Mare liberum: enhancing trade across two oceans with TPP and TTIP
- There currently two large trade agreements under negotiation that could have a major economic impact in the world as they involve both the US, the EU and a dozen Pacific countries
- The Trans-Pacific Partnership (TPP), comprising 12 countries on both sides of the Pacific is expected to intensify trade flows between the countries involved.
- The Trans-Atlantic Trade and Investment Partnership (TTIP) is a large comprehensive negotiation between the US and the EU and includes innovative provisions on regulatory cooperation that could lead to global standards in automotive and pharmaceutical sectors
- Lower trade barriers will lead to increased competition and reallocation of labour and capital towards most productive sectors which will spur efficiency. This can have a major impact on certain sectors
- The exact benefits of both free trade agreements (FTA’s) are difficult to quantify as models tend to be sensitive to assumptions about price elasticities and reductions of non-tariff barriers
- Overall we expect a positive effect of both agreements on trade and GDP in countries involved in the negotiation. Countries not involved in the negotiation may suffer in trade and GDP as a result of trade diversion
Currently two major regional trade liberalization initiatives are being negotiated that both include the US as a key player: the Trans-Pacific Partnership (TPP) and the Trans- Atlantic Trade and Investment Partnership (TTIP). The TPP, when concluded, will enlarge the current Trans-Pacific Strategic Economic Partnership Agreement (2005) between New Zealand, Chile, Singapore and Brunei to include the US, Canada, Mexico, Japan, Vietnam, Malaysia, Australia and Peru. TTIP stretches across the other great ocean and aims to boost trade between the US and EU.
Comparison between TTIP and TPP
There are some notable differences between TTIP and TPP and these stem mainly from the negotiators involved. TPP involves a diverse group of countries, it includes some countries with the highest income per capita like the US, Canada, Australia and Singapore but also emerging markets like Malaysia, Mexico and Peru. Especially in countries where public governance is still less developed, we see that governments wield more influence in the economy than in fully fledged market economies. Also the intellectual property rights framework is less developed and the respect for international labour standards is lower. That is why TPP, next to tariff measures, includes provisions on state-owned enterprises, labor protection standards and the protection of (intellectual) property rights. These represent innovations to the ‘plain vanilla’ free trade agreements which focus on reduction of tariffs and non-tariff measures. If we categorize TPP as an FTA 1.5 for this reason, then TTIP surely is an FTA 2.0 (see Table 1 for an overview of the different categories of free trade agreements or FTAs). TTIP is an agreement between OECD countries which differ much less in terms of public governance or the role of state enterprises. Moreover, on the European side, there has been legal convergence through legislation on the European level and jurisprudence by the European Court of Justice (ECJ). The innovations of TTIP are much more far-reaching than TPP. Next to removing direct trade barriers and lowering tariffs, TTIP encompasses articles on mutual recognition of product standards in areas where they are high in both countries (e.g. cars or pharmaceuticals). Moreover, TTIP creates a dialogue to cooperate on developing legislation for new products. When the two largest markets for manufacturing goods start developing joint product standards, these are de facto global product standards. As such both TPP and TTIP are difficult to separate from the geopolitical context. From the US perspective both deals can viewed as containment policy vis-à-vis China.
Timelines for the agreements
The TPP negotiations began much earlier than those on TTIP so it is only natural that they are in more advanced stage of negotiation. In early 2015 the TTIP negotiations moved into their 10th round while TPP’s 19th round already ended in 2013, after which the TPP negotiations moved into the political level. Recently the US and Japan reached agreement on key issues. The ministers meeting held from the 28th until the 31st of August in Hawaii didn’t yield a comprehensive agreement. This is because most negotiating countries had not stated their key positions, letting the US and Japan sort out their differences first. The Hawaii talks forced countries to reveal their positions on key issues, and now it will likely take weeks of talks and another meeting to really come to a deal. So far, the main problem areas are dairy (New Zealand and Australia vs Canada), origin rules for cars (US vs Mexico and Canada) and the protection of intellectual property rights on drugs (US vs Chile and Australia).
Looking at TTIP, it becomes apparent that the agreement benefits from the fact that there are two de jure negotiators, even though de facto, EU member states hold significant sway over negotiating positions taken by the European Commission. TTIP negotiations are unlikely to reach the political level until TPP is concluded, as the US needs it resources and political capital to secure TPP, the latter being salient for the US’ geopolitical strategy in Asia. For TPP a deal is expected before the end of 2015, for TTIP the communicated deadline has shifted from end of 2015 as stated last year to 2016 stated this year.
