What is a trade agreement, anyway?
Trade tensions between the United States and the European Union are not dissipating. The most recent spat is publicly unfolding over President Biden’s signature climate legislation, the Inflation Reduction Act (IRA).
Nowhere was the lack of rapprochement clearer than during French President Emmanuel Macron’s state visit to Washington last November, where he was reported to have told Sen. Joe Manchin (D-W.Va.), a critical architect of the bill, “You’re hurting my country.”
The reason for such an accusation stems from a provision in the IRA that will give consumer tax credits for purchases of electric vehicles (EVs) that meet certain criteria, including sourcing the critical minerals that go into EV batteries from countries with which the United States has a trade agreement. The problem? Manchin seems to have discovered only recently that the United States does not have a trade agreement with the European Union (EU). The Treasury Department, which is developing guidance on implementation of the IRA, may have a solution. However, its attempts to address the most recent transatlantic trade friction could create a bigger problem.
The world economy consists of 193 economies, with the United States being the largest.
As per World Bank estimates, the nominal world GDP in 2017 was $80,683.79 billion. In 2018, the nominal world GDP was $84,835.46 billion in 2018, and it’s projected to be $88,081.13 billion in 2019.
The World Economy is formed by 193 economies. In this conglomerate, 40 countries are directly involved in the sanctions against Russia.
So where the 40 countries participating in the Russia sanctions and representing more than 50% of the World GDP have found alternatives and substitutes?
How is the real impact on the 153 countries that are not participating in the Russia sanctions?
How the rest of the World Economy is actually impacted by such decline and dependency of Russia on international supply and demand?
These are the real and targeted interrogations that are not presented here par this portrait of “colossal damage to the Kremlin’s ability to wage war. And the damage will only grow over time.”
Is this damage only growing over time for the rest of the World Economy?
Or is this just the problem for Russia?
How about the Rest of the World and in the first place these 153 countries not involved in the Russia Sanctions but are on the front line also of the Trade and Economic Wars resulting from the Sanctions against Russia which is adding more conflictual relationships and cementing the International competition and other trade antagonisms already existing in the world before even the Russia – Ukraine War.
Would it be more informative if the European Commission had provided more accurate inputs based on an assessment and evaluation with references to what is the real impact of Russia Sanctions on all the aforementioned aspects within the countries participating and those not participating in the sanctions against Russia?
What are the Contingency plans that the European Commission had built to reduce those impacts worldwide?
GLOBAL ALTERNATIVES and TRADE ARRANGEMENTS
REGIONAL INTEGRATION
In response to the dilemmas of trade, most nations have fashioned some amalgam of mercantilist and liberal policies, seeking to capture the benefits of each approach without surrendering to the liabilities of either. One increasingly popular strategy is regional integration, which creates free trade within a group of nations but practices mercantilism toward nations outside that group. (1)
In this chapter I examine two variants of regional integration at very different stages of evolution: the European Union (EU) and the North American Free Trade Agreement (NAFTA). The NAFTA and the EU appear to foreshadow a global political economy of regional trading blocs which could signal an end to the open structure that has defined international economic affairs since the end of World War II.(2)
The European Union was created in 1993 as the most recent of a progression of institutions that embody a vision of regional integration laid out in a 1946 speech by Winston Churchill: “I see no reason why, under the leadership of the world organization, there should not ultimately arise the United States of Europe, both those of the East and those of the West, which will unify this Continent in a manner never known since the fall of the Roman Empire, and within which all its peoples may dwell together in prosperity, in justice, and in peace.”(3)
For nearly fifty years this image has guided a regional integration effort that has widened from six to fifteen nations and deepened from a narrow technical focus to an ambitious social, political, and economic agenda. The Treaty of Paris, signed in 1951 by France, Germany, Italy, Belgium, the Netherlands, and Luxembourg, founded the European Coal and Steel Community (ECSC).(4) The treaty not only pooled and centralized the production of coal and steel, it also introduced the High Authority, the Council of Ministers, the Court of Justice, and the Parliamentary Assembly, all of which remain part of the institutional framework of the much broader EU [that] has subsequently evolved.
The Treaty of Rome, signed in 1957 by the same six nations, established the European Atomic Energy Community (EURATOM), and the European Economic Community (EEC), which greatly expanded the scope of the ECSC treaty by calling for the dissolution of barriers dividing Europe, the improvement and equalization of living and working standards, the abolition of restrictions on international trade, the removal of obstacles to concerted action among governments, and the enhancement of peace and liberty through closer relations among states. In 1967, the executives of these three European communities were merged. The Single European Act, which went into effect in 1987, was designed to create by 1992 the “single European market” that had been envisioned in the Treaty of Rome but had not been realized, “an area without internal frontiers in which the free movement of goods, persons, services and capitals is ensured”. In 1993 the Treaty on European Union, signed at Maastricht the previous year, entered into force, renaming the expanding web of institutions the European Union.(5) This institutional structure is increasingly state-like with legislative, executive, and judicial branches (Parliament, Commission, Council of Ministers, and Court of Justice); economic institutions (Investment Bank, Central Bank, and Court of Auditors); and a variety of institutions that provide representation for the interests of various groups (Economic and Social Committee, Environmental Agency, Committee on Regions, Ombudsman, and many others). Meanwhile, Britain, Ireland, and Denmark had become members in 1973; Greece in 1981; Portugal and Spain in 1986; and Austria, Finland, and Sweden in 1995. As of 1999, eleven additional countries have applied for EU membership and several others have reached trade agreements with the EU which give them some of the advantages of membership.
Despite this growth, the future of the EU itself remains somewhat uncertain, because considerable opposition has arisen in many member countries as integration has deepened. A long-standing objection of critics is that European integration implies a substantial abdication of national sovereignty because it requires that national law be brought into accordance with EU law and because regional institutions are slowly eclipsing national ones as governing bodies. In fact, the Treaty on European Union was initially rejected by a national referendum in one member country and survived very close votes in several others. Its most controversial elements were the call for a common defense policy and, especially, a monetary union with a single currency that would replace national ones.
It has long been apparent that the continuing liberalization of trade in Europe required a considerably more stable monetary arrangement than the system of freely floating exchange rate that had existed among all developed countries since the demise of the fixed exchange rate system of Bretton Woods in the early 1970s. The most recent attempt at stabilization, the introduction of the currency called the euro, is discussed in greater detail later on. It illustrates that the dilemmas involved in trade, especially those concerning national sovereignty, carry over into the monetary arrangements required to facilitate it. Because of this concern over national sovereignty, not all the EU nations have joined the euro arrangement. Furthermore, because EU members fear that such intensive ties to nations with weaker economies would introduce too much instability, they established criteria for participation in the euro that many of the nations seeking EU membership would not meet. Regional integration is a strategy that attempts to maximize the benefits and minimize the costs of trade by very carefully selecting partners in trade and in the institutions that must accompany it.
INTEGRATION: LIBERAL ON THE INSIDE AND MERCANTILIST ON THE OUTSIDE
Regional integration is best thought of as trade policy that is liberal on the inside and mercantilist on the outside. Within the community, free trade is encouraged by the elimination of trade barriers and the harmonization of economic policies. Trade barriers remain against the outside world, however, and the community achieves mercantilist goals of self-sufficiency and enhanced power that would be impossible for the constituent nations individually.[ Even the largest EU member, Germany, has a GDP barely a quarter of that of the United States, but the economy of the EU as a whole is slightly larger than the U.S.(6)]
Though liberals argue that both peace and prosperity could be achieved more fully through global free trade, regional integration may deal more effectively with trade dilemmas. First, regionalism [dampens, though it does not eliminate,] mercantilist worries about sacrificing national self-sufficiency[ and autonomy]. Regional interdependence is less risky than surrendering control of the economy to the vicissitudes of global markets and the economic policies of 150 other nations, especially because regional nations are likely to share basic values and economic structures. Second, regional integration creates a level of governance above the nation that can soften the dislocations and resolve the disputes that inevitably arise from trade.
THE MERCANTILIST ROOTS OF THE EU
The presence of trade diversion makes it clear why outside nations typically see the mercantilist face of regional integration rather than its liberal face, which is turned inward. From their standpoint, regionalism not only furthers the classical mercantilist goal of protecting domestic industry, it does so through a classical mercantilist melding of foreign policy concerns with economic aims. Rather than erect trade barriers against all foreign competitors equally, the EU discriminates against nations outside the region, often because they are seen as a threat.
