Judging a Free Trade Agreement - A Proposal for Framework (April 2005)
I. Introduction -
Trade and investment have great potential for creating sustainable development, reducing poverty and meeting basic rights (Oxfam Briefing Paper 37, Make Trade Fair). The devil, as the phrase goes, is in the details. The nature of Free Trade Agreements (FTA) is that gains are dispersed and pain is concentrated. This inherent character of FTA, along with inefficient policies and misleading campaigns cause the emergence of an anti-FTA consensus among NGO's which are concerned with the worlds poorest.
Public policy and lobbying campaigns should focus on addressing the needs of the poor and the losers of the FTA. It is well in the power of the United States Government to include policies and programs that will ease the adjustment of the hurting people into the growing sectors and a brighter future.
II. The Benefits of Trade -
Analyzing the impact of FTAs entails studying of four categories: trade creation vs. trade diversion, the terms of trade, scale effects and non-quantifiable effects (US International Trade Commission, U.S.-Central America Free Trade Agreement: Potential Economywide and Selected Sectoral Effects).
1. Trade Creation (welfare enhancing) vs. Trade Diversion (welfare reducing) -
Trade creation improves welfare and occurs when partner country production displaces higher-cost domestic production. Trade diversion reduces welfare and occurs when a partner country's production displaces lower-cost imports from the rest of the world. Every FTA causes creation and diversion in different sectors.
Whether the trade creation or the trade diversion effect dominates depends on a variety of factors, such as external trade barriers, cost differences, relative supply and demand responses and other domestic policies. Thus, the overall welfare impact of FTA can be empirically determined.
2. Terms of Trade -
The impact of FTA on economic welfare depends on whether the terms of trade improve or deteriorate. Terms of trade improve when the price of exports increase relative to the price of imports. FTA can lead to improved terms of trade by eliminating tariffs and therefore decreasing the price of imports. It can also improve the terms of trade by opening new markets and increasing the price of exports. FTA can, however, lead to deterioration in the terms of trade.
3. Scale Effects -
To the extent that FTA enlarges markets, it can offer firms an opportunity to exploit economies of scale and to lower costs by expanding production. The enlarged FTA market may also attract greater Foreign Direct Investment (FDI), especially investment for which market size is important. The effects of FDI on a local population are not primarily through job creation, but rather through integrated packages that include technologies, business techniques, management skills, human-relations policies and marketing capabilities.
4. Non-Quantifiable Effects -
In addition to the generally quantifiable effects discussed so far, regional integration in an FTA can provide other potential benefits that are more difficult to evaluate quantitatively. These include: enhanced security, increased bargaining power in international forums, and greater policy stability by "locking in" domestic policies under the FTA.
III. Dispersed Gains and Concentrated Pain -
Any FTA results in winners and losers. In contrast to popular notion, the line between the winners and losers does not converge with national borders. Rather, the division is a sectarian one - winners and losers exist in all states that are members to the agreement.
One of the greatest challenges is that while the gains of an FTA are dispersed, the losses are concentrated in specific sectors. In Central American Countries, for instance, poultry products that cost $26 prior to CAFTA will cost $10 to all consumers with the implementation of the agreement (elimination of a 164% tariff) (CAFTA-DR Agriculture; Specific Fact Sheet. United States Trade Representative). Many of the Central American farmers, however, are expected to be taken out of business as they cannot compete with subsidies American imports. In this case it is important to understand that the hurt to Central American farmers is caused by American agriculture subsidies, not CAFTA.
A smaller number of significantly-hurting people will always be better mobilized and organized than a large number of slightly better-off people. The challenge is to maintain a broad understanding of the overall effects and focus on helping those who suffer the losses.
IV. An Anti Free Trade Consensus -
There are three main reasons for the emerging anti free trade campaign. First, the United States Government maintains unfair rules that govern trade and international investment, such as agricultural subsidies. Second, the United States Government (as well as other rich countries) does not pursue sufficient policies to address the hardships FTAs bring on specific sectors. These policies include: grants for vocational training, micro-financing opportunities, labor protection, and education programs. Third, political leaders, trying to rally support for free trade agreements take on misleading campaigns that beg opposition, such as the failure to recognize publicly that there are losers in every agreement in all member countries and that actions need to be taken to ease these people's transition.
As a result, many NGOs, which are concerned with the world's poor, form coalitions and lobbying campaign in order to influence policies and ratification of FTAs.
V. Recommendations -
Analyzing and understanding the costs and benefits of FTAs and the political dynamics in which they are formed and ratified, lead to the following recommendations:
1. Considering the value of FTA should start with a cost-benefit analysis. The analysis should include four categories: trade creation vs. trade diversion, terms of trade, scale effects and non-quantifiable effects.
2. A winners and losers analysis will identify the sectors which carry the concentrated pain.
3. Policy recommendations to address the hurting people's transition and adjustment should be the center of lobbying efforts in the United States Government. These recommendations can include: grants for vocational training, micro-financing opportunities, labor protection, and education programs.
4. Unfair rules that govern trade and international investment should be aggressively lobbied against. Most importantly, U.S. and EU agricultural subsidies must be reformed or eliminated.