competitive liberalization and global free trade_ a vision for the early 21st century

8/13/2019 Competitive Liberalization and Global Free Trade_ a Vision for the Early 21st Century

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1/9/14 Competitive Liberalization and Global Free Trade: A Vision for the Early 21st Century

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Working Papers

Competitive Liberalization and Global Free Trade: A Vision for the Early 21st Century

by C. Fred Bergsten, Peterson Institute for International Economics

Institute for International Economics

The March Toward Free Trade

A large part of the world has eliminated all barriers to trade or is in the process of doing so. The f ifteen members of

the European Union have created a "single internal market." Australia and New Zealand have completed their freetrade area. Several large groupings are en route to a similar outcome: the North American Free Trade Agreement(Canada, Mexico, United States), Mercosur (Argentina, Brazil, Paraguay, Uruguay), and the ASEAN Free Trade

Agreement (Brunei, Indonesia, Malaysia, Philippines, Singapore, Thailand, and now Vietnam). There are numerousfree trade areas among smaller countries.

In addition, a series of new groupings have pledged to abolish all impediments to their international trade in thecoming years. The European Union and the Mediterranean countries (EUROMED) have committed themselves tofree trade by 2010. The 34 democracies of the Western Hemisphere agreed at their Miami summit in December 1994to work out a Free Trade Area of the Americas (FTAA) by 2005. The eighteen members of the Asia Pacific EconomicCooperation (APEC) forum--which account for half of would output and include the three largest national economies(China, Japan, United States)--decided via their Bogor Declaration of November 1994 to establish free trade andinvestment in the region by 2010 for their higher income members, that make up 85 percent of their commerce, and

by 2020 for the rest. History suggests that these targets will be met well ahead of schedule because private sectorsbegin investing to take advantage of the eventual steady state, and thereby accelerate the whole process, as soon

as the deals become credible.1

There have been many proposals for additional free trade regimes. The most significant by far would be aTransAtlantic Free Trade Area (TAFTA), joining Europe and North America. In a wholly different setting, Russia hasproposed reverting to free trade among some of the republics of the former Soviet Union. India is promoting anassociation of countries that rim the Indian Ocean.

Even without any additional configurations, over 60 percent of international commerce now takes place within existingor planned free trade regimes (table 1). This share is rising rapidly, both because of the onset of new arrangementsand because trade expands more quickly under such conditions. The question thus arises: why not eliminate all tradebarriers throughout the world? Why not launch a movement toward global free trade at the WTO Ministerial

Conference in Singapore in December 1996? Why shouldn't APEC, having agreed to achieve free trade in its ownregion but not wanting to create a new discriminatory bloc, propose that the world as a whole emulate its approach?

Table 1: Regional Free Trade Arrangements (share of world trade, 1994)

European Union 22.8

EUROMED 2.3

NAFTA 7.9
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Mercosur 0.3

Free Trade Area of the Americas (in addition to its subregionals) 2.6

AFTA 1.3

Australia-New Zealand 0.1

APEC (in addition to its subregionals) 23.7

TOTAL 61.0

Competitive Liberalization

In answering these questions, it is first essential to understand why so many countries, in so many different parts ofthe world, with such different economic systems, at such different stages of development, have all headed in thesame direction. There are of course different national circumstances which explain the detailed strategies and timingof the individual initiatives. The overarching force, however, has been the process of competitive liberalization.

The rapid increase of global interdependence has forced all countries, whatever their prior policies or philosophies, toliberalize their trade (and usually investment) regimes. Economic success in today's world requires countries tocompete aggressively for the footloose international investment that goes far to determine the distribution of globalproduction and thus jobs, profits and technology. Most countries offer direct incentives to foreign investors but anopen trade and investment regime is essential for this purpose. Mexico overcame its historic aversions to tradeliberalization and embracing its northern neighbor, and proposed NAFTA, when it became convinced that doing sowas essential to avoid losing out in the global competition for capital.

Moreover, success in today's global economy requires countries to compete effectively in international marketsrather than simply at home. This is true no matter how large the domestic market: the world's most self-containedeconomies including Brazil, China, India, Russia and perhaps most notably the United States--which maintainedextensive quotes on autos, machine tools, steel and numerous other products only a decade ago--have all joined thecompetitive liberalization race.

Competitive liberalization is pursued by countries that until recently had deeply entrenched protectionist traditions.France is a dramatic cases in point. So is virtually all of Latin America, which embraced important substitutiondoctrines as recently as two decades ago. The most stunning reversal of all comes from the former commandeconomies of the Communist world, ranging from China through Central Europe and the former Soviet Union to nowVietnam.

An intellectual and ideological sea-change underlies this historic development. Import- substitution and even autarkicmodels of development and national economic strategy were reasonably respectable into the 1960s and even the1970s. But their follies were then exposed, including by the third world debt crisis of the 1980s, and replaced by anew consensus of "outward orientation." The political onset of conservative governments throughout theindustrialized world, and in many parts of the developing world as well, hastened the implementation of these reformmodels.

This change in basic thinking does not, however, explain the onset of regional (or other international) tradearrangements. Why didn't the new attitude simply produce a spate of unilateral trade liberalization, which alltextbooks recommend as the most direct route to maximizing trade benefits for an individual country? The answerlies in the politics of trade reform.

The Political Economy of Trade Reform

To be sure, a good deal of unilateral liberalization has taken place. This has been especially true in East Asia. It hasalso occurred in the United States, most of whose quotas were abolished without any foreign quid pro quo. Butdomestic political opposition usually blocked countries from simply abolishing their traditional barriers. Entrenchedinterests fought hard, and frequently with prolonged success, to maintain their protected positions. The politics of

economic reform were difficult and contentious in virtually every case. 2

The standard strategy for achieving trade reform was to mobilize enough pro-trade interests to overcome those whoresisted further market opening. These included beneficiaries of imports such as consumers and industrial users of

imported inputs.3 However, such groups rarely organized and their gains from liberalization were both modest andwidely diffused. Hence they produced little political counterweight against those who would be adversely affected by


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increased foreign competition.

