What's in a trade deal?

Virtually all of Colombia's exports enter the United States tariff-free, a  fact that is advertised in the USTR web site to assuage US critics who worry about adverse employment implications in this country.  But of course the same fact suggests Colombia is not getting much out of the proposed FTA either (or at least any more than what it could have gotten on its own).  Kevin Gallagher writes:

The U.S.-Colombia Free Trade deal is one of the most deeply flawed trade pacts in U.S. history. It will hardly make a dent in the U.S. economy, looks to make the Colombian economy worse off and accentuate a labor and environmental crisis in Colombia. The Democratic majority in Congress is right to oppose this agreement and call for a rethinking of U.S. trade policy.

According to new estimates by the United Nations Economic Commission for Latin America, the net benefits of the agreement to the U.S. will be a miniscule 0.0000472 percent of GDP or a one-time increase in the level of each American's income by just over one penny. The agreement will actually will make Colombia worse off by up to $75 million or one tenth of one percent of its GDP; losses to Colombia's textiles, apparel, food and heavy manufacturing industries, as they face new competition from U.S. import, will outweigh the gains in Colombian petroleum, mining, and other export sectors, it concludes.

I haven't checked the ECLAC study, but I think it is safe to assume that the conventional economic gains from the agreement are not too different from zero for both partners. 

So it must be the politics right?  Daniel Drezner makes the by-now standard lock-in argument for FTS:

FTAs matter more than unilateral reductions of trade barriers because they decrease the likelihood of policy reversals (which, again,is why Hillary Clinton's proposals to renegotiate FTAs every five years or so is such a God-awful idea). Ratifying the FTA with Colombia increases the likelihood that labor killings will continue to decline.

"Hmm..." is the thought that comes to mind.

But the lock-in notion needs to make a distinction between two different kinds of settings--one of which is much more defensible on traditional "delegation" grounds than the other.  Let me quote myself: 

Consider first the case where the government faces a "time-inconsistency" problem. It would like to commit to free trade ... but realizes that over time it will give in to pressure and deviate from what is its optimal policy ex ante. So it chooses to tie its hands through external discipline. This way, when protectionists ... show up at its door, the government says: "sorry, [the FTA with the US] ... will not let me do it." Everyone is better off, save for the lobbyists and special interests. This is the good kind of delegation and external discipline.

Now consider the second kind. Here, the government fears not its future self, but its future opponents: the opposition party (or parties). The latter may have different views on economic policy, and if victorious in the next election, may well choose to shift course. Now when the incumbent government enters an international agreement, it does so to tie the hands of its opponents. From an ex-ante welfare standpoint, this strategy has much less to recommend itself. The future government may have better or worse ideas about government policy, and it is not clear that restricting its policy space is a win-win outcome. So next time you hear the external-anchor argument, ask yourself whether the government in question wants to "import" external discipline for the first reason or the second.

So what's the real reason the Colombian government wants this deal?

UPDATE: My colleague Maurice Kugler send this clarification:

There is an interview with the Colombian chief trade negotiator that illustrates the thinking of Colombian technocrats by and large. Some of the arguments are precisely the ones you mention. More investment, particularly FDI, due to perception of permanent removal of trade frictions. Also, there is a view that the FTA may contribute to the business environment though political stability. Other additional arguments in favour include the fact that Colombian
producers will have access to cheaper intermediate inputs (currently the average effective tariff is 20% in manufacturing), and the expectation that food prices will drop (though as you point out in your piece on Zoellick, this may cut both ways). Personally, I would be cautious about how large the above purported
benefits can be. However, I believe that market access for Colombian entrepreneurs may make structural transformation more likely as investments and explorations for new exports would have a higher return.

Under APTDEA (with its extension due to expire next year), 90% of Colombian exports enter the US market dutyfree. Under the FTA, 99.98% of manufactures would have been allowed dutyfree. While current exports enter largely without tariffs, it may be that potential exports are supressed by existing tariffs. If potential exporters/investors perceived a permanent drop in tariffs for all manufactures, they may be more likely to sink costs needed to diversify Colombia's export supply.

Comments

[Justin Rietz]

I was unable to find the ECLAC report - do you (or anyone else) have a link?

Thanks.

