Working Papers

Competitive Liberalization and Global Free Trade: A Vision for the Early 21st Century

by C. Fred Bergsten, Peterson Institute for International Economics

© Institute for International Economics

 


The March Toward Free Trade

A large part of the world has eliminated all barriers to trade or is in the process of doing so. The fifteen members of the European Union have created a "single internal market." Australia and New Zealand have completed their free trade area. Several large groupings are en route to a similar outcome: the North American Free Trade Agreement (Canada, Mexico, United States), Mercosur (Argentina, Brazil, Paraguay, Uruguay), and the ASEAN Free Trade Agreement (Brunei, Indonesia, Malaysia, Philippines, Singapore, Thailand, and now Vietnam). There are numerous free trade areas among smaller countries.

In addition, a series of new groupings have pledged to abolish all impediments to their international trade in the coming years. The European Union and the Mediterranean countries (EUROMED) have committed themselves to free trade by 2010. The 34 democracies of the Western Hemisphere agreed at their Miami summit in December 1994 to work out a Free Trade Area of the Americas (FTAA) by 2005. The eighteen members of the Asia Pacific Economic Cooperation (APEC) forum--which account for half of would output and include the three largest national economies (China, Japan, United States)--decided via their Bogor Declaration of November 1994 to establish free trade and investment in the region by 2010 for their higher income members, that make up 85 percent of their commerce, and by 2020 for the rest. History suggests that these targets will be met well ahead of schedule because private sectors begin investing to take advantage of the eventual steady state, and thereby accelerate the whole process, as soon as the deals become credible.1

There have been many proposals for additional free trade regimes. The most significant by far would be a TransAtlantic Free Trade Area (TAFTA), joining Europe and North America. In a wholly different setting, Russia has proposed reverting to free trade among some of the republics of the former Soviet Union. India is promoting an association of countries that rim the Indian Ocean.

Even without any additional configurations, over 60 percent of international commerce now takes place within existing or planned free trade regimes (table 1). This share is rising rapidly, both because of the onset of new arrangements and because trade expands more quickly under such conditions. The question thus arises: why not eliminate all trade barriers throughout the world? Why not launch a movement toward global free trade at the WTO Ministerial Conference in Singapore in December 1996? Why shouldn't APEC, having agreed to achieve free trade in its own region but not wanting to create a new discriminatory bloc, propose that the world as a whole emulate its approach?

 

Table 1: Regional Free Trade Arrangements (share of world trade, 1994)

European Union 22.8
EUROMED 2.3
NAFTA 7.9
Mercosur 0.3
Free Trade Area of the Americas (in addition to its subregionals) 2.6
AFTA 1.3
Australia-New Zealand 0.1
APEC (in addition to its subregionals) 23.7
TOTAL 61.0

Competitive Liberalization

In answering these questions, it is first essential to understand why so many countries, in so many different parts of the world, with such different economic systems, at such different stages of development, have all headed in the same direction. There are of course different national circumstances which explain the detailed strategies and timing of the individual initiatives. The overarching force, however, has been the process of competitive liberalization.

The rapid increase of global interdependence has forced all countries, whatever their prior policies or philosophies, to liberalize their trade (and usually investment) regimes. Economic success in today's world requires countries to compete aggressively for the footloose international investment that goes far to determine the distribution of global production and thus jobs, profits and technology. Most countries offer direct incentives to foreign investors but an open trade and investment regime is essential for this purpose. Mexico overcame its historic aversions to trade liberalization and embracing its northern neighbor, and proposed NAFTA, when it became convinced that doing so was essential to avoid losing out in the global competition for capital.

Moreover, success in today's global economy requires countries to compete effectively in international markets rather than simply at home. This is true no matter how large the domestic market: the world's most self-contained economies including Brazil, China, India, Russia and perhaps most notably the United States--which maintained extensive quotes on autos, machine tools, steel and numerous other products only a decade ago--have all joined the competitive liberalization race.

Competitive liberalization is pursued by countries that until recently had deeply entrenched protectionist traditions. France is a dramatic cases in point. So is virtually all of Latin America, which embraced important substitution doctrines as recently as two decades ago. The most stunning reversal of all comes from the former command economies of the Communist world, ranging from China through Central Europe and the former Soviet Union to now Vietnam.

An intellectual and ideological sea-change underlies this historic development. Import- substitution and even autarkic models of development and national economic strategy were reasonably respectable into the 1960s and even the 1970s. But their follies were then exposed, including by the third world debt crisis of the 1980s, and replaced by a new consensus of "outward orientation." The political onset of conservative governments throughout the industrialized world, and in many parts of the developing world as well, hastened the implementation of these reform models.

This change in basic thinking does not, however, explain the onset of regional (or other international) trade arrangements. Why didn't the new attitude simply produce a spate of unilateral trade liberalization, which all textbooks recommend as the most direct route to maximizing trade benefits for an individual country? The answer lies in the politics of trade reform.

The Political Economy of Trade Reform

To be sure, a good deal of unilateral liberalization has taken place. This has been especially true in East Asia. It has also occurred in the United States, most of whose quotas were abolished without any foreign quid pro quo. But domestic political opposition usually blocked countries from simply abolishing their traditional barriers. Entrenched interests fought hard, and frequently with prolonged success, to maintain their protected positions. The politics of economic reform were difficult and contentious in virtually every case.2

The standard strategy for achieving trade reform was to mobilize enough pro-trade interests to overcome those who resisted further market opening. These included beneficiaries of imports such as consumers and industrial users of imported inputs.3 However, such groups rarely organized and their gains from liberalization were both modest and widely diffused. Hence they produced little political counterweight against those who would be adversely affected by increased foreign competition.

To overcome such opposition, it became necessary to appeal to exporters and others who gain directly from the opening of markets abroad. The political economy of trade liberalization in individual countries thus rested heavily on parallel liberalization in partner countries. The most assured technique for achieving such parallel action was to insist on reciprocity, through the negotiation of trade agreements with enough existing or potential markets to tip the internal balance in favor of the desired liberalization. The United States finally agreed to get rid of its textile quotas by negotiating foreign concessions from the rest of the world, in the Uruguay Round at the GATT, on intellectual property rights and agricultural barriers. Through that same negotiation, Japan and Korea began to open their rice markets by appealing to the export interests of their (especially high-tech) manufacturers.