To overcome such opposition, it became necessary to appeal to exporters and others who gain directly from theopening of markets abroad. The political economy of trade liberalization in individual countries thus rested heavily onparallel liberalization in partner countries. The most assured technique for achieving such parallel action was to insiston reciprocity, through the negotiation of trade agreements with enough existing or potential markets to tip the internabalance in favor of the desired liberalization. The United States finally agreed to get rid of its textile quotas bynegotiating foreign concessions from the rest of the world, in the Uruguay Round at the GATT, on intellectual propertyrights and agricultural barriers. Through that same negotiation, Japan and Korea began to open their rice markets byappealing to the export interests of their (especially high-tech) manufacturers.

Negotiated liberalization thus turned out to be far more feasible than unilateral liberalization. The key became acountry's ability to persuade its foreign partners to proceed in tandem with it. Large trading entities, such as theUnited States and the European Union, obviously have the most leverage in this context because of the attraction toothers of the opening of their markets.

Another key variable is the stage of liberalization at which a country finds itself. Initial reductions of very high tariffsare frequently easy because they put few dents in the real level of protection and thus can often be implementedunilaterally. But most countries have found that they must apply the traditional political economy approach toengineer the later (and most beneficial) phases of the process.

Chile is a recent case in point. Its policy desire to achieve totally free trade is clear but it must now mobilize strongsupport from its exporters to overcome resistance to eliminating its last 10 percent or so of protection. Its strategy is

to try to negotiate reciprocal deals wherever it can--in Mercosur, NAFTA, APEC, bilaterally and/or globally through thenew World Trade Organization (WTO).

Regional vs. Global Liberalization

In seeking reciprocal liberalization, countries could turn either to their respective geographic region or to the globaltrading system as a whole. The global approach is fundamentally superior because it maximizes the number offoreign markets involved and avoids the economic distortions (and political risks) of discrimination among tradingpartners. Indeed, the succession of GATT "rounds" throughout the postwar period has made a major contribution tothe freeing of global trade.

As the urgency of competitive liberalization accelerated over the last decade or so, however, the regional approachhas increasingly come to dominate the process. It simply turns out to be less time-consuming and less complicated

to work out mutually agreeable arrangements with a few neighbors than with the full membership of well over 100countries in the WTO. Moreover, regional groupings are demonstrably willing to proceed much more boldly: many ofthem have decided to adopt totally free trade, as noted above, whereas none of the global conclaves to date haseven considered such an ambitious goal. The rapid growth in the membership of the WTO, whose predecessor GATThad fewer than 50 members though the first several postwar negotiations, added to this change in the calculation.

Desires to overcome traditional political rivalries have also been a driving force in the success of several of theregional economic arrangements. The cardinal goal of the European Union was to end the historic hostility betweenFrance and Germany. Mercosur sought to end the arms race, including its nuclear dimension, between Argentina andBrazil. A successful APEC would reduce the risk of intra-Asian and trans-Pacific conflicts, which have been soprevalent over the past century-- including three wars for the United States. Regional trade arrangements are thusoften motivated by priority national security concerns. This is another reason why they often move more quickly andmore boldly.

Much of the political economy of competitive liberalization in recent years has in fact played itself out in the dynamicinteraction between regional and global initiatives to reduce trade barriers. This creative tension has been presentthroughout most of the postwar period. The United States initiated the Kennedy Round in the 1960s to counter thediscrimination inherent in the creation of the European Common Market (as well as for broad foreign policy reasons)and the Tokyo Round in the 1970s to counter the additional discrimination from the Community's expansion to includthe United Kingdom. The Europeans cooperated in both ventures and thus enabled the regional and global efforts to"ratchet up" the scope and pace of liberalization.

The positive interaction between the two strategies accelerated sharply in the 1980s and 1990s as competitiveliberalization became the norm and countries searched for tactics to obtain the needed domestic support. The United


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States reversed its traditional aversion to regionalism by embracing free trade agreements with Israel and Canadaafter the European Community blocked the launch of new negotiations in the GATT--to which the EC responded bydropping its veto and permitting the Uruguay Round to begin. When the Round faltered in the late 1980s, the three

North American countries launched NAFTA and the Asians initiated APEC. 4 When the Round almost failed to meetits final deadline in December 1993, APEC's initial summit in Seattle in November 1993 induced the Community tofinally agree because, according to one top European negotiator, it "demonstrated that you had an alternative and wedid not." The regional initiatives also reinforced each other: APEC's Bogor Declaration was instrumental ingalvanizing the Miami summit, a few weeks later, to commit to free trade by a date certain in the Americas.

This positive interaction also extends to the subregional level. President Bush's offer in 1991 to extend NAFTA

throughout the Western Hemisphere led to an explosion of bilateral and plurilateral agreements across South andCentral America as countries sought to prepare themselves to qualify for free trade with North America. In Asia,

AFTA has accelerated its timetable and substantially broadened its coverage to stay ahead of APEC. AFTA andAustralia-New Zealand have discussed possible linkages between the groups.

Hence regional and global liberalization initiatives have been mutually reinforcing throughout the past three decadesor more. The fears of some observers that regionalism would derail globalism have been demonstrably overcome.

The Threats to the Trading System

But determined leadership has been required to avoid conflicts between regionalism and globalism. Doing so has alsorequired the maintenance of effective global trade rules to provide a framework that would deter conflict between theregional arrangements, including rules that apply to the arrangements themselves, and an institution to enforce them.

Even so, there have been some close calls--especially when the global system faltered. The major new regionalarrangements spawned by the missed deadlines of the Uruguay Round were intended to serve as alternatives to theglobal regime if needed. An ultimate failure of the Round, which almost occurred, would have discredited the entireglobal system and raised a real specter of competing blocs.

Moreover, the European Union frequently seems to focus so heavily on its regional agenda that it forgets its globalresponsibilities. The United States is sometimes viewed as preoccupied with NAFTA or APEC. By joining East Asiaand North America, APEC has eliminated any possibility of the evolution of the three-bloc world that was so widely--

and rightly--feared a few years ago5 but a failure to work out accommodations with Europe could instead create atwo-bloc world that would convey substantial dangers as well. South America might decide to halt its liberalizationonce Mercosur had consolidated, and Brazil might be happy to leave its new leadership of that region undisturbed forat least a while. There is a constant need to keep the global-regional interaction on a supportive course. This is onekey reason why a new initiative is now required to consolidate the regional liberalization initiatives into an agreementto achieve global free trade in the 21st century.

