This is the second article in a series of four explaining trade agreements and why they are important. You can find the first article covering the Principles of Free Trade Agreements here.
In this section we’ll look at the recent history of trade deals, cut through the jargon, look at the key principles and, after all of that, get a pretty good understanding of why FTAs are so difficult to negotiate.
In the beginning there was the General Agreement on Tariffs and Trade, or GATT.
Well, not the beginning of time, but 1948. It was put forward by the UN after the end of the second world war to resolve the failure of negotiating governments to create the International Trade Organisation (ITO). Initially, GATT was signed by 23 nations in Geneva on 30 October 1947, and took effect on 1 January 1948.
The General Agreement on Tariffs and Trade (GATT) was originally a forum creating a legal agreement between many countries, whose overall purpose was to promote international trade by reducing or eliminating trade barriers such as tariffs or quotas. According to its preamble, its purpose was the “substantial reduction of tariffs and other trade barriers and the elimination of preferences, on a reciprocal and mutually advantageous basis.”
Introducing the World Trade Organisation, or WTO
It remained in effect until the signature of the Uruguay Round Agreements by 123 nations in Marrakesh on 14 April 1994. That established the World Trade Organisation (WTO) on 1 January 1995. The WTO is sometimes described as a successor to GATT, but that’s incorrect; rather, the WTO is an organisation created to manage and further develop GATT. Indeed, much of the original GATT text from 1947 is still in effect.
GATT or WTO Rules as they are today
So now GATT is basically, then, a boilerplate global trade agreement that fixes rules and tariffs for international trade between its 164 member nations. It’s exactly what it says – a General Agreement for Tariffs and Trade. It’s possible for individual countries to set up their own bilateral or multilateral trade agreements, but, by definition, the terms have to be better than GATT terms – GATT is the default.
There’s the GATS – General Agreement on Trade in Services – too, but we’ll talk about that in a later part of this series. For now, we’re sticking with tangible goods and agriculture.
The WTO now has 164 members and 23 observer governments. Liberia became the 163rd member on 14 July 2016, and Afghanistan became the 164th member on 29 July 2016. In addition to states, the European Union, and each EU country in its own right, is a member.
So who’s not a member of the WTO? The most significant countries are Iran, Algeria, Sudan, Belarus, Serbia, Turkmenistan, Azerbaijan and Bosnia Herzogovina. Almost all of them want to be members and are in various stages of adapting their own laws and regulations to comply with WTO rules.
The WTO deals with regulation of trade between participating countries by providing a framework for negotiating trade agreements and a binding dispute resolution process aimed at enforcing participants’ adherence to WTO agreements. These have all in turn been agreed to by member governments.
A good example of WTO rules is that countries are not allowed to create trade deals for specific industries or agriculture. Two countries couldn’t agree a trade deal that just covered aircraft and defence equipment, or just wheat and soya beans, for example.
Every country that’s a member of WTO has to publish its own schedule of tariffs, and that has to be accepted by every other member country. The UK doesn’t have its own schedule, at least not yet – it uses the common EU schedule. If Brexit goes ahead, it will have to publish its own, and in theory that could be vetoed by any member country, however small. However, that risk is minimal as there would have to be very good reasons that stack up under other WTO rules.
GATT, and its successor WTO, have successfully reduced tariffs. The average tariff levels for the major GATT participants were about 22% in 1947, but were 5% after the Uruguay Round in 1999. Experts attribute part of these tariff changes to GATT and the WTO.
Next steps – the Doha and Bali rounds
The WTO has been trying to go further in what’s called the Doha round, started in 2001 with the aim of creating a multilateral trade agreement between all WTO members. It’s aims are very ambitious – the intention has been to push development of emerging economies by removing barriers on financial services and removing agricultural subsidies in rich countries – but it got stalled in 2006, because the farm lobbies in the EU and US wouldn’t agree.
That seemed to paralyse the WTO for several years, but it overcame the hurdles. The Doha round is still theoretically in play, but new agreements have successfully been made in recent years.
The first big agreement in the WTO’s history was called the Bali Package, agreed by all members on 7 December 2013. That simplified and streamlined customs standards and cut bureaucratic red tape to make international trade easier.
Then in 2017, the TRIPS amendment to the WTO (TRIPS stands for Trade Related Aspects of Intellectual Property Rights) should secure a legal pathway to access affordable remedies under WTO rules for developing countries.
So WTO terms become the default for countries that don’t have their own FTAs – at least for the countries that are members, which is most of them. And the WTO has highly influenced the text of trade agreements, as most FTAs are based on the GATT standard.
