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Free Trade Agreements v Unilateral Free Trade

Rogoff's Alternative to the Wa... Rogoff on How to Deal with Eme...

by Pierre Lemieux

In order to be useful...a free trade agreement must further free trade more than it restricts it through international standards and regulatory harmonization.
The current renegotiation of the North American Free Trade Agreement (NAFTA) raises two sorts of questions. First, is NAFTA a free trade agreement? Will it be a free trade agreement after it is renegotiated? Second, do we need free trade agreements to have free trade? (Addressing the second question may answer some of the reader comments on my recent post about comparative advantage.) I am using "free trade agreements" loosely to include all forms of reciprocity, that is, situations where one country opens its borders to another one only if the latter reciprocates.

On the first set of questions, NAFTA has reduced barriers and increased trade among the three partner countries - the United States, Canada, and Mexico. US exports to NAFTA countries have increased from about 2% of GDP to more than 2.5%. In a regional or plurilateral trade agreement (as opposed to a world treaty like the ones administered by the World Trade Organization), a trade diversion effect (diverting trade from other countries) can reduce or eliminate the trade creation effect, but this is less likely in NAFTA's continental-wide trade.

A revamped NAFTA may not deserve the label of free trade - for example, if its regulatory content is expanded through labor, environmental, gender, or other sorts of standards. The Canadian government is pushing in that direction, and the US government agrees at least for the labor and environmental standards. I'll come back to this issue later.

The second line of questioning is, why pursue reciprocity when we can have unilateral free trade instead, that is, when any government can open its country to trade without waiting for others to reciprocate? This question is especially relevant in view of Douglas Irwin's new book (Clashing over Commerce: A History of Trade Policy), which suggests that for two centuries and a half, American trade policy has oscillated between protectionism and reciprocity, ignoring the option of unilateral free trade.

Unilateral free trade provides a large part of the benefits of free trade, although we should note that the welfare economics of free trade is trickier than it looks at first sight. The only thing we can safely say is that, for any participating country, the monetary benefits of free trade are nearly always greater than its costs. We can translate this, a bit loosely, into the statement that most individuals benefit from free trade. If a foreign country is protectionist, the government of your own country only compounds your problems by adopting protectionism too. As economist Joan Robinson suggested in her Essays in the Theory of Employment (1947), protectionist retaliation looks like the decision "to dump rocks into our harbors because other nations have rocky coasts." One's own government's trade policy should not depend on the restrictions that foreign countries impose on their own citizens.

It is always useful to remember that, from the viewpoint of a country (this collectivist way of speaking being just a shortcut), imports are the benefits, and exports are the cost, not the other way around. James Mill, the 19th-century economist who was also the father of John Stuart, correctly wrote in his Elements of Political Economy:

The benefit which is derived from exchanging one commodity for another, arises, in all cases, from the commodity received, not from the commodity given. When one country exchanges ... the whole of its advantage consists in the commodities imported. It benefits by importation, and by nothing else. ... That country, or, more properly speaking, the people of that country, have certain commodities of their own, but these they are willing to give for certain commodities of other countries. They prefer having those other commodities. They are benefited, therefore, not by what they give away; that it would be absurd to say; but by what they receive.

For a country - that is, for most of its residents - unilateral free trade provides not only part of the benefits of reciprocal trade, but probably most of them. Look at this from the perspective of a protectionist country P exporting to a unilateral-free-trading country U. A country can only export to the extent that it imports an equivalent volume of goods and services, at least over a certain time period, directly or indirectly. If P exports to U, the latter needs P's currency (call it $P) to pay. U can obtain $Ps by exporting to P. Or else U must export to a third country that has some $Ps because it has itself exported to P. Thus the protectionist country ends up importing as much as it exports. The same conclusion obtains if P accepts U's currency ($U) for its exports, for what will P do with its $Us? And using foreign currency for foreign investment amounts to future imports. As Jean-Baptiste Say put it, "nothing can be bought from strangers, except with native products."

The most famous example of unilateral free trade was Britain's abolition of the Corn Laws in 1846. Another example is Hong Kong, which has had unilateral free trade in merchandise (goods) since the mid-19th century, although this freedom did not extend to importing services such as telecommunications, air transport, and banking.

Partial examples of unilateral free trade can be found in the spontaneous reduction, and sometimes elimination, of specific tariffs by many governments, as Doug Irwin points out in Free Trade Under Fire. In 2010, the average applied tariff among WTO countries was 3.7% compared to an average bound rate of 9.9% - "bound" meaning capped by WTO rules. The typical government voluntarily imposed lower tariff rates than it could legally have imposed.

Does not that imply that free trade agreements are useless (as I once myself believed)? Last month, I raised the issue during a short presentation at a Mont Hamilton Society luncheon. I was not surprised that at least one libertarian participant sided with my former self.

