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Economics Update
VOL. 21 NO.2
MARCH 2015
What happened to the dream?
In this issue:
FEATURE: What ever happened to the dream of global free trade?*
EXAM STRATEGY: An approach to Australia’s Balance of Payments
The future of international trade and why a multilateral free trade agreement continues to prove elusive.
ECONOMIC SNAPSHOT:
The first quarter of the year has been a melting pot of macroeconomic developments. In early March, the Reserve Bank of Australia resolved to maintain benchmark interest rates at their historical low of 2.25%, opting to observe the impact of prior adjustments before loosening the monetary lever further. Interest rate analysts expect the benchmark cash rate to finish the year at just 1.5%, down from the post-financial crisis high of 4.75%. Meanwhile, RBA executives acknowledged the central bank was fast approaching the limitations of monetary policy as all eyes begin to shift towards the Abbott Government’s second budget. Economists will be looking for specific policies that assist in the transition away from mining related investment towards new sources of growth. In managing expectations, the Prime Minister was quick to suggest that the Federal Budget, due the second Tuesday of May, would be “pretty dull, pretty routine”. These comments come on the back off falling iron
ore prices that continue to drift towards the $50 per tonne mark. Analysts estimate that each $1 drop reduces government revenue by $200 million, placing more pressure on the already revised timeline for the budget’s return to surplus. Growth figures released in March showed that GDP growth slowed to just 0.5% in the last quarter of 2014 while labour market data for the month of February revealed the unemployment rate eased slightly to 6.3%.
Abroad, the US dollar continues to climb against all major currencies as talk of higher interest rates in the world’s largest economy sees stronger demand for US dollar denominated assets. Meanwhile, the Euro continues to plunge as the European Central Bank launches its long awaited quantitative easing program, a form of unconventional monetary policy that lowers borrowing costs and weakens the currency, as the Eurozone edges closer and closer to deflation.
Economics Update March 2015
2
What ever happened to the dream
FEATURE:
The grand vision of open trade is increasingly under threat from the proliferation of preferential trade agreements and non-tariff measures.
of global free trade?
Off Course: The New Global Trade System
In November 2008, as financial markets around the world
were thrown into turmoil, leaders and policymakers from
the top twenty industrialised economies met in
Washington DC. With the global economy descending
further and further into recession, leaders promised not to
repeat the mistakes of the 1930s which saw nations raise
trade barriers and revert to economic isolation as fears of
economic contagion gripped global export markets. Such
actions only hastened the economic deterioration that
precipitated the Great Depression and this time,
representatives of the world’s major industrialised
economies were careful not to repeat the policy missteps
of the past. At the summit, leaders reaffirmed their
commitment to free trade and were unequivocal in voicing
their outright rejection of protectionism.
In the six years since, it is apparent the world economy
has become less transparent and less open. After almost
three decades in which goods, capital and labour were
moving ever seamlessly across regional borders, barriers
particularly in the exchange of goods and services have
emerged, albeit in more subtle and less conventional
forms. This is not to say that global trade volumes are
declining, in fact, year-on-year, global trade flows continue
to grow modestly. Conventional wisdom among economic
policymakers in both advanced and developing worlds still
overwhelmingly advocates the principles of cross-border
free trade and investment.
Rather, individual economies are becoming more selective
in which aspects of globalisation and international trade
they want to be involved with. Nations want to enjoy the
very best that global trade has to offer, but as much as
possible, they want little to do with the adverse
consequences of international commerce, such as the
threat of foreign competition. The result, is a fragmented
and distorted global trade system where economies ‘cherry
-pick’ trading partners and secure preferable trading
agreements that serve their national interests at the
expense of the broader globalisation process.
Meanwhile, the World Trade Organisation, the successor to
Economics Update March 2015
3
the General Agreement on Tariffs and Trade, has struggled
with building a strong consensus for a comprehensive
multilateral free trade agreement. Instead, it continues to
see its influence weaken as regional and bilateral trade
agreements gain popularity, stoking fears that globalisation
is stalling against what appears to be a shift towards
regionalisation.
