The dangers of intuitive economics
One problem with the debate over the trade aspects of the “Free Trade Agreement” with the United States is that a lot of FTA supporters are inappropriately relying on intuition derived from arguments about free trade in a context where trade barriers are removed in a nondiscriminatory fashion. For example, Jason Soon says
Let’s note that unilateral lifting of trade barriers is almost always a good thing so the fact that the Australia has ‘given up’ on more trade barriers than the US is irrelevant. The fact that Australia under the FTA is now committed to the gradual phasing out of car and textile tariffs which hurt consumers is a good thing regardless of whether we get more access to the US market
and Stephen Kirchner pushes the same argument further.
The claim is valid in the context of a small country unilaterally reducing tariffs on a non-discriminatory basis. In this case, the world price is unchanged by tariffs, so the entire burden of the tariff falls on domestic consumers. Provided that the tariff revenue can be matched by a less distorting tax, reducing the tariff unilaterally will improve welfare.
This argument does not work in the case of a decision by country A to make a unilateral cut in tariffs for imports from one country (say country B), but not for others. In this case, in general, the incidence of the tariff cut will be shared between consumers in country A and suppliers from country B. Unless the distortions associated with the tariff are large, the net impact on country A will be negative. (This is a special case of the larger literature on trade diversion and trade creation, all of which casts doubt on the claim that bilateral free trade deals will be economically beneficial to the parties concerned). A straightforward first approximation to assessing the issues in the case of the US-Australia FTA is to look at the reductions in tariff revenue. As I mentioned in the post to which Kirchner took objection, this article states that
Currently, the United States pays 10 times as much as Australia does in tariffs in the joint trade between the two countries.
Except under extreme assumptions about elasticities, this implies that Australia will be worse off under the trade aspects of the deal simply by virtue of the associated revenue losses. Because our tariffs are already close to zero, these transfers will not be offset to any significant extent by reductions in deadweight losses. A straightforward calculation indicates that the deadweight loss from a 5 per cent tariff on imports is around 0.05 per cent of GDP. Since the US only accounts for something like 20 per cent of our imports, the associated loss is around 0.01 per cent of GDP or about $70 million per year, which is trivial in the context of tariff revenues around $1 billion per year
Of course, the trade aspects are less important than the issue of institutional integration, beginning with intellectual property and the PBS, but likely to extend in future rounds to issues such as privatisation, environmental regulation and taxation.
UpdateAlexander Downer has been quick to accuse critics of the deal of being anti-American, and Ken Parish takes a similar line, making the point that no similar objections were made to CER with New Zealand.
The implication is that I and other critics would have welcomed a comparable deal with, say, the EU, one which left the Common Agricultural Policy intact, but removed all restrictions on imports of European goods and gave Brussels the right to control Australian domestic policy, for example by prohibiting the use of any names for varieties of wine or cheese to which Europeans laid claim (a standard EU claim in trade negotiations, which we’ve acceded to on some occasions and rejected on others, comparable to the situation, until now with American claims on IP).
I suggest on the contrary, that most of those who’ve supported the FTA would agree with me in regarding such an agreement as outrageous (I make an exception for those who, mistakenly as I’ve argued, support all unilateral reductions in Australian tariffs). But perhaps I’m wrong on this, and such a deal would be welcomed with open arms.