Negotiated liberalization thus turned out to be far more feasible than unilateral liberalization. The key became a country's ability to persuade its foreign partners to proceed in tandem with it. Large trading entities, such as the United States and the European Union, obviously have the most leverage in this context because of the attraction to others of the opening of their markets.

Another key variable is the stage of liberalization at which a country finds itself. Initial reductions of very high tariffs are frequently easy because they put few dents in the real level of protection and thus can often be implemented unilaterally. But most countries have found that they must apply the traditional political economy approach to engineer the later (and most beneficial) phases of the process.

Chile is a recent case in point. Its policy desire to achieve totally free trade is clear but it must now mobilize strong support from its exporters to overcome resistance to eliminating its last 10 percent or so of protection. Its strategy is to try to negotiate reciprocal deals wherever it can--in Mercosur, NAFTA, APEC, bilaterally and/or globally through the new World Trade Organization (WTO).

Regional vs. Global Liberalization

In seeking reciprocal liberalization, countries could turn either to their respective geographic region or to the global trading system as a whole. The global approach is fundamentally superior because it maximizes the number of foreign markets involved and avoids the economic distortions (and political risks) of discrimination among trading partners. Indeed, the succession of GATT "rounds" throughout the postwar period has made a major contribution to the freeing of global trade.

As the urgency of competitive liberalization accelerated over the last decade or so, however, the regional approach has increasingly come to dominate the process. It simply turns out to be less time-consuming and less complicated to work out mutually agreeable arrangements with a few neighbors than with the full membership of well over 100 countries in the WTO. Moreover, regional groupings are demonstrably willing to proceed much more boldly: many of them have decided to adopt totally free trade, as noted above, whereas none of the global conclaves to date has even considered such an ambitious goal. The rapid growth in the membership of the WTO, whose predecessor GATT had fewer than 50 members though the first several postwar negotiations, added to this change in the calculation.

Desires to overcome traditional political rivalries have also been a driving force in the success of several of the regional economic arrangements. The cardinal goal of the European Union was to end the historic hostility between France and Germany. Mercosur sought to end the arms race, including its nuclear dimension, between Argentina and Brazil. A successful APEC would reduce the risk of intra-Asian and trans-Pacific conflicts, which have been so prevalent over the past century-- including three wars for the United States. Regional trade arrangements are thus often motivated by priority national security concerns. This is another reason why they often move more quickly and more boldly.

Much of the political economy of competitive liberalization in recent years has in fact played itself out in the dynamic interaction between regional and global initiatives to reduce trade barriers. This creative tension has been present throughout most of the postwar period. The United States initiated the Kennedy Round in the 1960s to counter the discrimination inherent in the creation of the European Common Market (as well as for broad foreign policy reasons) and the Tokyo Round in the 1970s to counter the additional discrimination from the Community's expansion to include the United Kingdom. The Europeans cooperated in both ventures and thus enabled the regional and global efforts to "ratchet up" the scope and pace of liberalization.

The positive interaction between the two strategies accelerated sharply in the 1980s and 1990s as competitive liberalization became the norm and countries searched for tactics to obtain the needed domestic support. The United States reversed its traditional aversion to regionalism by embracing free trade agreements with Israel and Canada after the European Community blocked the launch of new negotiations in the GATT--to which the EC responded by dropping its veto and permitting the Uruguay Round to begin. When the Round faltered in the late 1980s, the three North American countries launched NAFTA and the Asians initiated APEC.4 When the Round almost failed to meet its final deadline in December 1993, APEC's initial summit in Seattle in November 1993 induced the Community to finally agree because, according to one top European negotiator, it "demonstrated that you had an alternative and we did not." The regional initiatives also reinforced each other: APEC's Bogor Declaration was instrumental in galvanizing the Miami summit, a few weeks later, to commit to free trade by a date certain in the Americas.

This positive interaction also extends to the subregional level. President Bush's offer in 1991 to extend NAFTA throughout the Western Hemisphere led to an explosion of bilateral and plurilateral agreements across South and Central America as countries sought to prepare themselves to qualify for free trade with North America. In Asia, AFTA has accelerated its timetable and substantially broadened its coverage to stay ahead of APEC. AFTA and Australia-New Zealand have discussed possible linkages between the groups.

Hence regional and global liberalization initiatives have been mutually reinforcing throughout the past three decades or more. The fears of some observers that regionalism would derail globalism have been demonstrably overcome.

The Threats to the Trading System

But determined leadership has been required to avoid conflicts between regionalism and globalism. Doing so has also required the maintenance of effective global trade rules to provide a framework that would deter conflict between the regional arrangements, including rules that apply to the arrangements themselves, and an institution to enforce them. Even so, there have been some close calls--especially when the global system faltered. The major new regional arrangements spawned by the missed deadlines of the Uruguay Round were intended to serve as alternatives to the global regime if needed. An ultimate failure of the Round, which almost occurred, would have discredited the entire global system and raised a real specter of competing blocs.

Moreover, the European Union frequently seems to focus so heavily on its regional agenda that it forgets its global responsibilities. The United States is sometimes viewed as preoccupied with NAFTA or APEC. By joining East Asia and North America, APEC has eliminated any possibility of the evolution of the three-bloc world that was so widely--and rightly--feared a few years ago5 but a failure to work out accommodations with Europe could instead create a two-bloc world that would convey substantial dangers as well. South America might decide to halt its liberalization once Mercosur had consolidated, and Brazil might be happy to leave its new leadership of that region undisturbed for at least a while. There is a constant need to keep the global-regional interaction on a supportive course. This is one key reason why a new initiative is now required to consolidate the regional liberalization initiatives into an agreement to achieve global free trade in the 21st century.