Despite falling average tariff levels across export markets,
modern day trade protection continues to flourish in both
developing and advanced nations, albeit in new and hidden
forms, masquerading under the guise of ‘industry
assistance’ or ‘health and ethical restrictions’. For advanced
liberal economies that have long preached the ideals of
market liberalisation, such policies send a conflicting
message to newly emerging economies seeking guidance
on how to become more active in global trade activities.
Against these metrics, the global trade system today has
deviated far from the market liberal paragons that defined
and dominated the globalisation era of the 1980s. In the
post financial crisis era, the grand vision for a global free
trade regime is quickly becoming neglected as the day to
day realities around national interests and political patience
drown out any concerted attempt to create a framework that
supports a fairer, stronger and more participative global
trade system.
Enforcing Cross-border Trade Rules
One of the more challenging aspects of managing the
explosion in global trade over the last three decades lies in
how the global economy resolves trade disputes. The World
Trade Organisation, formed in 1995 to replace the outdated
General Agreement on Tariffs and Trade, marked an
important step towards creating a consistent global trade
framework. To this day, the WTO’s objectives remain
relatively unchanged. First, the organisation seeks to
promote global free trade by establishing common
agreements in relation to the exchange of goods and
services that are negotiated and signed by member nations.
These agreements are effectively contracts that guarantee
member countries certain trade rights. Once signed,
member nations ratify these agreements and ensure that
their respective trade policies at home are consistent with
those of the WTO.
The second mandate of the WTO rests with its role in
dispute resolution. This is where the WTO has seen the
most success in recent times. Disputes occur when trade
friction exists between different member nations. When
nations engage in trade practices that are in breach of WTO
agreements, a case may be lodged with the organisation’s
dispute settlement process (DSP). The method employed by
the WTO underscores ‘rule of law’ principles, where the
resolution process hinges on clearly defined rules with
adequate appeal provisions and strict resolution timetables
that ensure open cases are dealt with in a timely manner.
The dispute settlement method aims to work constructively
with the affected parties to resolve disputes informally and
arrange for remediation that it mutually agreeable.
Nonetheless, there remain flaws with the WTO’s dispute
resolution process, namely in relation to the challenges
associated with enforcement. Enforcing trade rules, like all
international laws, is inherently difficult given the lack of a
credible enforcement mechanism. When member nations
are deemed to be non-compliant with WTO agreements and
fail to take corrective action, the WTO may grant permission
for other nations to impose higher trade barriers on the
offending nation. The efficacy of such an approach is
questionable, as some commentators put it ‘using trade
protection to fight trade protection’ may not produce
desirable outcomes
Adding to the weakness with the DSP is its lack of
consistency in dealing with trade disputes. Despite attempts
to channel all trade matters through the structured dispute
settlement process, it remains common practice for nations
to engage directly in retaliatory trade measures to what one
nation may unilaterally perceive to be a breach in WTO
standards. In 2012, the US Department of Commerce
unilaterally raised import tariffs on Chinese solar panels by
up to 35.2 per cent without involving the WTO’s formal DSP
and at the time sparked concerns of a potential trade war.
Last year, the officials at the World Trade Organisation
denounced the actions taken by the US, claiming that such
moves were ‘inconsistent and in violation’ of WTO
mandates.
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Economics Update March 2015
4
The Rise of Mega-regional Trade Agreements
After more than a decade of multilateral trade talks, an
enforceable set of standardised trade rules has yet to materialise.
At the same time, regional ‘preferential trade agreements’ (PTAs),
have proliferated, running counter to the principles of universal
trade liberalisation, raising concerns that the global economy is
being segmented into regional clusters with inconsistent rules
governing international commerce.
While the rapid growth of regional and bilateral PTAs does
indicate that the world hasn’t given up on trade liberalisation, it
does suggest that global trade is becoming more splintered. PTAs
have been sharply criticized by some economists to have
distracted important policy debates away from multilateral trade
discussions. The genuine concern is that the discrimination such
PTAs entail may undermine the thin layer of trust and confidence
in the globalisation process itself.
The discussion about whether regional trade agreements help or
harm multilateral trade has gone on for many decades.
Supporters argue that once nations engage in RTAs, there is an
incentive for others to join or to arrange their own RTA.
