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Home , Balance of trade, Comparative advantage, Deglobalization

Applied Econometrics and International Development Vol. 17-1 (2017) TREATIES AND Christopher E.S.WARBURTON* Abstract The central issue in this paper is whether technological and can spur economic growth and sustainable development within a structured environment of trade agreements. By analyzing historical precedents and data on trade imbalances, innovation, dynamic , weighted exchange rates, poverty, and wages, the evidence suggests that freer international trade very often has a greater potential for increasing welfare and sustainable development, although a few exceptions hold when implies unfair trade, diminution of industrial production per head and strong trade deficits. Implicitly, must be strongly encouraged when wages are stagnant, poverty is substantial, production costs are low, and disposable income is insufficient to substantially absorb domestic production. On the other hand, trade imports have positive effects on domestic market when they increase production, productivity and income per head. JEL Codes: F13, F15, F18, F31, K33, O 13, O24, O44, O51 Keywords: Dynamic Comparative Advantage, Free Trade Area, , Trade Weighted Dollar, Trade Law, Renewable Energy, and Sustainable Development

1. Introduction This paper investigates the performance of free trade areas (FTAs) as models of economic growth and sustainable development. Members of an FTA agree to trade among themselves without erecting and non-tariff barriers. On the other hand, a is an elevated form of an FTA in which the members agree to have a common trade policy against the trading interests of outsiders. In another form of , a common market, the members adopt a common trade policy, but also allow the free movement of and services as well as the factors of production. The highest form of economic integration is a monetary union in which the members decide to use a common currency in addition to the previously identified freedoms. At the time of this writing, factor movement is increasingly coming under stringent scrutiny. The central issue in this paper is whether technological innovation and international trade can spur economic growth and sustainable development within a structured environment of trade agreements or laws. By analyzing historical precedents and data on trade imbalances, innovation, dynamic comparative advantage, weighted exchange rates, poverty, and wages, the evidence suggests that very often freer international trade has a greater potential for increasing economic growth, economic welfare, and sustainable development. Implicitly, exports trade must be strongly encouraged when wages are stagnant, poverty is substantial, production costs are low, and disposable income is insufficient to substantially absorb domestic production. This paper provides additional dimension to the trade literature by analyzing the interaction of multiple

* Christopher E.S. Warburton, Ph.D., Department of Political Science and . East Stroudsburg University, Pennsylvania, United States. E-mail: [email protected]

Applied Econometrics and International Development Vol. 17-1 (2017) variables in the context of dynamic changes and the changing comparative advantage of the US economy. I conclude that US trade negotiations must be encouraged, but that they must also be sensitive to laws for their successful implementation. In this paper, “deglobalization” alludes to the bifurcated mechanisms that reduce the volume of trade and economic welfare. The re-emerging patterns are evaluated from two perspectives with common insular effects. First, the concept is used to analyze traditional forms of trade restrictions, tariffs and non-tariff barriers (without trade talks). Second, the concept is used in the context of the prompt repudiation of trade talks, sometimes due to a false sense of nationalism without careful thought about the effects of technological innovation and dynamic changes that are generating new opportunities for robust trade and sustainable development (inter-generational equity of resource consumption). The paper cuts across a broad spectrum of international trade and sustainable development to highlight the usual importance of freer trade and trade negotiations (talks). I discuss the literary background and some historic experiences in the next section. The economic and lawful bases for international trade are then presented in Section 3. The theories of dynamic comparative advantage and sustainable development are discussed in Section 4. The arguments for freer trade, within even relationships in a trade area, and the findings in support of economic integration are continuously reported through the paper under different and appropriate categories of importance. I finally provide brief comments at the end of the paper.

2. The literary background of deglobalization The US has a long experience with insular trade policies and the lessons are very unpleasant. Of course, when policy makers think about tariffs they are generally preoccupied with the real sector. They generally see no compelling reason why identical thought patterns should be extended to the financial sector or financial markets. That is, there is a presumption that imprudent decisions that can unfavorably destabilize one sector of a macroeconomy are not applicable to another. Lessons of aggressive tariffs are immutable and new proposals to employ old tariff theories will not change the adverse and apparent consequences of restrictive trade. In the history of the US, two tariffs—the 1828 Tariff (of Abominations) and the Smoot- Hawley (1930)—are particularly enlightening. The destructive political and economic consequences of the tariffs were strongly influenced by negligent parochial politics of the nineteenth century, and the outcomes are unsurprisingly unsavory. The 1828 tariff, which was passed by Congress on May 19, 1828, was designed to protect American industry from cheaper British goods. The hated tariff became resentfully known as the “Tariff of Abominations.” The southern opponents of the tariffs were rightfully concerned about the increase in taxes on raw materials like cotton and tobacco, and the increase in southern opposition led to a Nullification Crisis.1 The southerners knew that the outrageous and hateful taxes on tobacco and

