“The Proliferation of Free Trade Disagreements (FTDs)” by Jayant Menon

2019/85, 21 October 2019

It was not that long ago that trade economists were concerned about the effect that the proliferation of bilateral free trade agreements (FTAs) were having on the multilateral trading system. For instance, the number of bilateral FTAs in-effect involving at least one country from the Asia-Pacific, the epicenter of FTA proliferation, increased four-fold from 39 in 2000 to 159 in 2019. The pace of the proliferation has slowed dramatically, however, with only 3 such agreements going into effect in the last two years. [1]

While supporters of multilateral free trade may cheer the slowdown, the support for the WTO is also waning. At the plurilateral level, we have seen how the Trans-Pacific Partnership had to be reconstituted after its key proponent, the United States, withdrew, and the remaining members are struggling to bring into effect even a much watered-down version. The Regional Comprehensive Economic Partnership (RCEP) is still lingering, as we keep being assured that this will be year, for at least the third time, that it will be concluded. Then of course we have Brexit and the ongoing US-China trade war.

FTAs are being replaced by a new kind of proliferation – free trade disagreements, or FTDs. Unlike FTAs, FTDs are not that easy to measure or define, as they could cover a wide range of actions, as well as inactions. They may be difficult to quantify, but they are real. There are some relatively well defined indicators that we can look at, however. Anti-dumping actions and countervailing duties have increased sharply over the years, with developing countries now also taking actions against developed countries, when it used to be mainly the other way around. Other forms of ‘murky protectionism’ are also on the rise, from the use and abuse of sanitary and health regulations to widespread use of illegal subsidies and restrictive procurement arrangements to green protectionism. The distorting effect of these forms of protection is generally much higher than tariffs or other taxes.

What is driving the proliferation of FTDs? A lot has already been written about globalization and its discontents. The unequal distribution of gains (real or perceived) between countries, and the unprecedented increase in inequality within countries, have led to an electoral backlash that have pushed some politicians to review trade and investment policies. In developed countries, fear over the continuing “export of jobs” have driven some politicians to pursue short-term measures that are sometimes ineffective and are almost always counter-productive in the long term.

As the agenda on trade reform deepens to include more difficult and sensitive issues, the prospects for disagreement also increase, as does the risk of failure. The attempt to deepen existing FTAs, or to negotiate new, deep ones, can lead to an increase in FTDs. In a sense, Brexit illustrates the backlash from pushing the regional economic integration process too far and too deep, while the repeated annual failure to conclude RCEP is partly due to the ambition of the project being beyond the aspiration of one or more of its members.

Increased integration and consequent interdependence between countries are expected to act as insurance against the possibility of conflict. This is simply because the costs are higher, when there is more at stake. The Nobel Peace Prize winning journalist Norman Angell wrote in The Great Illusion in 1910 that interdependence among nations made conflict illogical and counterproductive, referring especially to the strong trade relations between France and Germany. World War One broke out a few years later. Disagreements that lead to conflict or even war can and do often defy economic rationality.

Both the current US-China trade war, and the US-Japan trade tensions 30 years ago, are also born out of increasingly interdependent relationships. But the US considered them to be unfair or imbalanced because of the large bilateral trade deficits it ran with each.

Familiarity may also breed contempt, or there may be other issues at play, but tensions that sometimes lead to conflict of varying degrees seem to come about when there are significant shifts in the distribution of global economic power. As the economic size of rivals catches up to the prevailing hegemon, the risk of conflict also rises sharply. With Japan in the past and China more recently, the response appears to be triggered when their share of the GDP of the US, as the global hegemon, surpasses the 60 percent mark. And when new major economic powers emerge, they generally do so by increasing their commercial relations with existing ones, as they generally must, which adds to greater interdependence. If this is true, then there is a sense of inevitability to such conflicts, and all that can be done is to contain them and manage their consequences. So far, we have done a rather poor job of both.

Why should we be concerned about the proliferation of FTDs? Apart from the obvious harm it is doing by reducing the mutually beneficial gains from free or freer trade, there are more subtle effects to be concerned about. At a fundamental level, it threatens the efficacy of a rules-based order, and all the benefits that such a system provides. The WTO overseas a rules-based multilateral trading system, but its role and influence continues to diminish. The US has been blocking appointments and reappointments of members to the Appellate Body of its dispute settlement mechanism – often hailed as the “jewel in the crown”. With membership down to three (from seven), some foresee a crisis.

The marginalization of the WTO and US-China trade tensions started long before the Trump administration, but they have increased dramatically during his term. The enduring US-China trade war could contribute to further weakening of a rules-based order by generating a domino-type effect not dissimilar to that with the proliferation of FTAs. The US has been engaged in much less publicized mini-trade wars with India and the European Union, already affecting trade in steel and aluminum and which could worsen. In March 2019, the US also removed India’s designation as a beneficiary developing country, while in October the US decided to impose more than $10 billion in tariffs on imports from the EU stemming from a dispute about their subsidies to Airbus. Japan and Korea are also engaged in an escalating trade dispute.

It is often said that trade wars are easy to start but hard to end. Not only can they escalate quite quickly, but they can spread to new issues, sectors and regions, as well as ignite new wars. The proliferation of FTDs is therefore not only more pernicious than the proliferation of FTAs that preceded it, but threatens to damage a rules based order that may take decades to recover from, with some things left beyond repair.

[1] Author’s calculations based on data from ADB’s FTA database: https://aric.adb.org/fta.