There are other risks to the continued triumph of competitive liberalization that need to be met by a new globalinitiative. The most threatening of these challenges do not arise in the countries that have rejected openness moststrongly in the recent past, the developing and former command economies, although some of them do harborlingering doubts that could again assume ascendance. Paradoxically, the strongest pressures to reverse the liberalcourse can be found in the countries that created, nurtured, and championed the postwar order: the United States anthe European Union.

Two structural changes dominate the evolution of the American economy over the past generation. One isglobalization: the share of trade has more than doubled and now exceeds the same share as in the European Unionas a group and (especially) in Japan. The other is the stagnation of real incomes and a regressive shift in income

distribution: the United States has created tens of millions of new jobs but the median family income is lower todaythan a generation ago, the average real wage is flat or down for more than half the population, and only the top 20

percent is unambiguously better off.6

The central question for present purposes is the degree of causality between the two phenomena. Virtually alleconomists agree that globalization has produced some of the problems cited. The majority believes the relationshipaccounts for 10-20 percent of the problem and that a retreat into protectionism would make it work. But at least a fewserious studies attribute a larger part of the country's chief economic difficulties to globalization and call for a shift intrade policy as a result.

American politic s frequently reflect this tension. Only the extremists of both right and left--Pat Buchanan, Ralph


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Nader, Ross Perot and organized labor--have launched frontal attacks on the bipartisan trade policies of the past 60years, and all their campaigns have been decisively rejected. But President Clinton, who faithfully implemented theReagan-Bush commitments to NAFTA and the Uruguay Round and expanded on them substantially with APEC andthe FTAA, made explicit decision to keep trade policy out of the political discussion in 1996. So did Senator RobertDole, who supported all the prior initiatives but announced strong opposition in late 1995 to "any more tradeagreements" for the foreseeable future.

The situation in Europe is fundamentally similar if quite different in its details. Europe's chief economic problem ishigh unemployment, which has risen from 2-3 percent a generation ago to about 10 percent now--from well below the

American norm to almost twice as high. But average wages and incomes in Europe have risen substantially over this

period, in sharp contrast to their stagnation in the United States.

These two great industrial areas have thus made very different social choices. By limiting its social safety net andpermitting firms to downsize virtually at will, the United States forces its displaced workers to find new jobs atwhatever wage is available--pricing its labor competitively and thus maintaining full employment. Europe has bycontrast become a generous welfare state with extremely rigid labor laws, discouraging new hires from both thesupply and demand sides while maintaining social peace through government transfers of a share of its higherincomes to the poor. Sir James Goldsmith and others blame the resulting unemployment on competition from low-wage countries.

The TAFTA idea for free trade between North America and Europe thus poses a subtle but potentially deadly threat tothe global trading system. Skilled protectionists in both America and Europe have already learned that frontal attackson liberalization are bound to fail. Hence they have opted for process protection that employs devices to counter

unfair practices, such as dumping and government subsidies, in ways that go far beyond the legitimate use of suchpolicies. They insist on new international agreements on environmental and labor standards (and native populations !that could also provide cover for new trade barriers.

The case for TAFTA is similar: it posits that free trade is acceptable as long as it takes place among countries atroughly equal (i.e. high) income levels. The rich (and white) countries would combine to erect new discriminationagainst the poor (and a few rich Asians). Preferences would perversely be provided to richer rather than poorer tradingpartners. China, Malaysia and others would be offered a rare but powerful justification for their paranoid fears of beingcontained rather than engaged. No wonder this particular free trade proposal has been embraced so enthusiasticallyby the likes of Richard Gephart and former AFL-CIO President Lane Kirkland, seizing on the good intentions buteconomic naivete of the foreign policy gurus (including Henry Kissinger as well as the foreign ministers of Germanyand the United Kingdom) who launched the idea in a desperate attempt to find new cement for a crumbling Atlantic

alliance.7

Such a circling of wagons by the old rich would reverse one of the most beneficial trends of the regional initiatives ofthe past decade or so: their inclusion of both richer and poorer nations, which has ended the North-South conflict forall practical purposes. The European Community led that process by including southern European countries with percapita incomes that were about one fifth that of northern Europe. NAFTA expanded the process, adding Mexico withone eighth the income of the original members of the Canada-United States Free Trade Area. The ratios are evenhigher in EUROMED, the FTAA and especially APEC--where the gap between Japan and Indonesia is about thirty toone. A discriminatory TAFTA would reverse all this progress and reignite hostility across the potentially explosiveincome divide, especially with over 80 percent of the world's population and virtually all of its growth in the poorercountries.

The bottom line is that neither Europe nor the United States has been able to generate a steady increase in thenumber of well paying jobs. Europe has rising incomes but high unemployment. America has low unemployment butflat incomes. Perceptions and politicians in both could come to treat trade as a major source of the problem, or eventhe major source of the problem, and thus pave the way for a massive reversal of global liberalization.

The Asian giants, Japan and China, also pose major threats to the continued openness of the trading system. Thepolitical economy of liberalization succeeds in winning domestic support, even in a country as large as the UnitedStates, only when its major foreign markets (especially if they are also its toughest competitors) are seen as joiningthe process and contributing their fair shares to the process. Japan has grudgingly participated in all the GATT

rounds but access to its markets remains extremely truncated.8China has not yet committed to the minimumreforms necessary to join the World Trade Organization. Protectionists in other countries, with some justification, willuse the reluctance of Japan and China to liberalize to oppose further reduction of their own nations' barriers.


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Japan could also cause problems because of its internal developments, which are beginning to resemble those in theother higher income areas. Unemployment is at a postwar high. Traditional socioeconomic norms, such as lifetimeemployment and keiretsu supplier relationships, are eroding in large part due to globalization (and its allegedhollowing out of the domestic production base). Deregulation could be slowed even further and it would beunsurprising if protectionist voices began to be heard in Japan in the near future.

Restarting the Bicycle

Why does it matter? New or expanding blocs would divert trade from outsiders, to be sure, but almost everybodywould be in a bloc and the diversion would almost certainly be swamped by faster growth and hence trade creation fo

everybody--as in the case of the European Union over the past forty years. International trade and investment areflourishing. Business needs simply to be assured that no new impediments will be placed in its path.

