August 21, 2015 | By

Why are Trade Deals Complicated?

David Ricardo’s trade model presumed that consumers were people who liked to dress and imbibe. REUTERS/Alessandro Garofalo

Over at National Review Online, Kevin Williamson offers a stirring defense of free trade agreements. Squaring off against Donald Trump, he deftly covers NAFTA battles and misperceptions about US manufacturing. It’s a very good piece and well worth a read.

Having thus endorsed it, I’ll now use it as a launching pad to take on an important and misunderstood characteristic of trade agreements: they’re long and complicated. Williamson concedes this as a flaw and cites his colleague:
Jonah Goldberg has written that an ideal free-trade treaty would be one sentence long: ‘There shall be free trade between...’ But NAFTA, like our other trade accords, is more Rube Goldberg than Jonah Goldberg, an overly complex piece of political machinery.
Why not embrace the one-sentence FTA? I would endorse the idea if trade were as it was back when David Ricardo was blogging about it in the 19th century. Ricardo famously explained why England and Portugal could both benefit if the Brits shipped bolts of cloth in exchange for bottles of Port. Setting aside his central argument about comparative advantage, we can focus instead on the kind of trade he described: each country manufactures a good, puts it in a crate, and ships it across the sea. The free trade policy prescription is straightforward: don’t tax the crates when they move through customs. No tariffs. Just let the commercial magic happen.

It’s a great argument, but consider three examples of the complications that have arisen over the years.

Example #1: Ricardo’s model presumed that the ultimate consumers were regular people who liked to dress and imbibe. If you offered them stuff at a lower price, they would obviously buy it and be better off for it.

What if, instead, the consumer were a government? Now politics can enter in:  ‘Dress Portuguese soldiers in Portuguese cloth!’ Even if Portuguese tariffs were zero, British clothiers might have their sales cut significantly if they were not allowed to bid for government contracts in Lisbon. [If this all sounds far-fetched, go back and review the “Buy American” clause President Obama accepted in the 2009 stimulus bill].

For some of the countries in the Trans-Pacific Partnership talks, government purchases make up a decent chunk of overall consumption: For Australia, Canada, Japan, and New Zealand the share is roughly 20 percent (the United States is around 15 percent and the number is often lower for developing countries). One could address this point by reaching a deal on open bidding processes.

So modern trade agreements often have a chapter on government procurement.

Example #2: suppose the crate of imports trying to pass through customs is full of toddler toys, each with a shiny coat of lead paint. This is clearly not a good idea. So perhaps we amend our stance to only allow free trade in products that are safe. But what if a domestic industry facing import competition has a sudden inspiration – its competitor’s products cause early death! What evidence would they need to support such a claim? Will each country accept the other’s regulatory judgment? Who decides which products are safe?

Now our simple FTA has another chapter: sanitary and phytosanitary regulation.

Example #3: modern trade includes services, not just goods. For the US economy, services make up more than three quarters of economic activity and the US runs a surplus in services trade. “So what?” you may ask. Why should this be different than goods trade? Just let those service providers do their thing unhindered.

We usually regulate services more heavily. You cannot hang out a shingle to practice law or medicine in the United States without passing the bar or taking a license (and these are state regulations; we don’t even let domestic lawyers or doctors roam free, much less foreign ones). Even if we felt exceptionally charitable and were inclined to accept other countries’ verdicts on service providers, there are some reasons why this might not work well.

Suppose Country A regulates engineering services by tightly controlling who gets to be an engineer. Once engineers are certified, however, they are pretty much allowed to do as they please. Suppose Country B takes a different approach; it lets anyone be an engineer, but closely scrutinizes the plans for any new construction. Either approach to regulation could work, but a blend in which ill-qualified engineers from Country B face little scrutiny in Country A would be a big problem. [I owe this example to Prof. Brad Jensen of Georgetown, an authority on services trade].  

Now our once-simple FTA has another new chapter on services.

None of this is to argue that the modern trade agreement is a model of efficiency, with every codicil carefully pared back to minimize distortions. Far from it. But in this golden era for policy analysts, in which we have a fresh excuse to explain why the issues are not quite so simple as The Donald makes them seen, I could not resist the opportunity to trump the noble folks at National Review.
 

About

Phil Levy is senior fellow on the global economy at The Chicago Council on Global Affairs. Previously he was associate professor of business administration at the University of Virginia’s Darden School of Business. He was formerly a resident scholar at the American Enterprise Institute and taught at Columbia University’s School of International and Public Affairs. From 2003 to 2006, he served first as senior economist for trade for President Bush’s Council of Economic Advisers and then as a member of Secretary of State Rice’s Policy Planning Staff, covering international economic matters. Before working in government, he was a faculty member of Yale University’s Department of Economics for nine years and spent one of those as academic director of Yale’s Center for the Study of Globalization.

His academic writings have appeared in such outlets as The American Economic ReviewEconomic Journal, and theJournal of International Economics. He is a regular contributor to Foreign Policy magazine’s online Shadow Government section and writes on topics including trade policy, economic relations with China, and the European economic crisis. Dr. Levy has testified before the House Committee on Foreign Affairs, the Joint Economic Committee, the House Committee on Ways and Mean, and the US-China Economic and Security Review Commission. He received his PhD in Economics from Stanford University in 1994 and his AB in Economics from the University of Michigan in Ann Arbor in 1988.

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Why are Trade Deals Complicated?

Why not embrace the one-sentence free trade agreement? Consider three examples of the complications that have arisen over the years.