Indeed, from its beginnings, European unification has accelerated whenever threats from outside have been perceived. The early EC was designed to protect Europe against the Soviet military threat posed by a large army and aggressive doctrine as well as the American economic threat posed by large productive capacity and expansionist marketing plans. The Single Market initiative culminating in 1992–Carlo DiBenedetti called it “a deadline not to be dead”–was energized by the economic threat of rapidly growing productivity in Asia and the resulting “Euro-pessimism.” Again we see that nations turn in a mercantilist direction when their industries fear more competitive firms abroad and when their states fear the rising power of rivals. The EU’s goals are no different than those of Queen Elizabeth’s sixteenth-century industrial development or Japan’s postwar export promotion: its uniqueness lies in the regional emphasis of its mercantilism, which can be seen most clearly by contrasting liberal and mercantilist viewpoints on trade diversion.
Whereas liberal theory disapproves of trade diversion because it compromises efficiency, mercantilism finds it perfectly acceptable if it helps to achieve other national goals. Since many values and goals conflict with efficiency, nations may prefer to trade with one country rather than another for several reasons. First, a nation may divert trade in order to benefit an economy whose resulting prosperity produces greater side benefits for it. For example, for reasons of physical proximity and economic integration, Germany is much more likely to gain from the prosperity of France than it is from the prosperity of a nation–for example, Japan or the United States–that is thousands of miles away.
Second, trade diversion under regional integration is reciprocated: Germany diverts its trade toward France, and in exchange, France diverts its trade toward Germany. Third, most European nations are more comfortable with depending upon other Europeans than upon Japan or even the United States. Not only do they share more security concerns with their European neighbors but they also have more common views on issues that always arise in trade matters (e.g., dilemmas involving job security, welfare arrangements, and environmental protection). Furthermore, they can create regional institutions such as those of the EU to cope with whatever conflict may stem from differences in how they respond to trade dilemmas.
The liberal roots of the EU
Despite these undeniable mercantilist motivations, the EU is also deeply rooted in liberal ideas, especially the gains from trade promised by Ricardian theory. For example, the Cecchini report (1988) was instrumental in gathering support for the Single Market initiative by estimating trade gains resulting in a 35 percent boost in GDP. However, gains from specialization and enhanced competition are not the only benefits of the EU seen by liberal theorists.
Economies of scale, which have always been a strong motivation for the smaller countries of Europe, were especially visible in the ECSC. Because steelmaking requires large-scale plants and equipment that are efficient only when producing large volumes of output, a steel industry could never emerge in a small country unless a firm could be guaranteed access to the larger European market. The ECSC provided that guarantee in the form of the pledges by European governments not to interfere with free trade in these goods. The result was a key industry with production facilities scattered among different countries, each dependent on other nations to provide both demand for the final product and part of the supply capacity. A side benefit of this arrangement was the fulfillment of the liberal dream of an interdependence that would prevent war by making it suicidal.
In fact, the EU’s economic institutions were constructed for a political purpose. The mission of European integration, as stated in the preamble to the ECSC treaty, is to “substitute for age-old rivalries the merger of their essential interests; to create, by establishing an economic community, the basis for a broader and deeper community among peoples long divided by bloody conflicts; and to lay the foundations for institutions which will give direction to a destiny henceforward shared.” Thus, the ECSC was an innovative form of peace treaty, designed, in the words of Robert Schuman, to “make it plain that any war between France and Germany becomes, not merely unthinkable, but materially impossible.” In the aftermath of two devastating wars in the previous thirty years–which more conventional tools of international politics such as the European balance of power, the League of Nations, and international law could not prevent–European nations were willing to tolerate the erosion of national autonomy and self-sufficiency implied by interdependence in order to weaken the nationalism that had provoked so much violence.
THE POLITICAL ROOTS OF THE EU
Throughout its history, European integration has been seen as a means of escaping the liberal and mercantilist horns of trade dilemmas by providing a regional level of governance to deal with common problems that no single nation could solve. For example, the Common Agricultural Policy (CAP), born in 1962, embraced a concern with the distributional dilemma of trade that would have been at home in parliamentary debates of the eighteenth century: Its goals included “the assurance that those working in agriculture will enjoy a standard of living comparable to that enjoyed by workers in other sectors.” Because it was evident as early as 1951 that this motivation implied an ambitious institutional design, the Treaty of Paris went well beyond limited economic objectives to create the executive and legislative institutions that remain at the heart of the contemporary EU. Later, the Treaty of Rome’s social and political provisions–which included the creation of the Economic and Social Committee to provide a strong voice for workers, employers, consumers, and academics–made the EC much more than a mechanism for advancing free trade.
These arrangements were a direct outgrowth of the values and theories that influenced national economic policies in Europe, especially where working-class political parties of the left came to power–Labour in Britain, Social Democrats in Germany and Scandinavia, and Socialists in France, Italy, and Spain. Rooted in powerful trade union movements, those parties embraced values of egalitarianism that emphasized the welfare and security of workers and shared the conviction that it was safer to entrust these goals to the state than to free markets. They erected welfare states to provide institutional protection against the vagaries of markets that were quite distinct from the more laissez-faire arrangements in the United States. For example, vacations, maternity leave, and health insurance, which are all voluntary fringe benefits in the United States, are determined by law in most EU states.
Furthermore, because some constitutions list the right to work among human rights, the ability of firms to hire and fire workers is sharply constrained. When European national governments spend an average of 25 percent of GDP on social protection, it is hardly a surprise that an agreement to increase trade would include a provision to compensate those who would lose in the resulting dislocations. Indeed, the Social Fund, created in 1951 to finance worker retraining and relocation necessitated by the ECSC and now charged with aiding trade-damaged geographic regions, has become the second largest expenditure in the EU budget (behind agriculture).
Economists contend that compensating losers–though second best to laissez-faire–is preferable to protecting jobs through trade barriers, which are inefficient because the price increases they induce cut consumption and reward less efficient domestic producers. The second-best alternative is to augment free trade with programs that directly compensate displaced workers, such as unemployment insurance. However, because the taxes to finance such programs may be more visible to voters than trade barriers, protectionism may be politically first best though economically third best, at least where redistributive measures have limited philosophical support, such as in liberal America. The European socialist tradition makes it easier to sustain much more generous welfare provisions, but such policies are not costless. They may be responsible for unemployment levels of over 10 percent throughout Europe in the 1980s and 1990s, which would be completely unacceptable in the United States both because of the hardship on the unemployed and the tax drain of supporting them. By contrast, European polities would not tolerate the American approach, which accepted “high risk and high reward, and left its losers to be pushed far from the economic and social mainstream,” resulting in a “frisky, but cruel economy.”(8)
However, it is difficult to maintain social protection–which inevitably imposes costs on business–when diminishing trade barriers force firms to compete with those in other countries that do not bear such burdens. For example, French firms demand a level playing field in competing with Spanish firms whenever the French government mandates employee benefits, health and safety rules, or environmental regulations more costly than those in Spain. In fact, free trade tends to harmonize many national policies, making it especially difficult for a nation to sustain different tax policies than its neighbors. Denmark, for example, found it impossible to maintain a value-added tax (VAT, i.e., sales tax) 8 percent higher than neighboring Germany’s because Danish citizens could simply evade the tax by purchasing goods in Germany and bringing them across the border duty free.
Thus, some trade barriers must exist if nations wish to maintain different laws with respect to many aspects of economic, social, and political life. Of course, different nations do choose different policies because they reflect different values and theories, different economic circumstances, and different balances of political power. Different tax policies, for example, reflect fundamentally different philosophies concerning how big the state should be, what functions it ought to perform, and how progressive taxation should be. In most nations, such key issues trigger mighty partisan battles over philosophical principles and the distribution of costs and benefits. In short, trade poses fundamental dilemmas, made more troublesome when nations pressed together by trade ties view such dilemmas differently, as in the case of the United States and Japan. Indeed, regional integration is attractive to many nations precisely because it increases trade with regional neighbors–who are presumably similar in important ways–while retaining insulation from nations who are more distant not only geographically but in policy preferences.
Even in Europe, however, these dilemmas have been recognized but not resolved; instead, the battleground has shifted from national-level to regional-level politics. For example, workers fear that without regional coordination, diminishing trade barriers will tend to harmonize national policies by driving all nations to emulate those with the weakest social protection, an outcome called social dumping. Recognizing that national policies would increasingly converge, leftist parties successfully sought to foster harmonization in which the more laissez-faire countries emulate those with the most elaborate social policies. For example, the goal of the EU’s Social Charter in 1989 was to promote “convergence between social protection policies to avoid … competition between the systems with the attendant risk of decreasing social standards.” In particular, the European Parliament recognized “fundamental social rights which should not be jeopardized because of the pressure of competition or the search for increased competitiveness.” Of course, such a preference runs directly contrary to the values, theories, and political constituencies of more conservative parties throughout Europe, who prefer more laissez-faire arrangements.