Eventually, the global trading system becomes saturated with
RTAs that trading barriers fall, forming the impetus for
policymakers to enter into multilateral deals. Those critical of
RTAs claim that once part of a trade agreement, members secure
favorable trading conditions for themselves, often by
discriminating against outsiders and eventually become
complacent enough to lose interest in pursuing multilateral trade
discussions.
In the early stages of the globalisation era, the former was
certainly true, multilateral and regional trade agreements co-
existed without so much as a hint of mutual exclusivity. In the
decade leading up to the new century, the Clinton
administration signed the North American Free Trade
Agreement (NAFTA) just as the Uruguay round of
multilateral trade talks were being completed. In the early
2000s, China was accepted into the WTO just as the
European Union expanded its reach into the former Soviet
Bloc.
This started to change over last ten years. Regional trade
agreements are now seen more as ‘alternatives’, rather than
a supplement to multilateral trade agreements. The launch of
the Doha Development Round in 2001, intended to enhance
market access and economic opportunity for the developing
world, encountered fierce resistance as soon as negotiations
began. Emerging market economies balked at the grand
bargain: across-the-board cuts in industrial tariffs for greater
access to the markets of advanced economies.
Doha was always seen as an ambitious multilateral trade
framework that was predicated on two core principles: non-
discrimination and national treatment. The former is known
among economists as ‘the favoured nation principle’ which
seeks to ensure that trade benefits extended to one country
are extended to all. The latter requires all imported and
locally produced goods to be treated equally. After 13 years
and more than nine rounds of talks, few inroads have been
made.
One of the most significant factors weighing on progress in
multilateral trade talks is the changing balance of global
economic power. The BRIC economies (Brazil, Russia,
India, China) consider themselves as economies still poor
enough to justify the need of protection for their industries.
But advanced economies increasingly view the BRICS as
capable players in the global economy that have an
obligation to shoulder more responsibility in opening up to
the rest of the world. Since 2008, when multilateral
negotiations collapsed in Geneva, there have been several
attempts to revive the dialogue, but a lack of leadership from
the US and China continues to drag on progress.
Meanwhile, the appeal of regional trade agreements
flourished on the back of floundering multilateral talks. Since
2001, the number of active RTAs have doubled, increasing
from just over 200 to 398 in the first quarter of 2015
according to data compiled by the World Trade Organisation.
In recent times, the constructs of RTAs themselves have
been changing. New generation RTAs such as the highly
controversial Trans-Pacific Partnership (TPP) and the
Transatlantic Trade and Investment Partnership (TTIP) in
addition to blanket trade liberalisation, seek to go ‘beyond
the border’ and address topical issues such as harmonizing
tax laws, strengthening intellectual property rules and raising
environmental protection standards.
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Economics Update March 2015
5
An unintended consequence of the popular rise of bilateral and
regional trade agreements is that the World Trade Organisation
has become increasingly marginalised. The failure of multilateral
trade talks has had a significant effect on diminishing the
organisation's credibility within the international trade system.
This is a particularly concerning prospect for the global economy.
As the de facto mediator in trade disputes and the chief advocate
for trade liberalisation, the WTO serves an important role in
building trust and confidence in the global trade framework - a
role that will only become more important as new emerging
economies look to become more active in global export markets.
Murky Lines: Non-tariff Measures
World leaders are often quick to draw attention to falling average
tariff levels as positive confirmation that global export markets are
becoming more open. According to data prepared by the World
Bank, average global tariffs are now at just 3 per cent, down from
35 per cent in the mid 1990s. In Australia alone, average tariff
levels are well below 2 per cent, down from over 36 per cent in
the pre-globalisation era. While it is true that conventional tariffs
are now far lower than they were prior to the 1980s, trends in
average tariff levels alone are not representative of the true
conditions within the global trade system.
One of the more pressing threats to the progress of creating a
fairer global trade system is the rise of non-tariff measures
(NTMs). NTMs are any protectionist policies other than
conventional trade tariffs. They share similar outcomes to
conventional tariffs in the effect they have on disrupting global
trade flows and limiting market access. The rise of NTMs or
’covert protection’ has coincided with efforts by the World
Trade Organisation to liberalise export markets and
harmonise trading rules. According to reports by Global
Trade Alert, a monitoring service of the Centre for Economic
Policy Research, more than 5,784 such measures, including
new tariffs, have been introduced since 2008.
