Bill Carmichael, former chairman of the Industries Assistance Commission (now Productivity Commission), has urged new trade minister, Steve Ciobo, to rethink Australia’s free trade agreement (FTA) negotiations. From The Canberra Times:
The present conduct of trade policy is based on a myth, perpetuated by the Department of Foreign Affairs and Trade, that all the gains come from winning access to external markets…
The opportunity to improve the performance of the economy in this way was missed in all three FTAs concluded last year. In those negotiations our agenda was simply a market-access wish list; negotiations were conducted in secret; the outcome for domestic efficiency was the accidental outcome of the market-access arrangements negotiators were able to agree about, rather than a central objective in deciding which domestic barriers to reduce; and success was measured by whether the outcomes improved access to external markets…
When we fail to structure our market opening offers to improve allocative efficiency, by reducing the barriers protecting our less competitive industries, we forgo the major productivity gains from negotiations…
All that is needed to introduce the change is for the government to ask the Productivity Commission, before future trade negotiations get under way, to report on how Australia’s market opening offers should be structured to secure the productivity gains available – regardless of how other countries approach negotiations.
Regular readers will know that I am no fan of preferential FTAs, which can often have deleterious impacts on efficiency.
One common cost is so-called “trade diversion”, which arises when the importing country shifts its buying from a more efficient, lower cost country whose goods are subject to a tariff towards the less efficient and higher cost FTA partner whose goods are not subject to a tariff. In such circumstances, the importing country loses the tariff revenue, whilst its consumers do not fully benefit from a price reduction, potentially making it worse-off overall.
Another cost associated with FTAs is the complex rules of origin (ROO) that are typically attached to such agreements. ROOs are designed to stop imports coming from third party (non-FTA) countries via an FTA partner, in order to circumvent tariff requirements. The ROOs, which can be either based on value-added requirements (i.e. the percentage of value-added by the FTA partner) or product specific (i.e. individual rules for each individual product imported), can raise administrative costs for businesses (including complying with paperwork requirements) and custom services in administering and auditing the ROO, undermining the benefits from the FTA.
The costs associated with ROOs will be greatest where there is a large number of FTAs each with different requirements, resulting in a “spaghetti bowl effect” of increasing complexity.
Of course, there are other potential competitive distortions that can arise from binding rules within an FTA.
For example, the Australia-US FTA, concluded in the mid-2000s by the Howard Government, saw the inclusion of non-trade provisions, such the extension of patent and copyright terms, which will lessen competition and increase costs for Australian consumers over the longer-term. The recently signed Trans-Pacific Partnership (TPP) trade agreement has fortified these intellectual property protections.
Obviously, the first best option in trade policy is to seek trade liberalisation at the multilateral level, whereby all parties agree to drop trade barriers all at once. However, such liberalisation has proved time and again next to impossible, with successive multilateral trade negotiations collapsing during the 2000s.
With multilateral liberalisation off the agenda, this leaves bilateral liberalisation (as discussed above) or unilateral liberalisation. For mine, unilateral liberalisation is the second best option.
Most people wrongly view trade barriers, like tariffs, as merely a negotiating coin that can be traded-off in exchange for other nations dropping their trade barriers. However, such a view is misplaced – trade barriers impose real costs on the domestic economy, both to consumers in the form of higher prices and to productivity overall by reducing competitive pressures.
Reducing one’s own trade barriers, therefore, can not only improve outcomes for consumers via lower prices, but also increase competitive pressures on domestic industry, helping to spur greater innovation and productivity in order to survive. Of course, equity considerations must also be considered and weighed against any potential efficiency gains.
In my view, Australian trade policy and trade liberalisation needs to be viewed more in this light – as a form of domestic competition policy, rather than something that can be traded away for a bunch of questionable bilateral deals with spurious efficiency and equity impacts.
At a minimum, the Productivity Commission should be engaged to analyse trade negotiations for their equity and efficiency impacts both before, during and after negotiations are completed. In trade negotiations, process matters.
