Bilateral Trade Agreements - Term Paper Example

Bilateral Trade Agreements "A free trade agreement is a pact between two countries or areas in which they both agree to lift most or all tariffs, quotas, special fees and taxes, and other barriers to trade between the entities" (White). The Underpinnings of Bilateral Trade International trade traces its roots from the modern economic concepts popularized by economists such as David Ricardo. Particularly, it has its foundation on the "principles of comparative advantage" which supports international trade (Mankiw). Introduced by David Ricardo in 1817 through his book On the Principles of Political Economy and Taxation, comparative advantage posits that trade can create value for both countries even if one has the fewer resources in the production of all goods. Using the production possibilities frontier, Ricardo was able to prove this, achieving a significant breakthrough in the field of international economics. Practically, Ricardo believes that given the situation, both countries can still gain by having the less efficient country specialize in the production and exportation of the commodity in which its absolute disadvantage is smallest and import the product in which it has its greatest absolute disadvantage. The commodity in which one country has the least absolute disadvantage can be thought of as one in which it has the comparative advantage. The gains are realized as both countries specialize in the production of commodity in which it has the least opportunity cost (Mankiw). In a high-income and low-income country comparison, the book, Making the International: Economic Interdependence and Political Order highlighted that in a two-commodity example of food and pills, specialization will benefit both countries as each will be producing the commodity with the least opportunity cost, simply saying that trade can help increase income even for the low-income countries (Mackintosh). The Rise of Bilateral Trade In the recent years, there is an observed rise in the number of bilateral trade agreements between countries. Experts say that for a powerful country like the USA, "smaller FTAs accomplish the goal of liberalization and the expansion of markets for U.S. goods" in the absence of a broader agreement like the Doha round (MacMahon). On the part of the smaller countries, bilateral trade agreements increase the local employment and provide a better climate for investors from the powerful nations (MacMahon). It is generally accepted that open economies which engage with the outside world do better than economies that are inward looking. Economic historians provide evidence of economies which prospered, starting with a low base, by the introduction of new ideas entailed in movement of people and capital and evidence of economies that declined (e.g. China) by erecting walls against new ideas and people (Cippola). In more recent times, developing countries which have paid attention to getting higher prices for their raw material have fared worse than countries which have re-orientated their production to suit international markets. An Asian country, Bangladesh has apparently benefitted from its clothing industry. The country has apparently experienced an enormous expansion of its clothing industry when it was opened to trade in other countries with the largely developed countries as its market (Audio program 1 (2004) Trade and state). Both Ghana and South Korea started from similar levels of per capita GDP in 1970 (Hill). The GDP per capita in Ghana was US$260 and the corresponding figure for South Korea was US$250. By 1992, they had diverged greatly, 450 and 6790 for Ghana and South Korea, respectively. Ghana is still a poor developing nation, but Korean wages would be an envy to workers in Wales. Politicians in Ghana spent their time arguing at international meetings about the need for fair price for commodity exports and the politicians in South Korea spent their effort in re-directing production to goods for which there was demand abroad. Recent Concepts and Developments in Bilateral Trade There are recently concluded Bilateral Trade agreements among bigger nations. This includes the Japan-Thailand and U.S.-South Korea FTAs. "Japan has shown interest in an FTA with the United States in response to the U.S.-South Korea agreement. There are 220-odd such agreements in existence today, and they are expected to scale up to 400 by the end of this decade. The agreements have played a key role in fostering freer trade in a globalizing world. With the establishment of the General Agreement on Tariffs and Trade after World War II, the multilateral approach was the preferred method of trade liberalization. The World Trade Organization was brought into existence after GATT to fix the anomaly resulting from special treatment allowed under GATT for its member nations to subsidize production or agriculture and export and limit market access. This practice ultimately resulted in decreased commodity food prices, distortions in global agriculture trade and frustrations from non-subsidized agriculture exporting nations. One of the noble objectives of the WTO was to eradicate this trade distortion and improve food prices thereby, improving the welfare of farmers" (Doshi). The Doha round launched in 2001 was followed by subsequent rounds of negotiation but it has not been successful due to the issues that the developing nations have brought up-specifically the issues in agriculture subsidies given by large countries to their local farmers (Doshi). "Due to a deadlock in negotiations, the discussions were halted in July 2006 until the recent meeting of the United States, the European Union, Brazil