Why isn’t that good enough for all countries? Wouldn’t it be better if everyone agreed to a global free trade deal? Ah, the dreams of an ideal world…. But back to reality. Countries are naturally cautious. They put up barriers to protect their own economies – to keep jobs, protect their farmers, and so on, and to ensure that they don’t become dependent on others for strategic materials and products such as defence.
When people or politicians think barriers have fallen too far, there are protests against globalisation. It’s inevitably somewhat hypocritical – the country still wants to sell more to other countries, it just wants to restrict imports.
However, all countries want to grow their economies. Every country has specific other countries that it has special interests in exporting to, or importing from. Most commonly it’s because the other country has a big market for something that the exporting country is good at, and it thinks it could sell a lot more if the other country got rid of its import duties, or cut its bureaucracy, or simplified its regulations, or all 3.
So the countries that want to improve their trade, with a better deal than WTO terms, start the process of negotiating Free Trade Agreements – often a long and tortuous process.
What’s a Most Favoured Nation?
One of the key issues that gets in the way of agreements is what’s known as MFN – Most Favoured Nation status. It’s also a common term in many trade agreements, except in those it’s a matter of corporations or customers – here, we really are talking about Nations.
What does it mean? Basically, that the parties to the agreement pledge never to offer better terms of trade to any other country. In practical terms, that means that the participating countries enjoy the lowest tariffs and the fewest barriers to trade. All Most Favoured Nation partners must be treated equally. It’s very desirable, particularly for emerging economies.
All members of the WTO who are relying on its terms – so, all those that do not have their own specific bilateral or multilateral agreements – enjoy Most Favoured Nation status, so in other words the tariffs are the same for all countries. If, for example, the UK leaves the EU and sets a tariff rate of zero for a certain type of good or agriculture, then that zero percent rate would apply to every country that’s a member of WTO, from Afghanistan to Zimbabwe.
So, at last, to Free Trade Agreements
However, members of a bilateral or multilateral free trade agreement, even if they’re members of the WTO themselves, don’t have to extend the same benefits to other countries as a matter of course. So it’s possible to set up a FTA between two countries with a special low tariff rate – at least lower than the WTO schedule, and in most cases zero – without having to offer the same terms to everyone else.
The EU is itself, by one of its definitions, a huge free trade agreement.
If the UK leaves and goes onto WTO terms, then whatever tariff rates the UK set have to be applied equally to all countries because of the Most Favoured Nation rules.
So setting zero rate tariffs on certain goods or agriculture to attempt a level playing field with EU countries would also mean that every other country gets to trade with the UK on zero rate terms too. That would quite possibly decimate British agriculture, as well as quite a few industries.
The other important consideration here is that a country sets its own import tariffs on its WTO schedule.
As discussed in Episode 1, when I explained Unilateral Trade Deals, most countries set these high where needed to protect their own industries and agriculture. If they set some of the tariffs low, it’s typically to help other emerging countries grow their markets by exporting products that don’t conflict with its own economy. So, whilst a country is free to reduce its tariffs unilaterally, even to zero, that’s to enable imports to flood in. It doesn’t do anything to help exports – they’ll hit the import duties levied by the countries they’re exported to.
Most Favoured Nation rules don’t just apply at WTO level.
Many existing bilateral and multilateral Free Trade Agreements include their own Most Favoured Nation clauses. For example, the EU has a FTA with Canada that includes a MFN clause. That means that the UK can’t negotiate a better deal with Canada than it has with the EU, or a better deal with the EU than it has with Canada, without all those countries getting the same better terms. There are lots of such FTAs with MFN clauses, and the limitations that places on deals is one reason that the negotiations typically drag on for years and years.
Rules of Origin
There’s one more important consideration of Free Trade Agreements that businesses need to be aware of, which is Rules of Origin (RoO). Basically, when countries drop their tariff barriers to imports from another country, they want to be certain that those goods did actually originate in that other country. They need to be sure that there’s no risk of that country importing goods from a third country with which it also has a Free Trade Agreement, adding a “Made in X” sticker and then re-exporting it to them.
Of course, the origin of manufactured goods is not always so easy to define. As we’ve seen before, and taking the example of car manufacturers, a car assembled in Mexico may have a gearbox made in Britain, body panels made in Brazil and an engine made in Canada. How much of that car is Mexican?
Rules of Origin define the percentage of value added in the country that exports the end product, and those in turn define how it gets treated by an importing country with which it has a Free Trade Agreement.
