By Invitation Only: Cozy Free Trade Deals Subvert Global Integration

In November, when Chile signed a new free-trade deal with the United States, the event was hailed in Santiago as the nation's "finest moment." Understandably, because Chile has aimed for just such an arrangement with the US since 1990, and has since signed trade pacts with Mexico, Canada, Central America, the European Union, and South Korea. A Santiago business professor summed up his country's view: "The more free trade deals the better."

East Asia is the scene of similar activity. In Southeast Asia, the ASEAN nations have long had such an agreement, at least on paper, and two years ago, China surprised the world with its announcement it would seek a free trade agreement (FTA) with ASEAN. That plan has now been formalized: at an ASEAN conference in November, China and the Southeast Asians announced they would achieve a free trade area within ten years. In Northeast Asia, Japan and Korea are talking about a similar arrangement, and Tokyo has also put out feelers to ASEAN. In January 2003, the Bush administration informed Congress of its plans to create an FTA with Singapore, expanding the two countries' already robust trading partnership.

The United States is in fact the main factor explaining today's regional movements, which differ greatly from earlier efforts. The late '50s and early 1960s saw many proposals for "regional economic cooperation," in trade especially, but two large distinctions separate then from now. The first is that although there were proposals in every world region, the only one that genuinely took root was in Europe. In 1958 the Treaty of Rome established the European Community, and its continuing enlargement and intensification has led to the successful EU we know today. In contrast, the steps taken elsewhere to promote intra-regional trade--in Asia, Latin America, and Africa--are often still on the books, but none has any significance today.

The second difference between then and now is the US role. Washington was largely indifferent to those earlier efforts, with the exception of Europe. It backed instead - sometimes almost single-handedly - a global, or "multilateral" effort to expand and intensify trade. That effort, the General Agreement on Tariffs and Trade (GATT) dates from the very early postwar period, and is best remembered for its various "rounds" (Kennedy, Tokyo, Uruguay, etc.). Some were quite successful in lowering tariffs, but GATT was a non-formal structure, had no effective method for resolving disputes, and often led a cliff-hanger existence. A decade ago, largely under US prodding and pressure, its instability led to the creation of the World Trade Organization (WTO). Like GATT, its main mission has been to enhance and expand worldwide trade, and with its more than 150 members the WTO is quintessentially a global body.

In that essential and defining respect, the WTO mandate contrasts fundamentally with today's proliferating "free trade areas." That difference underlines the great paradox now confronting the international political economy generally and the United States in particular: although Washington was for a very long time the main champion of the multilateral system of world trade, its current trade policy has made it the main factor promoting regional trade groups.

The roots of that paradox need to be explained. They stem from the 1980s, when US frustration with GATT led Washington first to toy with, then threaten, and ultimately to enact bilateral trade agreements, such as those with Chile or Singapore. Its initial efforts (aside from a domestically-grounded FTA with Israel in the mid-1980s) largely focused on the Western Hemisphere. A free trade agreement with Canada was first, and was extended in 1993 to include Mexico, in what became NAFTA. Even in the late 1980s, however, there was often a leitmotif of a much wider FTA - extending from "Alaska to Argentina" - and in December 1994, President Clinton formalized that goal. His Miami "summit of the Americas" called for an FTAA, the "Free Trade Agreement for the Americas."

That step profoundly altered the world trade environment, because it signaled to the rest of the world - especially East Asian and Pacific nations - that the United States would no longer press for trade liberalization exclusively at the global, or WTO level. The result was to open a floodgate of overlapping and potentially competing bilateral and regional FTA proposals. Thus the late1990s saw tentative Japanese overtures to South Korea; formal proposals for FTAs from New Zealand, Australia, and Singapore; a revival of a Brazilian trade plan known as MERCOSUR; and by late 2001 both Japan and China were separately proposing free trade deals with ASEAN.

Two points need to be made about this widening pattern, particularly its American roots. The first is that what started as a US tactic - to prod GATT members to more quickly and effectively support global trade expansion - was transformed into an over-riding US strategic goal. Indeed it is a goal with strong bipartisan support: it began in the Reagan administration, was then adopted by the first President Bush, and finally was completely taken over by both Presidents Clinton and the second George Bush. Robert Zoellick, his principal trade negotiator, has made this transformation very clear:

I believe a strategy of trade liberalization on multiple fronts - globally, regionally, and bilaterally - enhances our leverage and has promoted open markets... it took the completion of NAFTA and the first APEC summit in 93-94 to persuade the EU to close out the Uruguay Round. I favor a "competition in liberalization" with the U.S. at the center of the network.¹

The second point is that Americans tend to believe, quite falsely, that their exports do poorly in foreign markets. Their popular discourse has for so long emphasized America's trade deficits (a subject that would require another essay), that calls for corrective action - for example to "open up foreign markets" and "level the playing field" - are common. They include warnings that unless the US builds FTA's with its export markets, America will lose out to Japanese and European competitors.