and India in Potsdam, Germany in June 2007, after which discussions halted again. They may resume only after the U.S. presidential election next year. A direct consequence of the slowdown in the Doha round was the resurgence of regional trade agreements in the form of FTAs and bilateral trade agreements. FTAs, many of which are bilateral, are arrangements in which countries give each other preferential treatment in trade by eliminating tariffs and other barriers on goods. Each country continues its normal trade policies with other countries outside the FTA agreement" (Doshi). Bilateral trade agreements are deemed advantageous as countries have more options as when to enter into agreements (Doshi). How Small Nations Suffer from Bilateral Trades "Trade agreements are important for development. Trade liberalization helps to create bigger, more efficient, attractive and dynamic markets, thereby benefiting the economy at large. Bilateral trade agreements can also create political and economic ties between the parties, which in turn provide more stability" (Rodrguez). However, it provides loopholes wherein powerful nations can exploit the agreements to the disadvantage of the developing countries. One of the opposition to the free trade, such as the bilateral trade agreements is the "infant industry argument" (Mankiw). It is based on the belief that the industries of the developing nations might not be well equipped to compete against the giants of the more powerful nations. This then will lead to the death of the local industry. Bilateral trade agreements simply kill the local industries who have not exhibited economies of scale. In economics terms, the failure to achieve economies of scale on the part of the local industries, because they are relatively new will result to a less efficient production compared to those who are old in the industry and this will be manifested in the relatively high prices of the former (Robert S. Pindyck). This argument is validated by the study of Rodriguez. According to him trade agreements between nations with large economic level discrepancy can actually hurt the weakest party (Rodrguez). Moreover, he gave the following effects on the developing nations of trade agreements. Reciprocity and national treatment (the obligation whereby foreign goods, services and economic operators must receive the same treatment as local ones) oblige developing countries to implement broad liberalisation in market access in goods, services and government procurement, which may result in surges of imports; moreover, tariff elimination, besides depriving developing countries of revenues, removes powerful instruments of industrial and agricultural policy to protect their infant industries. Market access gains for developing nations may be limited if agricultural subsidies in rich nations are not reduced; restrictive rules of origin, technical barriers to trade (TBTs) such as quality standards and supply-side constraints also limit the possible gains from improved access to developed countries' markets. Reduction of policy space for developing countries; many of the issues included in the current North-South FTAs 'reduce or fully remove policy options and instruments available to a developing country to pursue its development objectives' (UNCTAD, 2007) Source: Rodrguez Bilateral Trade's Impact on Business "Many of the manufacturing firms participating in international trade are very large, in terms of turnover and in relation to their markets. The consequences of the size of these firms for their production and costs give us another reason why trade in manufactures helps generate growth. In many manufacturing industries, as a firm's output expands, its costs per unit of output decline. That is, the firm benefits from increasing returns. This concept is now used to refer to a wide range of different reasons why firms' costs can decline over time with rising output. There may be large unavoidable set-up costs for a manufacturing plant, and these are then spread over larger and larger output, so that the average cost per unit of output falls as the firm expands. Furthermore, as a firm's output becomes very large, it may be able to invest in more cost-efficient production methods, for example greater use of automation" (Mackintosh). These big companies enjoy increasing returns. "Increasing returns imply that larger firms have a market advantage over smaller rivals: they can undercut rivals' prices while remaining profitable themselves since their costs per unit sold are lower. Since established firms are quite likely to be larger than new entrants to an industry, it is then hard for new firms to get into an established market. The problem is that it can and does take time for a firm to establish itself at a level of cost per unit that allows it to be internationally competitive. The more international markets integrate, through falling transport and communications costs and declining trade barriers, the more scope there is for large firms to exploit increasing returns" (Mackintosh). This economic concept of increasing returns creates an advantage for large firms to the point of killing small business industries of small countries. This can be an inevitable result of globalization. This fear then urges smaller countries to practice protectionism. To distinguish the gains from trade of each country, it is very important to know the terms of trade. It is simply defined as the price of a country's exports relative to its imports (Mackintosh). It is such an essential thing so that even if in terms of volume one's production is comparable to its imports, a relatively lower price for its products would mean that its exports would