The EU transformed this political contest between parties of the left and right into a controversy over the dilemma concerning effects of trade (and trade organizations) on the state, especially in Britain. In the 1980s, British labor unions recognized that the social legislation they preferred was more likely to be enacted by the EU than by a British government dominated by Conservatives. In effect, they preferred to have labor law written by the French Socialist Jacques Delors, president of the European Commission, rather than by Conservative British prime minister Margaret Thatcher. By allying with the Socialist Parties of Europe, the British Labour Party sought to reverse through EU legislation the conservative revolution that Thatcher had achieved through national legislation. Such calculations lead to controversies over how much national sovereignty must be sacrificed in order to achieve the gains from trade. Thatcher condemned the EU as an attempt “to suppress nationhood and concentrate powers at the centre of a European conglomerate.” She is certainly correct in that assessment, but one wonders whether her defense of national sovereignty would be as spirited if the majority of the EU were more inclined to support her brand of conservatism. In any case, citing national sovereignty, Britain opted out of the Social Charter in 1989, the social-policy annex to the Maastricht Treaty in 1992, and participation in the euro in 1998. In 1994, Conservative prime minister John Major blocked the election of the head of the European Commission because the leading candidate favored a larger role for the EU at the expense of the constituent national governments. The link between trade and other values cannot be severed.
Still, despite the loss of sovereignty implicit in economic interdependence, we can now see why regional trade liberalization generates momentum to create even closer forms of integration. In the liberal vision, every increment of liberalization hints at the greater benefits that lie ahead if integration progresses. For example, if free trade permits low-wage labor in Spain to produce products cheaply for the rest of Europe, free movement in factors of production such as capital would obviously enable Spain’s comparative advantage to be exploited even more fully. As each barrier to trade is diminished, remaining ones become more visible and vulnerable to political pressure. In the mercantilist vision, regional integration also tends to generate momentum: Because each step increases interdependence, it is natural that each nation would welcome more intensive integration arrangements that impose greater constraints on the disruptive policies of other governments. As trade increases, the dilemmas it creates become more onerous and demands for institutions capable of dealing with them rise.
Thus, regionalism tends to progress along parallel tracks, one market-based, the other institutional. Even though the deepening of regional integration encourages greater integrative steps, it tends to sharpen political clashes over the form that it should take, especially the role it should play with respect to trade dilemmas. Liberals emphasize the economic dimension of free trade, in part because its tendency to undermine the capacity of national governments to sustain social protection could further the laissez-faire agenda of diminished state activity and an enhanced role for private enterprise. Fearing just such an outcome, others accept free trade only in exchange for the package of protection against the dilemmas of trade embodied in the social dimension. That is, it opts for an activist regional government to replace the increasingly impotent national governments.
However, greater levels of integration in Europe will require the precise resolution of ambiguities that, up until the early 1990s, were responsible for the acceptance of integration by groups with incompatible views. A key issue has been whether the leveling of trade barriers will arise from the opening of the most protectionist nations or the closing of the most liberal ones. The 1992 Single Market initiative was valued by some for its free trade face (Germany, England, Belgium, and Luxembourg); others were attracted by its protectionist face (France, Italy, and Spain).
The assessment by nations outside the EU will also depend heavily on the balance between trade creation and trade diversion. The real danger is that the complicated games among European governments and interest groups will be resolved principally by shifting costs onto foreigners. The ambivalent U.S. attitude toward the EU has always been heavily dependent upon how protectionist it would become. However, the United States originally supported the EC as a means to European recovery at a time when Europe was seen to be more valuable as a political and military ally than it was seen to be dangerous as an economic competitor. The EC also tied West Germany to the West, discouraging a policy of neutrality or alignment with the Soviet Union in pursuit of German reunification. Now, however, the U.S. interest concerns its own exports, since about a quarter of them go to the EU and most of the rest face competition from EU firms. Further, because any preferential tariff area has the potential to become a heavily protectionist trade bloc, the behavior of the EU is continuously monitored by those who see it as the precursor of an international system composed of such regional arrangements.
While the EU does appear to be moving in a liberal direction–its average MFN tariffs on industrial products should fall under 3 per cent by the turn of the century–in some areas of special interest to the U.S. that movement remains slow. Its agricultural tariffs still average over 20% and import protection and the use of contingency measures remain significant in particular industrial sectors such as textiles, automobiles and consumer electronics, where high tariffs co-exist with intense anti-dumping activity that also limits market access. As protection at the border is gradually reduced, internal obstacles to competitiveness and efficient allocation of resources become more apparent. Community subsidy programs remain sizable by international standards and the opening of public procurement, which accounts for 12 per cent of the Union’s GDP, has so far had limited effect on external suppliers.
Within Europe, however, the major controversies concern the tensions provoked by the dilemmas of trade, an enlightening example of which is the chaos surrounding the collapse of the European Monetary System (EMS) and the subsequent creation of the euro.
The dilemmas posed by exchange-rate policy
Since the collapse of the European Monetary System’s Exchange Rate Mechanism(ERM) in 1992, exchange-rate policy has been at the center of the trade dilemmas concerning national sovereignty that have threatened to derail further integration. As traditional trade barriers have diminished, the trade-dampening effects of a system of multiple currencies have acquired increasing visibility. The most obvious effects are the simple transaction costs associated with currency exchanges: A consumer purchasing goods made in another country must pay the costs of exchanging the currency of his or her country for that of the nation in which the good was produced. Some costs are direct and visible, as when tourists pay a fee to a foreign-exchange broker; others are born by businesses and passed along invisibly to consumers. In the mid-1990s, currency conversion alone cost European business $15 billion per year, and transaction costs associated with currency exchanges have been estimated to waste 2 percent of the value of trade. Firms also had to maintain accounting systems and bank balances in several currency units simultaneously and cope with multiple currencies in legal contracts, taxation, and strategic planning.
Moreover, when currencies are traded freely in foreign exchange markets, natural variations in supply and demand cause their values to fluctuate unpredictably, sometimes in wild swings of sentiment. This uncertainty concerning future currency valuations represented a major risk for businesses trying to operate across the European market. Long-term production and marketing plans were complicated because firms could not predict costs and revenues that were denominated in different currencies. In particular, firms feared that an increase in the value of their nation’s currency would leave them suddenly uncompetitive elsewhere. This risk discouraged trade because firms preferred to plan for the relative predictability of their domestic market. Indeed, as tariff rates among European economies declined, this system of floating currencies came to have a greater trade-dampening effect than traditional trade barriers.
Thus, as a logical extension of the desire to increase trade, a single European currency to replace the fifteen national currencies has been a long-term goal of the EU for more than two decades. However, nations have strongly resisted giving up central elements of their national sovereignty: the rights to issue currency, to profit from the creation of a monetary asset, and to manage the economy by controlling the money supply. Any state harboring even a modicum of the mercantilist inclination to influence the economy–and all states do–would find the ceding of monetary policy to a regional authority an uncomfortable prospect. Moreover, a single currency would not be feasible until the various economies converged into a single market with similar levels of growth, inflation, and interest rates.
In the meantime, a less ambitious strategy was followed that preserved national currencies but restrained changes in their relative valuation. Early steps included a short-lived system of fixed exchange rates dubbed “the snake in the tunnel” in the mid-1970s. The European Monetary System (EMS), which launched the European currency unit (ECU) and included the Exchange Rate Mechanism (ERM), began operation in 1979. EU nations that joined the ERM pledged to maintain currency valuations within a mandated range much like a regional version of the fixed exchange-rate system created under Bretton Woods. Whenever the value of their currency drifted beyond its agreed upon bounds, they were obligated to use foreign-exchange reserves to buy or sell currency until supply and demand were once again in balance at the accepted value. When such actions were ineffective, however, governments were further bound to alter domestic interest rates or other macroeconomic policies in order to stabilize the values of their currencies. It was expected that national economic policies and conditions would eventually converge, thus minimizing exchange-rate volatility and the need for governments to take extraordinary action to maintain their treaty obligations. In fact, however, different economic conditions in different countries–especially trade deficits, inflation, and interest rates–inclined foreign exchange markets to push the value of national currencies in different directions. Furthermore, because the priorities of different governments conflict, they often adopt policies that become incompatible with their obligation to maintain stable exchange rates. Thus, monetary integration poses the dilemmas of national sovereignty and value trade-offs, which is why only seven nations joined the ERM at its inception, while three others joined more than ten years later.