There are other risks to the continued triumph of competitive liberalization that need to be met by a new global initiative. The most threatening of these challenges do not arise in the countries that have rejected openness most strongly in the recent past, the developing and former command economies, although some of them do harbor lingering doubts that could again assume ascendance. Paradoxically, the strongest pressures to reverse the liberal course can be found in the countries that created, nurtured, and championed the postwar order: the United States and the European Union.

Two structural changes dominate the evolution of the American economy over the past generation. One is globalization: the share of trade has more than doubled and now exceeds the same share as in the European Union as a group and (especially) in Japan. The other is the stagnation of real incomes and a regressive shift in income distribution: the United States has created tens of millions of new jobs but the median family income is lower today than a generation ago, the average real wage is flat or down for more than half the population, and only the top 20 percent is unambiguously better off.6

The central question for present purposes is the degree of causality between the two phenomena. Virtually all economists agree that globalization has produced some of the problems cited. The majority believes the relationship accounts for 10-20 percent of the problem and that a retreat into protectionism would make it work. But at least a few serious studies attribute a larger part of the country's chief economic difficulties to globalization and call for a shift in trade policy as a result.

American politics frequently reflect this tension. Only the extremists of both right and left--Pat Buchanan, Ralph Nader, Ross Perot and organized labor--have launched frontal attacks on the bipartisan trade policies of the past 60 years, and all their campaigns have been decisively rejected. But President Clinton, who faithfully implemented the Reagan-Bush commitments to NAFTA and the Uruguay Round and expanded on them substantially with APEC and the FTAA, made explicit decision to keep trade policy out of the political discussion in 1996. So did Senator Robert Dole, who supported all the prior initiatives but announced strong opposition in late 1995 to "any more trade agreements" for the foreseeable future.

The situation in Europe is fundamentally similar if quite different in its details. Europe's chief economic problem is high unemployment, which has risen from 2-3 percent a generation ago to about 10 percent now--from well below the American norm to almost twice as high. But average wages and incomes in Europe have risen substantially over this period, in sharp contrast to their stagnation in the United States.

These two great industrial areas have thus made very different social choices. By limiting its social safety net and permitting firms to downsize virtually at will, the United States forces its displaced workers to find new jobs at whatever wage is available--pricing its labor competitively and thus maintaining full employment. Europe has by contrast become a generous welfare state with extremely rigid labor laws, discouraging new hires from both the supply and demand sides while maintaining social peace through government transfers of a share of its higher incomes to the poor. Sir James Goldsmith and others blame the resulting unemployment on competition from low-wage countries.

The TAFTA idea for free trade between North America and Europe thus poses a subtle but potentially deadly threat to the global trading system. Skilled protectionists in both America and Europe have already learned that frontal attacks on liberalization are bound to fail. Hence they have opted for process protection that employs devices to counter unfair practices, such as dumping and government subsidies, in ways that go far beyond the legitimate use of such policies. They insist on new international agreements on environmental and labor standards (and native populations !) that could also provide cover for new trade barriers.

The case for TAFTA is similar: it posits that free trade is acceptable as long as it takes place among countries at roughly equal (i.e. high) income levels. The rich (and white) countries would combine to erect new discrimination against the poor (and a few rich Asians). Preferences would perversely be provided to richer rather than poorer trading partners. China, Malaysia and others would be offered a rare but powerful justification for their paranoid fears of being contained rather than engaged. No wonder this particular free trade proposal has been embraced so enthusiastically by the likes of Richard Gephart and former AFL-CIO President Lane Kirkland, seizing on the good intentions but economic naivete of the foreign policy gurus (including Henry Kissinger as well as the foreign ministers of Germany and the United Kingdom) who launched the idea in a desperate attempt to find new cement for a crumbling Atlantic alliance.7

Such a circling of wagons by the old rich would reverse one of the most beneficial trends of the regional initiatives of the past decade or so: their inclusion of both richer and poorer nations, which has ended the North-South conflict for all practical purposes. The European Community led that process by including southern European countries with per capita incomes that were about one fifth that of northern Europe. NAFTA expanded the process, adding Mexico with one eighth the income of the original members of the Canada-United States Free Trade Area. The ratios are even higher in EUROMED, the FTAA and especially APEC--where the gap between Japan and Indonesia is about thirty to one. A discriminatory TAFTA would reverse all this progress and reignite hostility across the potentially explosive income divide, especially with over 80 percent of the world's population and virtually all of its growth in the poorer countries.

The bottom line is that neither Europe nor the United States has been able to generate a steady increase in the number of well paying jobs. Europe has rising incomes but high unemployment. America has low unemployment but flat incomes. Perceptions and politicians in both could come to treat trade as a major source of the problem, or even the major source of the problem, and thus pave the way for a massive reversal of global liberalization.

The Asian giants, Japan and China, also pose major threats to the continued openness of the trading system. The political economy of liberalization succeeds in winning domestic support, even in a country as large as the United States, only when its major foreign markets (especially if they are also its toughest competitors) are seen as joining the process and contributing their fair shares to the process. Japan has grudgingly participated in all the GATT rounds but access to its markets remains extremely truncated.8 China has not yet committed to the minimum reforms necessary to join the World Trade Organization. Protectionists in other countries, with some justification, will use the reluctance of Japan and China to liberalize to oppose further reduction of their own nations' barriers.

Japan could also cause problems because of its internal developments, which are beginning to resemble those in the other higher income areas. Unemployment is at a postwar high. Traditional socioeconomic norms, such as lifetime employment and keiretsu supplier relationships, are eroding in large part due to globalization (and its alleged hollowing out of the domestic production base). Deregulation could be slowed even further and it would be unsurprising if protectionist voices began to be heard in Japan in the near future.

Restarting the Bicycle

Why does it matter? New or expanding blocs would divert trade from outsiders, to be sure, but almost everybody would be in a bloc and the diversion would almost certainly be swamped by faster growth and hence trade creation for everybody--as in the case of the European Union over the past forty years. International trade and investment are flourishing. Business needs simply to be assured that no new impediments will be placed in its path.