As you’ll understand, then, there’s no easy made-to-measure set of Rules of Origin – those too need to be defined when FTAs are negotiated. Each importing country sets its own rules for each class of goods, and then the exporter has to provide a Certificate of Origin (CO) or a Preferential CO – these are ones specially tailored to meet FTA rules that can be obtained easily via a Chamber of Commerce.
If you’re in a business that exports or plans to export, and want to take advantage of Free Trade Agreements, you’ll need to know more about Rules of Origin and those certificates.
Lobbying for better terms of trade
But let’s now move away from the rules, the organisations and the jargon, and look at an entirely different big factor when it comes to negotiating free trade agreements – lobbyists. It’ll come as no surprise to anyone that when there are trade deals in the offing, big business spends big on lobbying to get its interests looked after.
That’s because trade deals don’t have to cover every type of industry – some get top-notch preferential treatment, whilst others get overlooked. In the US, UK and EU, the big spenders – and the winners almost every time – are sectors like defence, cars and pharmaceuticals.
Big multinationals in those and other sectors are inevitably those who benefit most from trade agreements – they’ve already got international operations that they can leverage to take advantage of the best trade terms on offer.
So if a multinational household goods company makes the same laundry detergent in many different countries, including ones that are the subject of a FTA negotiation, they’ll be interested in an opportunity to import that product from the lower cost country.
That will meet the objectives of free trade deals in that the economy of the cheaper country will grow – as the detergent factory there will have more work and employ more people – whilst costs will be cut if they can close down the factory or scale back production in the more expensive country. Advantage – and disadvantage – encapsulated.
Do SMEs benefit from trade deals?
Recently I’ve heard the owners of a number of small and medium size businesses talk about their dreams of increased business when free trade deals are struck. Potentially that’s true, but probably only if they’re in the same sector as a big lobbyist or part of their supply chain. There’s at least as much risk that they’ll suffer from cheaper imports from the other country.
It’s not just industry where lobbyists are active. Farm and Fishing lobbies are extremely powerful – and when the trade deal is being negotiated with a country where agriculture gets government support, even if they get their own, they’ll be shouting especially loudly. Agricultural lobbies are so powerful that they’re what sunk the Doha agreement that I was talking about earlier. And if the other country has especially cheap labour-intensive industry, you can expect the trades unions to be shouting too, though of course they’re a lot less powerful than they were in the past.
The Environmental lobby
Now there’s a new and strengthening lobby – the environmental one. As of yet, perhaps it doesn’t have the money and clout of big business – but it looks like its day will come, very soon indeed.
Finally, before leaving this episode, let’s consider what creates the appetite in governments to pursue these free trade agreements.
Remember that every country or bloc that’s a member of WTO can rely on its terms and agreed tariffs. So there’s nothing really to stop international trade. It’s just that there would be much more of it – both imports and exports – if there weren’t such high taxes and duties, and if regulations – red tape and bureaucracy – could be made to disappear.
But negotiating a free trade agreement takes years of patient negotiation, and there’s only any point in it if both sides can really see great opportunities.
Each country is looking for which other countries represent a much bigger potential market for products that it’s good at producing – or where it forced to import a lot of expensive product that it cannot produce in its own country, or at least cannot produce economically. So if a country has a big aircraft industry, there’s no incentive for it to negotiate with another country that’s unlikely to buy more than one or two planes a decade.
So every country or bloc really wants free trade agreements with other big market economies, and has less interest in others unless they produce something they really need. Logically, that also answers the question “With many countries clamouring for trade deals with another, who gets priority in the queue?”. Inevitably, each country’s priorities are those countries which are its biggest potential markets.
That priority level is unlikely to be reciprocated. The UK, looking at all the countries it will want a trade deal with, is bound to prioritise the USA as the biggest market on earth. The USA, however, is likely to rate bigger markets such as China or the EU ahead of the UK.
To get a desired country to the negotiating table, and get priority, the weaker country inevitably has to offer early concessions – in the form of agreeing to remove import tariffs or regulations on some of the other country’s exports.
How effective are trade deals? What lessons can be learnt from the ones that have been negotiated and in place for at least a few years now?
That’s what we’re going to look at in the next episode, episode 3, when we’ll look at a number of actual trade deals and how they’ve worked in practice.
If you’d like to discuss trade agreements or any other aspect of international expansion, the author, Oliver Dowson, offers free advice and initial consultations to subscribers to growinternational.org – just get in touch using our contact page