Wednesday, February 20, 2013

Freeing the transatlantic economy – prospects, benefits and pitfalls

In mid-February, the EU and the US agreed to launch negotiations aimed at sealing a Transatlantic Trade and Investment Partnership (TTIP). Like Yogi Berra, cynics might be tempted to dismiss the project as déjà-vu all over again. After all, this is hardly the first such initiative the two sides have launched. In 1990, they signed a Transatlantic Declaration; in 1995, a New Transatlantic Agenda; in 1998, a Transatlantic Economic Partnership; and in 2007, they established a Transatlantic Economic Council (TEC), a body that was supposed to give political impetus to freeing up commercial relations across the Atlantic. Past attempts to lower the barriers that impede trade and investment across the Atlantic are a story of rising ambition, but frustratingly elusive results. So why bother?

Part of the answer is that the scale of the transatlantic economy makes the effort seem worthwhile. Despite the rise of China and other emerging economies, the transatlantic axis remains the largest bilateral commercial relationship in the world. Although the data indicates that the EU and the US now trade more goods with Asia than they do with each other, such figures are misleading. One reason is that they are distorted by the increasingly global nature of supply chains (so that finished goods like iPhones show up as Chinese exports, even though the value added to an iPhone in China is tiny). Another reason is that they ignore trade in services and foreign direct investment (FDI). Yet FDI has been growing faster than trade in goods for years; sales generated by foreign outlets outstrip those derived from cross-border trade; and services account for a rising share of transatlantic commerce.

The transatlantic economy, then, is larger than a casual look at the data for ‘visible trade’ might suggest. Despite the rise of Asia, moreover, the axis has tightened, not loosened, in recent years. Trading across borders is important, but it is a less intimate relationship than establishing a physical presence to produce and sell goods and services in another country. And it is the second mode which dominates the transatlantic economy. US firms are the largest foreign investors in the EU, and vice versa. Taken together, the investment of American firms in the EU and of European firms in the US approaches $3 trillion. Despite the economic difficulties they have experienced since 2008, the EU and the US still meet most of the leading criteria that influence where businesses want to invest: they offer wealthy consumers, skilled workers, political stability and predictable business environments.

Yet for all its value, the transatlantic economy is still riddled with barriers to trade and investment. Tariffs, though low on average (at 4 per cent), have not been eliminated, and remain astronomical for certain goods – notably in the agricultural sector. Eliminating tariffs, however, would still not free up the transatlantic economy, because the principal barriers to trade and investment now lurk ‘behind the border’. Examples of non-tariff barriers that clog up transatlantic commerce include: regulations (such as the EU’s ban on imports of genetically-modified foods); burdensome customs procedures (particularly in the US since 9/11); different product standards; curbs on foreign ownership of companies (in, for example, the US maritime freight sector); subsidies (notably to aircraft manufacturers); public procurement markets that are still closed; and so on.

The size of the transatlantic economy means that even a partial reduction of some of these barriers could yield non-trivial economic gains, mainly through the ‘dynamic effects’ of increased competition on productivity. A recent study by the European Centre for International Political Economy (ECIPE) estimates that eliminating tariffs alone would yield GDP gains of 0.5 per cent for the EU and 1 per cent for the US. Such gains are not to be sniffed at. It is misleading, however, to think of the TTIP as providing a boost to growth and jobs at a time when economic activity (particularly in Europe) is so weak. Set aside the time-lag that will elapse before a deal – if one is reached – enters into force. Even if such a lag did not exist, trade deals are long-term, supply-side measures: they are not a solution to the short-term, demand-side weakness that afflicts much of Europe.

So what are the prospects for an agreement to lower trade and investment barriers? Seasoned observers caution that such barriers are notoriously difficult to get rid of. In many policy areas, trade-impeding barriers reflect conflicting regulatory approaches – for example, the EU’s ‘precautionary principle’ versus the US’s reliance on risk-based scientific evidence – that remain deep-seated. If such barriers had been easy to dismantle, they would have been a long time ago. The TTIP may therefore struggle to avoid the fate of previous such initiatives, which have tended to get bogged down in technical detail, resulting in a loss of political interest at the top; have become hostage to trivial-sounding but often rancorous disputes that cannot be resolved, like trade in chlorine-rinsed chicken; and have consequently delivered far less market opening than originally hoped for.

Set against this, optimists counter that the political stars appear to be better aligned than for a long time. The intellectual case for lowering barriers to transatlantic trade and investment is arguably more widely accepted than it has ever been by politicians and businesses on both sides of the pond. Cheerleaders are more numerous, refuseniks more muted. President Obama, who took little interest in transatlantic trade during his first term of office, mentioned it in his State of the Union address on February 12th. The rise of China has provided further impetus. The US and the EU recognise that there is more to the TTIP than just transatlantic relations. In addition to promoting a trade liberalisation agenda at a time when the Doha Round is moribund, a successful TTIP would influence behaviour, regulations and technical standards in third countries such as China.

How should the success of the TTIP be measured? The TTIP should not be judged relative to an idealised but unrealistic outcome. It is wholly unrealistic to expect the result to be a transatlantic free trade area (which would imply the complete elimination of tariffs), let alone an enlarged version of the EU’s single market (which would imply full freedom of movement for people, goods, services and capital across the Atlantic). A successful TTIP would make steps towards a free trade area (by reducing, but not eliminating, tariffs), and modest ones towards a single market (perhaps by delivering some mutual recognition of regulations, reaching some agreements on common technical standards, and by improving market access in services). But it would fall short of both. The test of the TTIP is not whether it eliminates all barriers, but whether it lowers some of them.

The prospects for a successful outcome would be greatly improved if the two sides could agree on some rules of engagement. First, they should not allow the best to be the enemy of the good: better to focus on credible objectives and deliver than to be unrealistically ambitious and fail to do so. Second, to provide a sense of purpose and momentum, the two sides should commit to early tariff cuts, before proceeding to the more difficult barriers ‘behind the border’. Third, they should identify the regulatory and other issues on which progress is least likely and agree to set them aside for the time being. Fourth, they should refrain from linking unrelated issues by making progress on one conditional on the other. If the EU and the US fail to observe such rules of engagement, the TTIP is more likely to produce finger pointing and recrimination than any substantive market opening.

Philip Whyte is a senior research fellow at the Centre for European Reform.

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