The problem with this "stand pat" scenario is its instability. The history of trade policy teaches forcefully that failure to move steadily forward toward liberalization condemns the trading system to tip sideways or fall backward in the face of protectionist pressures--the "bicycle theory." For example, protectionism scored major successes during the prolonged periods when the GATT became moribund immediately after the successful conclusion of the Kennedy Round in the late 1960s and the Tokyo Round in the early 1980s. As noted above, there are strong pressures throughout the world--including in the United States and Europe--that would seize on any stalling of the forward momentum and try to reverse the trend toward liberalization. Renewed financial crises a la Mexico could, as in the past, produce a wholesale adoption of new import controls.

One of the great advantages of the contemporary regional initiatives is that they have kept the bicycle moving forward after the conclusion of the Uruguay Round. The Round itself also helped by scheduling future negotiations in a number of sectors, some of which are underway. It now becomes necessary, however, to roll the regional efforts into a consolidated global strategy that will simultaneously keep the bicycle moving forward and avoid the centrifugal risks of drifting into conflicting blocs.

The substance of a new global initiative would include elimination of all remaining tariff and nontariff border barriers. The Uruguay Round teed up these remnants of traditional protection for decisive action by converting agricultural quotas into tariffs, removing quota protection from textiles and apparel, and obtaining bindings of most tariffs in developing countries. One more major effort should condemn these practices to the dustbin of history.9

In addition, new negotiations are needed to enable the global system to catch up with some of the "new problems" that are plaguing international trade relations. Protectionists in all countries are ingenious in staying "one step ahead of the judge" and the system needs continuous updating to stay within reach.

For example, most American (and others') complaints about Japan no longer relate to that country's border barriers. They focus instead on the anticompetitive behavior of its firms with their exclusive supplier or distributor arrangements (vertical keiretsu, as in auto parts and film, respectively) and domination of particular markets (horizontal keiretsu, as in glass or soda ash). The United States has been using trade measures, such as Section 301, to address nontrade problems.There is an urgent need to work out new international agreements on competition policy and corporate behavior.10

Investment is a second area in which the international rules have lagged far behind commercial practice. Investment is now an essential element of international trade, especially in services but in traditional manufacturing as well. Aside from a few very modest covenants on trade-related investment measures agreed in the Uruguay Round and APEC's inadequate "nonbinding investment principles," however, there are virtually no multilateral agreements on the issue.11

Another pending issue is regionalism itself. The GATT article that governs such arrangements is extremely weak and its implementation has been even weaker: of the 100 or so "free trade agreements" that have been notified to the GATT, none have been rejected and only two have been approved. Now that regionalism is so prevalent, the WTO needs to adopt much stronger provisions and procedures to make sure that they evolve in an open manner.

A number of other topics must be addressed as well. The numerous linkages between environmental measures and trade must be sorted out in ways that both protect the environment and avoiding providing new excuses for protecting against trade. The relationship between trade and labor standards needs to be resolved as well.

A broader yet clearly related issue is international monetary arrangements. The current regime of flexible exchange rates periodically permits sizable and prolonged misalignments of major currencies, such as the huge overvaluation of the dollar in the first half of the 1980s and the large undervaluation of the yen in the late 1980s. These misalignments in turn lead to large trade imbalances that intensify protectionist pressures in the deficit countries by tilting the domestic political balance against exporters and in favor of import-competing industries. The WTO will not solve this problem but should push the International Monetary Fund, and the G-7 as its informal steering committee, to improve the functioning of the monetary system to reduce some of the pressures on the trade regime.12 Such trade-monetary linkage featured prominently in the original planning for the Tokyo Round in the early 1970s and to a lesser extent in the planning for the Uruguay Round in the middle 1980s.

The need for the WTO to address a series of new trade issues also replicates the earlier postwar history. The Kennedy Round produced a major reduction in the high tariffs that were the major tool of protection in the early postwar period. The Tokyo Round then attacked government procurement, subsidies and other nontariff border barriers. The Uruguay Round turned to major behind-the-border problems such as intellectual property rights and services rules. Each of these liberalizations exposed a new set of constraints on market access that required a new initiative to bring the international rules up to date, and the present period is no exception.

It would be possible to address all these issues in a series of separate regional negotiations. Indeed, some of the regional agreements have innovated successfully in addressing new topics in the past: the Canada-United States Free Trade Agreement provided a model for some of the services talks in the Uruguay Round, Australia-New Zealand successfully meshed their competition policies in a manner that also enabled then to eliminate antidumping duties, and NAFTA has pioneered in forging effective rules on investment. There would be a serious risk of inconsistency if such issues were addressed differently in the different regional fora, however, and it would be much more efficient to derive worldwide approaches that could be applied by all. The case for globalism is again compelling. The "Grand Bargain" The members of the WTO should therefore agree to consolidate the free trade arrangements that have already been set at the regional level, covering more than 60 percent of world trade as described at the outset, into a global commitment to achieve worldwide free trade by a date certain. The date could be 2010, on the APEC and EUROMED models, with a possible extension to 2015 or 2020 for the poorer countries. Implementation of the agreement would keep the bicycle moving forward for some time.

Such a commitment would rest on a "grand bargain" between two groups of countries: the high-income mature economies of North America and Western Europe and the rapidly growing, lower income countries that make up most of the rest of the world plus Japan. The lower income fast growers (and Japan) owe much of their spectacular success to the openness of the world economy that enabled them to pursue "export led"--or, more accurately, "outward oriented"--development strategies. Hence they need insurance against any reversion to protection by the "old rich," including procedural safeguards against "process protection" and other subtle methods of undoing prior market opening. In the regional agreements already adopted, they have demonstrated a willingness to pay the premium necessary to buy such insurance.

There is a second component of the "insurance motive" in a number of developing countries: insurance that their domestic successors will not reverse the recent liberalization of their own economies. Such reforms can be "locked in" by binding the country's liberalization in international agreements, regional and/or global. Such bindings apply only to trade and investment policies and directly related domestic measures but it would be difficult to reverse most domestic reforms if it were impossible to raise new external barriers to support a reversion to dirigism.