These dilemmas were brought home even more dramatically in fall 1992 when the ERM shattered and the prospects for further European integration consequently dimmed. At the time, Germany was suffering high inflation while struggling to unify formerly communist East Germany with capitalist West Germany. To restrain further price increases, German monetary authorities maintained high interest rates to slow the economy’s growth. Meanwhile, both Britain and Italy, which were suffering high unemployment, sought low interest rates in order to accelerate growth. However, this disparity in interest rates induced British and Italian investors to transfer capital into Germany. As they sold investments denominated in the lira and the pound, the decreased demand for those currencies drove down their values while the higher yielding Deutsche mark increased in value.
Under the terms of the ERM, Britain was required to sustain the pound at a value above 2.78 Deutsche marks (DM), and Italy was bound to maintain a value of 1,000 lira at DM1.30. As the German central bank refused to lower its interest rates, both the pound and lira drifted to the bottom of their legal bands and finally sank beneath them. Britain spent more than $15 billion (half its total foreign-exchange reserves) to support the pound, and the Bundesbank spent nearly $50 billion to support the lira; but those sums were not enough. Italy was forced to acknowledge that it could not meet its treaty obligation to maintain the lira’s value and withdrew from the ERM. Britain raised interest rates from 10 percent to 15 percent in a last futile attempt to remain in conformity but eventually abandoned the effort and similarly withdrew from the ERM. The pound quickly fell to DM2.53 and the lira to DM1.18 per 1,000. The Spanish peseta was also devalued by 5 percent and the Irish punt and Portuguese escudo soon followed. A few months later, the French franc was supported by over $10 billion of intervention in a single afternoon before the effort was abandoned. The ERM collapsed in a hail of recriminations that undermined faith in the ability of the EU to simultaneously accomplish region wide goals while respecting differences in national-level priorities.
The ERM had succumbed to the same forces that had doomed the fixed exchange rate system of Bretton Woods twenty years before–large capital flows that would destabilize currency values unless counter-acted by policies that were politically unacceptable. It also foreshadowed the Asian financial crisis five years later, which is described in the following chapter. Economists refer to this interaction among interest rates, exchange rates, and capital flows as the Mundell-Fleming constraint: A nation cannot simultaneously maintain unrestrained capital flows, a stable exchange rate, and independent monetary policy. Yet, the EU was committed to the free movement of capital by the Single European Act, the ERM mandated stable exchange rates, and domestic constituencies demanded monetary policies suitable to the unemployment and inflation conditions in their own country. In effect, to maintain the stable exchange rates that sustained free trade required nations to abandon the freedom to choose policies that would satisfy other goals, such as the reunification of Germany or the control of unemployment in Italy. Faced with this clear dilemma of national sovereignty, several governments chose policy independence over the regional arrangement to encourage trade.
In August 1993, the first attempt to rebuild the ERM acknowledged the Mundell-Fleming constraint, but accepted the primacy of national sovereignty. Nations were required to maintain their currencies only within a very wide band of 15 percent on either side of their central target, virtually an unmanaged float in comparison to the previous stringent requirement of 2.25 percent. The benefits of exchange rate stability for expanding trade were thus sacrificed in this interim agreement so that governments could use monetary policy and even currency devaluations to better achieve domestic goals. But the fear of the disruptive impact of exchange rates that were permitted to move as much as 30% made this only a temporary expedient, chosen over two even less attractive options.
The first, a return to a real fixed exchange rate system, was incompatible with independent monetary policy, even if it could be accomplished in the face of large scale flows of capital. The need for independent monetary policy could be minimized, of course, if economic conditions were similar across all countries. But to more closely align economic conditions implied even greater constraint on the policies that produced them (the budget deficits that produced inflation, for example) and even greater sacrifice of national sovereignty.
The second option, the preliminary plans for which had been underway for some time, was to proceed with full monetary union by adopting a single currency. This too required policy coordination, especially with respect to budget deficits which could now produce inflation community-wide, and sacrificed even more national sovereignty because it eliminated all independent monetary policy. However, this single currency option, later to evolve into the euro, not only offered a more permanent solution to exchange rate instability, it also transformed the national sovereignty problem that most irritated the French. France felt that the old ERM had degenerated into a system in which Germany would use its monetary policy to achieve its own goals –such as unification and the control of inflation–while the pressures of that decision would require that all other ERM members use its monetary policy to keep a stable link with the D-mark. Thus, Germany benefitted from a system that was being sustained by the sacrifice of national sovereignty by all the others. If European nations were to sacrifice economic independence, they preferred that it be surrendered to an independent Central Bank rather than to a long-time political, military and economic rival such as Germany.
So was born the European Monetary Institute, established in 1994, to be transformed into the European Central Bank in January 1999. Its mission was to issue a single currency, the euro, and thus to determine monetary policy for the entire region. The Euro was launched as an accounting unit on January 1,1999 with 11 of the 15 EU nations participating (all but Britain, Sweden, Denmark, and Greece). Euro notes and coins are to be issued on January 1, 2002, and all national currencies of the participating countries will cease to be legal tender on July 1, 2002.
Such an unprecedented ceding of autonomy over monetary policy entailed major risks that required careful selection criteria of participating nations and strict limitations on the economic policies that could be enacted by them subsequently. Without monetary policies to insulate the national economies from the conditions prevailing in others, inflation and high interest rates induced by a budget deficit in one country could quickly spread to the others, for example. Thus, the Maastricht agreement established criteria for entry, the most constraining of which were that the budget deficit must be under 3% of GDP, the national debt under 60% of GDP, and inflation under 3.2%. In fact, these criteria were relaxed, with most nations qualifying only after obvious accounting tricks, but the effort to meet them did have a substantial constraining effect on national policies. Even more constraining is the “stability and growth pact” which requires that all participants continue to observe the 3% limit on budget deficits or face substantial fines.
In democracies where tax and expenditure levels are fiercely debated, the imposition of external controls undermines the ability of citizens to determine the most important policies of their governments. Moreover, the treaty explicitly forbids the European Central Bank to “seek or take instructions from Community institutions or bodies, from any government of a member state or from any other body”. These arrangements may also unwisely prevent national governments from stimulating the economy during recession, a concern given greater weight by the statutory goal of the ECB. Unlike the Federal Reserve in the United States, the ECB is not required to take employment or output levels into account, but only to maintain price stability, which it has defined as inflation under 2% a year. “In modern times, no major economy has hit such a target consistently over a run of years…In short, a radically undemocratic institution has been charged to achieve, without compromise, an exceptionally demanding goal of virtually zero inflation”. And the public support for such a massive transformation in authority remains precarious, with the percentage of citizens reporting that they feel well informed about the EMU well under 50% in all eleven euro countries and under a third in eight of them.(9)
Clearly, the EU represents an extreme example of one resolution of the dilemma of national sovereignty raised by the desire to achieve the benefits of free trade. Of course, the EU has other goals as well, many of which are not shared by the regional integration schemes that have sprung up all over the world in partial emulation of the EU. We now turn to the case of NAFTA, in which the dilemmas of trade manifest themselves in similar ways, but a very different type of regional trade arrangement has resolved them quite differently.
THE NORTH AMERICAN FREE TRADE AGREEMENT – NAFTA
1991 – Field Research in Mexico on NAFTA by Said El Mansour Cherkaoui
Extract of Research on Mexican Economy Published by the Golden Gate University Review, San Francisco in 1991
Interview in 1991 of Cuauhtémoc Cárdenas in his Father’s Home at at Mexico City
(Version Francaise)
This pollution originates largely in maquiladora firms, fully 10 percent of which admitted that they had migrated to avoid American environmental regulations and take advantage of the weaker environmental laws and notoriously lax enforcement in Mexico. For example, the La Paz agreement of 1983 required that industries importing chemicals into Mexico return any resulting hazardous wastes to the country of origin, but a 1988 report of the U.S. EPA showed that only 1 percent of maquiladoras had done so. This record cannot be a surprise: In 1990, the Mexican federal government budget for environmental law enforcement was only $3.15 million.
Environmentalists also feared that NAFTA would trigger value trade-offs similar to those that have arisen from conflicts between various environmental policies and previous free trade agreements, including the WTO. For example, the Bush administration successfully pressured British Columbia to end a government-funded tree-planting program because it was an “unfair subsidy” to the Canadian timber industry. Similarly, government payments to farmers to promote soil and water conservation could be interpreted as an unfair subsidy of agricultural exports. Export restrictions on lumber designed to enforce practices of sustainable forestry could be considered a violation of prohibitions against export restraints. Restricting imports of food contaminated with pesticides now banned in America can be grounds for foreign governments to sue the United States for establishing non-tariff barriers to trade.
