Another Bad Bush Doctrine: Competitive Liberalization

[This post originally appeared on another blog written by Jonathan Dingel. It has been imported into Trade Diversion. For more recent thoughts, see my posts on regionalism is here to stay, empirical research, assessing competitive liberalization, a test of competitive liberalization, and measuring regionalism.]

While the current administration’s policy of preemptive war has received plenty of criticism, little attention has been paid to the “Bush doctrine” of “competitive liberalization,” invented by USTR Robert Zoellick in the wake of the Cancun meeting’s failure last September. This trade negotiation strategy vigorously pursues bilateral and regional “free trade agreements,” better understood as preferential trade agreements, to form a “coalition of the willing” in trade. Zoellick’s tactic significantly escalates the departure (begun by Clinton) from non-discriminatory trade liberalization. Bush’s “competitive liberalization” will have deleterious political and economic effects upon the world trading system, perhaps to such a degree that no liberalization would be preferable to the “competitive” kind.

To observers unfamiliar with the economics of international trade, competitive liberalizations appears to be a perfectly logical strategy – the administration pursues trade liberalization in bits and pieces with partners that are willing to hop on board, instead of waiting for tedious negotiations amongst over one hundred nations to finally reach a consensus. Even veteran trade scholars such as Brink Lindsey have endorsed Zoellick’s strategy. I, however, side with Jagdish Bhagwati, the world’s leading trade theorist, on this issue. As Christine Wallace summarized, “non-discriminatory and multilateral are the gold standard of sound trade policy.” [“Welcome to the bloc,” The Australian, 2003.10.21]

Economists have been frequently warning about the dangers of bilateral and regional trade agreements since the mid 1990s, after the completion of NAFTA caused some observers to contemplate the possibility of a Free Trade Area of the Americas. Their economic objections rest on these deals’ economic inefficiency and preferential nature. Equally strong arguments against PTAs arise from their effects on the political process controlling the global economy.

The traditional economic argument against selective trade liberalization is that it creates “trade diversion” by shifting production and exchange from efficient to inefficient producers of a good. This shift causes a loss of producer surplus and government revenue while increasing consumer surplus; it is possible for the net effect to be negative. This diversion also represents real damage to the economic system in the long term, even if the increased consumer surplus outweighs the losses, as uneven tariff schedules hand economic rewards to member-nation producers by decreasing the revenue of non-member-nation producers. This shift from efficient to inefficient suppliers drives the efficient producers out of the market, damaging the efficiency of the particular economic sector in question and likely producing spill-over effects in other areas of the economy.

PTAs’ preferential nature require that countries guard against allowing in goods from non-member nations at member-level tariff rates. In response to the threat of trade deflection, a producer tactic similar to transfer pricing, nations implement rules of origin, which apply the tariff schedule to a good based upon in which country value was added to the good. These rules create additional difficulty in managing a nation’s border, for trade officials not only have to prevent the smuggling of goods past tariff barriers, but also guard against traders’ attempts to incorrectly apply the rules of origin to their benefit. This extra layer of regulation is another place where the laws of public choice theory come into play: lobbyists attempt to capture concentrated benefits with distributed costs. Jagdish Bhagwati explains:

Rules of origin, which are inherently arbitrary despite the extensive codifications that accompany them, multiply under FTAs because different members have different external tariffs. This makes the role of the lobbyist… and the customs officer… immensely profitable at our expense… More generally, it is increasingly arbitrary to operate a trade policy on the assumption that one can identify which product comes from which country… the phenomenal globalization of investment and production makes a Who’s Whose listing of which products come from which country more and more of an anomaly, tying up trade policy in knots and absurdities and facilitating protectionist capture of rules of origin. [Law and Policy in International Business, Summer 1996, p.867]

It is probably impossible to calculate the total cost of rules of origin. They diminish international trade and investment by discouraging the division of production processes amongst multiple countries, divert capital and investment towards member-nations so goods qualify for “originating” in those nations, slow the exchange of goods and services with additional border checks, and extensively complicate the tariff schedule. The criss-crossing tariff rates determined by a multiplicity of sources of origin has turned the global trading system into a “spaghetti bowl,” as Bhagwati calls it. The problem is so bad, he says, that “in the guise of freeing trade, PTAs have managed to recreate the preferences-ridden world of the 1930s as surely as protectionism did at the time.” [The Wind of the Hundred Days: How Washington Mismanaged Globalization, p.244]

Each additional PTA exacerbates the problem. The additional damage is multiplicative, not additive, due to the intersecting nature of the rules of origin and how tariff schedules are calculated. As the damage multiplies, more countries join the race to push the damage onto another nation, cutting their own preferential deals with various trading partners, regardless of the partner’s trading relevance. The mindset instilled by “competitive liberalization” achieves part of its goal – countries are racing each other, but they’re racing to do more damage with bad trade deals.

The preferential nature of these trade deals also creates another problem – it provides an economic incentive to not liberalize further. It is true that trade diversion creates an incentive for non-member nations to seek to join the trade bloc, as they are cut out of the increased trade between member countries. However, if Zoellick’s “coalition of the willing” includes members trying to increase their exports to the United States from inefficient producers, then they are unlikely to want to expand the PTA to new members with more efficient producers.

