Hamish McRae: New mood favours free trade with US

Economic View

It is as yet a distant rumble, a sign the earth may be about to move rather than of any immediate seismic shift, but it seems a reasonable possibility that in two or three years' time North America and Europe could be joined in a free trade area.

Talks between the EU and the US on a free trade deal, joining the world's two largest trading blocs, are scheduled to start in the summer. If deal comes off, it would sweep in the rest of North America, through the US membership of the North American Free Trade Agreement, which took effect nearly 20 years ago, and the rest of Europe, through the agreement between the EU and the two other European trade groups, the European Free Trade Association and the European Economic Area.

For many people it might seem strange that we don't already have a free trade agreement, for our economic links are so embedded. Looked at from the UK, the US is the largest foreign investor and our largest export market – though if you add all the European countries together they buy more from us than the US. So there is plenty of trade; the question is whether there might be a whole lot more.

Why now? In a sense the EU and the US are leaders of two rivals, co-operating most of the time but with scratchy relations over many details of trade. For example, trade in agricultural products is restricted by cultural barriers that go beyond the regulatory ones. You don't see much Californian wine on sale in a French supermarket. Other non-tariff barriers also restrict trade. For example, it has been estimated that differing safety standards for US-built and European-built cars are equivalent to a tariff barrier of more than 10 per cent.

By the way, the French are particularly adept at using the law to crowd out foreign competition. A court in Albertville, France, has just ruled "social skiing" illegal. This is when a tour company takes guests on a tour of the slopes, showing them good lunch spots and how to avoid queues. Guess which tour companies are in the dock? Yup, 12 British ones.

But the political mood is changing, and the French approach does not universally apply. For Europe, a deal with the US is seen as helping the EU's slow-growing economies to gain better access to a faster-growing one. For the US, doing more trade with Europe is seen as a counter-balance to the rise of China. You could say that in the boom years neither side felt it needed the other very much; now both, for different reasons, feel frightened, as indeed they should be.

You can see the background to this shift from the graph. As you can see, the EU taken together has a large and growing trade surplus with the rest of the world. That is partly because its most successful regions, Germany of course but also northern Italy, have been successful as exporters, but more because vast swathes of Europe, especially the southern fringe, have slashed their imports.

By contrast, the US had run a consistent trade deficit, but both exports and imports have recovered much more strongly than those of Europe. That is consistent with its more solid economic recovery.

Quite how much our two regions might gain from a free trade area is hotly debated. Estimates by the German Marshall Fund put the gain for Europe at the equivalent of 1.5 per cent of GDP, and for the US at 0.9 per cent of its GDP: worth having, but not something that utterly changes the economic performance of either. But the impact will not come from a one-off boost, and the EU estimates that a "comprehensive and ambitious agreement" would increase annual growth by 0.5 per cent, which if achieved would very much be worth having.

There is, however, an issue that goes far beyond the detail of the negotiations between the EU and the US. It is that if you start doing bilateral deals between trading blocs you undermine the progress towards global free trade, as encompassed by the series of free trade rounds, the last being the Doha round, which is pretty much stalled. You also undermine the World Trade Organisation, which has sought with some success to police international trade so that countries follow the rules in a reasonably fair way. Yes, countries cheat, for example by holding down their exchange rates, but at least there is a mechanism for countries to object to the most egregious examples of trade manipulation.

The Doha round is still alive – it resumes, confusingly, in Bali later this year – and will be given a new impetus by the new still-to-be-chosen director general, who will take office this summer. But many of the smaller developing countries are concerned that any move away from multilateralism will work to their disadvantage. The large trading powers talk of giving access to smaller emerging nations but in practice often shut them out.

So there is a decent argument that a huge trade deal such as this one would undermine what has been a broadly successful process of progressive multilateral trade liberalisation that has embedded global economic growth, first in the developed world, more recently in the emerging world, since the Second World War. Seen in that light, a US/EU trade deal would be a second-best solution. But in the real world, second-best solutions are better than nothing.

It is always hard, amid the clamour of daily financial and economic news to pick out the events that really change things. It is also hard to defend free trade pacts because the people and businesses that are disadvantaged are obvious and identifiable, whereas the beneficiaries are widespread and hard to pick out. But a US/EU trade deal feels like an idea whose time has come.