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FTAs need a cautious approach

BusinessLine | 6 September 2021

FTAs need a cautious approach

by Ajay Srivastava

Going by the US sign-ups, they often drive the rich country’s agenda on IPRs, digital trade and re-manufacturing

A US government report has reignited the debate if free trade agreements (FTAs) are worth it, after all. The report, The Economic Impact of Trade Agreements, was released by the United States International Trade Commission (USITC) in June. US Congress commissioned it.

The report says that the trade agreements signed by the US had only a small positive impact on the US economy, trade, and jobs. Using 2017 as the base year, the report estimated a 0.5 per cent ($88.8 billion) increase in real GDP, a 0.3 per cent (485,000) increase in jobs, and slight growth in trade.

The findings provide insights for countries currently negotiating more than a hundred FTAs.

The US has 14 FTAs in force with 20 countries. But it does not have FTAs with major economies like the EU, China, Japan or ASEAN.

The share of FTA partners in the US merchandise exports is 43 per cent. The share becomes less than 13 per cent if trade with neighbours Mexico and Canada under the North American FTA (NAFTA) is excluded.

Low duties and complicated rules have increased trade costs and lowered FTA utilisation. Average import duties in the US are 3.7 per cent. Its FTA partners like Singapore allow duty-free imports of all products from all countries. Israel also allows duty-free import of over 60 per cent of products. Elimination of such low duties under an FTA gives little price advantage to exporting firms. Complicated FTA Rules of Origin take away even this little advantage.

Rules of Origin define conditions when a product becomes eligible for FTA concessions. The US has negotiated many complicated Rules of Origin to protect its industry.

Consider the export of a car from Mexico or Canada to the US under the USMCA (United States-Mexico-Canada Agreement). The carmaker must source at least 70 per cent of the steel and aluminium used from North America, pay factory workers wages exceeding $16 per hour. The car must use fewer imported parts to ensure at least 62.5 per cent local value-addition. The imported content cannot exceed 25 per cent after five years.

The rules are also strict for apparel. Under NAFTA, apparel-makers must use fabric and yarn made in the region. For most other US FTAs, the yarn forward rule applies. This means apparel makers must import yarn which must be woven into cloth for making the apparel.

The US uses FTAs to push its global trade agenda on intellectual property, e-commerce, old machinery, etc. The WTO’s Trade-Related Aspects of Intellectual Property Rights (TRIPS) outlines the minimum IPR standards members must follow. The US pushes its FTA partners to take onerous TRIPS Plus obligations to ensure greater IPR protection for its pharma and technology firms.

The report says that the effects of such provisions are ambiguous. This contradicts most academic writings that say TRIPS has spurred trade in IPR-intensive sectors and TRIPS Plus provisions fare better.

On e-commerce, WTO members have agreed to charge no import duty on products transmitted electronically for the time being. It is a big issue at the WTO. The US FTAs include provisions to ensure partners do not renege from the promise at the WTO at a later date.

A big battle awaits the issue of disposal of outdated or old gadgets and machinery. Such products are ‘re-manufactured’ and pushed for sale in developing countries. Fearing the import of old technology, many countries have banned the import of such goods. At least 12 of the US FTAs contain provisions prohibiting partner countries from imposing such bans.

Many of the US FTAs include provisions requiring domestic policy changes in the partner countries. The US FTA with Korea restricts the support provided by the Korean government to pharmaceutical and medical devices.

Technical barriers

With average import duties already low, the US uses FTAs to harmonise standards and address technical barriers to trade. It also uses FTAs to drive its global agenda on IPRs, digital trade and re-manufacturing. But only the US can dictate terms. For all other countries negotiating FTAs, here are two pointers.

One, the outcome is dependent on the choice of the partner country. To understand, let us divide world trade in manufactured goods into two broad groups. Medium- to high-tech goods account for 70 per cent of world trade, and labour-intensive goods like shirts and shoes account for the remaining 30 per cent. Developed countries charge zero or low import duties on most medium- to high-tech goods. And high duties on shirts and shoes, manufactured by poor/developing countries. Now, what would happen when a poor country enters into an FTA with a developed country is easy to guess.

The poor country gets preferential access for its shirts and shoes in the developed country. In return, it has to remove duty on most products. The poor country gets additional market access in 30 per cent of products while the rich nation would get additional market access in 100 per cent of products. The resulting zero duty imports may disrupt any domestic programme to enhance manufacturing in medium- to high-tech sectors.

Two, appropriate MFN (most favoured nation) duty level is vital for trade. Consider, X, a country with high MFN import duty and a large market, enters into an FTA with Y. This may tempt countries like China to manufacture in Y to export to X.

Half the world trade happens at zero MFN Customs duty, and the FTAs account for less than a quarter of world trade. To grow trade and attract investments, countries must reduce MFN tariffs on critical inputs and lower the cost of inputs. The American study is a reminder that FTAs are just one of the many instruments for promoting trade.

The writer is an Indian Trade Service officer. Views are personal

 source: BusinessLine