Doing free trade agreements as if policy really matters
At the World Economic Forum meetings in Davos, US Secretary to the Treasury Stephen Mnuchin expressed his optimism that a UK-US free trade agreement could be signed by the end of 2020. Noting that the UK was also negotiating with the EU, he said he was a little bit disappointed that US had not been alone at the head of the queue. He then went on to say the US would impose duties on UK car exports should the UK persist in its idea of implementing a digital tax. Even accounting for their rhetorical nature, these – at time conflicting – comments underscore the challenging trade agenda the UK faces as it ceases to be a EU member state, and seeks out trade agreements of its own.
The challenges in part reflect the “need for speed” that the UK government has imposed on itself. The government wants to avoid any political fallout from extending the transition period beyond 31 December 2020. It believes that quick progress on negotiations with the US will give it bargaining leverage in dealing with the EU.
The prospect of trade deal with the US – and specifically a trade deal under the current US administration- also plays into a wider political narrative on both sides of the Atlantic. Namely that Brexit can be portrayed, even if simplistically, as a rejection of an “European approach” that leaves a larger role for the state in domestic policy and multilateral institutions internationally, and in favour of a “US” one based on less intervention domestically and greater unilateralism internationally.
The possibility that trade deals act as totems for various political views creates further challenges for the UK. From an economic perspective, the starting point for trade policy is not what policy adjustments should be made to secure a certain type of trade deal with particular partners. The starting point is to work out what policies raise living standards for the UK, and then to see how these feed into the structure of trade agreements, and the type of partner with which they are struck. And because modern trade negotiations involve commitments on matters of regulation and public policy that go well beyond border measures, working out what approaches are desirable for the UK is complex, and requires time and resources. The political need for speed acts against the former, and the UK’s fledgling institutional capacity on trade matters constrain the latter.
In this remainder of this article, we consider some key points.
What purpose do preferential Free Trade Agreements serve for the UK?
Trade liberalisation is supposed to improve living standards by enabling countries to specialise in goods and services in which they have a comparative advantage. This in turn boosts productivity and innovation which in turn leads to economic growth. This argument for trade liberalisation does not depend on whether other countries are also freeing up trade.
From a political economy point of view, though, domestic liberalisation creates winners and losers. The losses of the latter are more concentrated and hence create powerful political forces against liberalisation. Reciprocal free trade agreements try to overcome that by creating a coalition of winners (domestic consumers and exporters gaining access to foreign markets) that helps to overcome protectionist forces.
The reason countries commit to liberalisation through treaties – whether multilaterally under the WTO or preferentially through FTAs – is to guard against future “backsliding” into protectionism. Tying ones hands and “locking-in” reforms in this way can give some stability to the policy regime, allowing investors local and foreign to make long term decisions they might otherwise be unwilling to make.
While this traditional way of thinking about FTAs finds strong acceptance, its application to the UK’s situation needs to be qualified. First, the UK is currently seeking to undo, in part at least, a long standing arrangement: EU membership. This, along with FTAs negotiated by the EU, has defined the UKs trade regime and provided it with stability. The future shape of UK trade policy is unsettled, not only because it is unclear how trade relations with major trading partners will be governed, but also and especially because the UK has not yet worked out what its optimal trade policies are and how, if at all, these should be locked in by treaty.
Secondly, modern trade negotiations are much more about regulation and commitments in areas of public policy than they are about border measures. Recent references to pharmaceuticals pricing, digital taxes and agriculture are high profile examples; but also important are maters such as regulation in financial services, audio-visual and media, or environmental standards. The payoffs from regulatory reform require a careful cost-benefit analysis, and the traditional argument that liberalisation and locking-in is beneficial will not always hold.
Thirdly, research into international trade points to the importance of firm-level and workforce characteristics in driving the gains from trade. More productive firms and workers stand to benefit from trade, and less productive ones may lose out. But if that is the case, one needs to look not just at whether trade liberalisation gives a boost to productivity, but what measures can be taken to improve productivity so that trade is beneficial all.
Policy oversight or an oversight of policy?
The intersection between trade agreements and public policy means that formal commitments made in negotiated agreements are the tip of the iceberg. These commitments to avoid discriminatory measures, enhance market access and agree to regulatory convergence sit on top of a very large matrix of public policy. A commitment, for example, on the extent of public sector broadcasting, or on pharmaceutical pricing, are ones affecting market access for, respectively, suppliers of audio-visual services and pharmaceutical products. But both these policy measures are ones that are underpinned by a broader policy framework targeting various policy objectives in their respective fields, and go well beyond trade. Assessing whether these should feature in trade deals, in exchange for say enhanced access for financial and professional services, and if so how, requires close scrutiny.