Mexico was motivated by such a package of external and internal considerations to propose NAFTA, join APEC and conclude trade deals with a number of other countries. Similar factors have played a major role in the other Latin American countries as they pursue their subregional liberalizations en route to a FTAA. The external element of this "insurance strategy" has been important for many Asian members of APEC.

The Asian and Latin American countries have been predominantly concerned about a possible reversion to protection in the United States, by far their largest market, and hence have emphasized trade deals with that country. They are also concerned about Europe, however, so are pursuing that dimension as well: Mercosur through a pending trade agreement with the European Union, East Asia through its new summits with the Europeans. Neither of these arrangements are likely to produce much substance, however, so East Asia and Latin America--which are likely to be the two fastest growing parts of the world economy over the coming decades--would benefit greatly from engaging Europe in the same kind of free trade commitments they have already elicited from the United States. This can probably be done only through a global effort in the WTO.13

The second part of the "grand bargain" would provide the higher income countries with increased, and eventually full, access to the markets of the lower income but rapidly growing countries around the world (and Japan). Most of this latter group, despite their impressive liberalizations over the past decade or so, retain substantial trade barriers.

This part of the bargain would be attractive to the rich countries because they too are heavily dependent on export expansion. Such dependence is nothing new for Europe but, as noted above, has only evolved in a major way for the United States over the past two decades. As exemplified by the "Big Emerging Markets" strategy of the Clinton Administration, this rich-country interest focuses primarily on countries with large and rapidly growing markets that still maintain substantial access barriers. Hence the United States and Europe would benefit greatly from the proposed "grand bargain."

There is nothing new conceptually in this proposal for the "old rich" to pledge to avoid new barriers while the "rapid growers" commit to eliminate theirs. Such asymmetric liberalization has lain at the heart of the agreements on NAFTA, the FTAA and APEC and even the European Union. In these regional versions of the "grand bargain," the poorer countries have bought assured continued access to the markets of the rich countries by agreeing to catch up over time with those countries' prior liberalizations. There is a rough justice in the proposed asymmetry because the willingness of the rich countries to facilitate the "outward oriented" growth strategies of the poor, by reducing their barriers much further and much faster, enabled some of the latter to start catching up with the income levels and standards of living of the former.

The novel element here is to shift the context to the global plane via the WTO. This would consolidate and link the existing regional agreements. It would also bring the former Soviet Union, South Asia, Africa and the few other uncovered parts of the world into the deal. It would keep the bicycle moving forward for some time.

The Path to the "Grand Bargain"

Who would take the lead in proposing and pushing for the "grand bargain"? One possibility would be the United States and the European Union, the ultimate closers of each of the major multilateral trade negotiations in the postwar period to date. Conversion of the TAFTA idea into their assuming joint leadership of a new global initiative would be an extremely healthy development.

There are reasons to doubt the success of such an effort, however. The United States attempted to move in that direction with its "Open Markets 2000" proposal at the G-7 summit in Naples in July 1994 but was turned down by the European Union--replicating Europe's rejection of the American effort to restart global trade talks in 1982 soon after the completion of the Tokyo Round. Several EU members blocked a proposal by the European Commission to join the United States at the Madrid summit in late 1995 in agreeing to study the TAFTA idea--a conclusion that was substantively correct but was adopted for protectionist reasons rather than the systemic considerations advanced here. Seen in the context of the EU's overarching focus on its own regional concerns, centering on the expansion of its membership to the east and the deepening of its integration including monetary union, it is doubtful that Europe will be prepared for such a leadership role in the global system at any early date.

The alternative is APEC. From its inception in 1989, APEC has proceeded under the mantra of "open regionalism"--a term deliberately chosen to contrast it with the inward-looking regionalism that many Asians feared might prevail in both Europe and North America. Every pronouncement of APEC leaders, including the Bogor Declaration that committed its membership to "free and open trade and investment in the region," has emphasized the group's commitment to further global liberalization and its antipathy toward becoming an exclusionary bloc.

APEC has not defined "open regionalism." Its members have however, committed themselves to continue reducing their barriers to nonmember countries as they move toward free trade in the region. Some of them might extend their APEC liberalization to nonmembers unconditionally, which they are perfectly free to do as APEC has no intention to become a customs union with a common external trade policy.

Most likely, however, APEC will offer to generalize its regional liberalization to the rest of the world on a reciprocal basis. As noted above, this is the proper course for any trading area that is large enough to induce outsiders to respond positively to its proposals. APEC clearly meets that criterion, accounting for about half the world economy and almost half of world trade.

There are two reasons why APEC should condition access to its liberalizing markets on reciprocal offers by nonmembers. The first is external: global liberalization and hence world economic benefits will be doubled because outsiders could not afford to reject the offer. The second reason is internal: as noted earlier, the political economy of trade policy requires the mobilization of domestic export interests by offering them sufficiently enhanced access to foreign markets to induce them to undertake the effort necessary to win national support for liberalization.

APEC thus has the capability, the inclination and the positioning to initiate the next major episode of global trade liberalization. It has already committed to achieve free trade in its region and is hard at work converting its vision into practical reality. It is thus in an ideal position to assume leadership of the global trading system.14

The World Trade Organization will be holding its first ministerial meeting in Singapore in December 1996. This would be the natural occasion to begin the process of achieving global free trade in the early part of the 21st century. APEC could galvanize the process by seeking agreement of the full WTO membership to emulate its goal of achieving free trade and investment by 2010/2020.

It would probably be premature, however, to seek a global free trade pledge at that time. The United States will have just concluded a presidential campaign in which the incumbent, who took a courageous lead in signing free trade pacts during his first two years in office, declined to discuss the issue and his opponents were equally hesitant. In addition, the European Union will be preoccupied well into 1997 by the InterGovernmental Conference on the future of its integration process, including its trade and other external dimensions. The two largest trading entities, that have traditionally determined the course of the world trading system, may not be ready for major initiatives this year.

Moreover, APEC--the proposed new leader for global liberalization--may not yet be far enough along in implementing its own plans to provide a credible inducement for others to join it. It would have to take convincing steps at Subic to demonstrate that it was serious about fulfilling its own regional goals. One way to do so would be for APEC to make such commitments in a single key sector, for example, the Information Technology Agreement that is now being actively discussed, and then challenge the rest of the WTO to join in.

