Australia makes a rare appearance on the Op-Ed page of the NYT with an editorial denouncing the Free Trade Agreement and observing

The deal with Australia is a huge setback in the process of liberalizing global agricultural trade. Poor nations whose only viable exports are agricultural goods are hampered by excessive protectionism. And by making a deal with Australia that leaves out sugar, Washington has jeopardized chances for meaningful progress on a hemispheric Free Trade Area of the Americas, and the latest round of negotiations at the World Trade Organization. As part of this effort to lower trade barriers, developing countries are rightly insisting that rich nations stop subsidizing their farmers and open up their markets to competition.

The agreement sends a chilling message to the rest of the world. Even when dealing with an allied nation with similar living standards, the administration, under pressure from the Congress, has opted to continue coddling the sugar lobby, rather than dropping the most indefensible form of protectionism. This will only embolden the case of those around the world who argue that globalization is a rigged game.

A few observations on this. First, as the editorial notes, the exclusion of sugar from the deal is bad for the US as well as for Australia.

The NYT’s negative view of the deal is echoed by US and international commentators across the spectrum including The Singapore Straits Times, The Miami Herald, the Grocery Manufacturers of America, the Washington Post (reproduced in the Oz). The only favorable comment from outside Australia I’ve been able to find is one also reproduced by the Oz from the Christian Science Monitor, which has no comment on the content of the deal and treats the whole thing as a continuation of the Iraq war.

Finally, I’d like to remind those who still seem to be supporting the deal that all Australians will pay for the failure to hold the line on sugar, in the form of more distorting and inefficient bribes to the sugar industry and yet more ethanol crony capitalism.

A surprising number of commentators have made the claim that only anti-US or anti-government motives could explain opposition to such a deal. The (nearly) universally negative reception it has received outside Australia suggests the opposite – only partisans of the government or those who advocate unconditional compliance with the wishes of the US Administration could support it, once they have examined all the evidence (The fact that the details are still secret, and that the summaries released in the two countries differed radically is, of course, evidence in itself).

The Nationals and the FTA

My column in yesterday’s Fin (subscription required) argues that the Nationals should either return to the old days of the Country Party, negotiating coalitions to form governments but not in permanent coalition with the Libs, or else go the whole hog and merge with the Liberals. I also have a bit more. As website updates are a bit behind at the moment, I’ve appended the whole thing for anyone who wants to read it.

UpdateObviously, my analysis proved compelling. The day after its publication, not only did Queensland National Leader Lawrence Springborg call for a merger with the Liberals, but Trade Minister Mark Vaile admitted the FTA had been oversold and might require amendment to get through Parliament (the latter item only in the AFR report, which isn’t available online. From a government as tightly disciplined as this one, Vaile’s comments are like a shout from the rooftops that Howard made him sign.
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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.

The aftertaste

For those still inclined to defend the Free Trade Agreement with the US, the news that the sugar industry is to be bought off should be the clincher. Both in the specific terms of the Agreement, with respect to copyright, the PBS and other issues, and in the payoffs to those who were left out this deal represents a commitment to bad public policy. What’s the betting we’ll see yet more handouts to Manildra and the ethanol lobby out of all this.

Free trade or economic integration ?

It looks like we have all the information about the “Free Trade Agreement” with the United States, and I’ve finally had the time to formulate a proper response.

I’ll begin with an observation about responses to the agreement. Although everybody recognises that the official name is a misnomer, immediate responses have naturally focused on what was missing, such as any market access for sugar. But it’s a mistake to view this deal primarily as a free trade agreement with some pieces missing. If that description was correct, it would be reasonable to support the deal.

But far as free trade in the traditional sense is concerned, Australia has almost no trade barriers of any significance to the US, and therefore nothing to remove (a point I’ll refer to). Our general tariff of 5 per cent is at a level which implies minimal distortions and can be justified under the revenue tariff provisions of the GATT.

The US has a lot of relevant barriers and distortions, but the most important, the production and export subsidies in the Farm Bill, weren’t even on the table. In addition, most of the specific barriers to Australian exports of any relevance remained in place. The announcement trumpeted the removal of restrictions on imports of lamb, but we’ve never had any success in persuading the Americans that eating lamb is a good idea.

