Transatlantic trade deal is a step in the right direction
22 April 2015
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Economic Theory
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Ever since the new European Commission took over at the end of last year, TTIP (the Transatlantic Trade and Investment Partnership) has been the talk of the town in Brussels. Like Jean-Claude Juncker’s €315bn investment plan and the Digital Single Market, the prospective free trade agreement between the EU and the US is the kind of big-ticket item that EU officials love to bring up to tout the importance of EU policy to a largely uninterested public. For pro-EU and moderately eurosceptic politicians here in Britain, it is an example of a positive contribution made by the Union, going some way to counter perceptions of the EU as a relentless regulation factory. Indeed, TTIP has repeatedly been described as key to the recovery of European economies – an unprecedented boost to transatlantic trade.
If the deal is to be judged against such expectations, it is almost certain to disappoint. Most studies of its potential impact find relatively modest –albeit consistent– economic gains, ranging from an additional 0.2% to 0.5% of GDP for the EU and 0.2% to 0.4% for the American economy, with much depending on how ambitious the final deal is. This is partly because trade between the two blocs is already largely free, and partly because some of the sectors that would benefit most from liberalisation (financial services, data flows, some public services) will either be excluded from the deal or liberalised only to a limited extent.
Some analysts have even argued that TTIP would be detrimental to free trade and enterprise. Writing for CapX last week, Theodore Bromund from the Heritage Foundation argued that the negotiations are fraught with such complexity and detail that only large corporations can navigate them. This will lead, Bromund claims, to a deal that is tailored to the interests of big business and that will come at the expense of competition, harming challenger companies and consumers. Specifically, he argues that regulatory harmonisation between the EU and the US will raise already high barriers on both sides, and he points to recent European experience as an example of the economic ossification that harmonisation brings with it.
First of all, let me state where I think Bromund is right. He is correct to point out that trade agreements have of late become less about their original purpose of removing tariffs and other explicit barriers to commerce between nations, and more about investment protection and non-tariff barriers, i.e. regulations that make it harder for foreign firms to compete with domestic ones. He is also right when he says that the complexity and obscurity of negotiations work to the advantage of insiders and big business lobbyists, though I would also add large (and often state-funded) pressure groups and NGOs to the list of organisations that thrive in this environment. Finally, I agree with Bromund that regulatory harmonisation is a bad idea, as it is likely to lead countries to increase rather than reduce state intervention, and it undermines regulatory competition which can promote best practice.
But it doesn’t follow from the above that TTIP would damage free trade and the free market. The key issue is the form that negotiations on regulatory barriers take. As Simon Lester and Inu Barbee from the Cato Institute in Washington write, there are two ways that regulatory cooperation could take place. It could either be based on harmonisation, which as pointed out above is more likely to do harm than good. Or they could be founded on the principle of mutual recognition or functional equivalence. The latter would not involve equalising regulatory standards in the two countries, but rather recognising each other’s rules as appropriate or equivalent. This may sound trivial, but the lack of mutual recognition right now means that many EU goods exported to the US are subject to two sets of standards – the ones required by Brussels and/or national governments in Europe, and those mandated in America. The concomitant increase in red tape, compliance costs and uncertainty is a clear barrier to transatlantic exchange. Vehicle crash tests are a good example of where standards on both sides are very similar, but where the lack of recognition/ equivalence delays the release of new products and increases costs for producers.
Mutual recognition is preferable to harmonisation because it preserves regulatory competition while also reducing the compliance burden on exporters. One may also argue that, to the extent that each side’s regulations respond to the preferences of their respective citizens, mutual recognition also leads to more optimal outcomes than one-size-fits-all harmonisation. (Although given rent-seeking by interest groups and regulatory capture, it is doubtful that state rule-making is driven by common-good considerations.) Indeed, mutual recognition was the preferred mechanism to make regulations compatible between EU Member States until the 1990s – not least in banking and insurance, as my colleague Philip Booth has explained. Mutual recognition led to increased trade and greater consumer choice and welfare across the Union. It is only recently that, due to a change of attitude in the Commission and some national governments as well as a mistaken conception of what free trade in the Single Market is, harmonisation has carried the day.
The EU’s transition from the flexibility and competition provided by mutual recognition, to the uniformity and bureaucracy of harmonisation, illustrate the stark difference between the two approaches and the perils of embarking on the latter. But it also shows that harmonisation is not the sole way to make regulations compatible with one another, or indeed the most desirable. Of course, EU and US regulators might still choose the wrong course, but it is no given that they will. Indeed, considering their different policy approaches on a range of areas – from post-crisis financial regulation to the precautionary principle – and both sides’ commitment to retain their own independent right to regulate, it would seem more likely for standards to either be mutually recognised, or not made equivalent at all.
The final point to remember is that, if big business has come to dominate trade negotiations between the EU and the US, this is only an extension of their influence on domestic policy-making on both sides of the pond. The legislative process in both Brussels and Washington is fraught with opportunities for lobbying and rent-seeking, not least thanks to the powers to grant favours and extract punishment that officials have awarded themselves. Opportunities to introduce further competition in EU and US markets, and to reduce politicians’ arbitrary power, ought to be embraced. This free trade deal seems to go some way in achieving both.