The problem with this "stand pat" scenario is its instability. The history of trade policy teaches forcefully that failureto move steadily forward toward liberalization condemns the trading system to tip sideways or fall backward in theface of protectionist pressures--the "bicycle theory." For example, protectionism scored major successes during theprolonged periods when the GATT became moribund immediately after the successful conclusion of the KennedyRound in the late 1960s and the Tokyo Round in the early 1980s. As noted above, there are strong pressuresthroughout the world--including in the United States and Europe--that would seize on any stalling of the forwardmomentum and try to reverse the trend toward liberalization. Renewed financial crises a la Mexico could, as in thepast, produce a wholesale adoption of new import controls.

One of the great advantages of the contemporary regional initiatives is that they have kept the bicycle moving

forward after the conclusion of the Uruguay Round. The Round itself also helped by scheduling future negotiations ina number of sectors, some of which are underway. It now becomes necessary, however, to roll the regional effortsinto a consolidated global strategy that will simultaneously keep the bicycle moving forward and avoid the centrifugalrisks of drifting into conflicting blocs.

The substance of a new global initiative would include elimination of all remaining tariff and nontariff border barriers.The Uruguay Round teed up these remnants of traditional protection for decisive action by converting agriculturalquotas into tariffs, removing quota protection from textiles and apparel, and obtaining bindings of most tariffs in

developing countries. One more major effort should condemn these practices to the dustbin of history. 9

In addition, new negotiations are needed to enable the global system to catch up with some of the "new problems"that are plaguing international trade relations. Protectionists in all countries are ingenious in staying "one step aheadof the judge" and the system needs continuous updating to stay within reach.

For example, most American (and others') complaints about Japan no longer relate to that country's border barriers.They focus instead on the anticompetitive behavior of its firms with their exclusive supplier or distributorarrangements (vertical keiretsu, as in auto parts and film, respectively) and domination of particular markets(horizontal keiretsu, as in glass or soda ash). The United States has been using trade measures, such as Section301, to address nontrade problems.There is an urgent need to work out new international agreements on competition

policy and corporate behavior.10

Investment is a second area in which the international rules have lagged far behind commercial practice. Investmentis now an essential element of international trade, especially in services but in traditional manufacturing as well.

Aside from a few very modest covenants on trade-related investment measures agreed in the Uruguay Round andAPEC's inadequate "nonbinding investment principles," however, there are virtually no multilateral agreements on the

issue.11

Another pending issue is regionalism itself. The GATT article that governs such arrangements is extremely weak andits implementation has been even weaker: of the 100 or so "free trade agreements" that have been notified to theGATT, none have been rejected and only two have been approved. Now that regionalism is so prevalent, the WTOneeds to adopt much stronger provisions and procedures to make sure that they evolve in an open manner.

A number of other topics must be addressed as well. The numerous linkages between environmental measures andtrade must be sorted out in ways that both protect the environment and avoiding providing new excuses for protectingagainst trade. The relationship between trade and labor standards needs to be resolved as well.


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A broader yet clearly related issue is international monetary arrangements. The current regime of flexible exchangerates periodically permits sizable and prolonged misalignments of major currencies, such as the huge overvaluationof the dollar in the first half of the 1980s and the large undervaluation of the yen in the late 1980s. Thesemisalignments in turn lead to large trade imbalances that intensify protectionist pressures in the deficit countries bytilting the domestic political balance against exporters and in favor of import-competing industries. The WTO will notsolve this problem but should push the International Monetary Fund, and the G-7 as its informal steering committee,

to improve the functioning of the monetary system to reduce some of the pressures on the trade regime.12 Suchtrade-monetary linkage featured prominently in the original planning for the Tokyo Round in the early 1970s and to alesser extent in the planning for the Uruguay Round in the middle 1980s.

The need for the WTO to address a series of new trade issues also replicates the earlier postwar history. TheKennedy Round produced a major reduction in the high tariffs that were the major tool of protection in the earlypostwar period. The Tokyo Round then attacked government procurement, subsidies and other nontariff borderbarriers. The Uruguay Round turned to major behind-the-border problems such as intellectual property rights andservices rules. Each of these liberalizations exposed a new set of constraints on market access that required a newinitiative to bring the international rules up to date, and the present period is no exception.

It would be possible to address all these issues in a series of separate regional negotiations. Indeed, some of theregional agreements have innovated successfully in addressing new topics in the past: the Canada-United StatesFree Trade Agreement provided a model for some of the services talks in the Uruguay Round, Australia-New Zealandsuccessfully meshed their competition policies in a manner that also enabled then to eliminate antidumping duties,and NAFTA has pioneered in forging effective rules on investment. There would be a serious risk of inconsistency ifsuch issues were addressed differently in the different regional fora, however, and it would be much more efficient toderive worldwide approaches that could be applied by all. The case for globalism is again compelling. The "GrandBargain" The members of the WTO should therefore agree to consolidate the free trade arrangements that havealready been set at the regional level, covering more than 60 percent of world trade as described at the outset, into aglobal commitment to achieve worldwide free trade by a date certain. The date could be 2010, on the APEC andEUROMED models, with a possible extension to 2015 or 2020 for the poorer countries. Implementation of theagreement would keep the bicycle moving forward for some time.

Such a commitment would rest on a "grand bargain" between two groups of countries: the high-income matureeconomies of North America and Western Europe and the rapidly growing, lower income countries that make up mostof the rest of the world plus Japan. The lower income fast growers (and Japan) owe much of their spectacularsuccess to the openness of the world economy that enabled them to pursue "export led"--or, more accurately,"outward oriented"--development strategies. Hence they need insurance against any reversion to protection by the"old rich," including procedural safeguards against "process protection" and other subtle methods of undoing priormarket opening. In the regional agreements already adopted, they have demonstrated a willingness to pay thepremium necessary to buy such insurance.

There is a second component of the "insurance motive" in a number of developing countries: insurance that theirdomestic successors will not reverse the recent liberalization of their own economies. Such reforms can be "lockedin" by binding the country's liberalization in international agreements, regional and/or global. Such bindings apply onlyto trade and investment policies and directly related domestic measures but it would be difficult to reverse mostdomestic reforms if it were impossible to raise new external barriers to support a reversion to dirigism.

