Evan Soltas
Jun 29, 2013

Protectionism, or Free Trade?

(Originally published here.)

Are free-trade agreements protectionist? It sounds like a silly question, but it's always worth asking of regional (as opposed to global) trade pacts -- like the ones the U.S. is seriously considering with the European Union and the Pacific Rim.

Economists are often mocked for free-trade worship, but they're skeptical when appropriate. Jacob Viner, a University of Chicago economist, argued in 1950 that free-trade agreements don’t necessarily promote free trade.

Trade deals have two effects, he said: They create trade by lowering the cost of international exchange, but they also divert it by the selective reduction of barriers. Whether the first or the second effect predominates determines whether the deal is good or bad.

To see this more clearly, imagine three countries, Viner wrote, and call them A, B and C. Country A can import a good from B and C. At the beginning, A has the same import tariffs against both. B produces the good less efficiently than C, so A buys the good from C. Then A and B make a trade agreement, but they leave out C. The reduction in tariffs leads A to buy the good from B, the less efficient producer. Now the world is worse off and trade more distorted.

The example might become real life if "C" stands for China and the trade deal is the Trans-Pacific Partnership, an agreement that hopes to reduce trade barriers between the U.S. and Pacific-Rim nations such as Japan, Vietnam and Peru. Financial Times columnist David Pilling has called it the "'anyone but China' club."

If that's what TPP is, it's a mistake. The U.S. is inviting economic trouble -- not to mention other kinds of trouble -- if it adopts this approach. Paul Krugman put it well in a 1991 article: "Half a loaf may be worse than none." It's an opinion he shares with another prominent trade economist, Columbia's Jagdish Bhagwati, who called such tactical deals "termites in the trading system" in a book in 2008.

In practice, where would TPP and the proposed U.S.-EU agreement sit on the trade diversion-or-creation spectrum? Economists seem optimistic. "For the big free-trade agreements of the last 10 years, we find no significant trade diversion," said Gary Hufbauer, a trade economist at the Peterson Institute for International Economics. Hufbauer expects the same for the two new deals.

Economists Scott Baier and Jeffrey Bergstrand have also found in a series of research papers that agreements similar to the prospective TPP and U.S.-EU pacts create far more trade than they divert. "The deeper the trade deals are in terms of the number of regulations they harmonize, and the greater in breadth measured by the number of industries they cover and countries they include, the bigger the trade-creation effects," Baier said in an interview.

Peter Petri and Michael Plummer estimate that TPP would divert less than 3 percent of total exports from Asian nations not party to the deal. That isn't much to fear.

Nevertheless, U.S. officials say they're aware of the risk. "The U.S.-EU agreement will result in little trade diversion," said Robert D. Hormats, a U.S. Department of State undersecretary in an April speech. "In fact, it can complement and reinforce the multilateral system, and contribute to the development of global rules in areas where progress at the multilateral level has not been possible in the past."

Trade diversion, Hufbauer added, becomes a more salient issue when countries try to exempt particular industries from a deal. That's a big risk for agriculture, textiles and apparel, where protections are strict, he said. That's where U.S. negotiators should focus their attention if they want to make sure the deals maximize the free-trade benefits and minimize the protectionist costs.