It is as yet unclear what form TTIP negotiations on regulation will take, and how far they will reach in removing unnecessary duplicate requirements for European and American exporters alike. But it seems premature to claim that the potential transatlantic trade deal will hurt free enterprise and consumers. As things stand, TTIP will likely be a modest step towards freer commerce and greater prosperity on both sides of the pond.
This article first appeared on CapX.
If the deal is to be judged against such expectations, it is almost certain to disappoint. Most studies of its potential impact find relatively modest –albeit consistent– economic gains, ranging from an additional 0.2% to 0.5% of GDP for the EU and 0.2% to 0.4% for the American economy, with much depending on how ambitious the final deal is. This is partly because trade between the two blocs is already largely free, and partly because some of the sectors that would benefit most from liberalisation (financial services, data flows, some public services) will either be excluded from the deal or liberalised only to a limited extent.
Some analysts have even argued that TTIP would be detrimental to free trade and enterprise. Writing for CapX last week, Theodore Bromund from the Heritage Foundation argued that the negotiations are fraught with such complexity and detail that only large corporations can navigate them. This will lead, Bromund claims, to a deal that is tailored to the interests of big business and that will come at the expense of competition, harming challenger companies and consumers. Specifically, he argues that regulatory harmonisation between the EU and the US will raise already high barriers on both sides, and he points to recent European experience as an example of the economic ossification that harmonisation brings with it.
First of all, let me state where I think Bromund is right. He is correct to point out that trade agreements have of late become less about their original purpose of removing tariffs and other explicit barriers to commerce between nations, and more about investment protection and non-tariff barriers, i.e. regulations that make it harder for foreign firms to compete with domestic ones. He is also right when he says that the complexity and obscurity of negotiations work to the advantage of insiders and big business lobbyists, though I would also add large (and often state-funded) pressure groups and NGOs to the list of organisations that thrive in this environment. Finally, I agree with Bromund that regulatory harmonisation is a bad idea, as it is likely to lead countries to increase rather than reduce state intervention, and it undermines regulatory competition which can promote best practice.
But it doesn’t follow from the above that TTIP would damage free trade and the free market. The key issue is the form that negotiations on regulatory barriers take. As Simon Lester and Inu Barbee from the Cato Institute in Washington write, there are two ways that regulatory cooperation could take place. It could either be based on harmonisation, which as pointed out above is more likely to do harm than good. Or they could be founded on the principle of mutual recognition or functional equivalence. The latter would not involve equalising regulatory standards in the two countries, but rather recognising each other’s rules as appropriate or equivalent. This may sound trivial, but the lack of mutual recognition right now means that many EU goods exported to the US are subject to two sets of standards – the ones required by Brussels and/or national governments in Europe, and those mandated in America. The concomitant increase in red tape, compliance costs and uncertainty is a clear barrier to transatlantic exchange. Vehicle crash tests are a good example of where standards on both sides are very similar, but where the lack of recognition/ equivalence delays the release of new products and increases costs for producers.
Mutual recognition is preferable to harmonisation because it preserves regulatory competition while also reducing the compliance burden on exporters. One may also argue that, to the extent that each side’s regulations respond to the preferences of their respective citizens, mutual recognition also leads to more optimal outcomes than one-size-fits-all harmonisation. (Although given rent-seeking by interest groups and regulatory capture, it is doubtful that state rule-making is driven by common-good considerations.) Indeed, mutual recognition was the preferred mechanism to make regulations compatible between EU Member States until the 1990s – not least in banking and insurance, as my colleague Philip Booth has explained. Mutual recognition led to increased trade and greater consumer choice and welfare across the Union. It is only recently that, due to a change of attitude in the Commission and some national governments as well as a mistaken conception of what free trade in the Single Market is, harmonisation has carried the day.
The EU’s transition from the flexibility and competition provided by mutual recognition, to the uniformity and bureaucracy of harmonisation, illustrate the stark difference between the two approaches and the perils of embarking on the latter. But it also shows that harmonisation is not the sole way to make regulations compatible with one another, or indeed the most desirable. Of course, EU and US regulators might still choose the wrong course, but it is no given that they will. Indeed, considering their different policy approaches on a range of areas – from post-crisis financial regulation to the precautionary principle – and both sides’ commitment to retain their own independent right to regulate, it would seem more likely for standards to either be mutually recognised, or not made equivalent at all.
The final point to remember is that, if big business has come to dominate trade negotiations between the EU and the US, this is only an extension of their influence on domestic policy-making on both sides of the pond. The legislative process in both Brussels and Washington is fraught with opportunities for lobbying and rent-seeking, not least thanks to the powers to grant favours and extract punishment that officials have awarded themselves. Opportunities to introduce further competition in EU and US markets, and to reduce politicians’ arbitrary power, ought to be embraced. This free trade deal seems to go some way in achieving both.
It is as yet unclear what form TTIP negotiations on regulation will take, and how far they will reach in removing unnecessary duplicate requirements for European and American exporters alike. But it seems premature to claim that the potential transatlantic trade deal will hurt free enterprise and consumers. As things stand, TTIP will likely be a modest step towards freer commerce and greater prosperity on both sides of the pond.
This article first appeared on CapX.
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