Hamish McRae: Gordon Brown's Big Idea could prove a global winner

A free trade agreement between Europe and America deserves serious consideration

Gordon Brown made a really important speech in New York last week about the economic relationship between Europe and America. Sadly, its message was rather lost in the latest alleged infighting between the Prime Minister and the Chancellor about whether and when Britain should consider having the referendum on ending the pound and replacing it with the euro.

The Big Idea in the Chancellor's speech was that the world's two great trading blocs should move towards a free trade agreement. You can see the logic behind it: not only would there be immediate wealth gains to both sides, but it would prevent any tendency for Europe and America to start erecting ill-tempered trade barriers, a process that could ultimately be catastrophic to the world economy. For the UK there is a further attraction: it heads off the danger that Britain might have to choose between Europe and America, a danger discussed on this page by Gerald Holtham.

But the idea of a merger between the blocs raises a string of questions. For example, surely World Trade Organisation rules mean the two blocs can already trade freely with each other, so why a need for a merger? Is there a danger that if the two big trading blocs cuddle up together, small nations in both the developed and developing worlds will find themselves excluded? Why should the US buy into the idea, given the great run its economy has had under NAFTA: why not extend NAFTA to South America instead? And as for the EU, why should it seek a closer relationship with what, in the eyes of many Continental Europeans, is the EU's chief rival for influence on the world?

There is a simple answer to the first question of beefing up WTO rules. In theory, the WTO, like the GATT before it, ensures free trade, at least in manufactured goods, but in practice it is much easier to trade within NAFTA or the EU than it is between them. The creation of both groups led to a surge in regional trade. Clearly there are practical barriers to trade – regulation, labelling, customs clearance – that exist between blocs but not within them. There are huge barriers over trade in services or agricultural goods, and services especially have become a fast-growing aspect of global trade. In an ideal world there would be no need for regional trade blocs;in practice they have helped foster greater prosperity.

Has that been at the cost of countries that are outside? I suppose to some extent that may have been the case, but the evidence is mixed. East Asian countries such as Singapore and Taiwan have built their extraordinary prosperity by exporting to North America and Europe. On the other hand, sub-Saharan Africa has seen its share of world trade halve over the last 25 years. Many less developed countries feel they have been disadvantaged by the EU, and maybe also by NAFTA, but it is hard to see that their plight would be even worse were the two to join hands.

But why should America be interested? This is the key, for if the US is not, then it won't happen. At present there is no great enthusiasm in the administration, but that may change. It is quite hard, viewing the world from London, to appreciate the scale of US irritation with the EU over everything from Europe's attitude to the US on global warming, through its resistance to imports of GM foods, to its blocking of the merger between GE and Honeywell. But the GE bid in particular taught Americans something they did not want to know: that the power balance between Europe and America was pretty even. The US was going to have to learn to take European views into account.

The power balance between the two zones is shown in the left-hand graph. As you can see, NAFTA is well ahead on total GDP and on stock market capitalisation. Both measures are flattered by the strong dollar. Were it to come down, the gap would be much narrower. In any case, NAFTA is only just ahead on population and it is behind the EU on exports.

You can play some numbers games here but they don't really change the big picture very much. Were you to add in the potential recruits to the EU in Eastern Europe, Europe would move ahead on population, though it would still be behind on GDP. Were the US to try to extend NAFTA to the south to include Brazil, Argentina and the rest, it would move back ahead in population (there are 161 million people in Brazil alone) but this would not make an enormous difference in terms of GDP. The broad conclusion from all this is that, given the almost equal status of NAFTA and the EU, it is in the interest of NAFTA to try to deal. It could, for example, trade better access to the US market in exchange for more influence on how the EU develops. Trying to pretend that the EU is a slothful, sclerotic society that NAFTA can dominate won't wash. The more the US has to deal, the greater the case for a formal trade agreement.

And Europe? The EU has two big things on its plate: the euro and enlargement. Both should in theory strengthen it vis-à-vis NAFTA. But things may not turn out like that, just as the merger between the two Germanys weakened the country. It may be that coping with the "one-size-fits-all" interest rate will create more costs than benefits, and while the new applicants to the east bring vigour and enterprise, they are relatively poor. Insofar as the EU has a single position, it is probably that it does not need a deal with NAFTA. But this may change. The one thing that would really shift the balance of power between the two blocs would be if the UK were to switch sides. I am not advocating that: it is a romantic idea of the political right rather than a practical option. Still, as you can see from the graph on the right, NAFTA would suddenly become much larger than the EU in GDP and population, vastly larger in market capitalisation and close in exports.

Why bother making that calculation when it is not on the agenda? Well, nothing is for ever and this outlandish notion might, under certain circumstances, become a real option in another 15 years' time.

But, of course, a deal between the EU and NAFTA is better. So it is worth reminding both the US and the EU that they should try to co-operate rather than compete. Gordon Brown's idea deserves to be taken seriously in America as well as Europe. This could become one of the really big projects in global economics of the first quarter of this century.