The most dramatic episode occurred in the 1994 clash known as “GATTzilla versus Flipper”, in which a GATT tribunal ruled in favor of a complaint brought by the EU on behalf of European tuna processors who buy tuna from Mexico and other countries that use purse seine nets. The United States boycotts tuna caught in that way, since the procedure also kills a large number of Adolphins, but GATT ruled that the U.S. law was an illegal barrier to trade because it discriminated against the fishing fleets of nations that use this technique.
Initial experience with CUSTA confirms that such environmental trade-offs will arise under NAFTA. The first trade dispute under the free trade agreement involved a challenge by the U.S. to regulations under Canada’s Fisheries Act established to promote conservation of herring and salmon stocks in Canada’s Pacific coast waters. The provision to require reporting was struck down by the dispute panel. Similarly, the Canadian government challenged the U.S. EPA’s regulations that require the phaseout of asbestos, a carcinogen once frequently used as a building material. A balance between environmental concerns and free trade principles could be achieved, but NAFTA, which lacks the EU’s recognition of the social and political dilemmas of trade, does not do so.
The distributional dilemma and the politics of labor issues
In both Canada and the United States, however, the most controversial issue concerned the impact of NAFTA on jobs and wages. Unlike the Corn Laws, which posed the distributional dilemma principally in terms of sectors of the economy, in NAFTA the dilemma emerged as a class issue. Opponents contended that NAFTA would produce a net loss of jobs, especially among the unskilled, who are least able to adjust; a decline in wages among the unskilled who remain employed; and a transition period involving disruption and risk that is excessive given the small and uncertain projected gains.
Liberal trade theory made a persuasive case for NAFTA’s long-term benefits, including more job creation than job loss, though macroeconomic computer models generally showed the net effect to be quite small. Opponents of NAFTA questioned outcomes derived from such computable general equilibrium (CGE) models because they required unrealistic assumptions such as full employment, balanced trade, and capital immobility. It is especially noteworthy that the major fear–job loss–was assumed away by the CGE assumption of full employment. As one critic pointed out, “We might forgive the Ford employee for being less than convinced by a CGE model that crosses a deep ravine by assuming a bridge.” Arguments for free trade often appear most convincing to those who have no stake in their truth, but for the workers whose livelihood depends on the accuracy of the trickle-down models, the theories usually seem too flimsy to justify the risks.
Labor concerns arose from the recognition that NAFTA would destroy American jobs as some U.S. firms lost sales to Mexican firms and others moved production facilities to Mexico. Opponents emphasized dislocations from NAFTA-related job loss estimated in the range of 150,000 to 500,000. The transition period can be long and painful: It was estimated that 40 percent of laid-off workers would remain unemployed a year later and that the remainder would suffer wage losses averaging 10 percent for service workers, 20 percent for manufacturing workers, and 30 percent for automobile and steel workers. Within five years, most workers would have recovered their previous wages; but 35 percent would never again make the same wages, and three-fourths of workers would not go back to the same type of job. The average cost of a job loss for a worker was estimated to be about $80,000 over a lifetime.
Proponents observed that NAFTA-related job-loss estimates were modest in relation to the 2 million Americans expected to lose their jobs every year for the next decade for reasons unrelated to NAFTA. Further, they noted that job loss to low-wage countries was inevitable even in the absence of NAFTA. Finally, they pointed out that some job gains from NAFTA were just as inevitable as some job losses. Indeed, the positive employment effects of increasing exports should equal or exceed the negative effects of increasing imports. It is no wonder that businesses emphasized their vision of an efficient, comparative advantage-based economy that would eventually result from NAFTA and that labor organizations emphasized the transition costs that would be borne before such a future could emerge.
Free trade always triggers labor’s concern about employment, wages, and social dumping, but three considerations made the issue unusually acute in the case of NAFTA. First, huge disparities in wage rates and working conditions between the United States and Mexico increase the pressure on American workers. With wages for unskilled labor roughly eight to ten times higher in the United States than in Mexico, American firms have a strong incentive to either abandon production requiring unskilled labor or move it to Mexico. Negotiating under this kind of threat, American workers may be unable to resist a decline in wage rates and living standards. “A Wall Street Journal survey of 455 senior corporate executives taken just after NAFTA was initialled, found that 25 percent would use NAFTA to bargain down wages and 40 percent would move production to Mexico.” Furthermore, a 1997 study of 600 attempts by labor unions to organize workers or negotiate a first contract revealed that “62 percent of employers threatened to move their operations instead of negotiating with the union.” (11) The factor price equalization theorem, an elaboration of Heckscher-Ohlin, states that free trade will cause all factor prices, including wage rates, to equalize across nations. Supporters hoped that NAFTA would bring a growth boom to Mexico that would result in Mexican wages rising to U.S. levels rather than American wages falling to Mexican levels, but such a result is, at best, a long way off. Labor surpluses and weak labor laws in Mexico preclude substantial upward pressure on wage rates for many years. As a result, NAFTA might lower wages in the United States without raising them in Mexico, which would be especially alarming because wages for unskilled labor are already declining in the United States. For example, during the 1980s the real wages of those without a high school diploma fell 10 percent, and a similar effect seems to be spreading to high school graduates.
Second, capital mobility, which makes the relocation of labor-intensive production to Mexico easy, sharpens the competition between American and Mexican labor, especially by eroding productivity differences between them. The factor price equalization theorem holds that wage rates will fully equalize only if the productivity of workers in the two countries is identical. Thus, the current gap in wage rates should persist so long as American workers remain so much more productive than Mexican workers, but the modernization of the Mexican economy fueled by the foreign direct investment (FDI) of American firms could erode that difference for unskilled labor. By the end of 1991, foreign direct investment in Mexico totaled about $33 billion, with nearly two-thirds of it originating in U. S. corporations. In anticipation of NAFTA, capital inflows to Mexico were estimated at $18 billion in 1992, including $5 billion in foreign direct investment.
The maquiladora program can be seen as a kind of pilot project for NAFTA, demonstrating the power of combining American capital with Mexican labor. Since 1965, firms on the Mexican side of the U.S. border, known as maquiladoras, have been permitted to import parts duty free from the United States and to export the assembled product back into the country, also duty free. By 1992, nearly 2,000 factories operating under this program employed nearly 500,000 workers, about 20 percent of the total manufacturing labor force in Mexico. Meanwhile, employment and wages for American unskilled labor had stagnated.
Third, unlike the EU, NAFTA contains very little provision for dealing with dislocations, and, unlike in Europe, the social welfare system in the United States provides less protection from structural unemployment. In Canada, where the welfare state is more advanced than in the United States, the left feared that dislocations would overwhelm its capacity and force the abandonment of prized programs of social insurance. From 1990 to 1997, the proportion of the unemployed eligible to collect unemployment insurance dropped from 89 percent to 43%.(12)
Partisan alignments reflect the Stolper-Samuelson expectation that free trade will benefit the abundant factor of production (capital, in the United States) and harm the scarce one (unskilled labor is scarce in the United States relative to the huge surplus of cheap labor in Mexico). These distributional implications of free trade explain why more than 75 percent of Republicans voted for final passage of NAFTA in the U.S. House of Representatives and why more than 60 percent of Democrats voted no even after heavy lobbying by Democratic president Bill Clinton.
The Impact of NAFTA and the Mexican Collapse
More than five years after its inception, NAFTA’s effects continue to be disputed, not because the three economies remain unaltered but because the dramatic changes that have taken place cannot be definitively associated with NAFTA. Trade among the three countries has increased even more than expected – by 1999, it was more than twice its 1990 level – but the effect of NAFTA cannot be isolated from the broader liberalization strategy that was well underway in all three nations before NAFTA took effect. Moreover, trade levels were not the only source of the strikingly divergent paths taken by the three nations in this period. Both Canada and the United States entered recessions shortly after CUSTA took effect in 1989, but the downturn was far longer and deeper in Canada than in the U.S. The period from 1989 to 1996 was the longest period of below potential growth for Canada since the Great Depression in the 1930s, with unemployment rates exceeding 11 percent. Nearly 20 percent of all Canadian manufacturing establishments closed during this period, as many as half in response to the increasing competition under first CUSTA and then NAFTA. This trade competition encouraged fiscal and monetary policy designed to keep production costs low, but the competitiveness strategy also stifled growth in output, wages and employment while weakening government programs that provided social protection. Thus, rising levels of trade and even a growing trade surplus with the U.S. have not prevented a substantial increase in inequality in Canada. However, advocates of liberalization argue that these dislocations were temporary. Furthermore, they contend that the trade competition produced by CUSTA/NAFTA did not cause the painful policy changes but only demonstrated that they were necessary to correct pre-existing conditions in Canada.