Box 1: Investor protection trough ISDS
An issue that gets a lot of media traction in Europe is the investor state dispute settlement (ISDS). This provision which is relatively common in FTA’s is currently one of the most debated topics of TTIP in Europe. ISDS provides a mechanism to resolve disputes between investors and national governments when a government enacts legislation that hurts the value of the investment of the respective investor. This provision is desirable from the side of the investor as a country’s legal system can be biased against foreign investors. On the other hand it is argued that the prospect of litigation could cause regulatory chill, which is defined as “[a situation where] a State actor will fail to enact or enforce bona fide regulatory measures because of a perceived or actual threat of investment arbitration.” (Tietje& Baetens, 2014). Regulatory chill is bad news for democracy as it de facto limits national sovereignty. Politically we see that the consensus is that some form of investor protection is indeed desirable as Europe also hosts numerous companies that invest abroad. The discussion now focusses on the institution charged with arbitration. It is common practice to appoint an arbitration panel to deal with complaints. The setup of the arbitration panel is somewhat intransparent as the legal experts meet behind closed doors and appeal is not possible. In the latest mandate the European Parliament gave to the European negotiators, they let room for choosing a courtly setting of the panel that would allow for appeals and where the panel would consist of professional independent judges rather than legal professionals.
A step back; the benefits of free trade
Free trade between countries allows for an efficient allocation of production. By taking advantage of comparative advantages, global output can be maximized. A solid body of literature in international economics has shown how free trade would maximize output, hence welfare. Trade can also have a stabilizing effect on a domestic economy: When a country is hit by a country-specific shock, its production will be less negatively affected when it can export itself out of a recession.
In practice however, governments have created a vast array of trade barriers and ranging from tariffs to shield their domestic sectors from international competition. The usual explanations for protectionism are the protection of ‘infant industries’ and the generation of government tax revenues. Besides economic reasons, security, health and the environment are also used as arguments to restrict trade. However, these arguments can also be misused to disguise economic reasons. In fact, red tape can be effective in circumventing free trade agreements and giving domestic producers a competitive edge.
Winners, losers and special interest groups
Why does protectionism exist if all countries could benefit from free trade? While a country as a whole usually gains from free trade, opening up markets may lead to considerable re-allocations of production and income. These ‘allocative’ and ‘distributional’ effects will make certain industries and occupational groups worse off under free trade. Some worst cases show whole industries can disappear, often with specialized occupations alongside them. That is why free trade agreements are met with fierce opposition from the affected interest groups, such as ‘infant industries’ that need protectionist measures to compete, farmers who fear increased competition from abroad and labor unions trying to preserve current jobs. In contrast, multinationals often benefit from the allocative effects and tend to support free trade. The same is true for exporters that are currently facing trade restrictions. So while free trade is usually welfare-enhancing at the aggregate level, the political feasibility is not as straightforward and could require redistributional measures by the government to compensate those who lose from the free trade agreement.
Making the pie bigger… but only for invitees
After a set of global initiatives to liberalize trade, such as the General Agreement on Tariffs and Trade (GATT) in 1948 and setting up the WTO in 1995, global initiatives have gradually given way to regional trade agreements. Regional trade agreements reduce trade barriers between participating countries, generating trade flows that exploit the comparative advantages of each country. This effect is known as ‘trade creation’. However, a regional trade agreement also causes ‘trade diversion’ of imports from cost-efficient non-participating countries to inefficient participating countries. (Kohl et al. 2013) While trade creation enhances welfare, trade diversion is a welfare loss to the region. While ‘regionalism’ could make multilateral trade liberalization through GATT easier as trade barriers between participants have already been reduced, it also raises the risk of retaliation between trading blocs.
The possible impact of TPP and TTIP
There have been several attempts to quantify the effects of the two free trade agreements. In Table 3 and 4 we summarize the potential welfare gains from TPP and TTIP found in the various studies. The variation in outcomes is substantial, which can be attributed to a large extent to the research design. The authors have to choose a model and make assumptions about price elasticities and the amount of non-tariff barriers (NTBs) that will be reduced under a free trade agreement. Particularly the NTBs are tricky as they are intangible while they comprise the largest part of the barriers that exporting firms face. We can clearly see this effect between the less and more ambitious scenarios of TTIP, where the latter suggest much higher gains from TTIP. In the TPP literature, there is more variation in the chosen scenarios, resulting in even more variation in outcomes than between the TTIP studies. Another complicating factor is that most studies are commissioned by stakeholders of negotiations. We therefore exert some caution over the exact welfare gains from either agreement.