In determining a role for the Singapore Ministerial, however, it is important to first set long- term systemic goals and then work backward. An agreement to achieve "global free trade by 2010" could plausibly be reached , if not at Singapore, at the succeeding WTO meeting in 1998. To do so, planning needs to proceed on a number of fronts.

First, the biannual WTO meeting in 1998 should be converted into the first Global Trade Summit. The GATT never held a summit meeting. Yet summits have been a regular feature of the European integration process, the rapid evolution of APEC since 1993, the launch of the FTAA, and key subregional trade arrangements including AFTA and Mercosur.

Annual summits have proven particularly effective in APEC, elevating the institution from a purely consultative forum to an engine of regional--and potentially global--trade liberalization in only two years and maintaining strong pressure on ministers and officials to keep the process moving. Asian and European leaders have initiated a series of biannual consultative meetings. The WTO should bring together its heads of government at the last high-level meeting of the world trade body in the 20th century to set a vision for the global trading system in the 21st century.

Second, the Singapore ministerial should appoint a Wise Persons Group to make recommendations for the future of the trading system. A similar group, chaired by Fritz Leutweiler of Switzerland and including Senator Bill Bradley from the United States, was appointed by the GATT in late 1983. Its report in early 1985 made an important contribution to the decision to begin the Uruguay Round in 1986. The APEC vision as endorsed in the Bogor Declaration was initially proposed by that organization's Eminent Persons Group.15

Third, Singapore should initiate a work program to prepare the issues that would form the substantive core of the "global free trade" negotiations. Fortunately, there is already widespread agreement on that agenda. The Uruguay Round itself laid out an ambitious schedule of further negotiations including telecommunications and maritime services in 1996, financial services (again) in 1997, government procurement in 1999, and agriculture and services in 2000.16 Consultations among the WTO members have identified an additional set of priority topics along the lines of those outlined above: competition policy including its relationship to antidumping, investment, trade-environment linkages, perhaps labor standards and their relationship to trade, and several others.

Another important preparatory step is to complete the membership of the World Trade Organization. Singapore should accelerate the effort to bring China, Russia and the other large nonmembers into the institution in time to participate fully in the proposed negotiations. No move to "global free trade" can be effective without these countries--though they must of course comply with the organization's requirements to get in.

Finally, the WTO needs to firmly establish its own credibility throughout the world. This will mean effective implementation of its dispute settlement mechanism, more transparency of its operations so that all interested parties around the world can see how it works in practice, and efficient management of the overall organization. Trust in the institution itself if a necessary prerequisite for giving it the additional responsibilities suggested here, including to allay fears that it can "violate the sovereignty" of its member countries.

Beyond these preparatory steps, a number of key questions remain to be answered before a "global free trade" pledge could be adopted. For example, how should "free trade" be defined? Should it apply only to tariffs, quotas and other border barriers--which would require substantial liberalization in many developing countries but not much in most of the industrial world? Or should it extend to measures behind the border, at least for countries where--as in Japan--they play a central role in current and foreseeable trade conflicts?

Another key issue is the definition of "reciprocity" or "comparability." All agree in principle that any such negotiation must elicit fair contributions from all parties. But it is extremely difficult, in purely intellectual terms even before turning to the politics of the problem, to equate "concessions" across issues as disparate as tariffs and national competition policies. "Reciprocity" already lost most of its quantitative significance when the GATT turned to negotiating nontariff barriers, in the Tokyo Round and even more so in the Uruguay Round, and it may be impossible to restore any precision to the concept. Nevertheless, the political economy of trade requires each country to demonstrate that its own "concessions" were matched by those of its partners and it is highly desirable to buttress the case with orders of magnitude if not precise estimates.

Another question is whether the goal of "global free trade" should be achieved via one or more comprehensive trading "rounds" with a single deadline or via "continuous negotiations" over time on individual issues. At the end of each previous round, including the Uruguay Round, virtually all participants have dismissed the idea of launching such an all-encompassing effort ever again. Such "trade fatigue" is fully understandable from those who have had to labor to bring such an effort to conclusion, especially when it took seven years as in the latest example.

On the other hand, the logic of rounds has always prevailed in the past. Comprehensive coverage has proven necessary to offer the maximum scope for tradeoffs across sectors and issues, thereby inducing the greatest number of countries to agree to the largest possible liberalization. Sectoral or issue-specific efforts, by contrast, require intra-issue tradeoffs that tend to minimize the headway that can be made. The record to date of issue-specific negotiations since the end of the Uruguay Round is discouraging: the United States rejected the financial services package in 1995, and the telecommunications and maritime services efforts faltered earlier this year. The message, once again, is that broader inducements and packages will probably be needed. The tried-and-true alternative of a round should be kept foremost in mind--especially to achieve "global free trade by 2010," perhaps the most ambitious of all the multilateral trade initiatives ever attempted.

The Singapore Ministerial in December 1996 need not decide to embark on a path to "global free trade by 2010" nor whether to convert its successor meeting in 1998 into a Global Trade Summit. It should launch a work program on all these issues anyway as part of the routine evolution of the trading system, including its preparation for whatever might come next. As noted, many of the issues are already on the agenda and should be pursued without difficulty. The tactical considerations can be addressed later as long as the broad strategic vision begins to evolve later this year and a process is set in place that would permit it to eventuate.

Will It Fly?

The final question is the most crucial: is such a proposal politically feasible? Will it fly in the key countries? The doubts and fears outlined above suggest that a herculean effort would be needed to pull it off.

The main problem, as well as the pivotal actor, will probably be the United States. Most other countries have traditionally been more dependent on trade and have thus accepted, if sometimes grudgingly, the case for liberalization. The Europeans, for all their apparent insularity, have removed all barriers to each other and point out quite logically that it would be totally inconsistent for them to impose new restraints on nonmembers. Japan and Korea cannot afford to block progress sought by others, as indicated when they agreed to liberalize rice imports--their politically most sensitive sector by far--at the end of the Uruguay Round. Most developing countries are even more dependent on trade and, as noted at the outset, have been actively engaged for some time in a process of competitive liberalization.