[Cristina Arango]

I think there are three important reasons why Colombia is pursuing the deal: the first one is that even though it is true that the FTA is pretty much the same thing as the ATPDEA the former expires every couple of years (if not less) therefore long term investment is difficult to make when there is uncertainty if the preferences are going to hold. The second point is that we have very unstable neighbors which precludes us to make business with them (Venezuela shuts the border according to Hugo Chavez mood). Therefore is better for us to have a serious trading partner like the US. Finally, other countries of region have already sign a deal with the US and it is more likely that investment flows to those countries (Peru and Central America) than to Colombia.

At the end of the day, it is not the reduction of tariffs per se that make us (Colombians) want the FTA but the believe on the institution. Making a long term deal with the best partner of the region is like getting a AAA accreditation for the country.

[Don Pedro]

My perceptions--based on recent travels in Colombia and discussions with Colombian friends--is that Colombians see the trade agreement as a symbol of the country's forward movement, out of the period during which the country was dominated by violence and drug trafficking. I think that explains why the agreement is overwhelmingly popular in Colombia, as I show here:
http://econ4obama.blogspot.com/2008/02/trade-and-public-opinion-in-colombia.html

I'd like to see the ECLAC study. The results for the U.S. sound right and are unlikely to be substantially different in any similar analysis. But I suspect the estimated impact for Colombia is highly dependent on the assumptions that go into the analysis.

As a side note, Colombia has a bunch of exotic, delicious fruits that you can't buy in the U.S. I've wondered if this is because some sort of trade restrictions or just because there isn't enough demand (due to unfortunate ignorance of the wonders of Colombian fruit!)

[S Leo]

It seems very clear: colombians support the FTA because they fear losing its preferences under ATPDEA, which are responsible for a big part of Colombia's exports (the unreliable Venezuela takes other big part). Bolivia refused it and is begging for an extension of its ATPDEA preferences while USTR threats to cut them.
The point on investment also has its strenght. If it is not just wishfulthinking...

[Marco Llinas]

Some loose comments on Rodrik’s last posting on the FTA with Colombia:

• Rodrik starts his post by arguing that Colombia’s exports already enter the US tariff free and, thus, the failure of passing the FTA through Congress wouldn’t have much adverse implications in terms of employment in this country. This argument clearly obviates the fact that currently many exports have zero tariff due to some fickle unilateral trade preferences -under an agreement called the ATPDEA- that don’t give investors enough certainties to drive their investment decisions. Every time these preferences are about to expire the Colombian government has to fully employ itself in lobbying the US Congress for some extension, while producers back home are biting their nails off for the miraculous approval, without which they would fall prey to competitors that already have assured access to the US market under FTAs (ie. CAFTA). Thus, critics’ concern need not be assuaged by this argument –or just ask many Colombian cut-flower businessmen who are already talking about translating their investment to Central American countries.

• Rodrik continues his post by citing Kevin Gallagher’s writing where he cites some estimates from an ECLAC study of the economic impact that a FTA might have on Colombia. It is conventional wisdom that these models are static pictures of what would happen in the FTA scenario and, certainly, don’t capture dynamic effects that an FTA could bring about. To this argument Rodrik would say that the dynamic effects could be negative if the country ends up specializing –in accordance with its comparative advantages- in products that have lower productivity growth prospects. It is difficult to tell a priori if this would happen. The truth is that currently investment decisions in many sectors –yes, others than agriculture- are being withhold given the uncertainties surrounding the FTA ratification.

• Rodrik then imbues himself in this dissertation about the two different kind of lock-in settings. Although the argument is theoretically amusing, it is certainly not the reason why the Colombian government is taking the decision to engage in an FTA with the US. As I have told a colleague of mine at the MPAID program, this is no longer an issue of getting “preferential” access relative to other countries. It is about getting “equal” access relative to other competitors that would wipe ashtray Colombian firms in case we don’t get an FTA, with nefarious consequences in terms of this country’s efforts towards finding economically feasible alternatives to illicit crop cultivation.

[alex]

Don Pedro: "Colombia has a bunch of exotic, delicious fruits that you can't buy in the U.S."

Have you looked in the right areas? Seriously. Back when my wife worked in Jackson Heights, NY (an area that has a large Latin American population), she'd always buy fruit there. I don't know whether it was Colombian, but she'd get types of fruit that you couldn't buy elsewhere. The "standard" fruits were also better.

[Anh Tran]

Hello all,

Nice post by Dani and nice comments by others. I'd like to add a few things.

First, the economic analysis of the gain from trade is often very static. Here, showing a zero or near-zero economic gain of the deal ignores a whole array of dynamic dimensions, such as transparency, better governance, and less corruption, resulted from the trade deal. These "non-economic" gains, beleive it or not, do positively influence the economic well-being of the nation in turn.