If the agreement isn’t about free trade, what is it about? The real issue, is that of economic integration with the US. As the example of the European Union, cited by FTA supporters like Alan Oxley, shows, economic integration means common economic institutions. In the present case, it’s obvious that this means Australia adopting the institutions of the United States, and not vice versa. Examples that have come to light so far include the extension of copyright from 50 to 70 years and a range of other measures that enhance the capacity of US owners of intellectual property to act as discriminating monopolists. I expect that, when the details are rolled out, we’ll see things like restrictions on parallel imports.

There are two issues in deciding whether economic integration with the US is a good idea. The first is whether, in general terms, the economic and social institutions of the US are better than those of Australia. If you read the writings of FTA supporters, it’s pretty clear that they think this is the case, that we would be better off with less government intervention of all kinds, weaker unions, greater income inequality and so on.

The second issue, thrown into relief by the FTA negotiations is whether it’s a good idea to let our economic institutions to be determined by a government that is responsive to American interest groups, but not concerned with the welfare of Australians. The issue of copyright provides a nice example. There are a lot of arguments for and against long periods of copyright, but there are also issues of income distribution. In aggregate, an extension of copyright terms will redistribute income from Australians to Americans because the Americans own more copyrights of general interest than we do. Whatever the balance of the economic arguments, it’s a safe bet that American decisionmaking processes will err on the side of long copyright terms.

I’ve developed this argument at greater length here and in a submission to a Senate Inquiry which I’ll try to post here. Around the blogosphere, only Peter Gallagher has made the point that economic integration is the main issue.

A final observation on the FTA process is that it illustrates the validity of a traditional argument against unilateral tariff reductions. If you cut your tariffs unilaterally, you’ll have no bargaining chips to trade for reductions by less high-minded bargaining partners.

More precisely, I’d say that unilateral tariff reductions made sense given our previous focus on multilateral negotiations. In these negotiations our free-trade credentials gave us credibility as leaders of the “Cairns group”. But now that we’re moving to a bilateral approach, this counts for nothing, as we’ve seen.

In Defense of Rumsfeld

US Secretary of Defense has received general derision for the following rather convoluted statement

Reports that say that something hasn’t happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns – the ones we don’t know we don’t know

As I’m giving two papers on this general topic in the next couple of days, I feel I should come to his defense on this. Although the language may be tortured, the basic point is both valid and important.
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Dead on arrival?

My understanding of the legal status of treaties is imperfect, to put it mildly. I know that, unlike the US, there is no requirement for Parliamentary ratification of treaties. And I recall from the Franklin Dam case, that the Commonwealth Parliament can pass legislation to implement a treaty in a field that would otherwise be outside its jurisdiction, such as environmental protection.

But I don’t know what happens in the case of a treaty like the just-signed FTA, which apparently requires changes to Australian law in a large number of areas – certainly copyright and probably the PBS. I assume the entire treaty must be put to Parliament as a package and ratified without amendment, otherwise the US side can just walk away.

But if this is the case, I would judge that the treaty is already dead. It’s hard to see how Labor can consent to any watering down of the PBS, in full knowledge of the fact that Big Pharma is out to kill the scheme altogether. If no amendment is possible, they’ll have to vote against the treaty outright.

The politics of this seem entirely straightforward for Labor. Hardly anyone in Labors constituency has anything obvious to gain from the deal (in fact, the immediate benefits for anyone in Australia are trivial and the indirect benefits entirely speculative) Latham has already alienated anyone who objects to standing up to the Americans. OTOH, the majority of the Labor base who objected to the Iraq war can see that Howard hasn’t even managed to secure fair treatment in return for our loyal support of the US, let alone any favours.

Conversely, the politics seem diabolical for Howard. If legislation has to be pushed through Parliament that means De-Anne Kelly, Ron Boswell and the rest of the North Queensland Nationals will be opened up to ferocious attack from Bob Katter if they vote in favor. Labor can just sit back and watch, throwing in quotes from Howard and Anderson to the effect that they would “never ever” abandon the canegrowers (and, for that matter, the beef industry). And once the deal is rejected, everyone except the canegrowers and cattlemen will forget about it.

But of course, all of the above is premised on my shaky understanding of the procedural rules – would anyone care to set me straight.

Update Ken Parish answers my questions on the process and argues that the procedures for examining the treaty mean that nothing will come before Parliament until after the next election. It seems to me that this makes things even better for Labor. Rather than rejecting the treaty outright, they can say that, when elected, they will demand a renegotiation of the treaty (the fact that the US will also have an election complicates the issue, but mostly in a way favorable to this claim – for example, a statement by Bush that the terms of the agreement are ironclad can’t bind his successor).