By contrast, in the U.S. the recovery which began in 1992 produced the longest expansion of the post-World War II period and unemployment rates fell to around 4 percent, the lowest in more than 30 years. NAFTA does not appear to have played any substantial role in this growth, which has, however, easily absorbed whatever modest job loss may have been associated with NAFTA. Fewer than 200,000 workers–under 4 percent of the total number of U.S. workers dislocated during this period–have been certified as qualified for NAFTA-related Trade Adjustment Assistance. There is also little evidence that NAFTA has had much effect on U.S. wage rates; while real hourly compensation certainly has grown much less slowly than corporate profits, executive compensation, or productivity gains, such inequality in allocating the benefits of prosperity has been a growing trend since at least the late 1970’s. In short, though NAFTA has surely benefitted some and harmed others, its aggregate effect on the U.S. economy appears to have justified neither the most optimistic nor the most pessimistic predictions.
In Mexico too the effect of NAFTA is disputed because of its entanglement with other dramatic economic events, but here it is far easier to see the case made by critics. It is certainly impossible to evaluate NAFTA without considering the dramatic collapse of the Mexican economy barely a year after its initiation. The meltdown began with a currency crisis, which was marked by a 43 percent decline in the value of the peso that not only disrupted regional trade and precipitated a deep depression in Mexico but also triggered concern about Mexico’s ability to meet its foreign-debt obligation. In response, the Clinton administration, fearful of the political and economic consequences of a collapse in the Mexican economy, provided a $20 billion line of credit as part of a $50 billion international effort to rescue Mexico from imminent default.
It is instructive to note that NAFTA both contributed to Mexico’s economic problems and helped export them to the United States. The key role was played by the Mexican peso, which despite a temporary boost from NAFTA could not maintain its value under the pressure imposed by Mexico’s trade liberalization. As trade barriers fell throughout the liberalization of the late 1980s and early 1990s, Mexican imports soared, producing a trade deficit that finally reached 8 percent of GDP in 1994. Ordinarily this deficit would have caused the peso to decline steadily until its equilibrium value was reached, but instead it was offset for a while by a huge–but temporary–inflow of capital from abroad, more than $60 billion in portfolio investment alone from 1990 to 1993.
Much of this originated from foreign investors, especially in the U.S., who were persuaded by enthusiastic supporters of liberalization that post-NAFTA Mexico represented the next great investment opportunity. Inevitably, this capital inflow began to decline, putting downward pressure on the value of the peso. The Salinas government recognized that a falling peso would produce domestic inflation, erode the confidence of foreign investors, and undermine the reputation of the PRI for financial management, all of which it wanted to avoid during the 1994 presidential election. Thus, it expended treasury funds to artificially support the peso (and pressured the central bank to expand the money supply by over 20 percent). With foreign reserves nearly exhausted–falling below $7 billion–the new president, Ernesto Zedillo, was forced to announce a 13 percent devaluation of the peso less than three weeks after his inauguration in December 1994. This became the last in a string of incidents–among them the Chiapas revolt, a contested election result, and a political assassination–that had alarmed foreign investors over the previous year. The devaluation effectively acknowledged an economic crisis, which drove frightened investors to react in panic. Nearly $30 billion fled the country in a few weeks.
During 1995, the peso declined by 43 percent, the Mexican stock market sank by 38 percent, inflation soared to 60 percent, and unemployment nearly doubled. With American economic interests now tied to the stability of the Mexican economy and NAFTA’s prestige bound up with the success of the Mexican liberalization program, the Clinton administration arranged an emergency bailout with help from the IMF and other institutions. When default on foreign debt loomed, both the Zedillo administration and its supporters (primarily in the Clinton administration and the IMF) were seen to give priority to bailing out investors–especially those abroad–while ignoring the plight of the Mexican masses.
The changes in Mexican macroeconomic policy required by the crisis itself and those imposed as part of the bailout agreement guaranteed a sharp recession that, among other effects, would reduce the trade between Mexico and the United States that NAFTA was designed to boost. More significantly, real GDP per capita, already 10% below the level it had reached at the beginning of the 1980s, declined another seven percent in 1995. As the economy hit bottom in 1995 Mexico registered a 13% decline in private consumption, a 50 percent inflation rate, interest rates at 40 percent, a 20% decline in real wages, and a 70% increase in official unemployment (to 6.3%, but another 20% were reduced to part-time work). Since then Mexico has experienced a recovery, once again led by foreign investment.
At the turn of the century, the dislocations associated with Mexico’s trade liberalization and the NAFTA agreement meant to signify its permanence are more apparent than the benefits that remain projected for the future. The dilemmas of trade have been expressed in a variety of ways. Inequality has grown substantially throughout the liberalization process. The percentage of GDP going to labor declined from 38% in 1980 to under 25% in 1990 and has likely fallen further since then. The wage gap has widened between white-collar and blue-collar workers, skilled and unskilled labor, export-oriented vs. domestic manufacturing, and between border and non-border areas.
The security of workers is increasingly precarious, with fewer covered by Social Security and more employed in the informal sector, while the minimum wage has fallen to half its 1987 value. Foreign dependence has grown and self-sufficiency has declined. Not only has trade expanded, but it is increasingly integrated into the productive capacity of the economy. In 1994, 58% of the value of exports was composed of the imported inputs required to produce them (up from 12% in 1983). Foreign debt exceeds $170 billion, two and a half times its level during the debt crisis of 1982. As Teresa Gutierrez Haces puts it, “Mexico has converted itself into a country that is very attractive to international investors but not for millions of Mexicans who daily face conditions of extreme poverty.”(13)
Conclusion: lessons from NAFTA
Trade ties together the fate of nations. Prosperity in one country can be “exported” to another through trade, but dependence on others can also transmit less pleasing conditions. Trade is not equally desirable under all circumstances or with all possible partners, especially because its effect on value trade-offs, distributional patterns, and state concerns can vary dramatically. In this light, regional integration offers a cautious compromise between self-sufficiency and global free trade by allowing a nation to selectively choose its partners in destiny. Despite difficulties in the past and uncertainties about the future, the EU exemplifies the virtue of such an approach, taking advantage of the economic, political, and social compatibility of its members to forge an organization that can address common problems and achieve shared goals.
The early experience with NAFTA is less clear, and the decision to bind together the fate of all three North American nations cannot yet be definitively assessed. However, a major currency crisis that began less than a year after NAFTA’s implementation in January 1994 has cast doubt on whether Mexico is yet stable enough to be a reliable member of a regional trade organization.
Nonetheless, enthusiasm for liberalizing regional agreements remains strong, especially in the western hemisphere where MERCOSUR, the Central American Common Market, CARICOM, and the Andean Community are all in operation. In fact, less than a year after NAFTA’s inauguration, 34 democratically elected leaders in the region met to initiate negotiations over a Free Trade Area of the Americas (FTAA) which would reach from Alaska to Argentina and encompass a market of nearly 800 million people. Nine different negotiating groups are now considering various facets of this proposal, with negotiations scheduled to conclude by 2005. On a separate track, the U.S. is a leading member of the Asia Pacific Economic Cooperation (APEC) forum, a group of twenty one nations on both sides of the Pacific committed to greater liberalization of trade and investment. This is a far larger group–its members account for more than half of global trade–but it is much more loosely integrated and at an earlier stage in its development.
Trade generates dilemmas that can overwhelm its advantages unless nations and organizations are prepared to respond to them. The regional option is one strategy that appeals to some nations, but others are not located in a region where such an approach is feasible. For them, such as the Asian NICs considered in the next chapter, trade-led growth must occur in a context of globalization.
Endnotes
1. Regional integration can take a variety of forms. In a preferential trade area, a group of countries establishes lower barriers to the import of goods from member countries than from outside countries. The free trade area is a special case of a preferential trade area in which trade barriers between members are reduced to zero. A customs union is a preferential trade area in which the members adopt a common external tariff. A common market allows the free movement of factors of production such as capital and labor as well as free trade in goods. Finally, an economic union or community occurs when the economic policies of common market nations are coordinated and harmonized under supranational control and a single currency.