Second, even if we assume the economic outcome of neglegible gain, it does not mean that the Columbian government has no incentive to pursue the deal. As we all know, any policy option would create winners and losers. Here, if the Columbian winners of the deal have political clout, they would certainly push their government for the deal regardless of the overall outcome of the deal.

Finally, on the American side, people who oppose the deal do have have some compelling arguments, provided that these are sincere and not a disguise of protectionism. In this regard, I strongly believe that we need to take the negative environmental impact and labor abuse into account. These are market failures that need to be addressed. Beyond these, freer trade is certainly beneficial for all parties involved. The Columbian government is quite smart in pursuing this deal agressively. They have a lot more to gain than we do.

[dale]

"This way, when protectionists ... show up at its door, the government says: "sorry, [the FTA with the US] ... will not let me do it." Everyone is better off, save for the lobbyists and special interests. This is the good kind of delegation and external discipline."

Everyone is better off!??
I thought we were well beyond this sort of thinking in regard to who gains from these sorts of trade regimes.

[Punditus Maximus]

Dale -- long run, not short run. In the long run, almost everybody is better off is trade is pursued than if it isn't. South Korea is far richer than North Korea, to take the most extreme example imaginable.

In terms of why Columbia wants the deal, I presume that the local elites are selling out their constituents in order to curry favor with the current Administration in the hopes of getting greater access to US weapons technology. That's how these things usually seem to go.

[David]

When the ECLAC study says The agreement will make Colombia worse off by up to $75 million, does this include the benefits to Columbian consumers? My guess is no. Shouldn't those gains be included for an overall assessment of free trade for Columbians? Isn't free trade about expanding the production AND consumption frontier? (as a student, I'd really like if someone could answer me, thanks.)

[Gallagher]

Here is a link to the CEPAL Study:

http://www.eclac.org/publicaciones/xml/2/29502/lcg2333iDuranOtros.pdf

[Sebastian]

@Punditus -
do you not read Dani's books or don't you believe what's in them? ;-)
Seriously - South Korea is an odd example, because, while they did force their domestics firms to compete - by having them produce for export - for most of it's growth period South Korea can by no means be considered a "free trade" country.

BS on any study that predicts economic outcomes of FTAs with any meaningful precision. More interesting and probably actually answerable questions are distributional - who wins, who loses? I know that Dani doesn't want to do political economy anymore, but I'd suspect that somewhere there, in connection with Marco's smart post above is the answer of why the Colombians would go as far as hire Mark Penn to get the FTA...

[Nathan Smith]

"Now consider the second kind. Here, the government fears not its future self, but its future opponents: the opposition party (or parties)... From an ex-ante welfare standpoint, this strategy has much less to recommend itself..."

It has at least as much to recommend itself *in welfare terms* if you believe in free trade. Most economists seem either to believe in Ricardo's comparative advantage argument, or else to acknowledge that "strategic" trade policy could occasionally be advantageous but regard the government as very poor at "picking winners." If the next government is more protectionist than the current one, it's better for this government to make long-term policies and for the next government to have its hands tied.

What's more compelling is the idea that it might be *undemocratic* for the current government to tie the hands of the next one. But then, all sorts of growth-promoting policies inherently involve *commitment.* There is a sense in which property rights and free speech are anti-democratic. At the end of the day, it's just a good thing to have decisions about whether to trade or not be in the hands of the traders and not of bureaucratic meddlers. If FTAs get us closer to that ideal, more power to them.

[dale]

"At the end of the day, it's just a good thing to have decisions about whether to trade or not be in the hands of the traders and not of bureaucratic meddlers. If FTAs get us closer to that ideal, more power to them."

I find this sentiment quite troubling.
It seems just another way of granting political power to multinational corporations under the fig leaf of the word "free" in "free" trade. In a democratic society the representatives of the people would seem to have a greater degree of legitimation than do the fictional persons we call corporations.

[Gallagher]

What is interesting about the Cepal study (which yes is a basic GTAP analysis) is that in both Table 10 and 11 they predict that the losses from the FTA are greater than the losses accrued if they say no the FTA AND lose their preferences.

What could be going on with Colombia--if we assumed that they are rationally trying to attract gains but no model captures ideaology--is reacting in a "hub and spoke" fashion.

