Choices: Trade agreements or tired tirades?

August 28, 2006 (LBO) – In a discussion of two pieces of trade-related legislation now before Parliament, a JVP MP stated that they served the interests of the World Terrorist Organization as he described the WTO (World Trade Organization).

It is not surprising that his venom was directed at the WTO and the concepts free trade and globalization associated with it. The question is why normal people who should know better buy into this kind of thinking.

Now that the Doha Round has been suspended, one could ask why the WTO bashing continues. The friends of free trade are doing enough damage to it, why do its enemies need to bother?

But the JVP knows what it is about, unlike some of the moderates who unthinkingly adopt their positions.

The suspension of the Doha Round does not abrogate the treaties that the WTO is responsible for, the General Agreement on Tariffs and Trade (GATT) and the General Agreement on Trade in Services (GATS); it simply postpones progress on further liberalisation.

And suspensions of trade talks are nothing new. The previous Uruguay Round took seven years.

The bilateral trade agreements that are being negotiated, albeit at snail’s pace, with India and other countries, all use the grammars of the GATT and the GATS, the two treaties the WTO is responsible for.

If the JVP is to succeed in imposing its state-controlled Pol Potist vision upon this country, they must block trade agreements of all kinds and build protectionist barriers around the island. They must keep bashing the WTO and all trade agreements.

What’s special about trade?

Some wonder why protestors target meetings of the WTO and the World Bank/IMF and not those of the UN and its specialized agencies, such as UNESCO or the ITU (International Telecommunications Union).

Protestors target the meetings of the Bretton Woods triad because that is where the discipline, the power, resides. The other gatherings are toothless talkshops.

When a country breaks the rules of the WTO or of the IMF or the World Bank, it gets disciplined; not in the sense of being thrown into Bretton Woods jail, but in terms of countervailing duties being imposed on its exports or the withdrawal of support for its currency.

This is not the case if a country ignores an ITU recommendation or disregards a UNESCO declaration. The Taliban’s destruction of the Bamiyan Buddha statues in defiance of UNESCO brought no adverse consequences.

Trade agreements, for the most part, are disciplines; there are consequences to transgression.

Until the Canada-US Free Trade Agreement (FTA; which subsequently became the North American Free Trade Agreement, or NAFTA), trade agreements only covered goods. The objectives were to reduce the tariffs and lower the non-tariff barriers so that the overall efficiency of the trading nations would be improved by each party specializing in the activities it had comparative advantage in.

Goods would move through customs points at ports and other designated locations, where the provisions of the trade agreements would be implemented in the form of lower duties and less onerous clearance procedures. There was no intrusion into the domestic affairs of a country, and no obvious diminution of national sovereignty.

After multiple rounds of liberalization under the GATT brought down the tariffs on a large range of goods close to zero, attention began to focus on non-tariff barriers (NTBs) and subsidies, because they were now the main barriers to trade, not tariffs.

Now, the internal intrusions began to be visible: Americans complaining that the Canadian lumber industry was not more efficient than the American industry, but simply the beneficiary of unfair subsidies in the form of different fee structures for taking lumber from state land; Europeans complaining the US aerospace industry was the beneficiary of elaborate subsidies through the military procurement system. And so on.

The short-term effects of trade liberalization, or simply competition, necessarily resulted in some form of blaming of the other, which was easier to do if the other was foreign. It could not be that they were more efficient than I; they had been given some unfair advantage by their government; someone has to “level the playing field” for me.

As more and more people began to work in service industries, the thinking was that services would increasingly be traded across borders. Of course the Americans thought at that time that they had some kind of natural comparative advantage in services; but that was before Bangalore and accent neutralization!

There were the usual debates about how one could trade hair-dresser services across borders. But over time the conceptual issues were settled in a pragmatic way through the definition of the four modes:

  • Mode 1, where services are traded across borders, just like goods, with the seller in Country A and buyer in Country B;
  • Mode 2, where the buyer from Country B would travel to Country A, to consume the service produced by the seller in her location;
  • Mode 3, where the seller would establish a commercial presence in Country B to produce and sell services to the buyer; and
  • Mode 4, where natural persons (i.e., those other than the unnatural corporate persons establishing commercial presence) would travel from Country A to Country B to provide services to buyers from Country B.

So hair-cutting services could be traded in the following ways:

  • Mode 2, where the Indian person wishing to buy haircutting services would cross the border into Colombo for a haircut;
  • Pure Mode 3, where the Ramani or Nayana or whatever Sri Lankan chain would establish subsidiaries or franchises on the Indian side, but employ only Indians to cut hair;
  • Modes 3 and 4 combined, where the subsidiaries or franchises would bring in Sri Lankan hair cutters across the border; and
  • Pure Mode 4, where itinerant Sri Lankan hair dressers would cross the border to cut Indian hair.

