EU Trade Policy

Freedom of trade lies at the heart of the European Union. The first major agreement between its founding members, the European coal and steel community, created a common market for these raw materials. Other treaties, such as the Treaty of Rome and the Benelux agreement abolished custom duties between member states, further liberalising the European Economic Area. Those countries who wish to join the EU are largely persuaded by the access it would grant them to the lucrative European market. Yet while the vast majority of Europeans are aware, and indeed supportive of the common market, very few consider the EU’s external trade positions. The EU is the world’s biggest trader, and in theory, it is dedicated to seeking full liberalisation of trade across the world.

As a result of its common market, the EU also has a common trade policy, which applies to all its member states, significantly strengthening its position and bargaining power at the World Trade Organisation (WTO). This common commercial policy, or CCP, is an inherently complex tool, involving hard bargaining not just between the EU and non-member states, but between the Member States themselves. Thus while free trade remains the ultimate goal, due to various national and regional interests, the EU still restricts trade through four main methods. The most visible and the most recognisable, is the common external tariff, or CET. This applies to goods being brought in from the external market, and varies significantly based on the product being imported. Intermediate products, such as construction materials, have no tariff applied, while agricultural products have an average rate of 16.9% attached. The EU also still makes use of quotas, to a limited degree, to reduce the amount of imports of particular industries, especially textile-products from China. Meanwhile VER’s are agreements, usually obtained through political pressure, whereby an exporter ‘voluntarily’ undertakes to limit the quantity of goods consigned to the importing country. Furthermore, the EU makes use of anti-dumping measures, which prevents selling below cost. It should be noted that the EU also restricts trade through the use of sanctions, such as those applied against Russia and Iran. However, these are much more political in nature, and so do not form a part of the EU’s trade policy.

Benefits of Freedom of Trade

If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry employed in a way in which we have some advantage.

- Adam Smith

Despite the numerous restrictions imposed by the EU, there are enormous benefits to fully liberalized trade, and it should be matter of the utmost priority that this be achieved. The argument in favour of free trade is based on the comparative advantage model, one of the oldest theories of modern economics, first set forth by David Ricardo. In essence, the theory states that it pays countries to trade because they are different, and so will have different strengths and advantages. Take the United States and the EU for example. The EU may be better at producing both textiles and agricultural products than the United States, and so has a comparative advantage in these sectors. While the EU could continue to make both, it would be far better for both countries if it focused on the industry it excelled in best and left the United States to do likewise. As they both become more efficient and productive, this in turn makes the Global economy more efficient and productive. A free trade policy should enable a nation to generate enough foreign currency to purchase the products or services that it does not produce indigenously. While it would for example, be possible for the EU to produce its own banana’s or coffee beans, it would be extraordinarily expensive to do so. Far better, for both the people of European, and the world, for the EU to import these products and instead focus on where its comparative advantage lies. The process works best when there are few if any barriers to entry for such imports, and so a global abolishment of these barriers would lead to a significantly increased output and standard of living throughout the EU, and indeed, the world.

This is because one of the main benefits of free trade is that it can cause a country’s economy to grow and rapidly so. This is true for both rich-world economies and those of the developing world. The difference between East Berlin and West Berlin during the early days of the EU is a testament to this. Formerly insular economies on Europe’s periphery, especially those who experienced strict communist control, have expanded at much faster growth rates since they adopted free trade and liberalisation principles in the 1990s. Poland in particular, has a large trade surplus, thanks mainly to its liberalisation efforts. Yet free trade also helps the poor in developed countries. It does so by providing basic necessities such as food and clothing at a much lower price than if they had been made internally. One need only examine their clothes or electronics to find that the vast majority were made in China or Taiwan. It is far cheaper to produce certain goods in these countries than it would be in the EU. Likewise, the EU, as a set of highly developed nations, produces certain products far more efficiently than the developing world, and trade allows it to sell this surplus, promote prosperity and create jobs. It is therefore the poor, those of the developed world and those of the developing world, who stand amongst those set to gain the most from free trade.

The European internal market is one of the greatest strengths of the EU and one of the main reasons why so many countries are eager to join. The Commission calculates that over the period 1989–93 EU incomes increased by 1.1–1.5% more than they would have done without the Single Market. Yet as large as the common market is, it is dwarfed both in scale and size by the Global market, and so promoting external trade liberalisation is arguably far more important. France for example, exports a large amount of aircraft and heavy machinery, and were it to be limited to the European market, it would have to significantly scale back its production. Free Trade also increases competition, which can be particularly important in former centralised or state-run economies. One need only look at the airline industry, which is seen the average price of its tickets plummet to record lows in the last number of decades to see the benefits of this liberalisation. What is key to remember is that any tariffs or trade restrictions imposed by the EU likely to be retaliated with similar import controls from the rest of the world. It is therefore very likely that should the EU drop its tariffs, its trading partners will do likewise. The removal of tariffs leads to lower prices for European consumers, the effects of which will be spread throughout the economy.