For individual economies, NTMs provide an avenue to
circumvent the WTO’s multilateral trade standards, allowing
them to remain compliant with the shared principles of free
trade while hiding their protectionist agenda.
Over the last ten years, the face of trade protection has
shifted away from industrial tariffs towards the likes of
‘industry assistance’, ‘customs duties’ and ‘anti-dumping
measures’. This has complicated the role of the WTO and
added a new layer of disorganisation to the global trade
system. Nations have been known to exploit these NTMs as
cover for new protectionist measures. Nations often resort
to imposing outright import bans on the grounds of ‘poor
safety standards’ or introduce vague ‘administrative fees’ on
incoming trade. In early 2013, in an attempt to sway
Ukraine away from European integration, Russia banned
imports of Ukrainian confectionary, claiming they contained
harmful substances. Intrusive customs checks followed
soon after, slowing Ukrainian exports at border crossings to
a crawl. Late this month, the EU slapped Chinese steel
products with tariffs of up to 25.2 per cent on allegations of
‘dumping’. European authorities claimed that prices on steel
imports were ‘cheap as cabbages’, inducing significant
disruption to European steel markets.
> Decelerating: Since the global financial crisis, growth in global trade has slowed against growth in GWP Source: International Trade Statistics 2014, World Trade Organisation
Economics Update March 2015
6
In recent times, ‘industry assistance’, an obscure form of
protectionism, has garnered intense scrutiny from members
of the World Trade Organisation. The term ‘industry
assistance’ is used to describe any policy measure that
advantages a country’s commercial interests at the expense
of another. The definition has been broadened to include
direct subsidy schemes, tax rebates for research and
development, government bailouts, wage rebates, export
grants and preferable access to capital resources. Some
policymakers argue that government sponsored assistance
in the form of research and development for instance, is
crucial in encouraging innovation and productivity growth in
local industries, while critics argue such programs result in a
skewed playing field. Some analysts also go on to point out
that even varying levels of corporate taxes between
economies have a sizeable effect on international
competitiveness across an economy’s import competing
sectors.
It is clear that when it comes to matters involving industry
assistance, it is inherently difficult to ‘draw the line in the
sand’. In order to neutralise any bias one country may have
over another, corporate taxes and industry policies would
need to be standardised across different economies, an
almost impossible task. Therefore, the debate around
industry assistance has evolved in recent times and now
centres around what is deemed to be ‘fair’. What is
considered to be ‘fair’, however, is inherently subjective,
complicating matters for the WTO when it presides over
disputes. This often results in lengthy case hearings
including an iconic dispute filed by the US in 2005 against
the EU relating to subsidies extended to aircraft
manufacturer, Airbus, which after a decade of hearings, has
yet to be settled.
The rise of NTMs over the last decade along with the new
prominence of RTAs have been partly responsible for the
slowdown in global trade growth in recent times. Since the
start of the globalisation era, growth in global trade is on
average, in any given year, twice that of growth in gross
world product. In the two decades leading up to the financial
crisis, global trade grew at a rate that averaged 7 per cent,
more than double that of growth in GWP. In 2012 and 2013,
growth in global trade expanded by just 2.8 per cent and 3.2
per cent respectively, even as GWP grew by 3.1 per cent
and 3.2 per cent over the same period.
In September last year, the WTO revised down its 2015
forecasts for global trade growth from 5.3 per cent to just
4.0 per cent, well below the 20 year moving average of 5.2
per cent. Economists at the WTO cited a weakened global
outlook, geopolitical tensions, regional conflicts and the
Ebola epidemic in West Africa as reasons for the revised
estimate.
Currency Wars: The New Protectionism?
One of the most controversial topics among economists in
the post-financial crisis period is that of ‘currency
manipulation’ and its implications for the global economy. In
2010, Brazil’s finance minister coined the term ‘currency
war’ to describe how unconventional monetary policies
employed by advanced economies were pushing up the
value of other countries’ currencies, weakening their trade
competitiveness in export markets.
