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Buchanan: Preferential Trade with Larger Partners

The Problem of Preferential Trade with Larger Partners


Paul G. Buchanan
3-17-08

Chinese repression of Tibetan dissidents has pushed the issue of the impending Free Trade Agreement (FTA) between New Zealand and the Peoples Republic of China (PRC) back into the news. In a diplomatic sidestep both Helen Clark and John Key claim that events in Tibet have nothing to do with free trade. Perhaps that is true, but there are other issues to consider.

Signing of a bilateral FTA with the PRC in April is seen as a milestone in New Zealand’s economic development. Some believe it to be a precursor to a US-New Zealand FTA, especially since the US has signed bilateral trade agreements with several of New Zealand’s close trading partners. In an increasingly globalised system of production and exchange, the prevailing view is that New Zealand must negotiate trade agreements with as many compatible partners as possible. This is seen to diversify both sources of imports and investment as well as export markets using market competition to find the right balance between prices, quantity and quality of incoming and outgoing goods.

The arguments in favour of FTAs are many. However, there is need for a deeper look at what exactly a bilateral FTA with a much larger country implies.

In an essay bestowed the 2006 Asia Pacific Rim Universities (APRU) Fellows collaborative research paper award, Lin Kun-Chin and I examined the approaches of six Pacific Rim countries (New Zealand among them) to negotiating trade and security agreements. Although there is more data to mine before we can offer conclusive findings, some preliminary observations can be made that are pertinent here. The most interesting is that when it comes to trade, smaller partners prefer multilateral approaches while larger partners prefer bilateral approaches.

The reason is that under the terms of bilateral agreements larger partners are able to bring the weight of their economies of scale to bear on individualized trade with smaller partners. Given the comparative disadvantages, smaller players prefer the equalizing effects of a multilateral playing field. A larger partner will negotiate with consortiums of smaller partners (such as current US negotiations with the P4 trading partnership involving Brunei, Chile, New Zealand and Singapore, and its 2006 FTA with the Central American Common Market), while smaller countries will sign bilateral agreements with similarly sized partners or with countries that have complementary economies (such as New Zealand’s 2001 Closer Economic Partnership agreement with Singapore). As the European Union demonstrates, medium and small countries can find common ground within multinational economic umbrellas, which gives them collective strength when trading with larger extra-regional partners (although there is still much to be done in the “Europeanisation” project).

In the main, when dealing with larger partners smaller countries conduct their opening of trade within the framework of multilateral agreements that codify uniform rules and spread costs and risks equitably across the field. This is particularly important when considering that FTAs are not immune from the impact of future externalities, and countries with greater resource endowments are better able to weather the impact of changing trade preferences given uncertain market futures. Multilateral FTAs therefore help mitigate the adverse impact of negative externalities on small, trade-dependent nations.

Market logics push for vertical and horizontal integration of production. Producers will preferentially move to secure control of the production chain from inputs to outputs (e.g. from raw material extraction to retail of value-added commodity production), and then move to gain control of parallel distribution networks (via buyouts and takeovers) in an effort to limit the profit-reducing effects of competition. FTAs are a means by which offshore producers can gain entry into new markets in pursuit of those objectives. Small country investors are nominally at a disadvantage when entering larger partner’s markets, whereas large country investors have greater potential to achieve, either wholly or in part, vertical and horizontal integration in smaller economies. This especially the case when “after-entry” regulations are absent from the FTA.

FTAs are not just about imports and exports across open borders. In the first instance free trade is about deregulating financial markets, reducing tariffs, investing in local (human and natural) resource extraction, using foreign labor and local content to build an offshore value-adding export platform—the range and variety of capital interest is broad. Beyond the market-entry issues that are the main focus of FTAs, there are a host of “after-entry” factors to be considered: labor market standardization, environmental impact, gender and work/life balances, copyright issues, etc. Many larger partners use FTAs as a doorway to increased investment in the strategic assets of smaller partners. The sheer volume of those investments has the capacity, if unregulated, to erode local fair practice standards in the interest of greater profitability. In is rare to find a smaller partner imposing its notions of fair standards on a larger partner and in fact, the reverse is more often true. In many instances this has resulted in a “race to the bottom” whereby cost cutting and the search for cheap inputs results in degraded wages, increased pollution and the promotion of profit before people.

Importers will argue that an FTA with the PRC will lower the costs to New Zealand consumers, and exporters will say that it opens a gigantic market to them. But that is already happening. The flow of goods between the two countries is already significant and growing (more than NZ$4 billion per year), and of that 80 percent is in the form of Chinese exports to New Zealand. The bilateral FTA will reduce tariffs on New Zealand agricultural exports into China, but it also relaxes investment controls on both sides. In effect, what the FTA with the PRC is really about is opening investment flows—capital redirection by another name—in order to secure competitive advantages in production. For New Zealand producers this means re-directing investment (and jobs) to low wage value-added production on the Chinese mainland; for the Chinese, it means investment in primary good exploitation and natural resource-based manufacturing in New Zealand (which may increase jobs).

Another interesting finding of the APRU paper was that democracies are at a disadvantage when negotiating trade agreements with dictatorships. The latter have centralized decision-making structures with little outside scrutiny or transparency. Decisions are reached by leadership consensus and orders passed down to subordinates devoid of independence or autonomy. Domestic opposition is not considered and often suppressed. Local producers are protected by their political ties to the regime. There is the small matter of human rights, or the lack thereof, in such places. That combination of factors makes trading with such regimes entirely dependent on the whims and disposition of the regime elite, not the rule of law or public preferences.