Mexico was motivated by such a package of external and internal considerations to propose NAFTA, join APEC andconclude trade deals with a number of other countries. Similar factors have played a major role in the other Latin

American countries as they pursue their subregional liberalizations en route to a FTAA. The external element of this

"insurance strategy" has been important for many Asian members of APEC.The Asian and Latin American countries have been predominantly concerned about a possible reversion to protectionin the United States, by far their largest market, and hence have emphasized trade deals with that country. They arealso concerned about Europe, however, so are pursuing that dimension as well: Mercosur through a pending tradeagreement with the European Union, East Asia through its new summits with the Europeans. Neither of thesearrangements are likely to produce much substance, however, so East Asia and Latin America--which are likely to bethe two fastest growing parts of the world economy over the coming decades--would benefit greatly from engagingEurope in the same kind of free trade commitments they have already elicited from the United States. This can

probably be done only through a global effort in the WTO.13


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The second part of the "grand bargain" would provide the higher income countries with increased, and eventually full,access to the markets of the lower income but rapidly growing countries around the world (and Japan). Most of thislatter group, despite their impressive liberalizations over the past decade or so, retain substantial trade barriers.

This part of the bargain would be attractive to the rich countries because they too are heavily dependent on exportexpansion. Such dependence is nothing new for Europe but, as noted above, has only evolved in a major way for theUnited States over the past two decades. As exemplified by the "Big Emerging Markets" strategy of the Clinton

Administration, this rich-country interest focuses primarily on countries with large and rapidly growing markets thatstill maintain substantial access barriers. Hence the United States and Europe would benefit greatly from theproposed "grand bargain."

There is nothing new conceptually in this proposal for the "old rich" to pledge to avoid new barriers while the "rapidgrowers" commit to eliminate theirs. Such asymmetric liberalization has lain at the heart of the agreements onNAFTA, the FTAA and APEC and even the European Union. In these regional versions of the "grand bargain," thepoorer countries have bought assured continued access to the markets of the rich countries by agreeing to catch upover time with those countries' prior liberalizations. There is a rough justice in the proposed asymmetry because thewillingness of the rich countries to facilitate the "outward oriented" growth strategies of the poor, by reducing theirbarriers much further and much faster, enabled some of the latter to start catching up with the income levels andstandards of living of the former.

The novel element here is to shift the context to the global plane via the WTO. This would consolidate and link theexisting regional agreements. It would also bring the former Soviet Union, South Asia, Africa and the few otheruncovered parts of the world into the deal. It would keep the bicycle moving forward for some time.

The Path to the "Grand Bargain"

Who would take the lead in proposing and pushing for the "grand bargain"? One possibility would be the United Statesand the European Union, the ultimate closers of each of the major multilateral trade negotiations in the postwar periodto date. Conversion of the TAFTA idea into their assuming joint leadership of a new global initiative would be anextremely healthy development.

There are reasons to doubt the success of such an effort, however. The United States attempted to move in thatdirection with its "Open Markets 2000" proposal at the G-7 summit in Naples in July 1994 but was turned down by theEuropean Union--replicating Europe's rejection of the American effort to restart global trade talks in 1982 soon afterthe completion of the Tokyo Round. Several EU members blocked a proposal by the European Commission to jointhe United States at the Madrid summit in late 1995 in agreeing to study the TAFTA idea--a conclusion that was

substantively correct but was adopted for protectionist reasons rather than the systemic considerations advancedhere. Seen in the context of the EU's overarching focus on its own regional concerns, centering on the expansion ofits membership to the east and the deepening of its integration including monetary union, it is doubtful that Europewill be prepared for such a leadership role in the global system at any early date.

The alternative is APEC. From its inception in 1989, APEC has proceeded under the mantra of "open regionalism"--aterm deliberately chosen to contrast it with the inward-looking regionalism that many Asians feared might prevail inboth Europe and North America. Every pronouncement of APEC leaders, including the Bogor Declaration thatcommitted its membership to "free and open trade and investment in the region," has emphasized the group'scommitment to further global liberalization and its antipathy toward becoming an exclusionary bloc.

APEC has not defined "open regionalism." Its members have however, committed themselves to continue reducingtheir barriers to nonmember countries as they move toward free trade in the region. Some of them might extend their

APEC liberalization to nonmembers unconditionally, which they are perfectly free to do as APEC has no intention tobecome a customs union with a common external trade policy.

Most likely, however, APEC will offer to generalize its regional liberalization to the rest of the world on a reciprocalbasis. As noted above, this is the proper course for any trading area that is large enough to induce outsiders torespond positively to its proposals. APEC clearly meets that criterion, accounting for about half the world economyand almost half of world trade.

There are two reasons why APEC should condition access to its liberalizing markets on reciprocal offers bynonmembers. The first is external: global liberalization and hence world economic benefits will be doubled becauseoutsiders could not afford to reject the offer. The second reason is internal: as noted earlier, the political economy of


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trade policy requires the mobilization of domestic export interests by offering them sufficiently enhanced access toforeign markets to induce them to undertake the effort necessary to win national support for liberalization.

APEC thus has the capability, the inclination and the positioning to initiate the next major episode of global tradeliberalization. It has already committed to achieve free trade in its region and is hard at work converting its vision into

practical reality. It is thus in an ideal position to assume leadership of the global trading system. 14

The World Trade Organization will be holding its first ministerial meeting in Singapore in December 1996. This wouldbe the natural occasion to begin the process of achieving global free trade in the early part of the 21st century. APECcould galvanize the process by seeking agreement of the full WTO membership to emulate its goal of achieving free

trade and investment by 2010/2020.

It would probably be premature, however, to seek a global free trade pledge at that time. The United States will havejust concluded a presidential campaign in which the incumbent, who took a courageous lead in signing free tradepacts during his first two years in office, declined to discuss the issue and his opponents were equally hesitant. Inaddition, the European Union will be preoccupied well into 1997 by the InterGovernmental Conference on the future ofits integration process, including its trade and other external dimensions. The two largest trading entities, that havetraditionally determined the course of the world trading system, may not be ready for major initiatives this year.