2. Between 1990 and 1994, 26 preferential trade agreements were signed in the Western Hemisphere alone. 22 new regional trade agreements were reported to the WTO between mid-1997 and mid-1998.
3. Timothy M. Devinney and William C. Hightower, European Markets After 1992 (Lexington, Mass.: Lexington Books, 1991), p. 21.
4. The Benelux customs union among Belgium, Luxembourg, and the Netherlands had been formed in 1948.
5. For convenience, I will use the label EU to refer to both the current European Union and its predecessor organizations.
6. The EU remains slightly smaller than NAFTA in GDP, but its trade is more than twice as large.
7. The United States has never fully accepted the EU’s conformity with Article 24 because it has not eliminated tariffs on “substantially all” goods (failing, most notably, with respect to agriculture). Nonetheless, the U.S. has not opposed the EU, but it has been active in pushing the WTO to examine the conformity of all regional agreements with GATT.
8. “The Slippery Slope,” Economist, July 30, 1994.
9. “Gambling on the Euro,” The Economist, January 2, 1999.
10. Congress had nearly blocked the initial negotiations for the less controversial CUSTA but failed to do so when the Senate Finance Committee deadlocked at 10 to 10.
11. Bruce Campbell, Andrew Jackson, Mehrene Larudess and Teresa Gutierrez Haces, “Labour market effects under CUFTA/NAFTA,” (Geneva: International Labour Office,1999), p. 8.
12. Labor market effects,” p. 9.
13. Labour market effects, p. 118
Source: http://www.lehigh.edu/~bm05/research/chapter6.v2300.htm#N_1_
CARICOM TRADE STRATEGY AND HEMISPHERIC INTEGRATION
This paper examines CARICOM’s convergence strategy for building sub-regional linkages in the current process of hemispheric integration. It analyzes the concentric circles approach first advocated by the West Indian Commission, and assesses how it was implemented and the issues and problems it generated. The paper also examines the approach in the context of the developments in regional integration in the Hemisphere, and tries to highlight the extent to which convergence was feasible through attempts to link CARICOM to other regions, in particular the Andean Group and the CACM. Internal developments in CARICOM are also examined to show why the concentric circles approach failed. The main conclusion is that there is a need for a new diplomacy based on a new configuration of smallness and development criteria for CARICOM states to consolidate their convergence strategy.
CARICOM’S CONCENTRIC APPROACH: AN ASSESSMENT
Five sub-regional groups currently exist in Latin America: NAFTA, MERCOSUR, Andean Community (AC), Central American Common Market (CACM) and CARICOM. To these must be added ALADI[i], with eleven members, of which five belong to the Andean Community and four, to MERCOSUR. There are also several bilateral and trilateral agreements on economic complementation and trade liberalization between pairs of countries or between one country and a group of countries. Additionally, there are agreements with extra-regional groups or countries.
In looking towards the southern countries of the Western Hemisphere, CARICOM initially followed a notion of ever widening concentric circles based on similarities in size and levels of development and geographic proximity. The West Indian Commission[ii] which best articulates this position, grappled with the twin problem of widening and deepening of CARICOM in the new Post-Cold War era. It resolved this dilemma by arguing that CARICOM, by reason of its small size should remain as a separate integration scheme and collectively deal with large Caribbean and Latin American countries. Countries such as the Dominican Republic, Haiti, Cuba and Venezuela were considered as large and potentially having too great an influence on the movement. Their economic and social structures were also seen as different and capable of weakening the already fragile coherence of CARICOM. Suriname, and possibly some of the other small overseas territories and dependencies were regarded as potential entrants to CARICOM, satisfying the criteria for smallness. The signing of trade and economic cooperation agreements with other Caribbean countries was seen as a better approach than membership of these countries in CARICOM.
In the eyes of the West Indian Commission, the first concentric circle would be CARICOM, comprising the small countries in the Caribbean. Full entry into CARICOM, as exemplified in the case of Suriname, illustrated this approach. The next outer ring would be the other Caribbean countries and the CACM. In approaching the developing countries of the hemisphere therefore, CARICOM essentially targeted the wider Caribbean Basin countries. In 1996 CARICOM agreed to give priority to negotiating free trade agreements with Colombia, the Dominican Republic, the Central American Common Market (or Costa Rica) and Venezuela.[iii] CARICOM also adopted a model approach in negotiating trade and economic agreements with non-CARICOM countries of the Hemisphere. It stipulated that reciprocity would be given by the MDCs of CARICOM and non-reciprocity would be negotiated for the LDCs of CARICOM.
As to the rest of the hemisphere (NAFTA AND MERCOSUR) which could be regarded as the third outer ring, CARICOM also agreed in the above-mentioned decision that the region should signal its interest in entering into trade arrangements with MERCOSUR, without stating clearly the nature (reciprocal or non-reciprocal) of such agreements. The implication however, seemed to be an expectation that with such large countries and trade blocs as MERCOSUR and NAFTA, trade agreements should be non-reciprocal. CARICOM already enjoys non-reciprocal trading arrangements with the developed counties (Canada and the US) in the Hemisphere in the form of CARIBCAN and CBI.
CARICOM countries perceive regional trade negotiations as important in assisting them to make the transition to a more competitive globalized environment. They accept that trade preferences are on their way out but plead for a reasonable period of adjustment as small economies which are vulnerable to rapid changes in international prices, environmental hazards, etc. They believe that there should be some understanding on the part of the international and hemispheric community to the plight of small economies. Trade strategies, which are formulated in terms of special and differential treatment, are therefore linked to the vulnerability of small states, the UN SIDS programme, sustainable development and poverty reduction strategies. The majority of the social partners subscribe to this approach since they perceive the requirements for being internationally competitive as very exacting. They also argue for an adequate assessment of the negotiating environment facing CARICOM in the medium to long-term, in order to maximize the strategy towards hemispheric and multilateral trade negotiations.
Since the 1996 CARICOM decision on regional trade negotiations, CARICOM has concluded negotiations for a Free Trade Agreement with the Dominican Republic[iv] and a Partial Scope Agreement with Cuba[v]. It has also negotiated some reciprocity in the trade elements of the Agreement on Trade and Technical Cooperation between the Caribbean Community and the Government of the Republic of Colombia, through a Protocol amending the original Agreement.
In terms of special and differential treatment, the CARICOM/Cuba Agreement takes into consideration the differences in the levels of development between Cuba and the LDCs of CARICOM in the implementation of a programme of trade liberalisation between the Parties. The basic Agreement between CARICOM and the Dominican Republic is based on reciprocity with the The Agreement, together with the Protocol, provides for tariff treatment (duty free, phased reduction of duty, MFN rate of duty) to be extended to every category of good that would be traded between CARICOM and the Dominican Republic.
The CARICOM/Colombia Agreement began as a non-reciprocal agreement but had to provide for a level of reciprocity to Colombia after a period of four years. It makes provision for the four CARICOM MDCs to grant duty-free or duty-reduced treatment to identified products from Colombia, while Colombia provides similar treatment to a different and additional set of identified products from all CARICOM Member States, except the Bahamas which was not a party to the Agreement and Suriname which was not a member of CARICOM when the Agreement was concluded. MFN treatment applies with respect to other products. The CARICOM LDCs will continue to enjoy the benefit of preferences for their exports without having to reciprocate. A significant feature of all of the reciprocal trade arrangements that CARICOM has concluded is that the Less Developed Countries are not required to grant tariff concessions to imports from the Non-CARICOM parties to these agreements.
With regard to Central America, the history of working together in the CBI, along with geographic proximity and common strategic interests vis-à-vis hemispheric integration, has pushed CARICOM closer to the Central American countries. CARICOM/Central American cooperation has received more attention over the last decade. Central America has joined the Association of Caribbean States and within that framework, schemes of cooperation are being devised. In terms of trade arrangements, not much has occurred. Costa Rica expressed interest in associating itself with Trinidad and Tobago a couple years ago, and is now finalizing negotiations with the CARICOM grouping.
Over the last decade CARICOM’s relations with Mexico were governed by the CARICOM/ Mexico Economic Cooperation Agreement. There were no trade concessions in that agreement, which largely focussed on mechanisms to improve trade, such as information exchange, trade promotion and cultural and technical cooperation. Overtures from CARICOM have been made to conclude a trade arrangement similar to that with Venezuela and Colombia, but without success. Trinidad and Tobago has had inconclusive discussions with Mexico about a possible FTA but generally, Mexico is regarded as too competitive by the CARICOM countries.
