This article is an attempt to answer some of the basic questions regarding, free trade agreements. It also focuses on questions, such as, whether developing countries should enter into such free trade agreements? Is it in Pakistan’s interest to sign a free trade agreement with US and what are the consequences of such an agreement? Finally, what step should the Government of Pakistan follow in order to curtail any short term, adverse effects of the free trade agreement?
HISTORY
For thousands of years now, nations have entered into agreements for their mutual benefits. Classical Athens was known for its trading activity as early as 4th Century BC. It was said to have imported grain from Russia, Sicily and Egypt and Salt fish from Spain or the Black Sea. Trade was regulated by local legislations. Similarly Romans too attracted huge international trade. However, unlike classical Athens, Roman Empire entered into commercial treaties with many nations from time to time. Romans used these treaties to resolve disputes between themselves and foreigners.
In the last quarter of a century, globalizations and rapid growth of the world economy has forced the world nations to compromise some of their own interests for the mutual benefit of all. World Trade Organization is an example of such compromise.
WHAT IS A FTA?
In a Bilateral Trade Agreements (hereinafter: BTA), countries liberalize their trade by minimizing artificial barriers and other restrictions e.g. quotas, tariffs and subsidies that countries use for the protection of their own domestic industries. Free Trade Agreements (hereinafter: FTA) are intended to eliminate all these restrictions.
WHY JOIN A FTA ?
Countries enter into FTAs for various reasons. It provides for greater market access through reciprocal exchange of trade concessions and realignment of resources towards more efficient sectors. As tariffs are lifted, more imports enter the country resulting in drop of domestic prices. This drop in prices results in greater consumption of goods. In the end there are more goods, of greater variety and cheaper than under a tariff regime.
Secondly, if a competing country (a country whose exports are same) enters into a FTA with the intended country e.g. US in our example, it runs the risk of being left out and the cost of exclusion is associated with lost trade opportunity which is not very easy to quantify.
Thirdly, Political reasons may also encourage a country to enter into a FTA e.g. strategic alliance or better bargaining position in multilateral negotiations e.g. SAARC or ASEAN.
Lastly, Countries, especially developing countries are more interested to enter into FTA, owing to the relative slow progress of multi-lateral trade organizations, e.g. WTO. The huge size of such organizations and the competing interests of member countries have dampened the momentum of progress. On the other hand, FTA proves to be a much quicker way to open market and greater economic integration.
Increased returns and competition are some of the likely dynamic benefits arising from FTAs. Another consequence of market integration is the access to the larger markets, which makes it possible for producers to attain economies of scale in their output levels. Efficiency gains are thus realized from opening up local markets to external competition and potentially allowing producers to operate at a higher (and more efficient) level of output.
IS IT IN PAKISTAN’S INTEREST TO SIGN A FTA WITH A DEVELOPED COUNTRY LIKE THE US?
A move towards freer trade would certainly favor Pakistan’s industries (e.g. cotton, textiles and apparel, rice, and leather) that are already engaged in exporting to the US. Their access to the existing markets could only be enhanced.
FTA stimulates greater investment. The incentive to invest, for both member-country and foreign investors, depends on current and future trade policies, on the nature and level of uncertainty, and on the general macroeconomic and political environment. FTA with US can underline Pakistan’s commitment to cross-border trade and encourage Foreign Direct Investment (hereinafter: FDI). In other words, this incentive appeals to countries that may wish to ‘broadcast’ or make known to the international community its resolve to pursue a liberal regime.
Secondly, FTA acts as an assurance, whereby US guarantees Pakistan’s continued access to its market. This motive can be especially relevant if future trade restrictions are likely. It may explain why some agreements (BTA/FTA), particularly those involving a large and a small country have the smaller entering on relatively unfavorable terms. The worse terms can be considered as the premium for the insurance against future trade barriers of partners.
Thirdly, with an export market perspective, U.S. is already an important market for Pakistani export accounting for nearly one fourth of its total exports. FTA can secure continuous access even if the US decides to raise its tariff levels for other countries. This, in essence, is tantamount to buying guarantees. The recent protectionist move of the US is one of the motives that prompted Pakistan to engage in negotiations for bilateral arrangements. For small developing economies, like Pakistan a FTA will be a guarantee against market closure.
Lastly, Pakistan’s FTA with US would possibly make it a favored low cost supplier and will become more attractive to investors than the other low cost countries that are not party to any BTA. Under these circumstances, developing countries tend to enter into FTAs with larger partners for “fear of being left behind.”
