Free trade ain’t dead but a new approach is needed

Last week’s Brexit vote by the United Kingdom came as a surprise to many. In a single day of broad democratic participation, the majority of U.K. voters chose to undo 40 years of integration at the heart of the world’s largest trading bloc.

Free trade agreements (FTA) have had an impressive run. Over the last 25 years, the value of trade has grown by five times, according to the World Bank. Unfortunately, trade growth has slowed in recent years, with the value of 2015 global trade down 14 percent, according to the CPB World Trade Monitor.

Weak global demand and slowing appetites for trade liberalization are the key factors. While free trade is not dead, the utility of incremental tariff reductions under FTAs is diminishing rapidly.

From a demographic perspective, free trade is evolving to meet political demands for trade “fairness” in the greying developed world as productivity and income growth grind to a halt.

Trade revisionism has dominated recent U.S. politics, to be sure, but the movement is also alive and well in other industrialized countries, particularly in Europe, and has already intensified post the Brexit vote.

Economic and political realities have also begun to hit middle income countries such as Malaysia, where there has been strong push back to the Trans Pacific Partnership (TPP).

While the anti-free trade movement appears sudden, enthusiasm has been declining for at least a decade, as the Doha Round of the World Trade Organization (WTO) stalled after repeated attempts to regain momentum. In 2014, the WTO finally surrendered to prevailing sentiment by agreeing to a “trade facilitation” round that focused on processes, not reduced tariffs.

This lack of momentum reflects an important fact.

Tariffs have decreased substantially over the last 40 years, and there’s little to be gained with additional agreements.

The average tariff in the European Union (EU) is 4 percent and the value of the British pound has already devalued by 10 percent, so U.K. exports from outside the EU would be much more affordable today than they were just a week ago.

And according to the World Bank, the average tariff among TPP countries was between 3 and 4 percent in 2014. With the rule of thumb for transportation costs around 4 percent, average tariff reductions under TPP would be lower than the cost of transportation, so most things that could be sourced within the potential free trade area probably already are.

To this point, a recent study by the United States International Trade Commission concluded that the TPP would add only 0.15 percentage points to U.S. economic growth over the next 15 years with a 0.07 percentage point rise in employment, that’s less than one month of U.S. non-farm payrolls growth over 15 years. The estimated benefit of the TPP is marginal, at best.

So why do governments, including the Obama administration with the TPP and TTIP, continue to pursue new free trade agreements so zealously?

Certainly, statements against free trade only a year ago were seen as quaint, nativist throwbacks to the 1930s. But the deterioration of benefits is evident, even as the value of global trade last year actually declined.

Perhaps the next step is to move past further free trade incrementalism toward bilateral investment treaties (BITs) and even multilateral investment treaties (MITs) which focus on the realization of long-term cross border capital investments.

America, for example, has only 42 BITs – mostly with small developing economies. These deals can be powerful vehicles to stimulate investment and reduce uncertainty, where risks – rather than costs – are typically the biggest worry for cross border investors.

BITs focus on levelling the playing field for investments: foreign companies gain equal regulatory treatment as domestic companies, equal treatment in legal disputes, equal access to capital and so forth.

Importantly, these investments increase jobs, tax revenues and consumption where the investment is made. Undeniably, investment “in place” would have a longer positive, cumulative effect than incremental tariff reduction under new TPP- and TTIP-like trade rounds.

The U.S. is actively pursuing a number of BITs, including the much anticipated U.S.-China BIT. These are laudable efforts, but issues are likely to arise as Americans realize that negotiations have been less than transparent, just like the TPP and TTIP, which raised suspicion and opposition in the U.S., Europe, Japan and parts of Southeast Asia.

Nonetheless, much could be gained from agreement such as the U.S.-China BIT. Even without a BIT in place, China’s collective foreign investment in America during the first quarter of 2016 was equivalent to its total investment in the U.S. for all of 2015.

With a BIT in place, the U.S. would expect a significant rise in investment as Chinese industries – facing reduced political and legal risks resulting from the BIT – take advantage of skills, intellectual property, and proximity to end-consumer markets. Conversely, U.S. companies could expect broader, fairer access to China’s market.

Since the U.K. is at the start of a new era of trade and investment, it might be worthwhile for both the U.S. and China to work together on a U.S.-China-U.K. investment treaty. This would put the world’s two largest economies with the two largest global financial centers.

The opportunities for capital, investment, employment and tax revenues resulting from a U.S.-China-U.K. investment treaty could be monumental.

It’s time for policymakers to abandon the simple strategy of tariff reductions and embrace a new strategy that helps preserve trade liberalization and sustain the benefits of direct investment.

As the U.K. discovered last week, the worst thing governments could do is to ignore the erosion of public support for incremental free trade. Doing so could risk a total collapse of the trade regime and rock the global system.

Instead, trade partners ought to consider how the current political realities of trade can be managed more effectively. The era of transactional trade-centric globalization is coming to a close and a more sustainable, investment-focused chapter is set to begin.

Tony Nash is the CEO at Complete Intelligence, an economics, risk and industry advisory firm in Singapore and Chairman of the International Council for Capital Formation (ICCF). George David Banks is the executive vice president of the American Council for Capital Formation (ACCF) in Washington, DC.

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