CARICOM relations with the countries of the southern part of the Hemisphere have been virtually non-existent except in the case of Brazil where Trinidad and Tobago, Guyana and Suriname have developed trade and other economic ties. The CARICOM/Brazil Cooperation Agreement focussed largely on cultural and technical cooperation. The position of the CARICOM countries in relation to MERCOSUR has never been made clear by MERCOSUR[vii]. Even worse, the impression is sometimes conveyed that the CARICOM and the Central American countries are a US ‘burden’ and that integration in the Southern Hemisphere should proceed without them.
CARICOM countries themselves have also shown very little interest in developing new ties with these countries. Very few initiatives have been taken to explore what possibilities exist, and except for the odd visit, contact has remained extremely modest. CARICOM recently signed an Agreement with Chile to establish a CARICOM/CHILE Joint Commission on Cooperation, Coordination and Consultation as well as an Agreement on Scientific and Technical Cooperation. A similar one with Argentina is being contemplated. These would be arrangements similar to those existing with Mexico and Brazil. Beyond these arrangements, some interest has been expressed in free trade or partial scope arrangements mainly by Guyana, Suriname, and Trinidad and Tobago. Concretely, however, steps are still to be taken to indicate a real commitment and make this a reality.
The CARICOM concentric approach tended to over-emphasize smallness to the detriment of the importance of a stronger Caribbean community. It focused too much on physical size of population and territory without taking into consideration other factors such as culture, collective negotiating power, level of development, regional and hemispheric geopolitical balance, etc. It changed over time as indicated in the willingness of CARICOM to consider membership for Haiti as well as other larger Caribbean countries. However, this over-emphasis of smallness has conditioned CARICOM’s attitude towards the Free Trade Area of the Americas (FTAA).
CARICOM’S SMALLER ECONOMIES APPROACH IN THE FTAA
It is useful to recall that CARICOM, relatively more than most, if not all regions, has enjoyed sizeable non-reciprocal preferences over the last twenty-five (25) years which have allowed it to continue the production of high-cost basic agricultural commodities. The abrupt elimination of those preferences would now spell severe labour disruption and possibly even ethnic strife for certain CARICOM members. For economies that have enjoyed such high protection in developed countries’ markets, the adjustment and transitional costs are high not only in the economic equation but also in political and social terms. Coupled with such risks are the natural barriers that these states face and which are linked to their small size. These relate essentially to the relatively higher transport costs that stem from small volumes; higher per capita utility costs associated with lack of scale and indivisibilities; the greater difficulties inherent in diversification due to narrow specialization and small markets; the higher transaction costs that face their small firms in entering foreign markets in areas such as acquiring marketing information, penetrating distribution networks, etc; the disproportionate impact of natural disasters, and the binding constraints of limited technical and administrative capacity. These bottlenecks do not necessarily condemn small states to be less developed than large ones. They however, involve different risks and call for policies appropriate to these states.
An FTAA that focuses mainly on reducing trade barriers and harmonizing regulations would leave untouched these problems. Rather, it would focus on securing national advantages in other markets. The natural constraints faced by small states would remain and not be addressed. It is for this reason that CARICOM perceives no deeper development purpose at work that is preceding formal market integration. CARICOM’s own integration experience is one that embraces sharing, cooperation and solidarity among essentially small Caribbean states to ensure economic and political security. It is therefore not comfortable with the perception of an FTAA grouping where economic gain is the fundamental motive and not a supplementary benefit. CARICOM also has difficulty entering into an agreement in which the absence of non-trade concerns is further compounded by the presence of a wider region where geography is less relevant and so much more diversity has to be accommodated.
In addition, the slow pace of deepening CARICOM is a factor that does not induce its widening. Its proposed Single Market and Economy lacks depth as seen in the significant divergence between the proposed FTAA and the present state of integration in CARICOM. If one compares the nine negotiating areas in the FTAA with what pertains in CARICOM, it becomes clear that for seven of them the internal arrangements in CARICOM are either non-existent or in an embryonic stage. The latter are Services, Government Procurement, Competition Policy, Intellectual Property Rights, Investment, Subsidies and Anti-Dumping and Countervailing Measures, and Dispute Settlement. As it stands, only in Market Access and Agriculture can CARICOM claim to have some relevant depth. The proposed FTAA therefore far surpasses CARICOM in terms of a harmonized policy area, and this may well be so even if one were to accept that CARICOM has a common external tariff (more uncommon in many ways) and has some history of a community, in terms of functional cooperation and people-to-people collaboration.
In making the above structural comparisons, it is important not to neglect the process criteria that have affected CARICOM’s vision of the FTAA. It is worth noting that the failure of CARICOM’s concentric approach to hemispheric integration, which sought to embrace an inner ring of small states in Central America and the Caribbean, has taken away the comfort of approaching hemispheric integration with the solidarity of a wider coalition of interests similar to what the Benelux countries did in Europe. This lack of solidarity is expressed in the failure to speak with one voice in FTAA negotiations, inability to reap an early harvest on free trade among themselves, and the pursuit of different bilateral relations with the US and the rest of the hemisphere. The idea of linking the smaller states of the Caribbean Basin and opening markets progressively to increasing levels of competition never materialized although some diplomatic effort was discharged in this direction.
The reasons for such a lack of convergence are not clear but certainly diplomatic shortcomings must have played an important role. The initial effort to establish dialogue between the two regions began in the early 1990s. The need to give priority to the deepening of existing commercial linkages between the two sub-regions and the importance of a timely start to negotiations aimed at the creation, as soon as possible, of a Free Trade Area between the two sub-regions was recognized[viii]. However, progress in achieving the latter goals has been negligible. Except for the initiative taken by Costa Rica in the last few years to negotiate an FTA with Trinidad and Tobago and subsequently the CARICOM grouping[ix], efforts on both sides remained sporadic and inconsequential. long after the initial encounter. Indeed, the first Summit of leaders only took place in February 2002, long after positions had been established. Furthermore, the special diplomatic initiatives of both the Dominican Republic and Belize to build bridges between the two regions appear to have been ineffective and possibly needed more diplomatic support from the rest of the region.
CONCLUSION: THE WAY FORWARD FOR CARICOM
To sum up then, there have been some efforts to develop a coherent CARICOM pattern and strategy in forging stronger ties with Latin America and the wider Caribbean. Along the lines of open regionalism, a building block approach seems to be evolving, following a process of opening to increasing levels of competition, giving priority to the Caribbean Basin, and in sync with greater integration into the hemispheric and world economy. The Caribbean Basin is at the core of that building block process, and in particular the “inner Caribbean” which comprises the islands in the Caribbean Sea along with Central America, Venezuela and Colombia.
The failure of its concentric approach to build coalitions and promote stronger trade integration among small countries in the hemisphere has forced CARICOM to rely heavily on its smaller economies’ approach in the FTAA. Success in the latter, however, remains elusive in spite of the broad commitments made to assist small countries. At present, a new diplomacy based on a novel configuration of smallness and development is required in the FTAA as eligibility for special and differential treatment is being tackled in this crucial final negotiating phase.
In the years ahead it is expected that Latin America will grow in even greater importance for CARICOM. The FTAA process will impose on CARICOM the task of finding the optimum path to hemispheric integration. This will involve exploration of the various options for linking existing bilateral and regional agreements. It is a challenge that these states have already accepted and will result in significant new diplomatic initiatives in the near future.
NOTES
[i] Latin American Integration Association (LAIA).
[ii] West Indian Commission. “Time For Action-The Report of The West Indian Commission”, Black Rock, Barbados, 1992.
[iii] At its Seventeenth Meeting held in Barbados in July 1996, the Conference of Heads of Government took this decision.
[iv] This Agreement entered into force between the Dominican Republic and two CARICOM Countries (Jamaica and Trinidad and Tobago) from December 1st 2001.
[v] The Agreement on Trade and Economic Cooperation between the Caribbean Community and the Government of the Republic of Cuba was signed on 5 July 2000 and came into force on January 1st 2001.
[vi] Venezuela has since requested the extension to it of the preferential tariffs that were granted to Colombia by the CARICOM MDCs at the earliest convenience.
[vii] In Brazil’s proposal to expand MERCOSUR to the South American Free Trade Area (SAFTA), no mention was made of CARICOM.
[viii] CARICOM: Joint Communique Issued at the Conclusion of the Fourth CARICOM-Central America Ministerial Meeting, Georgetown, Guyana, 22 March 1999
[ix] The CARICOM-Costa Rica FTA, now in its final stages of negotiation, may open the possibility for a wider CACM-CARICOM Free Trade Agreement.
Said Cherkaoui 24 