Moreover, APEC--the proposed new leader for global liberalization--may not yet be far enough along in implementingits own plans to provide a credible inducement for others to join it. It would have to take convincing steps at Subic todemonstrate that it was serious about fulfilling its own regional goals. One way to do so would be for APEC to makesuch commitments in a single key sector, for example, the Information Technology Agreement that is now being

actively discussed, and then challenge the rest of the WTO to join in.

In determining a role for the Singapore Ministerial, however, it is important to first set long- term systemic goals andthen work backward. An agreement to achieve "global free trade by 2010" could plausibly be reached , if not atSingapore, at the succeeding WTO meeting in 1998. To do so, planning needs to proceed on a number of fronts.

First, the biannual WTO meeting in 1998 should be converted into the first Global Trade Summit. The GATT neverheld a summit meeting. Yet summits have been a regular feature of the European integration process, the rapidevolution of APEC since 1993, the launch of the FTAA, and key subregional trade arrangements including AFTA andMercosur.

Annual summits have proven particularly effective in APEC, elevating the institution from a purely consultative forumto an engine of regional--and potentially global--trade liberalization in only two years and maintaining strong pressure

on ministers and officials to keep the process moving. Asian and European leaders have initiated a series of biannuaconsultative meetings. The WTO should bring together its heads of government at the last high-level meeting of theworld trade body in the 20th century to set a vision for the global trading system in the 21st century.

Second, the Singapore ministerial should appoint a Wise Persons Group to make recommendations for the future ofthe trading system. A similar group, chaired by Fritz Leutweiler of Switzerland and including Senator Bill Bradley fromthe United States, was appointed by the GATT in late 1983. Its report in early 1985 made an important contribution tothe decision to begin the Uruguay Round in 1986. The APEC vision as endorsed in the Bogor Declaration was initially

proposed by that organization's Eminent Persons Group.15

Third, Singapore should initiate a work program to prepare the issues that would form the substantive core of the"global free trade" negotiations. Fortunately, there is already widespread agreement on that agenda. The UruguayRound itself laid out an ambitious schedule of further negotiations including telecommunications and maritimeservices in 1996, financial services (again) in 1997, government procurement in 1999, and agriculture and services in

2000.16Consultations among the WTO members have identified an additional set of priority topics along the lines ofthose outlined above: competition policy including its relationship to antidumping, investment, trade-environmentlinkages, perhaps labor standards and their relationship to trade, and several others.

Another important preparatory step is to complete the membership of the World Trade Organization. Singapore shoulaccelerate the effort to bring China, Russia and the other large nonmembers into the institution in time to participatefully in the proposed negotiations. No move to "global free trade" can be effective without these countries--thoughthey must of course comply with the organization's requirements to get in.


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Finally, the WTO needs to firmly establish its own credibility throughout the world. This will mean effectiveimplementation of its dispute settlement mechanism, more transparency of its operations so that all interestedparties around the world can see how it works in practice, and efficient management of the overall organization. Trustin the institution itself if a necessary prerequisite for giving it the additional responsibilities suggested here, includingto allay fears that it can "violate the sovereignty" of its member countries.

Beyond these preparatory steps, a number of key questions remain to be answered before a "global free trade"pledge could be adopted. For example, how should "free trade" be defined? Should it apply only to tariffs, quotas andother border barriers--which would require substantial liberalization in many developing countries but not much in mosof the industrial world? Or should it extend to measures behind the border, at least for countries where--as in Japan--

they play a central role in current and foreseeable trade conflicts?

Another key issue is the definition of "reciprocity" or "comparability." All agree in principle that any such negotiationmust elicit fair contributions from all parties. But it is extremely difficult, in purely intellectual terms even beforeturning to the politics of the problem, to equate "concessions" across issues as disparate as tariffs and nationalcompetition policies. "Reciprocity" already lost most of its quantitative significance when the GATT turned tonegotiating nontariff barriers, in the Tokyo Round and even more so in the Uruguay Round, and it may be impossibleto restore any precision to the concept. Nevertheless, the political economy of trade requires each country todemonstrate that its own "concessions" were matched by those of its partners and it is highly desirable to buttressthe case with orders of magnitude if not precise estimates.

Another question is whether the goal of "global f ree trade" should be achieved via one or more comprehensive trading"rounds" with a single deadline or via "continuous negotiations" over time on individual issues. At the end of each

previous round, including the Uruguay Round, virtually all participants have dismissed the idea of launching such anall-encompassing effort ever again. Such "trade fatigue" is fully understandable from those who have had to labor tobring such an effort to conclusion, especially when it took seven years as in the latest example.

On the other hand, the logic of rounds has always prevailed in the past. Comprehensive coverage has provennecessary to offer the maximum scope for tradeoffs across sectors and issues, thereby inducing the greatestnumber of countries to agree to the largest possible liberalization. Sectoral or issue-specific efforts, by contrast,require intra-issue tradeoffs that tend to minimize the headway that can be made. The record to date of issue-specificnegotiations since the end of the Uruguay Round is discouraging: the United States rejected the financial servicespackage in 1995, and the telecommunications and maritime services efforts faltered earlier this year. The message,once again, is that broader inducements and packages will probably be needed. The tried-and-true alternative of around should be kept foremost in mind--especially to achieve "global free trade by 2010," perhaps the most ambitiousof all the multilateral trade initiatives ever attempted.

The Singapore Ministerial in December 1996 need not decide to embark on a path to "global free trade by 2010" norwhether to convert its successor meeting in 1998 into a Global Trade Summit. It should launch a work program on allthese issues anyway as part of the routine evolution of the trading system, including its preparation for whatevermight come next. As noted, many of the issues are already on the agenda and should be pursued without difficulty.The tactical considerations can be addressed later as long as the broad strategic vision begins to evolve later thisyear and a process is set in place that would permit it to eventuate.

Will It Fly?

The final question is the most crucial: is such a proposal politically feasible? Will it fly in the key countries? Thedoubts and fears outlined above suggest that a herculean effort would be needed to pull it off.

The main problem, as well as the pivotal actor, will probably be the United States. Most other countries havetraditionally been more dependent on trade and have thus accepted, if sometimes grudgingly, the case forliberalization. The Europeans, for all their apparent insularity, have removed all barriers to each other and point outquite logically that it would be totally inconsistent for them to impose new restraints on nonmembers. Japan andKorea cannot afford to block progress sought by others, as indicated when they agreed to liberalize rice imports--theipolitically most sensitive sector by far--at the end of the Uruguay Round. Most developing countries are even moredependent on trade and, as noted at the outset, have been actively engaged for some time in a process ofcompetitive liberalization.