Despite the uncertainty over the exact effects of the free trade agreements, we can make some general inferences about the possible effects. As pointed out above a trade agreement may lead to intensifying trade between the FTA parties, but non-participating countries may see a decline in trade.
The effect of trade diversion caused by TPP for Europe is not expected to be large. The model of Petri et al. (2013) suggests that trade diversion effects for the EU are actually mitigated by an improvement in its terms of trade, limiting the welfare loss. In contrast, we would expect to see more substantial trade diversion from TPP affect East Asian countries that do not participate in TPP. As for trade creation, TPP will have a major effect on countries that are currently very protective of their own sectors as liberalizations will drive efficiency.
For TTIP we expect to see trade diversion for non-participating countries with industries that compete with both the US and Europe. Raza et al. (2014) suggest that middle income countries would be particularly affected by trade diversion effects. Looking at sectors we expect American or European sectors that are relatively competitive at the moment are likely to benefit while uncompetitive sectors will suffer from increased competition. According to the CEPR (2013) study, competitive sectors in the EU that would gain from TTIP are automotive, water transport and insurance sectors. For the US these include electronic machinery, metals and metal products and other transport equipment. The benefits of TTIP will not only be the result of trade liberalization but also of regulatory cooperation. The latter could set worldwide product standards for cars and pharmaceuticals.
The two free trade agreements are likely to boost trade and efficiency in a total of 29 countries involved in the negotiations. At the same time, trade diversion may have a negative impact on non-participating countries. There will also be effects on the allocation of production and the distribution of income. While countries as a whole are likely to benefit from free trade, government measures to redistribute the gains from free trade may be necessary.
Areerat, T., Kameyama, H., Ito, S., & Yamauchi, K. E. (2012). Trans Pacific Stategic Economic Partnership With Japan, South Korea and China Integrate: General Equilibrium Approach. American Journal of Economics and Business Administration, 4(1), 40.
Centre for Economic Policy Research (2013a). Reducing transatlantic barriers to trade and investment: An economic assessment. Study commissioned by European Commission, prepared under implementing Framework Contract TRADE10/A2/A16.
Centre for Economic Policy Research (2013b). Estimating the Economic Impact on the UK of a Transatlantic Trade and Investment Partnership Agreement between the European Union and the United States.
Kawasaki, K. (2015). The Relative Significance of EPAs in Asia-Pacific. Journal of Asian Economics.
Fontagné, L., Gourdon, J., & Jean, S. (2013). Transatlantic trade: Whither partnership, which economic consequences. CEPII, Policy Brief, 1.
Ecorys (2009). Non-Tariff Measures in EU-US Trade and Investment: An Economic Analysis. ECORYS Nederland BV, European Commission, study commissioned by Directorate-General for Trade (European Commission).
Kohl, T., Brakman, S., & Garretsen, H. (2013). Do trade agreements stimulate international trade differently? Evidence from 296 trade agreements.
Petri, P. A., & Plummer, M. G. (2012). The Trans-Pacific Partnership and Asia-Pacific Integration: Policy Implications. Peterson Institute for International Economics Policy Brief, Forthcoming.
Tietje, Christian and Freya Baetens (2014), The Impact of Investor-State-Dispute Settlement (ISDS) in the Transatlantic Trade and Investment Partnership, study commissioned by the Ministry for Foreign Trade and Development Cooperation, Ministry of Foreign Affairs, The Netherlands.
Raza, Werner et al. (2014): Assess_TTIP: Assessing the claims benefits of the Transatlantic Trade and Investment Partnership. Wien
Appendix: The Alphabet Soup
TTIP/Transatlantic Trade and Investment Partnership: The colossal free trade agreement (FTA) between the US and the EU. The deal is expected to reduce non-tariff barriers that often amount 20% of the value of products. TTIP extensively covers product standards, which means that in the future the US and the EU could be setting global industry standards jointly.
TPP/Transpacific Partnership: This free trade agreement includes a number of Pacific countries on both sides of the ocean. On the Eastern side it includes US, Mexico, Canada, Chile and Peru and in the east Japan, Australia, New Zealand, Malaysia, Vietnam, Singapore and Brunei. Next to lowering trade barriers, the FTA includes provisions on worker’s rights and the protection of property rights.
TPA/Trade Promotion Authority: This power can be granted by the US Congress to the president to negotiate a free trade agreement. When a deal is concluded, the resulting bill can only be accepted or rejected by Congress. This means a deal cannot be reopened by Congress and also that the bill cannot be filibustered (held up by endless speeches).