Global Trends by Martin Khor

Monday 28 November 2011

Need to assess costs, benefits of FTAs

Free trade agreements designed in a different era can prevent or hinder the policy measures developing countries need to address the growing global economic crisis, and deserve to be reviewed.


The European financial crisis does not seem to have abated, despite technocrats having taken over top political posts in Greece and Italy, the two countries recently at the epi-centre of the crisis.  If anything, the crisis seems to have worsened, with signs last week of weakened bond-investor interest in France and Germany.

This gives credence to growing expectations of a global economic slowdown or recession. In recent days, there are reports of the fears of a credit crunch that may spread to developing countries, and initial signs of reverse flows of capital out of emerging countries in search of safety.

Some prominent developing countries are seeing their currencies weakening rapidly. The South African rand has depreciated around 20% from 6.7 to the dollar four months ago to the present 8.5.

The global situation is prompting developing countries to re-think a range of their economic policies. These include the need for regulating capital flows to prevent excess volatility that can wreak havoc to their capital market and the currency, and the need to boost domestic demand and domestic firms to offset the slowdown in exports.

Measures that traditionally have been used to support local enterprises and the domestic economy are being introduced or revived in Brazil, South Africa, China and other countries.

They include subsidies, access to long-term credit, preference to local suppliers in government procurement and development projects, taxes on exports (to ensure supply of raw materials for local processing and manufacturing) and even tariff increases to slow down the surge in imports (as in the case of Brazil).

There is also the revival or strengthening of the development plan, which covers the whole economy, an expanded version of old-style industrial policy.  South Africa launched a national development plan on 11 November, Brazil has introduced three versions of a development productive plan, and China recently adopted its latest five-year plan.  Malaysia has its own five-year plan and the economic transformation programme.

However, there is also a counter-trend of some developing countries engaging in negotiations on free-trade agreements with developed countries, especially the United States and European Union.

These FTAs not only deal with trade in goods but are in fact mainly about services, capital flows, investment, government procurement, economic structures (competition policy) and regulations, labour and environment policies.

Examples are the Trans Pacific Partnership Agreement involving the US and 8 other countries (whose rules are mainly based on the US-FTAs), and the EU’s FTAs with African countries, India and Asean countries.

Perhaps the incentive prompting the countries into the negotiations is increased market access to the US and Europe, and the expectation that their investors will be more willing to come in.

Ranged against these benefits is the reduction of “policy space” or the ability to adopt a wide range of policy measures that are traditionally used to promote local enterprises and the domestic economy or to defend against speculative flows of capital.

This raises significant concerns. The goals of boosting the local economy and managing volatile capital flows should be given higher priority because of the global crisis, but policy measures to do so are prohibited or hindered by the FTAs.

The gains in exports of goods are quite limited because both the US and Europe do not want to place the reduction of their agricultural subsidies (their main trade distortions) on the FTA agenda.

In textiles, exporters have difficulty with the “yarn forward rule” in the US FTAs, according to which trade preference is given only if the yarn is sourced from the partner countries.

The developing country partners meanwhile have to lower almost all their tariffs to zero or near-zero, thereby exposing their local firms and farmers to competition from cheaper imports.  Those affected would have reduced revenues, market shares or close down.

The services chapter of the FTAs oblige the developing countries to open up a whole range of services to competition from the FTA partners.  In the WTO, countries are asked to list the sectors that they commit to liberalise. 

In contrast, in the US FTAs, there is a “negative list” approach, where all sectors are deemed to be liberalised, unless explicitly listed as exceptions. Thus, future services that do not yet exist (for example, the internet or certain types of financial services did not even exist a few decades ago) are also committed.

The investment chapter has major implications.  There is a commitment to allow free flows of various types of capital.  This is a barrier to controls on capital inflows and outflows, and hinders the ability of the financial authorities to prevent or manage financial volatility and instability.

It also obliges the countries to significantly loosen national laws and rules that  screen the entry of foreign companies, or set conditions for their establishment, such as the type of company (subsidiary, locally-incorporated, joint-venture, etc) and the degree of equity allowed.

Since performance requirements are prohibited, this affects the ability to set terms for foreign companies such as management (for example, the hiring of locals) or technology transfer.

The US FTAs also include a draconian investor-to-state dispute system, in which the foreign companies can sue the host governments for “expropriation”, whose definition typically includes “indirect expropriation” or the loss of future profits or benefits should there be policy changes or measures.

Many developing countries have been obliged to pay huge compensation, after being sued in international tribunals designated by the FTAs.

The procurement chapter obliges the governments to open up their purchases of goods and services and their development projects to the companies of the FTA partner countries.  The normal preferences given to local companies over foreign companies to supply goods or to obtain contracts for construction jobs and development projects would be severely curtailed.

The “competition” chapter would also place major constraints on the preferences and supports given to local enterprises, and curtail the rules under which government owned and linked enterprises operate.  Indeed, a large aim of the FTAs are to curb the scope and operations of state-linked companies, so as to open up opportunities for the foreign companies.

The intellectual property chapter obliges the developing countries to take on obligations that go far beyond the already policy-limiting rules of the World Trade Organisation’s TRIPS agreement.

The FTA rules are so constraining that producers and importers of generic medicines would find it even harder to operate or survive, with the result that the prices of medicines would go up, and in some cases out of the reach of patients.

Liberalisation and competition may have certain benefits, which is why many developing countries have embarked on de-regulation and privatisation. However, this is usually done in ways that benefit local enterprises and the domestic economy, while improving efficiency and gains to the consumer.

The extreme forms of liberalisation, de-regulation and opening up to the global financial and goods markets, that become obligatory under the FTA model of the US and EU, are however likely to create many problems.

In the context of the current economic crisis, when countries have to be nimble and look at many options in formulating future strategies, it is important for them to retain the freedom to use various policy measures.

On the other hand, a country joining an FTA or the TPPA expects to enjoy benefits beyond exports of goods, as its companies can also invest abroad with higher degrees of investor protection.

It is thus important that a cost-benefit analysis is done, not only on the trade and economic aspects, but also on the social and political aspects, as the FTAs will have impacts on the socio-economic structures and underlying political understandings in the countries.  The ramifications are far beyond trade and investment.