An example should make this clear. Consider Turkey, which has been seeking to establish a “qualifying industrial zone” with the United States that includes an exemption to the US’s heavy textile protectionism. If Turkey completed a deal with the United States, then its textile exports to the US would increase drastically. In upcoming WTO negotiations, Turkey would be unlikely to support further textile market liberalization, as a general lowering of US textile tariffs would allow more efficient East Asian textile producers to compete on even footing with the Turkish producers. Turkey’s economic strength is artificially inflated by their preferential access to the US market, and genuine global free trade would hurt their exporters. PTAs bring the old rules of protectionism back into play: just as domestic producers protected by tariffs lobby against trade liberalization when their livelihoods depend on protectionism against foreign competition, preferential trading partners benefitting from their special access will lobby against trade liberalization to protect themselves from other foreign competitors.

Preferential trade deals also have a fourth economic harm: they’re unable to address non-preferential market interventions. It is significant that my discussion of preferential trade deals has so far only considered preferential tariff levels. Consider the most important issue at Cancun – agricultural subsidies. How could this issue ever be selectively addressed? Subsidies benefit US producers at the disadvantage of foreign competitors, and it is impossible to contain the negative impact so as to not hurt preferential trading partners. Jagdish Bhagwati and Robert Baldwin complain that preferential trade deals are essentially irrelevant to global trade, given that the most burning issue at present is agricultural subsidies:

But the main problem with bilateral and regional deals is that they simply cannot deal with the issue of removing agricultural subsidies. How can production subsidies, which have proliferated in the US and Europe, be cut preferentially? It is impossible… If the world’s trading nations are to attack agricultural subsidies, going down the bilateral path is not merely unwise; it is also impractical. There is no escaping Doha. [Financial Times, 2003.12.18]

Those are the economic harms and weaknesses of preferential trade agreements. It is also important to consider the political processes involved and how PTAs impact global trade negotiations. The Bush doctrine of “competitive liberalization” drains valuable political capital from the multilateral negotiations and exposes liberalization to greater critique from anti-globalists, slowing and perhaps risking globalization’s advancement.

The time and resources of the US Trade Representative are limited; Robert Zoellick can only pay political attention to a limited number of issues at a time. Trading partners are unlikely to be willing to make serious compromises or lend steadfast support to trade negotiations if they feel that the WTO round is on the US’s back-burner. Unless the United States makes it clear that Doha is its number one trade policy priority, other countries are unlikely to do the leg work necessary. Zoellick has limited political capital, and he ought to spend it wisely.

The administration’s political capital is not only limited in regards to foreign trading partners – the US populace is likely to be unwilling to sign off on a large number of trade agreements. Congress will only pass a limited number of trade agreements before it becomes uncooperative, out of fear that it will be perceived as liberalizing too quickly. Pressure from protectionist constituents like steel workers has a significant impact upon political calculations. I perceive it as unlikely that free traders will have enough expendable political capital to win the swing votes required to pass both FTAA and Doha agreements in the same congressional session.

The problems of domestic political capital also hint at another trouble feature of bilateral trade deals – they expose free trade advocates to lobbying and criticism from anti-trade organizations. Every trade ministerial, no matter how minor or preliminary, is another chance for anti-globalization protesters to bring the circus to town. Consider the amount of news coverage the anti-globalists received when they appeared in Quebec and organized the March to Miami for those two FTAA meetings. The cause of free trade was dealt a blow, without achieving any meaningful advances, as the FTAA negotiations are stalled due to Brazil’s insistence that the United States lower its agriculture subsidies. There is no escaping Doha. The Bush administration should stop thinking otherwise, as it is giving anti-globalization more forums in which to advance their cause by doing so.

Even Brink Lindsey, who tentatively supports the “competitive liberalization” strategy, admits that the FTAA Miami meeting was “Cancun Redux,” while the Bush administration has been expending precious political capital and the public’s limited acceptance of trade liberalization to garner insignificant gains:

Call it trade policy on the cheap: negotiate on multiple fronts, but sign only those deals that don’t ask too much of America’s protectionist special interests. It’s liberalization of a sort, but hardly the kind of leadership by example that the world so desperately needs. []

For that, the Bush administration deserves a tongue-lashing. Consider what Jagdish Bhagwati said of the Clinton administration:

Proliferating “free-trade areas” have become a pox on the world trading system. It is a mark of Washington’s blurred vision and failure of leadership that, departing from a half-century of steadfast adherence to non-discriminatory multilateralism in trade, the administration has sought to build discriminatory free-trade areas instead. [The Wind of the Hundred Days: How Washington Mismanaged Globalization, p.229-30]

We have probably seen less meaningful trade liberalization under Bush than we did under Clinton. It is a mark of Bush’s blurred vision and failure of leadership that the administration has sought to pursue “competitive liberalization” at the expense of global economic efficiency and genuine multilateral trade.