Perhaps surprisingly, there are two reasons why the case for "global free trade by 2010" should be relatively easy tosell in the United States. First, increased trade can be a big help in enabling America to solve its most pressing


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economic and social problems as described above--wage stagnation and a regressive shift in income distribution.Export jobs pay 15-20 percent more than the average wage. Worker productivity at exporting firms is 20-40 percenthigher. These firms expand employment 20 percent faster than non-exporting firms and are 10 percent less likely tofail. Small and medium-sized exporters do even better than large ones and account for 70 percent of all sales

abroad.17 Hence even a shift to export jobs from import-competing jobs, which also pay more than the nationalaverage, would help considerably even if it had no impact on the American trade balance.

Better yet would be a shift to export jobs from the nontradeable (mainly services) sector, which pays considerablyless than all tradeables (mainly manufacturing). This is eminently feasible for the United States without raising majorinternational problems because it continues to run annual trade deficits of $150-200 billion. An improvement of even

$100 billion in America's net external position, lowering the deficit to about 1 percent of GDP, would create about 2million more of these high- paying export jobs than would be lost to growing imports. Total elimination of the externaldeficit would have twice as positive an impact.

To be sure, substantial adjustments in America's internal economy will be required to achieve such shifts. Nationalsavings must rise by 1-2 percent of GDP to obviate our need for the net capital inflows that are the counterpart of the

current account deficits,18but are likely to do so if the budget deficit is eliminated over the next several years even iprivate savings fail to rebound from their current historic lows. Individuals will need better education, training andretraining to enable them to compete effectively in the world economy--but will need these improvements to raisetheir incomes with or without further globalization of the American economy.

These internal efforts will fail, however, if American exports fail to win full access to foreign markets. Exports havedone well in recent years, almost doubling their share of total US output just since 1985. They would make anenormous contribution to solving our most basic economic and social problems if they could double again by 2010.

"Global free trade by 2010" could make a significant contribution to enabling the United States to reach that goal.Barriers to market access remain quite high in much of the rest of the world, especially the most rapidly growingmarkets of Asia. An elimination of Japan's barriers alone could expand American exports by $20 billion annually--

creating 400,000 very good jobs--or even more.19 Latin America's barriers average three times as much as our own.

"Global free trade" in practice would mean a sharp reduction in barriers in most other countries compared with very

little liberalization in the United States, where markets are already largely free. 20This asymmetric nature of theliberalization process, as described above in depicting the "grand bargain," is the second compelling reason why itshould be readily acceptable in the United States.

The United States would not receive a totally free ride in such a negotiation. Other countries, in both the industrialand developing world, would insist that the United States subject its import safeguard measures (such asantidumping duties) and its export promotion tools (such as Section 301) to expanded multilateral disciplines. This isa modest price for the United States to pay, however, and the reduction of actual barriers remains almost whollyasymmetric.

From the American standpoint, such an initiative is the only way to achieve a truly "level playing field" across theworld economy. It would bring foreign barriers down to our own. At a stroke, it would greatly increase and roll into asingle package the benefits that would otherwise be provided for the American economy by NAFTA, APEC, and theFTAA.

Unless one contemplates a reimposition of high tariffs and quotas by the United States, it is fruitless to debate theimpact of past trade liberalization negotiations. Their outcome is clear: a relatively open market in the United States

contrasted with severely impeded markets in many of the world's largest and most rapidly growing economies. Thecardinal goal of American trade policy must be to bring the others to its own level as quickly as possible. Theregional initiatives of the 1990s have represented initial steps in that direction. "Global free trade" by a date certain isthe only way to complete the process.

There is another strong reason for the United States to support, indeed to help lead, such an initiative: overall foreignpolicy. Trade and economics are now at the center of the global agenda for most countries. The only way for Americato retain global leadership in the post-Cold War period is to remain the leader on trade--as it was as recently as 1993,with the completion of NAFTA and the Uruguay Round, and 1994 with the launch of APEC and the FTAA. Foreignpolicy, as well as economic, considerations call for renewed American activism in this area.


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To be sure, a major political debate will be needed in the United States to endorse such an initiative. That debate willhave to come anyway, probably in 1997 or 1998, as the administration of the day seeks Congressional approval toproceed with the liberalizations already agreed in APEC and the FTAA. "Global free trade" would in fact add onlymodestly to the needed authority, adding Europe (with which trade is already largely free) and a few other developingcountries to the package- -always on a reciprocal basis, of course.

But the idea of "free trade" with China and Japan, or even Brazil and Argentina, will surely trigger a national debatebeside which the NAFTA legislation of 1993 will pale by comparison. History shows, however, that the United Statesis far more successful with large initiatives than small ones, certainly in trade. Sweeping visions, such as theKennedy Round and its successors, engage the President and the Congress in a major national venture. The

business community and other supportive constituencies make the investments needed to carry the day. Oncelaunched, the initiatives then have sufficient momentum to overcome rearguard efforts to derail or even erode them.

These political realities can be seen at present. The initiative to extend NAFTA to Chile has faltered in part becausethe potential gains are too small to mobilize enough domestic support to overcome the opposition, however modest,of those sectors (such as wine) and interests (such as labor) that oppose the idea. The political problem with NAFTAmay have been that it was too small: it applied to only one country that was about 4 percent the size of the UnitedStates, was pursued without a prior Congressional debate, and lulled President Clinton and the business communityinto waiting until the last minute before commencing their eventually successful lobbying efforts.

The pro-trade constituencies in the United States realize that the bicycle must be kept moving forward, that theglobal system must be re-emphasized to avoid the risk that the regional initiatives-- desirable as they are--couldevolve in an unhealthy direction, and that they will have to come forward in 1997 or 1998 to make the case again.

Presidential leadership will be essential, as always, and can best be guaranteed if the President himself were to playa leading role--or even the leading role--in catalyzing the entire process.