I now think that free trade agreements are not necessarily useless for the very reason why Donald Trump defends the opposite position. Free trade agreements "tie our hands," he complained in a speech in Asia. Indeed, they prevent national governments from yielding to the pressures of their own producers against their own consumers. It is more difficult for a national government to jettison trade freedom if international agreements need to be revoked. In other words, free trade agreements are welcome precisely as a means to tie the hands of our own Leviathan.

Trade agreements are especially useful to restrain Leviathan if public opinion is not enamored with unilateral free trade. For sure, trade agreements cannot forever resist adverse public opinion or demagogical propaganda. But they can hopefully hold the tide until people come to their senses.

In order to be useful, though, a free trade agreement must further free trade more than it restricts it through international standards and regulatory harmonization. It must not be an instrument for state cartels to restrict the liberty of their own subjects. It is in this perspective that we should evaluate "free trade" agreements - now called "partnerships" without the "free trade" as Doug Irwin perceptively observes in Clashing over Commerce.

Which brings me back to NAFTA. A rather free-trade NAFTA is good. One marred by stifling regulation and harmonization would not be.

Comments and Sharing

CATEGORIES: International Trade

COMMENTS (11 to date)
Jon Murphy writes:

As always, great post.

I'd add to your argument that not only do trade agreements "bind our hands," but bind the other guy's hands as well. In other words, they can prevent disastrous trade wars which just lead to rapidly increasing tariffs with no net benefits.

I hasten to add that "trade wars" need not be declared or even intentional. They can occur accidentally though an "optimal tariff" regime. Ignoring all the informational and knowledge problems of an optimal tariff, the optimal tariff only looks optimal because of poor accounting: it looks at the welfare of the home nation, but not the welfare of the foreign nation. When that is taken into account, net surplus falls, which means the cost to the foreign nation is higher than the benefits to the domestic nation (this is just standard textbook price theory).

So, if one nation imposes an optimal tariff, then the other nation is harmed. They may impose their own optimal tariff, which in turn harms the domestic nation. This, in turn, changes the calculus of their optimal tariff model, necessitating a new tariff, which in turn reduces the other nation's welfare, changing the calculus of their optimal tariff model, necessitating a new cetera and ad nauseam. An unintentional trade war is spawned. If "hands are tied," then such wasteful nonsense is avoided.

Pierre Lemieux writes:

Your are right, Jon. The more Leviathan hands are tied, the better. If it is true that country A cannot import more than it exports, though, retaliation for export-hungry mercantilists in country B should not last long. But it can do much damage while it lasts.

MikeP writes:

This brings to mind Australia's unilateral liberalization of trade.

From a 2002 speech by the Chairman of the Productivity Commission:

Australia has not been a conventional participant in multilateral negotiations. For many years our main export interest, agriculture, was essentially off limits, providing little scope for reciprocal concessions, so we were forced to think about the domestic implications of reducing our own trade barriers (and we pioneered tools of analysis to help us with that).

This turned out to be an important advantage, as we were among the first countries to act on the recognition that a country gains most of all from reducing its own trade barriers, regardless of what other countries do.


The upshot has been an economy characterised since the early 1990s by historically strong productivity and income growth — and an unprecedented capacity to withstand external shocks.

Moreover Australia’s pursuit of the domestic gains from unilateral liberalisation has not precluded us from participating in multilateral liberalisation efforts, where we have been able to enter into agreements to ‘bind’ our tariffs at lower rates — such bindings being the real object of WTO reciprocity.

There's lots of quotable material in that speech.

John R. Samborski writes:

I think Joan Robinson stole her line from Bastiat.

Pierre Lemieux writes:

@MikeP: Thanks for this comment and the interesting reference. I have downloaded it.

Pierre Lemieux writes:

@John R. Samborski: Would you know where?

Jon Murphy writes:


John may be right. I know Bastiat uses many similar examples in Economic Sophisms (putting bumps in roads, breaking railroad tracks). If he used the harbor example, it'd be found in that book almost surely. I'll take a look for you.

Jon Murphy writes:

Update for Pierre Lemieux and John Samborski:

That line is unique to Robinson. Bastiat uses similar examples but does not equate trade barriers with dumping rocks in harbors because the other guy has rocky coasts.

John R. Samborski writes:

I googled "Bastiat rocky coasts" and I found this:
The nineteenth century French economist [Frederic] Bastiat once summed it up this way: Saying that our country should be protectionist because other countries do not practice free trade is like saying that we should block up our harbors because other countries have rocky coasts." Krugman, Peddling Prosperity, p. 240. 43.

Maybe Paul Krugman was mistaken.

Jon Murphy writes:

@John R. Samborski

He doesn't give quotes or a citation. That's not to say Krugman is necessarily mistaken, but in my search of Economic Sophisms, Economic Harmonies, The Law, and That Which is Seen, I could not find that metaphor. Krugman may have been thinking of Robinson when he wrote those words but confused her with Bastiat.

Pierre Lemieux writes:

I would also think that, on this quote, Krugman unintentionally confused Robinson and Bastiat. Thanks to @Jon and @John for the little research, which confirms mine.

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