Commentary Magazine


Termites in the Trading System by Jagdish Bhagwati

As the world economy integrates more tightly with every passing week, the global trading system becomes more and more critical to a future of prosperity. That system was developed essentially in the waning days of World War II. The victors, or at least the democratic ones, realized that the beggar-thy-neighbor trade policies of the 1930’s—initiated by the passage of the Smoot-Hawley tariff in the United States—had been a disaster, both economically and geopolitically. It had deepened the Great Depression and helped to bring about the most destructive war in history. In 1947, resolving not to repeat this mistake, they formed, under American leadership, the General Agreement on Tariffs and Trade (GATT) to negotiate lower tariffs, eliminate non-tariff barriers to trade, and reduce market-distorting export subsidies.

Over the past half-century, in a remarkable series of eight negotiations, these barriers have been greatly reduced or eliminated, with tariffs falling by over 90 percent on average. In 1995, GATT was absorbed into the World Trade Organization (WTO), which currently has 157 member nations and a waiting list of 29 countries. A ninth negotiation has been under way for several years to continue the process begun in 1947.

The result, aided both by the near collapse (thanks to the microprocessor) of long-distance telecommunications costs and by a sharp decrease (thanks to the cargo container) in shipping costs, has been nothing short of spectacular. In 1947, total international trade stood at about $50 billion. In 2006 it amounted to $11.78 trillion, rising at a far faster pace than world gross product, which has multiplied roughly eight times since 1950. Just since 2000, world trade has increased by 88 percent.

Trade—whether between international corporations exchanging billions in goods and services or two neighbors exchanging surplus garden tools— takes place only when both sides benefit. That is why an economy is not a zero-sum game: as we get and spend, wealth is created because each side values what it receives more than what it gives away. Thus, although the exponentially expanding international trade of the last 60 years has caused much local economic disruption, on balance the world has become vastly richer. Much of its current economic travails, including the rapid run-up in the price of oil and farm products, is due to the spread not of poverty but of prosperity.

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But Jagdish Bhagwati sees a big problem developing. It is called the Preferential Trading Agreement, or PTA. A PTA is a pact between two or more countries: a customs union, for example, in which the members adopt a common tariff policy toward countries outside the group, or a free-trade agreement in which trade barriers are altogether dismantled within the group itself. He has written a book, Termites in the Trading System, to tell us why this is a problem, and why it must be surmounted.

Bhagwati is perhaps the world’s leading economist on matters of global trade, and a tireless proponent of more of it. Born and educated in India before continuing his studies at Cambridge University and MIT, he is now a University Professor at Columbia and the author of the most important book on his subject, In Defense of Globalization (2004). At seventy-four, he is rich with professional honors and the accolades of his peers. “In the struggle to improve the lot of mankind,” the Nobel laureate Paul A. Samuelson has written, Bhagwati has been “a tireless partisan of that globalization which elevates global total-factor-productivities both of richest America and the poorest regions of Asia and Africa.”

Bhagwati reminds us that PTA’s have been around for a long time—at least since ancient Egypt, which cut a deal with Cyprus to obtain that island’s copper and wood. What is now Germany started out as a customs union of states after the end of the Napoleonic wars. The European Union began as a free-trade agreement for coal and steel among France, Germany, Italy, and the Benelux countries. But in the last two decades, PTA’s have proliferated at an amazing rate. While there were only a handful in 1960, by 2005 there were well over 200 in operation around the globe.

Bhagwati explains the various factors behind this “plague” of special arrangements. Most policymakers, at least nominally, have been in favor of free trade for decades. But some, Bhagwati writes, are under the illusion that if free trade is good, then any free-trade agreement, whatever its implications for the world at large, must be good as well. He demolishes this idea in a single sentence: “It was as if an economist were to say, If you wish to cut spending in the national budget, just do it: every cut is as good as any other—a proposition that would soon be recognized as absurd.”

If policymakers are afflicted with simple thoughtlessness, for bureaucrats the main danger seems to lurk in narrow self-interest. As Bhagwati notes, free-trade agreements and customs unions always include mechanisms for enforcement and settling disputes, and these invariably come with fancy titles. The more PTA’s, the more titles with which to adorn office doors. As anyone who has dealt with government knows, such status symbols can be powerful drivers of official action.

But what exactly is so bad about these proliferating PTA’s? One major problem, according to Bhagwati, is that they distort economic decision-making. Instead of trade going to the country with the biggest comparative advantage, and thus the lowest prices, it tends to go to the country that has the biggest comparative advantage within the closed world of the PTA, thus propping up inefficient industries by insulating them from competition from elsewhere.

Another deeply problematic element is the chaos that results from the fact that many countries belong to not one but several PTA’s, each with its own rules and tariffs. Bhagwati provides illuminating charts for the overlapping trade agreements of the EU in the late 1990’s and the Asia-Pacific Free Trade Agreement as of 2007. With good reason, he calls them “spaghetti bowls.”

Thanks to globalization, furthermore, it has become increasingly difficult—and often impossible—to design “rules of origin” that make any sense in the real world. The death of Princess Diana serves Baghwati as an emblem of today’s economic situation:

An English princess with an Egyptian boyfriend crashes in a French tunnel, driving a German car with a Dutch engine driven by a Belgian who was drunk on Scottish whiskey, followed closely by Italian paparazzi, on Japanese motorcycles; treated by an American doctor, using Brazilian medicines.

How to keep track of all this? The rules of origins have made the NAFTA treaty (for example) the size of a phone book instead of a couple of pages long; imagine the mess when this is multiplied by the number of PTA’s in the world.

What to do about any of this? Bhagwati realizes that, politically speaking, there are now so many short-term beneficiaries of PTA’s that the longer-term benefits deriving from global free trade seem easy to ignore. But that is precisely why political leaders must continue to press hard for globally lower trade barriers through the WTO—for only this, if successful, will make PTA’s irrelevant. After all, what would be the point of having a preferential trade deal with one country if all countries were already trading freely?

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Bhagwati writes very clearly for an economist, and also supplies a handy glossary of terms to help the reader navigate inevitable patches of jargon. A blessedly brief book, Termites in the Trading System demonstrates a truth all too often forgotten or ignored in these days of computer-aided writing: namely, that the importance of a work cannot be measured simply by its length.

Above all, Baghwati remains fully aware that the real world in which politicians operate is the one that economists must constantly consider in tendering their theoretical advice—that is, if they want the advice to be worth anything. For this alone, it is always a deeply instructive pleasure to read him, as Termites in the Trading System reminds us once again.

About the Author

John Steele Gordon writes frequently for  COMMENTARY. His own economic history of the United States, An Empire of Wealth, was published in 2004.

 




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