My old professor Carsten Kowalcyk has advanced the hub and spoke theory of regional trade agreements:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=233701

The elegant theory is only for you super trade wonks but the very simple version is that nations are forced to sign these agreements to prevent their trading partners from obtaining gains and so as not to be hurt if their other trading partners sign agreements with a big country first.

[Alejandro Pelaez]

Folks, it is Colombia, not Columbia.

[David]

Concerning the ECLAC study, I agree with Dani when he says "it is safe to assume that the conventional economic gains from the agreement are not too different from zero for both partners."

After all, how can a country LOSE 75M$ by freeing up its exchanges? The ECLAC study does not captures consumer surplus and only looks at who gains and who loses among columbia's exporting industries. It's like saying exports=good, imports=bad.

If my memories of Econ 10 are right, free trade increase overall economic welfare. Some loses, some wins, but you can't end up with a 75M$ loss. If so, why don't all countries increase tarifs on all their products tenfold so we can all get richer.

[Jorge Romero-Habeych]

At what point did we start believing (as economists) that Free Trade = Managed trade? CAFTA and other FTAs do not represent free trade. Free trade occurs in the absence of government interference in the flow of goods. As economists and believers of free trade we should reject FTAs. FATs grant quasi-governmental international bodies the power to make decisions about American trade rules, as if we didn't have enough idiots in our own backyard. We don't need FTAs to reap the economic benefits that are derived from free trade, all we need to do is change our own harmful economic and tax policies. Congress has in many instances changed American tax laws for the sole reason that the WTO decided our rules unfairly impacted the European Union. All FTAs diminish American Sovereignty which in turn hurt the American consumer. Oh...and the most important reason for rejecting FTAs (not free trade), they are unconstitutional...congress alone has the authority to regulate free trade.FTAs give ammunition to the protectionist who blames "free trade" for the negative effects of a NAFTA , CAFTA, and so on...it allows that individual to shed negative light on the economic principle of free trade. A good example is our current economic crisis, everyone blames the free market and they lobby congress who in turn responds with more regulation and more government inefficiency setting us up for the next bubble burst which everyone will of course blame on free market capitalism. Maybe we should just stop fooling ourselves and admit the fact that we (as a nation) no longer practice free market capitalism but instead believe in CENTRAL PLANNING and MANAGED TRADE.

[wjd123]

Trade looked at in a different way, from the bottom up, yields some different conclusions.

From the bottom up these free trade agreements look like government lashed to the mast of the Ship of State in order to satisfy the ex anti concerns of global corporations. Government looks more as if it's protecting itself from the legitimate concerns of corporate stakeholders such as labor, suppliers, and communities than protecting itself from special interests since these stakeholder concerns are writ large within our political economy. They are not narrow special interest.

From a bottom up point of view, the view of workers who used their power to negotiate for better wages, and the communities who benefited form a more equitable distribution of income, government tying its hands because of a time inconsistency problem looks more like government raising its hand to stab the stakeholders' part of our political economy in the back.

That feeling intensifies the longer citizens don't find find those better jobs that were suppose to materialize as comparative advantage worked its magic.

Nor does it seem to naked labor elsewhere being push by some low cost bidder to meet the product needs of some American company that's its not America that is condoning their plight no matter how tied our government insists its hands to be from changing corporate power.

So from a bottom up point of view these trade agreement simply don't yield the foreign policy dividends at home or elsewhere that Daniel Drezner insists they do. Government attending to the ex ante concerns of corporations over the concerns of all their stakeholders appear to be little more than the organizing power and money of corporations capturing the people's government.

Looked at this way, government tying its hands to discipline itself doesn't save the government from itself as much as it opens the government to charges from the bottom up of illegitimacy.

Corporations will argue that they made their investments because of assurances that tariffs wouldn't be raised. This is what corporations want to believe. There never were such assurances. For instance with six months notice we can leave NAFTA and go back to normal trade relations.

That's the discipline that corporations have to remember as they become global citizens. A political economy with tariffs near at hand helps keeps corporate citizens from poising the political economies of nations by becoming global anarchist. That's not a bad thing.

I disagree with the ex ante arguments of corporations not because they aren't a legitimate concern but because they have no place in a global trade regime without international governments to discipline corporations.

And I disagree with both Dani's "time inconsistency" arguments because government gives up too much power to corporations at the expense of itself (legitimacy) and stakeholders (writ large) in our political economy.

If anything, reviewing free trade agreements every 5 years is a way of maintaining corporate discipline in the global marketplace: The Sword of Damocles that keeps some semblance of a check on corporate power.

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