Let trade winds blow across the Atlantic

An EU-US pact on liberalisation may encourage others to follow suit, write Richard Baldwin and Joseph Francois

In a set of discussions entitled the "New Transatlantic Agenda", the European Union and the United States are deliberating on closer co- operation on a wide range of issues, ranging from collaboration in Bosnia to environmental protection and international terrorism. One of the most concrete issues concerns transatlantic trade liberalisation.

Between them, the US and EU account for almost two-thirds of world trade and almost half of world income. Any bilateral liberalisation between these giants is, therefore, an important affair, as much for the EU and the US as for the rest of the world.

In a study recently published by the Centre for Economic Policy Research in London, we look at the potential benefits of the two regions pursuing a trade and investment agreement. The study addresses two main questions. Would such a bilateral initiative benefit EU and US citizens (and what would it do to those excluded from the deal)? Equally importantly, we ask whether the EU and the US would benefit more from a preferential bilateral initiative or from joint support for multilateral initiatives.

The short answer to the first question is: not much. The reason is simple, but first some facts. Trade between North America and Western Europe consists largely of two-way trade in similar industrial products. In 1994, almost 40 per cent of this trade was in machinery, cars and car parts and other transport equipment. Of $276bn (pounds 184bn) in total transatlantic merchandise trade, very little, in relative terms, was in politically sensitive industries such as textiles, clothing, steel and agricultural goods, where trade frictions are concentrated.

Much of this trade is already quite free due to a combination of Uruguay Round commitments to reduce tariffs and the Information Technology Agreement reached at the Singapore Ministerial of the World Trade Organisation. Indeed, most transatlantic trade will face either relatively low tariffs (generally less than 2.5 per cent) or zero tariffs by 2005, even without a preferential trade agreement. The notable exception is continued EU and US protection in sensitive items such as agricultural products, textiles and fisheries, but politicians are unlikely to tackle these "sacred cows" in a bilateral setting.

Because protection is relatively low, a narrow preferential agreement leading only to the elimination of tariffs on industrial goods is likely to have little, if any, discernible impact. We estimate that national income in North America would rise very slightly and the effect on EU income would be almost zero.

A deeper agreement that went substantially beyond tariff liberalisation to include barriers such as those tackled by the EU's Single Market Programme (for example, eliminating anti-dumping duties and opening up government purchases to importers) would generate modest increases in income and wages for the two regions. We question, however, whether this sort of westward expansion of the single market would be politically feasible. The EU and the US have shown an unwillingness to co-operate on deeper- than-tariff cutting liberalisation. The US's reluctance to join the financial services liberalisation is an example.

What would a TAFTA (TransAtlantic Free Trade Agreement) do to third countries? The implications vary depending on the degree of liberalisation. One finding that appears across most of our computer simulations is that a preferential agreement implies welfare losses for North Africa and the Middle East, usually of a magnitude roughly comparable as a percentage of GDP to the gains for the EU - small losses, but losses none the less. The harm comes from the way in which a preferential agreement between the EU and the US erodes the value of the tariff preferences these nations already enjoy in EU markets. In essence, a TAFTA would increase the competition that North African and Middle Eastern exporters face from Americans in the EU market.

While we find little to gain from two-way liberalisation, our results suggest that any potential economic benefits to Western Europe and North America of preferential liberalisation are easily swamped by the potential gains that would arise from comparable multilateral liberalisation. For other regions, particularly developing countries, the implications of such multilateral liberalisation depend critically on their own participation.

The main point here is the remaining protectionist regimes are not to be found in Europe or North America. They are in Asia, Latin America and Africa. In these regions peaks of protection (tariff equivalents of over 30 per cent) affect US and EU exports of fishery and mining products, textiles, clothing, fabricated metal products, transport equipment and machinery. To be fair, the US and EU have enormous protection barriers in food and clothing.

Interestingly, eliminating these barriers in Asia, Latin America and Africa would mainly benefit Asians, Latin Americans and Africans (although it would have benefits for the transatlantic economies too). How can this be? How can lowering your trade barriers improve a nation's standard of living? Describing the actual mechanisms could fill a library, but the basic notion is simple. Free trade is nothing more than letting the market work its magic on an international scale. Experience throughout the world shows that those who embrace the market usually thrive; those who shun it usually stagnate.

Where does all this leave us? Although a strictly transatlantic trade initiative is unlikely to yield economic benefits large enough to convince politicians to shoulder the inevitable political pain, such talks might trigger something much more important. Recent experience suggests that liberalisation begets liberalisation; that is, once countries start talking about lowering trade barriers on a preferential basis, we often see other countries joining the tariff-cutting. This is what we saw in the western hemisphere after the US-Mexico free trade talks started. It is also what we saw in Europe once the single market programme got under way.

This article reviews research reported in 'Preferential Trade Liberalisation in the North Atlantic', CEPR Discussion Paper No. 1611 (March 1997) by Richard Baldwin and Joseph Francois.

Mr Baldwin is Professor of International Economics at the Graduate Institute of International Studies in Geneva, and Co-Director of CEPR's International Trade programme. Mr Francois is Professor of Economics at Erasmus University in Rotterdam and a Research Fellow in CEPR's International Trade programme.