Global Free Trade by 2010

Both international and domestic considerations, around the world and within the United States, thus point in a singledirection: the initiation of an agreement in the World Trade Organization, at Singapore or within the next few years, toachieve global free trade by a date certain in the early part of the 21st century. Such an initiative is needed to keepthe bicycle of competitive liberalization moving forward. It is essential to provide effective multilateral means to dealwith the trade and other international economic disputes that will inevitably increase as economic interdependencegrows further. It is necessary to avoid the risk that the rapidly liberalizing regional arrangements, or new ones suchas TAFTA, could turn into hostile blocs with adverse effects on international security as well as global prosperity.

From an American standpoint, "global free trade" would provide an opening of markets in the largest and fastestgrowing economies in the world--and thus stimulate rapid growth in exports and the good jobs that they produce.From a European standpoint, such export growth could bring down unemployment. From the standpoint of Asia andthe rest of the developing world, outward-oriented growth strategies could be sustained with an assurance that therich industrial markets would not turn inward.

The proposed "grand bargain" would globalize the enormously encouraging progress in bridging the North-South gapthat has been pioneered in recent years by the key regional agreements-- the European Union, NAFTA, APEC, andthe FTAA. The countries that account for the bulk of the world's population, and virtually all of its growth, wouldbecome increasingly enmeshed with the "old rich" in a web of cooperative and mutually beneficial economicarrangements. There could be no better investment in securing future peace as well as prosperity.

When the victorious allies constructed the economic system for the postwar world, they included an International

Trade Organization (which became the GATT) to reduce barriers and resolve commercial disputes among nations.When Europe united in the late 1950s, the United States initiated a series of multilateral liberalizations to both forge atransAtlantic political partnership and reduce the discriminatory impact of the new Common Market. When thoseglobal efforts faltered in the 1980s and early 1990s, partly due to the end of the Cold War, regional liberalizationagreements blossomed around the globe to keep the bicycle moving forward and provide insurance against thesecurity as well as economic costs of failure at the center.

"Global free trade by 2010" would continue, and in a sense complete, these earlier acts of statesmanship. It wouldenhance the prosperity of all countries by underwriting the ultimate success for competitive liberalization. It wouldpreclude the risk that regional arrangements could develop into hostile blocs outside any comprehensive globalframework. It would terminate any risk of North-South conflict by engaging both sets of countries in a cooperative


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multilateral enterprise that met the needs of both.

It could turn out to be premature to attempt to launch a "global free trade" initiative in 1996. But planning should beginand initial steps taken to pave the way. Decisions should be made in the next couple of years to head off the riskthat key individual countries, including the United States or the Europeans, or existing or potential regional groupingswould veer in other directions. The vision of "global free trade by 2010" should guide this part of international affairsas the world enters the 21st century.

Notes

1. For example, the original European Economic Community and the Australia-New Zealand Closer EconomicRelationship negotiated 12-year periods to phase out their barriers but completed them in seven.

2. An excellent analysis of the political requirements for successful reform can be found in John Williamson, ThePolitical Economy of Policy Reform, Washington: Institute for International Economics, January 1994.

3. See I. M. Destler and John S. Odell, Anti-Protection: Changing Forces in United States Trade Polit ics ,Washington: Institute for International Economics, September 1987.

4. See Yoichi Funabashi,Asia Pacif ic Fusion: Japan's Role I n APEC, Washington: Institute for InternationalEconomics, October 1995.

5. Paul Krugman, The Move Toward Free Trade Zones, Policy Implications of Trade and Currency Zones, TheFederal Reserve Bank of Kansas City, August 1991.

6. See Running in Place, Recent Trends in US Living Standards, Washington: Competitiveness Policy

7. Council, September 1996.

8. See Ellen L. Frost, The New Transatlantic Marketplace, Washington: Institute for International Economics,forthcoming.

9. Yoko Sazanami, Shujiro Urata, and Hiroki Kawai, Measuring the Costs of Protection in Japan, Washington:

Institute for International Economics, January 1995, conclude that the consumer costs of these barriers total at least3-4 percent of Japanese GDP and that they block at least $50 billion of imports annually.

10. This case is made persuasively in John Whalley and Colleen Hamilton, The Trading System after the UruguayRound, Washington: Institute for International Economics, June 1996.

11. See C. Fred Bergsten, The United States, Japan, and APEC, lecture at SAIS-Japan Forum, Washington: Octobe26, 1995.

12. See Edward M. Graham, Global Corporations and National Governments, Washington: Institute for InternationalEconomics, May 1996.

13. Specific proposals can be found in C. Fred Bergsten and C. Randall Henning, Global Economic Leadership and

the Group of Seven, Washington: Institute for International Economics, June 1996.

14. See Noboru Hatakeyama, Comment in Jeffrey J. Schott, editor, The World Trading System: Challenges Ahead,Washington: Institute for International Economics, forthcoming, 1996.

15. APEC of course has undertaken numerous initiatives in addition to trade liberalization and will remain anextremely important institution even if its regional trade plans are globalized. One of its cardinal goals is to solidifyrelations between East Asia and North America, for security as well as economic reasons which it can pursuethrough trade facilitation and broader economic cooperation as well liberalization initiatives.

16. See especially the first two reports of the Eminent Persons Group: A Vision for APEC: Towards an Asia Pacific


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Economic Community, Singapore: Asia Pacific Economic Cooperation, October 1993, and Achieving the APECVision: Free and Open Trade in the Asia Pacific, Singapore: Asia Pacific Economic Cooperation, August 1994.

17. A full listing is in Jeffrey J. Schott, WTO 2000: Setting the Course for World Trade, Washington: Institute forInternational Economics, September 1996.

18. These and other data are derived in J. David Richardson and Karin Rindal, Why Exports Really Matter: More!,Washington: Institute for International Economics and Manufacturing Institute, February 1996.

19. These net capital inflows, though essential to fund domestic investment, are a direct cause of the trade deficit

because they push up the exchange rate of the dollar and thereby reduce American competitiveness in world markets(including our own).

20. See C. Fred Bergsten and Marcus Noland, Reconcilable Differences? United States-Japan Economic Conflict,Washington: Institute for International Economics, June 1993.

21. America's remaining barriers carry an economic cost of less than $10 billion in an economy of $7 trillion. SeeGary C. Hufbauer and Kimberly Ann Elliott, Measuring the Costs of Protection in the United States , Washington:Institute for International Economics, January 1994.

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