opaque. While the world has grown more interconnected, our trade policies have grown ever more fractious.

As an illustration, take discussions I had recently in Singapore about various "free trade" arrangements being negotiated in the Asia-Pacific region. During our conversation, one of the Singaporean negotiators warned that the United States would find itself locked out of key Asian markets if it didn’t join in all the free trade deals. The implication, of course, is that the parties to an FTA will have different and more favorable trading conditions among themselves than with outsiders. In a word, they will have a preferential trade deal. That’s all that FTAs really are; we should call them preferential trade agreements, or PTAs. And they are very similar to the kinds of arrangements that prevailed prior to World War II.

Over the last half of the 20th century, the world’s trade negotiators did everything they could to simplify the complicated, inefficient web of bilateral compacts that were weighing global trade down. The motivation was to get all trading countries onto the same playing field. Indeed, it was to forever avoid the evils of preferential trading that the General Agreement on Tariffs and Trade (GATT) was concluded in the wake of World War II and its successor, the World Trade Organization (WTO), was formed in 1995.

Now, however, quite the opposite is happening, and the PTAs are back in force. It is quite possible, for example, that a new FTA between players A, B, and C will nullify or impair the "free trade" results of an earlier FTA between players A,Y, and Z. Consider the Caribbean Basin Trade Partnership (CBTP) of 2000 between the United States and most of the countries around the Caribbean Sea. Part of that deal gives Caribbean countries such as Honduras lower-than-average tariffs on imports of their apparel into the U.S. market on the condition that they use U.S.-made yarn or fabric for making the clothes. Because it is conditioned on use of U.S. yarn, this deal is far from true free trade. Still, it has stimulated a huge amount of trade between the United States and the Caribbean countries and has provided jobs and a way out of poverty for hundreds of thousands of Latin Americans. The proposed Trans-Pacific Partnership (TPP) could undermine this success by extending tariff reduction on apparel to the Pacific countries as well as the Caribbean countries. But this time, producers likely wouldn’t have to use U.S. yarn; they could use cheaper, locally sourced raw materials. That would likely disrupt or even destroy the Caribbean industry, which still relies on more expensive American thread.

Let’s also be honest about the motive of these agreements, which is not free trade per se. The Caribbean deal was about boosting jobs in that region, so as to reduce the incentives for drug smuggling and illegal immigration. Unless it is negotiated and amended with extreme care, the emerging TPP could wholly undermine whatever effect the CBTP has had in that regard. And even if carefully negotiated, every new FTA undermines a little bit more the credibility and authority of the WTO — which really is about free trade. Although the WTO’s rules allow for FTAs — under the condition that they don’t raise tariffs or other protectionist measures above levels committed to in the WTO — their very essence contradicts what the organization is about: that each trading country should treat every other WTO member in the same way.

But dueling FTAs is the least of the problems. Far more significant is the question of whether any of our free trade negotiations, be they in pursuit of FTAs or in pursuit of new global arrangements under the auspices of the WTO, have any relevance to the actual problems in the global economy.

Take the question of exchange rates. FTAs, as well as all the WTO negotiations, including the Doha round, focus on tariff reduction and protection of intellectual property. Yet manipulated exchange rates can have a far greater effect on imports and exports than the tariffs that are so laboriously negotiated. Brazil, China, Japan, Malaysia, South Korea, and Switzerland all intervene in international currency markets to keep their currencies undervalued as a kind of indirect subsidy for their export-led economic growth strategies. Currencies can swing by 20 to 30 percent in the course of a few months, easily wiping out tariff reductions that might be equal to 2 to 5 percent of the cost of a product. Cordoned off as the domain of banks and finance ministries, one of the single most important determinants of trade is thus left out of discussions altogether.

Investment incentives play a similarly important (and ignored) role in trade. Countries as diverse as China, France, Ireland, Israel, and Singapore aggressively use offers of free land, zero or very low taxes, capital grants, utilities at half price, and other perks to lure investment and production to their territory — and away from locations where low operating costs would normally draw corporations to set up shop. Intel recently opened a facility in China for making advanced semiconductors, for example. A major consideration in the company’s decision was the huge tax breaks and capital grants offered by China, which succeeded in luring the investment away from a U.S. location that would have had lower operating costs and better initial quality. Because the United States has a trade surplus with China in semiconductors, largely as a result of Intel’s exports, the location of the new factory could well turn this surplus into another trade deficit. Yet again, these kinds of incentives are never the subject of free trade negotiations.

Even in cases where topics are nominally covered by the FTAs, the truth is that the FTAs may be largely meaningless. This is especially true for intellectual property and market opening. The proposed FTA between South Korea and the United States is a good example of both issues. It contains very strong language with regard to increasing protection of intellectual property. But the Korean legal system has demonstrated that it may rule otherwise. Over the past 15 years, for example, patents granted by the Korean patent office to FormFactor, an American company, for its probe cards (a device for testing semiconductor wafer circuits), were nullified by the Korean courts. This was not particularly surprising; Korean courts rarely rule in favor of non-Korean companies. Obviously the language of an FTA is pretty meaningless if a nationalistic legal system refuses to uphold it. In these circumstances, it does not make any difference what kind of FTA a country concludes; it will not achieve anything close to free trade.

FTAs are also meant to open markets, meaning that in any particular market, domestic and foreign producers are able to operate under the same conditions. Indeed, these deals are supposed to grant a sort of local treatment to nonlocal entrants into the market. Clearly, to sell a product in a given country, a producer must be able to get its products in front of the customer. Yet these FTAs never guarantee that. Take autos, for example: To sell them, an automaker must find dealers who will put the cars in their showrooms, service them, and market them. But in most countries, auto dealers don’t sell multiple brands. So even if auto tariffs are slashed to zero, in many countries imports of foreign cars won’t rise much because there are no or few dealers who will actually put the cars on their lots.

Of course, Ford, for example, may try to open dealerships in, say, South Korea. But opening a nationwide network of dealers takes a lot of time and a lot of money. Foreign companies entering the U.S. market, by contrast, don’t have to spend that time and money because American auto dealers sell all manner of cars, no matter their affiliation to automakers. An FTA with South Korea would not create equal sales potential for U.S. and Korean automakers. Let me emphasize that this is not a matter of unfairness. It is a matter of trade policies needing to catch up to the real world.

FTAs and other trade deals are always presented as win-win propositions that will increase trade and jobs for everyone. They don’t. And because they don’t, they give rise to cynicism about the benefits of free trade and globalization and to increasing resistance to further such agreements. For the WTO to continue to succeed and for trade deals to produce real benefits for all players, we will have to recognize that the current drivers of globalization are not tariff reductions and import-export rates. We live in a world in which the real issues are anti-trust policies, investment rules, and capital flows. It’s time that the negotiators caught up with the reality.