The alternative, to free trade, is protectionism. This involves the use of tariffs on imports and subsidies on exports, in order to serve one’s own economy better. This approach was adopted by many countries during the 1930s, in the wake of the Great Depression, as they closed their borders to prevent their currencies escaping abroad. The United States passed the Smoot-Hawley Act, which entrenched this protectionist policy, under the guise of saving jobs. This policy however, had the opposite result of what was intended. The global economy was crippled by the lack of trade, leading to widespread unemployment. Many historians now cite this policy as only furthering nationalistic sentiment and ultimately, being a precursor to the war. It was not until after 1945 and the creation of the General Agreement on Tariffs and Trade (GATT) that the Global Economy began to heal. However the cautions against protectionism should remain. Most economists now agree that full scale protectionism only ends up hurting those it is meant to protect. It leads to economic strife, civil unrest and worst of all, war. As Frederic Bastiat, the famous French economist put it, when goods cannot cross borders, armies will. Although economists are notoriously divided on almost every aspect of their profession, they are almost unanimously united on promoting free trade. Trade liberalisation is by far the best system for both the EU, and the wider world, and it should therefore be a key goal in Europe’s future.

Disadvantages of Free Trade

‘’...decisions were often made because of ideology and politics. As a result many wrong-headed actions were taken, ones that did not solve the problem at hand but that fit with the interests or beliefs of the people in power’’

-Joseph Stiglitz

With the economic arguments in favour of free trade so strong and the alternative (protectionism) so appalling, it is therefore surprising how opposed many in the world are to it. The main stumbling blocks tend to be political in nature. While the benefits of free trade are spread throughout society, those whom it harms are much more visible. Irish or Belgian farmers lose out due to increased competition and they naturally blame their politicians. To avoid political fallout, old and inefficient protectionist methods are enforced. In times of recession this problem is amplified tenfold, as many view freedom of trade as costing jobs rather than promoting them. Some believe that free trade is merely a tool for the upper classes to accumulate wealth, and so staunchly oppose it. In addition, many European leaders fret about a growing ‘trade deficit’ to developing nations such as China and India. Labour costs tend to be far less expensive in these regions, and so many worry that free trade will take employment away from Europe. One need only witness the protests against the WTO in Seattle, or the recent protests to the TTIP, so see how strongly opposed many are to such agreements. Many also feel that, combined with immigration, free trade undermines cultural diversity, as the world becomes ever more ‘Americanised’.

These arguments, while having some merit, do not do enough justice to outweigh the enormous benefits of freedom of trade. Yet there are also economic arguments to be made against free trade, as well as a growing anger at the developed world for what people see as it’s exploitation of the weak. Perhaps the strongest case against free trade is the ‘infant industry ‘model. The core of the argument is that nascent industries often do not have the economies of scale that their older competitors from other countries may have, and thus need to be protected until they can attain similar economies of scale. This is particularly true in the developed world; after all during the 19th century, almost all of today’s rich countries used tariff protection and subsidies to develop their industries. This enabled them to become the economic leaders they are now today, and it is perhaps wrong therefore, that they demand that developing economies not be allowed the opportunity to do likewise. This argument is not without its flaws; it can be very difficult for a country to correctly identify an infant industry, and can cause more harm on consumers. This happened Brazil in the 1980’s, as it banned foreign imports of computers as it tried to develop its own fledgling IT industry. Nevertheless, it is still an important factor that should be taken into account, and steps should be made to allow developing countries to nurture these ’infant industries’ before exposing them to the global market.

There are also times when it is better for a country not to trade, in what is known as the ‘Optimal Tariff’ rule. This allows a country to exploit its market power in international trade and improve its trading conditions. It does this by unilaterally restricting its exports if it faces a downward-sloping demand for them or restricting its imports if it faces an upward-sloping foreign export supply. This argument against free trade is over 150 years old but it remains central to modern theories that explain trade agreements and their rules. In essence the rule states that large countries should abuse their monopoly power over global markets. This can at best work only in the short run, but Keynes himself argued that the introduction of such Tariffs could help a country exit recession. Meanwhile, Nobel Laureate Joseph Stieglitz has suggested that for globalisation to work there should be free movement of labour but not of capital. This way, countries with the best schools services and hospitals could attract the best workers. Many criticise the ‘Washington Consensus’ of the IMF and World Bank and thus place an increasing emphasis on not just free trade but Fair Trade. The comparative advantage model has also come under scrutiny. Brander and Spencer demonstrated how, in a strategic setting with few firms competing for the world market, export subsidies and import restrictions can keep foreign firms from competing with national firms, increasing welfare in the country implementing these so-called strategic trade policies.