The current direction of travel – as seen in the Withdrawal Agreement Bill – is to reduce the scope for parliamentary scrutiny. This may be in part motivated by the inability of the previous parliament to agree to any form of Brexit. Moreover, historically, parliaments across the world have a patchy record in trade policy. The Smoot-Hawley tariffs that crashed global trade and worsened the great depression were a product of parliamentary politics. Parliaments can amplify the voice of protectionist constituencies. This fear partly explains why in the US, the authority granted to the president to negotiate agreements usually allows parliament a yes/ no vote on the whole deal, rather than the ability to pick through the minutiae of what has been negotiated.
The counterargument is that we have moved on from bartering tariff reductions to deal with domestic protectionism to engaging in discussions about regulation and public policy issues that also affect cross-border trade. It is therefore important to develop mechanisms that provide society with a voice. Much of the recent dissent against economic reforms reflects an anger at a lack of voice. Arguably, Brexit was one manifestation of that: resentment against decisions taken by institutions judged – rightly or wrongly – to be too far removed from the public and unaccountable to it.
Finally, allowing parliament a greater say could present negotiating advantages as well. By stipulating in legislation that certain issues must be discussed or must not be discussed, parliament can tie the hands of negotiators and enhance the credibility of their statements to their counterparts. In the United States, trade promotion authority constrains Congress’ ability to unpick agreements, but the quid pro quo is that Congress requires that certain issues (labour standards, intellectual property protection) must be on the table and that others (say, trade remedies) must not be.
Dynamic trade policy?
Usually, for advanced countries at least, domestic reforms precede commitments in trade agreements. That is, countries try to work out what reforms they want to pursue and then identify how entering into treaty commitments can provide security to these reforms (the locking-in argument referenced above). In the UK’s case, many of these policies need to be worked out.
Adding to this challenge is that trade policy now, more than in the past, needs be set based on priorities that are both cross-cutting and fast-moving. One example of this is decarbonisation and green-growth. The UK has its net zero-emissions target, while the EU has set out its plans for a “Green Deal”. The pursuit of climate and environmental objectives will require a mix of policy instruments such as standards, subsidies, and environmental/ emissions taxes. That in turn raises the question of how these instruments relate to agreements and multilateral trade rules. In particular, when there are difference between countries in terms of ambitions regarding environmental and climate objectives.
Another aspect is the digitisation of production and trade. This is already changing patterns of comparative advantage. Traditional distinctions between goods and services, and between sectors, are breaking down. Getting trade policy right in this area will require taking a view both on how the UK fits into these changing patterns. Moreover, the choice of policy instruments, and the nature of trade commitments, will depend on decisions made on various issues, including: the possible regulation and taxation of digital platform and network services, data protection and privacy, support for sectors and regions in accessing technological innovation, and consumer protection.
More than ever, trade policy will have to hit moving targets. A key question is what this means for the architecture of trade agreements. These still tend to be heavily siloed across sectors (reflecting past approaches to trading off commitments across sectors) and within them. In a dynamic world, “locking-in” may be detrimental if it locks in the wrong policy settings.
The micro-details that matter
As already explained, modern trade theory identifies the role of firm and worker characteristics in determining trade performance, and also who benefits from trade. The political economy implications of this can be profound, if one considers that firms and industries tend to cluster. Trade can increase disparities between regions that feature such clusters and those that do not. Technological progress such as artificial intelligence, 3D printing, machine learning, or “digital twins”, are likely to reinforce the ability of the most innovative firms and industries to benefit from trade. But they will also increase the disparities between regions that have clusters of such firms and those that do not.
The upshot is that trade policy will need to be more closely integrated with policies towards skills, innovation and productivity than in the past. Policies also need to be developed to address the distributional effects of trade. The stock-answer provided by economists in the past – transfers via the tax system – is unlikely to suffice. From an economic point of view, what is required is not simply a distribution of wealth, but of access and connection to the drivers of trade.
Buying time, creating space
The range of issues raised by modern trade policy creates a series of challenges for the UK. In the current context, the political need for speed clashes with the gains to the UK form a more considered approach. Navigating this conflict presents an immediate challenge, particularly given binding timelines the UK and the EU have imposed on themselves.
One strategy for the UK would be to secure an interim arrangement with the EU and seek a waiver from the WTO giving both parties to sort out outstanding issues ( a waiver would be required if the UK and EU treat each other preferentially without the legal cover of a formal agreement notified to the WTO). With other partners, the UK may want to reconsider the merits of striking deep free trade agreements in a rushed manner, and focus more closely on policy efforts that do not require binding negotiated commitments. These could include for instance, mutual recognition agreements in services sectors (already a UK competence prior to Brexit) and export promotion/ commercial diplomacy initiatives (likewise).
More broadly, the strategy for the UK would be to seek trade agreements that strike a balance between on one hand locking-in commitments, which would provide certainty to investors, and on the other, preserving the option of rolling out policies needed to respond to the range of questions that require a dynamic trade policy. A close scrutiny of the interactions between trade and public policy objectives could help strike this balance.
Download Professor L. Alan Winters’ slides from our event on public policy and the governance of trade negotiations here.
This article draws on the TKE event on trade and public policies, including the contributions made by the panel of speakers, Alan Winters and Emily Jones, and contributions from the floor.