Jun 24th 2014

Free-Trade Pitfalls

by Hans-Werner Sinn

Hans-Werner Sinn, Professor of Economics at the University of Munich, was President of the Ifo Institute for Economic Research and serves on the German economy ministry’s Advisory Council.

MUNICH − The Transatlantic Trade and Investment Partnership, currently the subject of intense negotiations between the European Union and the United States, is making big waves. Indeed, given the scale of the two economies, which together account for more than 50% of world GDP and one-third of global trade flows, the stakes are high. In order to ensure that the TTIP benefits consumers on both sides of the Atlantic, those negotiating it must recognize and avoid several key traps – some more obvious than others.

Bilateral trade agreements have been gaining traction lately. For example, the EU and Canada recently concluded a Comprehensive Economic and Trade Agreement, which is likely to become the basis for the TTIP.

This is not surprising, given the repeated failure of attempts to reach a global agreement via the World Trade Organization. The Doha Round of WTO talks was a flop, and the agreement reached in Bali last year, despite being sold as a success, does little more than accelerate the collection of customs duties.

As it stands, fear of insufficient consumer protection, distorted by vested interests, is dominating the TTIP debate. Consider the disagreement over the differing treatment of chicken. In the US, chicken meat is washed in chlorinated water; in Europe, chickens are stuffed with antibiotics while alive. In an effort that can be described only as absurd, European producers are attempting to convince their customers that the former method is worse for consumers.

In reality, consumer protection in the US is considerably better and stricter than in the EU, where, following the European Court of Justice’s Cassis de Dijon decision, the minimum standard applicable to all countries is set by the country with the lowest standard in each case. By contrast, the US Food and Drug Administration enforces the highest product standards, meaning that, under the TTIP, European consumers would gain access to higher-quality products at lower prices.

The main benefit of trade facilitation is that it enables countries to specialize in the areas in which they are most capable. As Ralph Ossa showed in a working paper for the US National Bureau of Economic Research, if Germany did not have access to international markets, its standard of living would be half of what it is now. The TTIP, according to the Ifo Institute’s Gabriel Felbermayr, could improve German living standards by 3-5%.

But these benefits are far from guaranteed. One major risk of trade facilitation is trade diversion – that is, a reduction in customs duties between two countries leads consumers to avoid less expensive products from third countries. If consumer savings do not outweigh the decline in countries’ customs revenue, the end result is reduced welfare.

Avoiding such an outcome requires provisions enabling a wider set of countries, in particular China and Russia, to participate in the trade-facilitation process on equal terms. Indeed, building a sort of “economic NATO” that excludes powers like Russia and China would be inadvisable both economically and politically. Instead, these countries should be included in the negotiation process.

Another potential risk concerns investment protection. As it stands, it is acceptable for the EU to assume responsibility when its own health and environmental-protection measures function as de facto trade barriers. EU directives capping the CO2 emissions of cars, for example, are actually a kind of industrial policy aimed at protecting small French and Italian automobiles. Investment protection would limit this kind of abuse.

But it is not acceptable for the EU to offer foreign investors protection from a European country’s inability to meet its obligations, in particular to service its debt. Such a move, as Handelsblatt’s Norbert Häring recently pointed out, would transform the TTIP into a mechanism for mutualizing liability within the EU.

EU-wide investment guarantees would artificially reduce the rate of interest under which single EU countries could borrow and thus encourage these countries to take on more debt, effectively suspending the self-correcting mechanism of the capital markets. That would lead to the next act in the European debt disaster, with consequences that far outweigh the TTIP’s benefits.

The TTIP undoubtedly has considerable potential to boost economic performance on both sides of the Atlantic. But it will mean nothing if the agreement is allowed to serve as a back door to European debt mutualization through what effectively might come close to Eurobonds.



Copyright: Project Syndicate, 2014.
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