The problem is not that free trade is bad or wrong, but that it is poorly managed, and its benefits are not evenly spread. This then raises the question of whether the World Trade Organisation has failed developing countries. Prior to December 2013, the answer would have undoubtedly been an assured ‘yes’. Having only existed since 1995, it has yet to successfully conclude a round of negotiations. Its precursor, the GATT, was created by the United States and the UK, and so has unfairly benefited the developed world. While the poorer economies have benefited from access to free trade, developed nations have benefited far more. In fact, the Seattle conference in 1999 ended in spectacular failure as developed nations, led by Brazil and India argued that they had received a bad deal from the previous Uruguay round, and refused to continue negotiations before these inequities were addressed. The main stumbling blocks nowadays are agriculture and patents. European and American leaders are reluctant to stand up to their farming and pharmaceutical lobbies, and thus are refusing to compromise. Cotton farmers on the North African coast cannot achieve sustainable development, due to the US’s subsidies to its own sector. The WTO require absolute consensus, and so talks had come to a deadlock over these issues. The conference in Bali in 2013 kept the Doha development round alive, with the benefits of this agreement flowing mainly to developing economies. India in particular managed to wring substantial concessions from rich-world economies. This is a good step; developing countries represent a far larger part of the world’s population than rich-world economies, but more must be done to spread the gains of free trade more evenly.

Future Development

‘’Next the US will argue that the time zone difference is an unfair competitive advantage enjoyed by India that enable our software developers to work while Americans sleep

-Jairam Ramesh

Despite its criticisms, free trade is undoubtedly a force for good, and should be promoted throughout the world. Nevertheless, there are significant difficulties ahead which must be dealt with. Many of these are administrative in nature. The consensus based approach of the WTO, while necessary, makes it incredibly difficult to reach any form of a conclusive agreement. Cuba, a nation of 11 million people, almost entirely derailed the talks in Bali due to its 11th hour insistence that the United States remove its trade embargo. The Great recession, and its austere aftermath have led to widespread dissatisfaction with the EU, and stoked nationalistic sentiment throughout its member states. Such nationalism is often accompanied by anti-immigration, and anti-globalisation demands, which increases political pressure and makes it more difficult to further commit to trade liberalisation. Non-tariff barriers such as quota’s or subsidies allow for the continued protection of inefficient industries and hamper free trade. Looking to the future, as the rise of China and other South-East Asian economies continues, they will come under increased pressure to stop hoarding their huge trade surpluses and increase spending. It is also instrumental that the benefits of free trade be proportionately spread, and not just to the rich-developed world.

Perhaps the greatest threat to the WTO’s plans, is the recent rise in regional trade agreements, such as the TTIP. These have grown rapidly in recent years, as the WTO has stumbled, and only serve to harm free trade rather than promote it. For one, they increase the influence of power imbalances in international trade relations, allowing large economies to impose their will on smaller economies. This would not occur if trade liberalisation were implemented globally, and tend to increase resentment to free trade in developing nations. The numerous amounts of these regional agreements has led to some incredibly complex rules and regulations, further increasing the costs of trade. However, their biggest drawback is that they allow countries to exempt sensitive political sectors from liberalisation, and this is particularly true of the TTIP. The main reason why the Doha talks are still ongoing, is because of the EU and the US’s refusal to end their protectionist policies for their agricultural sectors. The TTIP allows them to avoid angering Belgian farmers or Iowan corn growers, while reaping the benefits of free trade in other sectors. They will therefore have no incentive to conclude the Doha round, and while this may benefit them in the short run, it is simply not sustainable, and will severely damage the WTO and its trade liberalisation efforts.

Freedom of trade is one of the founding principles of the European Union. Promoting trade liberalisation throughout the world should be among its top priorities. The economic arguments in favour of such a policy are staggering, and far outweigh any downside. Yet the biggest obstacles today are political in nature, as rich world nations shirk the responsibility of standing up to powerful lobby groups. It is long past time for the EU to end its remaining protectionist policies and allow for fully liberalised trade. The benefits of doing so, both for Europeans, and for the world, would be enormous.