A very different picture is revealed by the actual record of US foreign trade, especially about the success of US exports. The United States is the world's leading exporter, and has been for a number of years. Even more dramatic is the remarkably steady share of the world's total exports accounted for by the US. For the past 100 years, aside from periods associated with the two world wars (when other major exporters were briefly absent), US exports consistently have held about 12% of the global merchandise market. During the past quarter-century, moreover, years in which major new exporters have come on the scene, American exports have not only held their share, but seen their share rise (see Figure 1).²

Probably even more surprising, and in strong contrast to Europe and Japan, is the nearly-equal global distribution of US exports. Figure 2 shows this: in 2001, half of US exports went to Europe and the Pacific Rim, in precisely equal portions, and a third to America's NAFTA partners, Canada and Mexico. Ironically, therefore, while the United States has become the leading force on behalf of regional trade pacts, the actual destination of its exports suggests it has the least need for the idea. Indeed, because regional trade deals are by definition preferential arrangements, the US probably has more to lose from such proposals than any other nation. (see Figure 2)

Nevertheless, the strong likelihood is that American policy, and that of some others, will continue to seek more free trade deals. Never mind that most specialists have long held that a single, multilateral trading system is economically more efficient--and politically far safer--than a 1930s-type world of regional economic blocs. That world was rejected by the early postwar planners, and the result was GATT and its WTO offspring. The wisdom of that choice is underlined by the potentially ominous rivalry now emerging between the Chinese and Japanese FTA proposals, as well as by the knowledge that within and between economic blocs, political rivalries inevitably develop, and that protectionist walls, by whatever name, necessarily rise between them.

The proliferation of FTAs will also present an institutional challenge to the WTO, on shaky ground since its disastrous Seattle meeting in 1999. Its best hope now is the newly-launched "Doha Round," and to its credit, the US has been supportive. Washington has offered imaginative and potentially courageous proposals--in fields relating to agricultural and industrial trade--that could make the Doha Round the most productive of all. But America's message is at best ambiguous, since it not only has signed the FTA with Chile, is pressing hard to complete one with Singapore, and called for one with Central America.

A mainly political goal explains each of these cases, since in none of them does an FTA represent an objective US economic need. Consider Singapore, which already largely practices free trade, and has long been a top US market (No. 11). Its key FTA attraction to the US is its symbolic value to others in East Asia. Likewise with Chile: though a tiny market, its low-tariff policy makes it the South American poster-boy the US wants others to emulate. An FTA with Central America, on the other hand, should prompt a giggle. The US already has at least 40 percent of that market, while the EU and Japan, America's "competitors," have less than 10 and 5 percent. Yet so strong is today's FTA fetish that when President Bush called for Central America as the next FTA, humor went out the window: the White House said US exports there were "more than to Russia, Indonesia, and India combined"-- forgetting that those three have long ranked at the bottom of America's markets.

Of course from the perspective of potential US FTA partners, especially the smaller developing nations, guaranteed access to the enormous American market is highly tempting bait. Nevertheless, some will see Faustian bargains in the Chile and Singapore agreements, or even as examples of a "bait and switch," and both are reminders that "the devil is in the details." In November, the US announced that "in substance," both FTA agreements had been settled - except for a "hot money" issue. Explanation: the US Treasury was insisting that American investors must be able, without restrictions, to withdraw funds from Chilean and Singaporean banks.

Chile and Singapore resisted the US proposal, and Tommy Koh, Singapore's lead negotiator, called Treasury's demand a "deal breaker." After all, both nations have been praised for their ability to limit or slow foreign-currency withdrawals, and the currency hemorrhaging that deepened the 1997 Asian financial crisis reinforced the point. Chile and Singapore both ultimately compromised, and agreed to not "substantially impede transfers of funds" even in a crisis. Their willingness to give in on a 'deal breaker' issue shows the value these nations place on FTAs with the US. .

Even Americans may be surprised by some specifics included in these FTA's. The agreement with Singapore, for example, includes two small Indonesian islands, so that items manufactured there will also benefit from US free trade coverage. Another provision concerns lawyers, whose American education the Singapore bar has not recognized. That may change with the FTA; it stipulates that Singapore will "recognize degrees earned from certain U.S. law schools for admission to the Singapore bar." But initially "only 4 law schools" are included,³ thus raising many questions about how and why so many others were excluded.

These cases highlight the problems of incorporating non-trade issues into trade agreements. Labor and environmental standards began the practice, but no clear end-points now exist. That recalls Jagdish Bhagwati's famous warning that "the spaghetti bowl effect" (by which he meant overlapping rules of origin) would make FTAs hopelessly complex and impossible to administer. Today we would add the "Christmas Tree Effect," the term used in Congress for the many items, each individually attractive though unrelated to a bill's main purpose, that are added to satisfy special interests. Similar baubles and ornaments characterize today's world of proliferating FTAs, and will be sought by powerful negotiating partners. Along with the profoundly dangerous capacity of FTAs to revive a world of blocs, they are among the best reasons to maintain instead the global trade system.

1 Letter to the author, 26 October 2001.

2 Figure One is based on the author's calculations, from data in a number of sources, as follows:

a. World export data for 1896-1937 from P. Yates, Forty Years of Foreign Trade, London: George Allen, Unwin, 1959, Table A18, p.226.

b. US data for those years (1896-1937) are from U.S. Department of Commerce, Historical Statistics of the United States, Series U187-200, pp.884-85.

c. 1937 data from League of Nations, Review of World Trade as reported by Yates, p.226, and US Commerce Department, Historical Statistics of the United States, Washington, 1960, p.537.

d. US percentage-shares in 1949 and 1960 are from the International Monetary Fund, International Financial Statistics Yearbook, 1979, as reported by T.D. Lairson and D. Skidmore, International Political Economy, 2nd. Ed., New York: Harcourt, Brace, 1997, Table 4.2 p.65.

e. 1970-2000 data, for both US and world exports, are from International Monetary Fund, Direction of Trade Statistics Yearbook, various years."

3 Email from Tommy Koh to Bernard Gordon, 31 December, 2002.