Services have been traded across borders for centuries.

What was new in the 1980s was the qualitative increase in services trade, enabled by improved communication, including both transportation and telecommunication.

Services trade was different from goods trade because services crossed borders in multiple ways, not in the nice, disciplined ways that goods did (Velvetiturai, and Uswetakeiyawa not withstanding).

If you think about it, every flight taking tourists out of Colombo is full of traded services: tourist and other services consumed at the point of production under Mode 2.

When an Indian accent neutralization specialist crosses the border to give training to BPO workers in Sri Lanka, he is engaging in Mode 4 trade in services. When a Sri Lankan buys a dot come URL from a US-based web registry over the Internet using a credit card, she is engaging in Mode 1 services trade over the web.

From the perspective of a government seeking to control and regulate trade, this poses a serious problem. How can one control things that do not go through chokepoints? Even more importantly, how can one extract duties from such things?

Traditionally, governments have not levied customs duties from services traded across borders. Regulation has been by means other than tariffs.

Bringing down tariffs a few percentage points at a time and ensuring that customs inspectors did not unduly delay shipments crossing the border could not liberalise services trade; it had to be done through the removal of barriers that were found throughout the economy, not simply at the border. It meant reaching into the very capillaries of government and changing procedures.

Sri Lanka’s WTO commitments led to my walking around with the Telecom Act, the country’s telecom commitments to the WTO and the incumbent’s license all bound together as one text, and telling people what could and could not be done under those disciplines during my tenure as Director General of Telecommunications.

Entering into trade agreements results not only in setting the rules within which transactions take place; it results in constraining what governments can do within their borders. That is why they have to be carefully negotiated; that is why totalitarian parties like the JVP hate them.

The dynamics of negotiation

Negotiations for the Canada-US FTA were driven by the Mulroney administration in Canada and those for NAFTA were driven by the Salinas administration in Mexico.

This contradicts the conventional wisdom of the Left that free trade agreements are imposed on weak and unwilling partners by powerful trading nations.

Why small countries with intelligent governments seek trade agreements is explained by the fact that the lack of rules or anarchy is advantageous to the powerful country and disadvantageous to weak one.

Therefore, it made sense for Canada to seek the rule-based regime of the Canada-US FTA and then agree to its widening into the NAFTA.

It makes sense for Sri Lanka to seek a rule-based system to govern its increasing trade in goods and services with India.

An analogy can help explain the hierarchy of solutions for governing trade between countries.

The analogy is that of a schoolyard bully who forcibly appropriates the lunch of, say, five children on a random basis.

The victims have a number of options, the most interesting being the creation of a regime, in the sense that the term is used in the field of international relations.

That is, they could negotiate with the bully to create a system of rules to govern the appropriation of the lunch, a fundamentally unfair act.

Instead of being randomly attacked and left hungry, they now take turns to bring extra helpings or whatever to look after their hunger and happiness.

The bully gets his lunch regularly without exerting any effort and without the risk under the previous circumstances of a bullied child fighting back. Though patently unfair, it is an improvement on the status quo ante for all parties.

The conclusion is that rule-based regimes are superior to anarchy, even when there is substantial asymmetry of power among the parties.

Of course, a rule-based regime that is entered into on the basis of principles of fairness and mutual respect, by parties that are equally endowed with knowledge and power, using means of negotiation that are equitable and non-violent, would be best. Therefore, in general:

No-rules, power-oriented regime < Rule-based regime agreed to by unequal parties < Rule-based regime agreed to by equal parties

Multilateral regimes, liked the GATT and GATS tend to be closer to the ideal than bilateral or plurilateral regimes, because the power asymmetries can be neutralized better as the number of parties increases.

This is a separate and distinct rationale for multilateral agreements, beyond the normal one regarding reduction of transaction costs.

The JVP, which thinks that North Korea is role model, will keep attacking the WTO, trade agreements, globalization and free trade.

It will take little more than the acquiescence of moderates for their protectionist campaign to succeed.

Those who see Singapore and India as role models, as opposed to the JVPs Myanmar and North Korea, must express support for the WTO and the principles of free trade.

They should not rejoice when a trade round fails, but should engage in the hard work of educating people on the long-term benefits of trade and trade rules.

Because the advantages of raw power decrease as one goes down the list given below, people of goodwill must support well negotiated multilateral and bilateral trade agreements.

  • No rules/implicit bilateral rules
  • Bilateral agreements (unequal)
  • Multilateral agreements (unequal, if badly negotiated)
  • Bilateral (equal)
  • Multilateral (equal/well negotiated)

The present environment of no rules or implicit bilateral rules does not benefit a small country like Sri Lanka.

What serves our interest best is a well negotiated round of GATT and GATS liberalization.