Trade agreements signed by democracies are subject to electoral pressures, relative bureaucratic independence, the veto potential of organized interest groups and judicial review. The scope and depth of trade negotiations is often limited to market entry conditions, with after-entry issues subject to the consent of domestic constituencies and scrutiny of independent agencies. Because FTAs can be challenged in court and in the political arena, full implementation is far more uncertain than under authoritarian regimes. For example, FTAs with the US are opposed by South Korean and Uruguayan farmers, delaying their ratification in both countries. The Colombian-US FTA is held up because of US congressional concerns about human rights abuses in Colombia. New Zealand-based forestry investors have found themselves confronted by indigenous groups in Chilean courts. Thus, whatever the original terms of the agreement, ratification and implementation of FTAs is a far more laborious under conditions of political democracy.

In contrast, trade deals signed by New Zealand with Brunei, Singapore, various Arabian Gulf states and the PRC did not pass through the filter of public scrutiny in those countries either prior to or after their implementation. That opens the door to questions about symmetry in the trade agreement being signed with the PRC. Are there health and occupational, minimum wage, collective representation and environmental impact clauses in the FTA? Do these apply to subsidiaries and contractors of New Zealand-based firms? Are there limits to the amount of capital flows directed into strategic industries and assets? Are there prohibitions against asset stripping? Are these controls (if extant) equal or symmetrical across the board? Even if New Zealand producers are advantaged by more permissive conditions of production in authoritarian partner countries, are such agreements really fair? If not, are FTAs signed with states such as the PRC really examples of free trade?

One of the major hurdles to effective implementation of FTAs is the lack of institutional mechanisms for dispute resolution. Such as been the case with the MERCOSUR regional trade bloc in South America, which has seen Brazilian dominance of the bloc not only because of its sheer size but because there is a lack of independent multilateral conflict resolution mechanisms to adjudicate disputes between contending parties. The 2006 P4 agreement suffers from the same flaw—it opens doorways to increased trade between New Zealand and its partners but does not provide a common institutional setting in which after-entry standards can be agreed upon and in which disputes can be resolved. It therefore remains to be seen if the FTA with the PRC is an improvement in that regard, and what sort of bilateral mechanisms have been created to adjudicate disputes. If conflict resolution is left to local courts, foreign investors are at the mercy of the political environment in which those courts operate. That may not be of concern for Chinese investors in New Zealand, but given the authoritarian character of the PRC, it is an open question as to whether judicial independence and equitable treatment can be guaranteed to Kiwi investors.

There is geo-strategic aspect to the matter. The PRC is in the process of expanding its influence in the Southwestern Pacific in parallel with a major military buildup (with a 17% increase in military expenditures in 2008, to nearly US$150 billion, making it the second biggest military spender after the US). Using dollar diplomacy, the Chinese have landed deepwater port and infrastructure construction projects in a number of Pacific island states. This serves the dual purposes of providing mooring space for commercial freight and military vessels as well as telecommunications facilities far offshore. That runs in concert with the expansion of China’s blue water fleet as it moves from being a primarily a defensive, land based military dominated by a mass Army working on war of attrition scenarios to a more flexible, high-technology offensive military capable of projecting concentrated force far from the Chinese mainland (to include cyber and outer space) in defense of PRC national interests. If economic interests are included in the definition of national security, then the convergent rationales of Chinese military and economic expansion in the South Pacific become clear. The New Zealand-PRC FTA must be seen in light of this, especially considering that it will provide a counter-balance to the Australia-Japan-US trade and security axis in the Western Pacific.

That raises the final point. FTAs are not negotiated solely because of economic reasons. Political factors are always involved in the mix, and can often outweigh economic benefits in the calculus as to whether to go forward with the negotiations. Clear examples are provided by the US-Australia FTA signed in 2006, which was a political sop thrown by the Bush administration to the Howard government over its support of the US in the war on terrorism (and which has not resulted in the benefits to Australian producers that many had hoped for); and the long-delayed US-Colombian FTA, which the Bush administration claims is necessary for national security reasons in the fight against narco-terrorism and neo-socialism in Latin America. Historical evidence shows that military allies are more likely to trade with each other than with non-allies, but that trade agreements can open the way to closer military cooperation. FTAs, in other words, can serve as diplomatic or military door openers as well as alliance reinforcements. But the door opens both ways.

New Zealand may primarily have economic motives for pursuing the FTA with the PRC. But the PRC clearly has more than economic interest in mind when it chose New Zealand as the first western democracy with which to sign an FTA. Recent New Zealand port visits by Chinese warships, ongoing reports of Chinese espionage and submarine activities in the South Pacific, and the extension of Chinese commercial networks throughout the Pacific Rim demonstrate that political-military as well as economic rationales are at play. It would be prudent for New Zealand to understand the larger strategic picture currently unfolding.

A rising tide of free trade may raise all economic boats, and an FTA with the PRC might well do wonders for New Zealand exporters and consumers. But the devil is in the details, and the details of the fine print of this FTA have yet to be placed before parliament and the informed public. Only once that has happened can definitive judgment be made on the pact, and that should have occurred before rather than after the April signing ceremony. Since that is out of the question, the signing ceremony is all symbolism with little substantive impact—unless the government decides to take a page out of its Chinese counterpart’s book and ratify the FTA without consultation. Fortunately that is impossible, but it is up to the electorate to demand that the details of the FTA be debated rather than rubber-stamped.

********

Paul G. Buchanan writes about comparative and international politics. The 2006 APRU Collaborative Research Paper Award-winning essay can be accessed at www.apru.org/activities/afp/collab_paper.htm.

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