Perhaps surprisingly, there are two reasons why the case for "global free trade by 2010" should be relatively easy to sell in the United States. First, increased trade can be a big help in enabling America to solve its most pressing economic and social problems as described above--wage stagnation and a regressive shift in income distribution. Export jobs pay 15-20 percent more than the average wage. Worker productivity at exporting firms is 20-40 percent higher. These firms expand employment 20 percent faster than non-exporting firms and are 10 percent less likely to fail. Small and medium-sized exporters do even better than large ones and account for 70 percent of all sales abroad.17 Hence even a shift to export jobs from import-competing jobs, which also pay more than the national average, would help considerably even if it had no impact on the American trade balance.

Better yet would be a shift to export jobs from the nontradeable (mainly services) sector, which pays considerably less than all tradeables (mainly manufacturing). This is eminently feasible for the United States without raising major international problems because it continues to run annual trade deficits of $150-200 billion. An improvement of even $100 billion in America's net external position, lowering the deficit to about 1 percent of GDP, would create about 2 million more of these high- paying export jobs than would be lost to growing imports. Total elimination of the external deficit would have twice as positive an impact.

To be sure, substantial adjustments in America's internal economy will be required to achieve such shifts. National savings must rise by 1-2 percent of GDP to obviate our need for the net capital inflows that are the counterpart of the current account deficits,18 but are likely to do so if the budget deficit is eliminated over the next several years even if private savings fail to rebound from their current historic lows. Individuals will need better education, training and retraining to enable them to compete effectively in the world economy--but will need these improvements to raise their incomes with or without further globalization of the American economy.

These internal efforts will fail, however, if American exports fail to win full access to foreign markets. Exports have done well in recent years, almost doubling their share of total US output just since 1985. They would make an enormous contribution to solving our most basic economic and social problems if they could double again by 2010.

"Global free trade by 2010" could make a significant contribution to enabling the United States to reach that goal. Barriers to market access remain quite high in much of the rest of the world, especially the most rapidly growing markets of Asia. An elimination of Japan's barriers alone could expand American exports by $20 billion annually--creating 400,000 very good jobs--or even more.19 Latin America's barriers average three times as much as our own.

"Global free trade" in practice would mean a sharp reduction in barriers in most other countries compared with very little liberalization in the United States, where markets are already largely free.20 This asymmetric nature of the liberalization process, as described above in depicting the "grand bargain," is the second compelling reason why it should be readily acceptable in the United States.

The United States would not receive a totally free ride in such a negotiation. Other countries, in both the industrial and developing world, would insist that the United States subject its import safeguard measures (such as antidumping duties) and its export promotion tools (such as Section 301) to expanded multilateral disciplines. This is a modest price for the United States to pay, however, and the reduction of actual barriers remains almost wholly asymmetric.

From the American standpoint, such an initiative is the only way to achieve a truly "level playing field" across the world economy. It would bring foreign barriers down to our own. At a stroke, it would greatly increase and roll into a single package the benefits that would otherwise be provided for the American economy by NAFTA, APEC, and the FTAA.

Unless one contemplates a reimposition of high tariffs and quotas by the United States, it is fruitless to debate the impact of past trade liberalization negotiations. Their outcome is clear: a relatively open market in the United States contrasted with severely impeded markets in many of the world's largest and most rapidly growing economies. The cardinal goal of American trade policy must be to bring the others to its own level as quickly as possible. The regional initiatives of the 1990s have represented initial steps in that direction. "Global free trade" by a date certain is the only way to complete the process.

There is another strong reason for the United States to support, indeed to help lead, such an initiative: overall foreign policy. Trade and economics are now at the center of the global agenda for most countries. The only way for America to retain global leadership in the post-Cold War period is to remain the leader on trade--as it was as recently as 1993, with the completion of NAFTA and the Uruguay Round, and 1994 with the launch of APEC and the FTAA. Foreign policy, as well as economic, considerations call for renewed American activism in this area.

To be sure, a major political debate will be needed in the United States to endorse such an initiative. That debate will have to come anyway, probably in 1997 or 1998, as the administration of the day seeks Congressional approval to proceed with the liberalizations already agreed in APEC and the FTAA. "Global free trade" would in fact add only modestly to the needed authority, adding Europe (with which trade is already largely free) and a few other developing countries to the package- -always on a reciprocal basis, of course.

But the idea of "free trade" with China and Japan, or even Brazil and Argentina, will surely trigger a national debate beside which the NAFTA legislation of 1993 will pale by comparison. History shows, however, that the United States is far more successful with large initiatives than small ones, certainly in trade. Sweeping visions, such as the Kennedy Round and its successors, engage the President and the Congress in a major national venture. The business community and other supportive constituencies make the investments needed to carry the day. Once launched, the initiatives then have sufficient momentum to overcome rearguard efforts to derail or even erode them.

These political realities can be seen at present. The initiative to extend NAFTA to Chile has faltered in part because the potential gains are too small to mobilize enough domestic support to overcome the opposition, however modest, of those sectors (such as wine) and interests (such as labor) that oppose the idea. The political problem with NAFTA may have been that it was too small: it applied to only one country that was about 4 percent the size of the United States, was pursued without a prior Congressional debate, and lulled President Clinton and the business community into waiting until the last minute before commencing their eventually successful lobbying efforts.

The pro-trade constituencies in the United States realize that the bicycle must be kept moving forward, that the global system must be re-emphasized to avoid the risk that the regional initiatives-- desirable as they are--could evolve in an unhealthy direction, and that they will have to come forward in 1997 or 1998 to make the case again. Presidential leadership will be essential, as always, and can best be guaranteed if the President himself were to play a leading role--or even the leading role--in catalyzing the entire process.

