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Economists not as hot on all trade deals as you might think

Both presidential candidates now oppose new trade deals. Most saliently the Trans-Pacific Partnership agreement that awaits ratification by Congress. But that may cause much less distress for economists than many would assume.

That lower trade barriers can increase economic efficiency and potentially raise living standards is a core belief for our discipline. But ad hoc bilateral pacts like the Canadian-U.S. Trade Agreement, that eventually morphed into NAFTA, or regional arrangements like the TPP, are viewed askance by many economists, despite our near-unanimous support of trade in general.

The core economic issue in narrow trade “deals” among a handful of nations versus broad-based trade agreements like those of the World Trade Organization is that of “trade creation versus trade diversion.” Broad efforts are more likely to create new trade, while narrow ones tend merely to divert it.

The issue is best illustrated with a historical example. The United Kingdom has been a net food importer for centuries. Prior to its joining the European Union in 1973, most U.K. food imports came from former colonies with which it had maintained ties under the aegis of the Commonwealth. It imported cheese, butter and lamb from New Zealand, beef and wheat from Australia, coffee from Kenya and so on. The first two, at least, were among the very lowest-cost, most economically efficient producers of these export commodities in the world. Britain bought from non-Commonwealth countries such as Argentina too, at low world prices.

However, the EU’s Common Agricultural Policy was an EU cornerstone. It was designed to make Europe self-sufficient in food and to increase incomes of rural dwellers. But local production of most foods was less efficient economically than importing. Food prices to EU consumers were substantially higher than in many other areas — particularly higher than in Britain. Cutting off imports from its old trade and cultural partners was the most bitter condition the U.K. had to meet to join the EU. But cut them off it did.

British imports from existing EU members burgeoned — cheese and butter from the Netherlands and Denmark, wheat from France and even beef from Italy. But this new trade was not a net increase. The increase in food imports from the continent was offset by decreases from the Commonwealth or from other low-cost food producers like Argentina or the United States.

Not every item of food Britain imported came from other EU members. But whatever was imported from outside the EU was subject to the high tariffs of the Union, including the notorious “variable levy” that increased whenever world prices decreased, keeping households in the EU from ever enjoying the benefits of good harvests, and low prices, globally.

Much trade was “diverted” from existing channels but virtually none was “created.” Since production moved to less-efficient producers, the result for the world food sector was that fewer human needs were met from the same use of resources.

Few outsiders noted, but in the U.S. there was strong opposition to NAFTA among many economists while it was being negotiated. They feared that reducing tariffs on imports from Mexico to near-zero while maintaining them at existing levels for shipments from other countries would simply divert production from more efficient producers to a less-efficient Mexico. Mexico would be a lowest-cost source for U.S. importers, but only because of the lower tariffs incorporated in NAFTA. There would be trade diversion but not creation.

This situation was different than Britain joining the EU. That had required increasing tariffs on U.K. imports from historical sources. It thus boosted household food costs. NAFTA kept existing low tariffs in place for all members of the WTO or its predecessor organizations and cut them for Mexico. It was low or lower. There was no increase that would catch consumer attention. All the political focus was — and remains — on employment effects.

Regardless, the slight tariff advantage Mexico gained over the rest of the world has since been swept away in the tsunami of U.S. imports from a burgeoning Chinese economy. On jobs many U.S. manufacturers did move production to Mexico, but this was driven largely by internal changes in Mexico and not related to NAFTA or tariffs.

The upshot is that economists have always been suspicious of one-off trade deals rather than broad-based global agreements. Some argue that the advantages of any particular pact may outweigh the costs. Or we may see some pact as the best one can do given a de facto freeze on changes within the WTO. But no economist ever claims that trade deals between small cliques are always good economics.

Moreover, deals like the TPP include provisions forcing other countries to move toward U.S.-style patent and copyright law and open their financial sectors completely to foreign banks. Many economists who strongly favor trade see these provisions as “rent seeking” — using political power to secure financial advantage — rather than opportunity for more efficient use of resources. Jagdish Bagwati, the most prominent trade economist who has not yet gotten a Nobel Prize, often makes precisely that argument. So skepticism about the role of big banks in forming U.S. trade policy is neither new nor particularly liberal or conservative.

From the point of view of efficiency of resource use, economists thus are not going to shed many tears if TPP is shelved. Most are “internationalists” however, and will have doubts about the foreign policy wisdom of discarding a pact designed to bolster our relationship with many historic friends in Asia who now feel threatened by an increasingly assertive China. That is the important question for all of us.

St. Paul economist and writer Edward Lotterman can be reached at boise@edlotterman.com.

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