Dialogue: Trading deals have a downside

By ROBERT SCOLLAY*

At the heart of the economic case against preferential trading arrangements, such as free-trade areas or customs unions, is their discriminatory character.

By granting access to one another's markets, the members of such arrangements discriminate against the countries outside the arrangement, who continue to face the existing tariffs of the member countries.

This obviously hurts the excluded countries and, less obviously, may also hurt the members themselves if the preferences they give each other encourage a switching of import sources in favour of inefficient suppliers in the partner countries.

Thus, NZ would certainly be hurt by exclusion from a US-Australia free-trade deal, but the US might also find it was shooting itself in the foot if the arrangement led to a rise in more expensive Australian dairy imports at the expense of cheaper, better-quality NZ products.

New Zealand's obvious defence is to seek a free-trade area of its own with the US. This is an example of the domino effect that is likely to operate in these situations. Once a trend towards preferential trade agreements is established in a region like the Asia-Pacific, country after country may seek to protect its position by pursuing its own set of preferential trading agreements with key trade partners.

As these agreements proliferate, the potential for escalating compliance costs for business is obvious. Even more worrying is the potential for escalating trade conflict, as countries are tempted to pursue their own interests at the expense of their competitors. Australia and New Zealand are already eyeing each other warily as potential suitors for the hand of the US, and situations like this are developing throughout the region.

The WTO principle of non-discrimination, requiring WTO members to treat all fellow members equally, was designed precisely to forestall this fragmentation of the world trading system through the proliferation of preferential trade agreements.

WTO rules make exceptions for preferential agreements, but attempt to ensure that, where such agreements emerge, they will be high-quality agreements, such as CER between Australia and New Zealand, or our closer economic partnership with Singapore, where potential for damage to the international trading system is minimised.

The hallmark of a high-quality agreement is an outward-looking approach, where barriers are reduced across all sectors and where barriers against non-members of the agreement are reduced simultaneously, or are already low, so that margins of preference are kept low. Unfortunately, WTO rules have been too weak to prevent new preferential agreements and initiatives of much more doubtful merit, driven, for example, by the desire to ring-fence sensitive sectors such as agriculture from international competition.

Apec, too, followed the WTO's non-discriminatory approach in putting forward its vision of free trade and investment in the Asia-Pacific. Instead of forming themselves into a preferential trade arrangement, Apec members were to lower their barriers on a non-discriminatory basis.

For NZ, an added bonus was that Apec embraced both sides of the Pacific and so offered the twin advantages of benefiting from region-wide trade liberalisation while avoiding any need to make awkward choices between alignments with key trading partners in East Asia and North America.

A distinct possibility is that there may be a gradual convergence or consolidation of today's confusing array of preferential initiatives. For example, where today the prospect is for three separate bilateral agreements linking the US, Australia and New Zealand, eventually the commonsense logic of a single, three-way agreement might prevail. The same logic would suggest a single agreement linking Australia, NZ and Singapore instead of three bilaterals. And then, with Singapore also pursuing a free-trade agreement with the US, why not a single agreement embracing all four countries?

A less benign scenario, however, would be the consolidation of the region's trading arrangements into two mega-blocs: on one side the Free Trade Area of the Americas, scheduled for launching in 2005; on the other an East Asian trade bloc, perhaps based on the Asean, plus three grouping of China, Japan, Korea, and the 10 Asean economies.

For NZ, exclusion from either or both of these two blocs is a most unappealing prospect. For example, the Latin American countries that will gain preferential access to the US market under the FTAA include formidable competitors for a number of our key export industries.

If these countries, perhaps with Australia, gain preferential access to the US market while NZ does not, it will be a blow not only to our trade, but to the prospects for attracting investment to this country.

But exclusion from an East Asian bloc would also be costly. In pursuing its trade interests with the US, NZ should not, as Australia has done, signal a lessening of its interest in economic links with East Asia.

* Robert Scollay is director of the Apec study centre at the University of Auckland.