Bilateral trade treaties are a sham

July 20, 2003
Singapore Democrats

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Jagdish Bhagwati and Arvind Panagariya
The Financial Times
13 July 2003

Pascal Lamy, the European commissioner for trade, recently wrote that “half the world’s economists” were opposed to the epidemic of bilateral free trade agreements (FTAs). That was a splendid example of British understatement from a Frenchman.

The fact of the matter is that nearly all scholars of international economics today are fiercely sceptical, even hostile to such agreements. By contrast, politicians everywhere have succumbed to a mania that originated in Europe but is now eagerly promoted by Robert Zoellick, the US trade representative, with Asia – the last holdout – now joining in.

We are witnessing possibly the biggest divide between economists and politicians in the postwar period. Unfortunately, the economists are right. The politicians’ lemming-like rush into bilateral agreements poses a deadly threat to the multilateral trading system. There are three reasons.

First, bilateral trade deals are undermining an essential principle of the World Trade Organisation: that the lowest tariff applicable to one member must be extended to all members (the most favoured nation status rule). While it is true that the architects of the WTO/General Agreement on Tariffs and Trade exempted free trade areas from the MFN rule, they surely did not foresee that a proliferation of agreements would fragment the trading system. By the end of last year, 250 FTAs had been notified to the WTO. If those currently under negotiation are concluded, that number will approach 300. The result is a “spaghetti bowl” of rules, arbitrary definitions of which product comes from where and a multiplicity of tariffs depending on source.

Second, if the Europeans started this fad, the Americans are now pursuing it with zeal, exploiting their hegemonic power and the lure of preferential access to a multi-billion dollar market. Unlike Brussels, Washington has adopted bilateral FTAs to advance the agendas of domestic lobbies, agendas that are not related to trade. The US is using one-on-one agreements with small countries as models for other multilateral trade agreements, hawking them around the world as the ideal way to further trade liberalisation.

Third, America’s tactic is weakening the power of poor countries in multilateral trade negotiations. Bilateral deals fragment the coalitions of developing countries, as each abandons its legitimate objections to the inclusion of extraneous issues in trade treaties. Having abandoned these objections in a bilateral deal with the US, how can those countries pursue them in WTO negotiations?

The process of trade liberalisation is becoming a sham, the ultimate objective being the capture, reshaping and distortion of the WTO in the image of American lobbying interests.

The protection of intellectual property provides a good example of US tactics. Washington has used both inducements and punishments to secure its interests. During negotiations over the North America Free Trade Agreement, Mexico was told that the price of a deal was acceptance of intellectual property protection provisions.

It was a price Mexico was prepared to pay. But the US has also demanded that other countries accept similar provisions or face retaliatory tariffs. Subsequently, during the Uruguay round of trade liberalisation, the US was able to insert the trade-related intellectual property regime (TRIPs) into the WTO, even though no intellectual case had ever been made that TRIPs, which is about royalty collection and not trade, should be included.

Mexico also had to accept provisions on environmental and labour standards annexed to the Nafta treaty. But such standards were put right at the centre of the free trade agreement with Jordan, drafted in the last days of the Clinton administration. And with the Bush administration currently negotiating an agreement with Central America, Democrats are under pressure from the labour and environmental lobbies to demand not just the enforcement of local standards but higher standards altogether.

In the free trade agreements with Chile and Singapore, the US Treasury insisted on inserting a ban on the use of capital controls, even though the International Monetary Fund has finally come round to the view that they might, on occasion, be justified. Chile and Singapore finally gave in, agreeing to a dispute settlement and compensation mechanism in case the controls were used. Washington has created another precedent.

Thanks to the myopic and self-serving policies of the world’s only superpower, bilateral free trade agreements are damaging the global trading system. They are undermining the most favoured nation rule ensuring equal treatment in the WTO. Bilateral deals have become a vehicle for introducing extraneous issues into the WTO for the benefit of narrow US domestic interests. They are thereby distorting the role of the WTO. Charles Kindelberger, the great international economist who died last week, looking back at the 19th and 20th centuries, developed the notion of the “altruistic hegemon” that delivered the public good of a multilateral trading system. Today, we have a “selfish hegemon” precisely delivering the opposite.

The writers are respectively university professor at Columbia University and professor of economics at the University of Maryland