SHORTCOMINGS IN SIGNING A FTA WITH US
It is submitted that one of the most contentious issues is the effect of free trade on the “import competing industries”. The brunt of the adjustment costs arising from the FTA will be shouldered by these industries. There would be little popular support for the FTA if the costs would be far greater than the benefits arising from the improved market access of the current exporters.
Negotiating with larger economies has its downside. Larger economies negotiating a FTA enjoy greater bargaining power and are in a position to successfully extract concessions of all kinds. These concessions are not just trade related but also include non-trade issues. For instance, USA is likely to demand concessions in intellectual property protection or investment guarantees from Pakistan in exchange for market access. Secondly, US has fairly, if not quite, liberalized economies. Consequently, Pakistan may get only small tariff concessions.
The adjustment costs involved during the transition may be quite severe and prolonged. For example, the unemployment costs may be too high for Pakistan especially in the light of very high poverty. At the same time, real life imperfections in the labor or financial markets may impede the resource allocation as proposed by theory. It is the lack of the necessary conditions, as assumed in theory, that may frustrate the desired outcomes of free trade and which ultimately lend capital to the growing view that free trade, though desirable, should be not be pursued as the overriding policy goal.
Ultimately, national interest will be the motivating factor in entering into a FTA. If national interest were defined in terms of the interests of exporters, import-dependent local producers, and the consuming public, then there could be broad public support for an FTA. If viewed from the perspective of job preservation or job creation, there might be opposition. Inasmuch as trade liberalization serves to render import competing domestic industries uncompetitive, resulting unemployment will increase resistance against entering an FTA.
PAKISTAN-UNITED STATES TRADE
The United States is by far Pakistan’s leading export market, accounting for nearly one-quarter of the total export. Pakistan’s primary exports are cotton, textiles and apparel, rice, and leather products. During 2005, total Pakistan’s exports to US were worth $3.25 billion (up 13% over 2004). About two-thirds of this value came from the purchase of cotton apparel and textiles. Pakistan’s imports from US during the same period were worth $1.25 billion (down 31% from 2004), led by fertilizers and cotton fiber. The State Bank of Pakistan reports a steady increase of FDI in the country with a total exceeding $1 billion for the year ending June 2005. More than one-quarter of this amount came from the United States. It is also estimated that total US assistance to Pakistan for the Year 2006 will be $781 million. Nearly half of that will be military assistance ($300 million).
CONCLUSION
If Pakistan’s “imports competing industries” have to survive, there are reforms that the Pakistan government will have to take. These include economic reforms to reduce the cost of business e.g. rationalization and simplification of tax regimes, regulation in the prices of the factors of production e.g. energy, real-estate, communication, transportation, implementation of rule of law, friendly governance and improving quality of workforce (leading to efficiency gains). BTA are undeniably the need of the hour but are we ready for the re-arrangements that ensue immediately after the FTA is a question still unanswered.
Nevertheless it is highlighted that, the benefits of FTA, for Pakistan, go beyond trade. It is submitted that FTA with US will enhance the attractiveness of local region for FDI. Thus to the extent that the employment generated from foreign investments can make up for the losses of the import competing industries that fail to compete. This approach should underscore that in evaluating joining FTA, the impact of investments should be factored in along with the trade issues. Furthermore, the gains will be greater for Pakistan if the FDI that were generated actually stimulate local investment as well. For this reason, the decision to join FTA should be tied up with investment policy reforms. Simply pursuing FTA without facilitating the investment process may not ameliorate the negative effects on employment in the short run.
On the occasion of President Bush’s visit to Pakistan the President said that the United States wants to “build a broad and lasting strategic partnership with the people of Pakistan.” This partnership is to be implemented through a new Strategic Dialogue in seven major issue-areas as found in the March 4 Joint Statement issued by President Bush and Pakistani President Musharraf. The Joint Statement emphasizes shared U.S.-Pakistan interests and calls for a significant expansion of bilateral economic ties. It is submitted that, sustained economic progress will only be ensured by trade agreements and not by aid and loans.
REFERENCES
Looking before leaping into Bilateral FTAs: Issues in Asian Bilateralism by John Lawrence Avila, Michael Lynch and George Manzano.
A brief History of International Commercial Law.
Free Trade Agreements: US Strategies and Priorities. Edited by Jeffrey J. Schott
Global Trends by Martin Khor
CRC Issue Breif for Congress: Updated 6 March 2006.
The Pros and Cons of Pursuing Free-Trade Agreements: A series of issue summaries from the Congressional Budget Office July 31, 2003
LAW AND POLITICS 