not be enough to cover for its imports. The declining prices can affect the developing countries much more than the high-income countries. This is due to the fact that the products in the high-income countries are diversified so that a reduction in the price of one of its products can be offset by the gains in other products (Mackintosh). On the other hand, the low income countries have relatively narrow product variety, which divests them of a cushion in case one of the prices declines sharply. A real-world example of this was the sharp decline of coffee prices in the world market in the years 1995 - 2000. The decline was more than 50% in 10 of the 14 least developed countries, giving a stain to the promise of free trade which is supposed to uplift the lives of these farmers. Since most coffee is grown in agricultural developing countries, it is them that were hurt the most. Some of the countries hurt by the decline in coffee prices are Nicaragua and Colombia. The plummeting of coffee prices in some provinces in Colombia has left children starving has endangered progress promised by trade (Jeffrey). Bilateral Trade with USA The United States is one of the countries who have been very active in pursuing bilateral trade talks against smaller nations. Some of these agreements are with Costa Rica, Chile and Singapore. "In the past two years, the US has initiated comprehensive free trade negotiations with 19 countries, a market representing an estimated US $2.5 trillion worth of opportunities to American business. Simultaneously, however, these agreements open the American market, exposing, in particular, US industries dependent on sweat labour that cannot compete with low labour costs in poorer countries around the world. The difference is that the US has the resources to diffuse the pain of the transition, amounting to support of US$1.8 billion in 2003, while developing countries simply suffer" (Herbert). Powerful nations can also use their vast financial resource to weaken the power of the developing coutnries to bargain. This is what happened to Bolivia whose technical and legal inexperience plus their economic desperation (dependent on US aid) makes trade with the USA very much one-sided. In the book 'Bilateral and Regional Free Trade Agreements Some Critical Elements and Development Implications', it was mentioned that "the comprehensive and strict obligations these FTAs impose will seriously constrain the developing country party's policy-making capacity to pursue national socioeconomic and development goals. As a result of this erosion of policy space and the drastic market-opening demanded by FTAs, no less than the country's development prospects would be undermined" (Khor). The experience of Mexico was that of falling wages and decline in the number of people with regular jobs in paid position. Many were transferred to a "subsistence level" job particularly in the informal sector. "The impact on workers in countries as India, Indonesia, and China has been even more severe, with innumerable instances of starvation wages, child workers, slave-labor hours and perilous work conditions" (White). Fears on Bilateral Agreement with EU "Trading with other European Union (EU)countries offers a number of key benefits to businesses in the UK. The EU's 27 member states include some of the world's wealthiest and most productive countries" (Business Link).The EU is a huge market in which to sell goods and services- it also gives access to a huge source of suppliers (Business Link). However oppositions to its trade talks with Africa grew louder as local residents of Cape Verde fear that they lose 80 per cent of its import revenues while three-quarters of Ghana's industry may collapse (Mutume). "In the short term, lifting tariffs on European goods would deprive many governments of an important source of fiscal revenue" (Mutume). Africa also feared that these trades would result to a similar situation as Senegal's where it resulted to massive lay-offs in the chemical, textile, footwear and automobile industry (Mutume). Works Cited Audio program 1 (2004) Trade and state. 2004. Business Link. http://www.businesslink.gov.uk. 12 August 2009 . Cippola, Carlo M. Before the Industrial Revolution. 2nd. London: Routledge, 1989. Doshi, Hiren. Multilateral vs.bilateral trade agreements. 29 January 2008. 12 August 2009 . Foreign Agricultural Service. http://useu.usmission.gov. 18 September 2008. 12 August 2009 . Herbert, Yuill. http://globalpolicy.org. 6 April 2004. 8 August 2009 . Hill, C. Iternational Business. 3rd. McGraw-Hill Higher Education, 2000. Jeffrey, Paul. "NCR Online." 7 February 2003. www.natcatch.com. 2009 March 07 . Khor, Martin. Bilateral and Regional Free Trade Agreements Some Critical Elements and Development Implications. Third World Network, 2008. Mackintosh, Maureen. "Gaining from Trade." Simon Bromley, Maureen Mckintosh, William Brown,Marc Wuyts. Making the International: Economic Interdependece and Political Order. London: Pluto Press, 2004. 46-72. MacMahon, Robert. "The Rise in Bilateral Free Trade Agreements." Council on Foreign Relations (2006). Mankiw, N.Gregory. Principles of Macroeconomics. Orlando, Florida: The Dryden Press Harcourt Brace College Publishers, 1998. Mutume, Gumisai. "Africans fear 'ruin' in Europe trade talks." Africa Renewal 21 (2007). Robert S. Pindyck, Daniel L.Rubinfeld. Microeconomics: An Integrated Approach First Edition. New Jersey: Pearson Prentice Hall, 2005. Rodrguez, Enrique Valerdi. Countries, The European Union Free Trade Agreements: Implications for Developing Countries. Working Paper. Madrid: Real Instituto Elcano, 2009. White, Deborah. http://usliberals.about.com. 12 August 2009 . Read More