Global Free Trade by 2010

Both international and domestic considerations, around the world and within the United States, thus point in a single direction: the initiation of an agreement in the World Trade Organization, at Singapore or within the next few years, to achieve global free trade by a date certain in the early part of the 21st century. Such an initiative is needed to keep the bicycle of competitive liberalization moving forward. It is essential to provide effective multilateral means to deal with the trade and other international economic disputes that will inevitably increase as economic interdependence grows further. It is necessary to avoid the risk that the rapidly liberalizing regional arrangements, or new ones such as TAFTA, could turn into hostile blocs with adverse effects on international security as well as global prosperity.

From an American standpoint, "global free trade" would provide an opening of markets in the largest and fastest growing economies in the world--and thus stimulate rapid growth in exports and the good jobs that they produce. From a European standpoint, such export growth could bring down unemployment. From the standpoint of Asia and the rest of the developing world, outward-oriented growth strategies could be sustained with an assurance that the rich industrial markets would not turn inward.

The proposed "grand bargain" would globalize the enormously encouraging progress in bridging the North-South gap that has been pioneered in recent years by the key regional agreements-- the European Union, NAFTA, APEC, and the FTAA. The countries that account for the bulk of the world's population, and virtually all of its growth, would become increasingly enmeshed with the "old rich" in a web of cooperative and mutually beneficial economic arrangements. There could be no better investment in securing future peace as well as prosperity.

When the victorious allies constructed the economic system for the postwar world, they included an International Trade Organization (which became the GATT) to reduce barriers and resolve commercial disputes among nations. When Europe united in the late 1950s, the United States initiated a series of multilateral liberalizations to both forge a transAtlantic political partnership and reduce the discriminatory impact of the new Common Market. When those global efforts faltered in the 1980s and early 1990s, partly due to the end of the Cold War, regional liberalization agreements blossomed around the globe to keep the bicycle moving forward and provide insurance against the security as well as economic costs of failure at the center.

"Global free trade by 2010" would continue, and in a sense complete, these earlier acts of statesmanship. It would enhance the prosperity of all countries by underwriting the ultimate success for competitive liberalization. It would preclude the risk that regional arrangements could develop into hostile blocs outside any comprehensive global framework. It would terminate any risk of North-South conflict by engaging both sets of countries in a cooperative multilateral enterprise that met the needs of both.

It could turn out to be premature to attempt to launch a "global free trade" initiative in 1996. But planning should begin and initial steps taken to pave the way. Decisions should be made in the next couple of years to head off the risk that key individual countries, including the United States or the Europeans, or existing or potential regional groupings, would veer in other directions. The vision of "global free trade by 2010" should guide this part of international affairs as the world enters the 21st century.

 

Notes

 

1. For example, the original European Economic Community and the Australia-New Zealand Closer Economic Relationship negotiated 12-year periods to phase out their barriers but completed them in seven.

2. An excellent analysis of the political requirements for successful reform can be found in John Williamson, The Political Economy of Policy Reform, Washington: Institute for International Economics, January 1994.

3. See I. M. Destler and John S. Odell, Anti-Protection: Changing Forces in United States Trade Politics, Washington: Institute for International Economics, September 1987.

4. See Yoichi Funabashi, Asia Pacific Fusion: Japan's Role In APEC, Washington: Institute for International Economics, October 1995.

5. Paul Krugman, The Move Toward Free Trade Zones, Policy Implications of Trade and Currency Zones, The Federal Reserve Bank of Kansas City, August 1991.

6. See Running in Place, Recent Trends in US Living Standards, Washington: Competitiveness Policy

7. Council, September 1996.

8. See Ellen L. Frost, The New Transatlantic Marketplace, Washington: Institute for International Economics, forthcoming.

9. Yoko Sazanami, Shujiro Urata, and Hiroki Kawai, Measuring the Costs of Protection in Japan, Washington: Institute for International Economics, January 1995, conclude that the consumer costs of these barriers total at least 3-4 percent of Japanese GDP and that they block at least $50 billion of imports annually.

10. This case is made persuasively in John Whalley and Colleen Hamilton, The Trading System after the Uruguay Round, Washington: Institute for International Economics, June 1996.

11. See C. Fred Bergsten, The United States, Japan, and APEC, lecture at SAIS-Japan Forum, Washington: October 26, 1995.

12. See Edward M. Graham, Global Corporations and National Governments, Washington: Institute for International Economics, May 1996.

13. Specific proposals can be found in C. Fred Bergsten and C. Randall Henning, Global Economic Leadership and the Group of Seven, Washington: Institute for International Economics, June 1996.

14. See Noboru Hatakeyama, Comment in Jeffrey J. Schott, editor, The World Trading System: Challenges Ahead, Washington: Institute for International Economics, forthcoming, 1996.

15. APEC of course has undertaken numerous initiatives in addition to trade liberalization and will remain an extremely important institution even if its regional trade plans are globalized. One of its cardinal goals is to solidify relations between East Asia and North America, for security as well as economic reasons which it can pursue through trade facilitation and broader economic cooperation as well liberalization initiatives.

16. See especially the first two reports of the Eminent Persons Group: A Vision for APEC: Towards an Asia Pacific Economic Community, Singapore: Asia Pacific Economic Cooperation, October 1993, and Achieving the APEC Vision: Free and Open Trade in the Asia Pacific, Singapore: Asia Pacific Economic Cooperation, August 1994.

17. A full listing is in Jeffrey J. Schott, WTO 2000: Setting the Course for World Trade, Washington: Institute for International Economics, September 1996.

18. These and other data are derived in J. David Richardson and Karin Rindal, Why Exports Really Matter: More!, Washington: Institute for International Economics and Manufacturing Institute, February 1996.

19. These net capital inflows, though essential to fund domestic investment, are a direct cause of the trade deficit because they push up the exchange rate of the dollar and thereby reduce American competitiveness in world markets (including our own).

20. See C. Fred Bergsten and Marcus Noland, Reconcilable Differences? United States-Japan Economic Conflict, Washington: Institute for International Economics, June 1993.

21. America's remaining barriers carry an economic cost of less than $10 billion in an economy of $7 trillion. See Gary C. Hufbauer and Kimberly Ann Elliott, Measuring the Costs of Protection in the United States, Washington: Institute for International Economics, January 1994.



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