Since 2008, advanced economies have experimented with a
previously little-known form of monetary policy called
‘quantitative easing’ (QE). It involves the central bank
intervening directly in financial markets by purchasing
various financial securities. This process adds more
‘liquidity’ or ‘loanable funds’ into capital markets which
results in lower borrowing costs for ordinary households and
businesses. The theory is that with these lower borrowing
costs, it would allow for more favourable investment and
consumption conditions which would help strengthen a
rebound in domestic growth.
A side effect of such policies, however, is that by adding
more liquidity into financial markets, the central bank
expands the money supply. A larger money supply, means
that each dollar’s purchasing power is reduced and hence
its value (represented by the exchange rate) is weakened.
By weakening a country’s currency, policymakers are able
to gain a competitive advantage as their economy’s exports
appear cheaper on international markets, helping to prop up
domestic growth.
Just over the last six months, central banks around the
world including Singapore, Canada, India and Australia
have progressively lowered benchmark interest rates while
Japan and the Eurozone continue with their respective QE
programmes.
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Statistics KEY AUSTRALIAN INDICATORS Latest Date 12 Months
ago
Economic Growth 0.5% Dec 14 0.8%
Unemployment 6.3% Feb 15 6.0%
Participation Rate 64.7% Feb 15 64.7%
Inflation (CPI) 1.7% Dec 14 2.7%
Underlying Inflation 2.3% Dec 14 2.6%
Wage Price Index +2.5% Dec 14 +2.6%
Household savings ratio 9.1% Dec 14 9.8%
RBA Cash Rate 2.25% Mar 15 2.5%
EXTERNAL ACCOUNTS
Current Account -$11.2bn Dec 14 -$11.6bn
CAD (% of GDP) -2.8% Dec 14 -2.9%
Balance on goods and services -$4.6bn Dec 14 -$0.5bn
BOGS (% of GDP) -1.1% Dec 14 -0.1%
Primary Income (% of GDP) -1.6% Dec 14 -2.7%
Net Foreign Liabilities (% of GDP) 54.1% Dec 14 54.1%
Net Foreign Debt (% of GDP) 57.8% Dec 14 54.7%
Net Foreign Equity (% of GDP) -3.7% Dec 14 -0.6%
Terms of trade (2010-11 = 100) 87.2 Dec 14 98.3
Trade Weighted Index 64.5 Mar 15 71.1
*Figures as at 26 March 2015
Quotes & Questions
Source: ABS, Reserve Bank of Australia
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Quotes
Free Trade
“The Doha Round was torpedoed by the United States’ refusal to
eliminate agricultural subsidies – a sine qua non for any true
development round, given that 70% of those in the developing
world depend on agriculture directly or indirectly. The US position
was truly breathtaking, given that the WTO had already judged that
America’s cotton subsidies – paid to fewer than 25,000 rich farmers
– were illegal. America’s response was to bribe Brazil, which had
brought the complaint, not to pursue the matter further, leaving in
the lurch millions of poor cotton farmers in Sub-Saharan Africa and
India, who suffer from depressed prices because of America’s
largesse to its wealthy farmers.
Given this recent history, it now seems clear that the negotiations
to create a free-trade area between the US and Europe, and
another between the US and much of the Pacific (except for
China), are not about establishing a true free-trade system.
Instead, the goal is a managed trade regime – managed, that is, to
serve the special interests that have long dominated trade policy in
the West.”
Nobel Laureate, Joseph Stiglitz
July 2013
“People trade with each other because it’s in their interest to do so.
Every time one person freely trades with another, wealth increases.
Just as trade within countries increases wealth, trade between
countries increases wealth – that’s why we should all be
missionaries for freer trade. At the very least, the G20 should
renew its commitment against protectionism and in favour of freer
markets. Each country should renew its resolve to undo any
protectionist measures put in place since the Crisis. Better still,
each country should commit to open up trade through unilateral, bi-
lateral, plurilateral and multi-lateral actions and through domestic
reforms to help businesses engage more fully in global commerce.
As a trading nation, Australia will make the most of its G20
presidency to promote free trade. Over time, everyone benefits
because, in a global economy, countries end up focussing on what
they do best.”
Australian Prime Minister, Tony Abbott
World Economic Forum
January 2014
Questions
1. Discuss the responsibilities of the World TradeOrganisation
2. Analyse the role of regional trade agreements insupporting global free trade
3. Evaluate the effects of protectionist policies on theglobalisation process