1 By “Nullification,” a State formally suspended the application of federal law within its borders. The concept was introduced to the US by Thomas Jefferson and James Madison, in opposition to the Alien and Sedition Acts, which was ostensibly intended to control the actions of foreigners in the US during an impending war. “The principle was accepted by the Hartford Convention of New Englanders in 1814 as well as many in the South, who saw it as protection 72 Warburton, C.E.S. Trade Treaties and Deglobalization cotton would seriously affect their ability to have access to foreign markets beyond the northern markets of the USA. Explicitly, by paying more for southern goods, the British importers were surely going to have less money to buy from the American farmers. The reduction in the volume of trade was invariably and adversely going to affect the welfare of the dissenting southern farmers. Apparently, even some New England industries were also opposed to the tariff, because it included provisions for increasing the taxes on raw materials. John Quincy Adams—the 6th American President (1825-1829)—who was more interested in protecting the business interests of the industrial and manufacturing class in the North, raised taxes on British imports to nearly 50 percent and confronted the strong southern opposition. In fact, the “Tariff of Abominations” was just one of many tariffs during the nineteenth century. A tariff of 1816, which was a response to a wave of nationalism (jingoism) after the War of 1812, placed a 20 to 25 percent tax on all foreign goods. An 1824 tariff imposed a 35 percent duty on imported iron, wool, cotton, and hemp. As time progressed, nineteenth century tariff philosophy degenerated from nationalism to regionalism (industrial north v. agrarian south) in the USA. The Nullification Crisis diminished the 1828 tariff and a Compromise Tariff became inevitable, even as the US Congress and the President (Andrew Jackson) tried to coerce South Carolina to pay its dues to the Federal government. By concurrently passing the Force and Compromise Bills of 1833 a compromise was reached. The compromise required reversion of the 1828 tariff to the 1816 level over a ten-year period. South Carolina eventually repealed its nullification of the 1828 tariff, but jarringly nullified the Force Act of 1833. By the 1930s, the tariff lessons of the nineteenth century had not been very well absorbed. In 1930, the US passed the Smoot-Hawley Act. This time, the Act was intended to protect the agricultural sector. Irwin (2011) estimates that the law probably raised the average tariff on dutiable imports by about 15 to18 percent, an increase of about 6 percentage points on previous tariff. The tariff was not as extreme as conventional wisdom might suggest, but it was problematic. For example, the tariff is reported to be far less than the Fordney-McComber tariff of 1922, which raised the average tariff rate by 64 percent.2 However, one major problem with the Smoot- Hawley tariff is that it compounded a tariff, the Fordney-McComber, which was already considered to be very high. The depression of the 1930s also inflated the tax rates of the Smoot-Hawley Act as the average tax rates fell. Irvin reports that at the time of the law, about two-thirds of the dutiable imports in the US tariff code were subject to specific (per unit) duties. As import prices plunged in the early 1930s, from 18 percent in 1930 to 22 percent in 1932, average tariff on dutiable imports went up from 53 percent in 1931 to 59 percent in 1932, the year in which US trade with other nations collapsed.3 against federal encroachment on their rights. It remained a point of contention and reached a crisis in 1832”; see www.u-s-history.com/pages/h333.html 2 See Irwing, p. 105. 3 Op. cit., pp. 107-108; where the tax rate = price per unit/average rate. Therefore, average rate = price per unit/tax rate. The price effect of the tariff is estimated as (1+t1)/(1+t0) -1, where t0 is the original tariff; see p.109 fn. 73

Applied Econometrics and International Development Vol. 17-1 (2017) It is estimated that dutiable imports fell by approximately 13 to 17 percent. While the economic impact of the tariff is precisely unknown, the tariff led to the discriminatory imposition of tariffs on US goods, which limited the capacity of the US. The foreign response was not any different from those in the nineteenth century. The US Congress had naively failed to anticipate the then forthcoming retaliatory foreign responses to restrictive US trade policies. Twenty five trading partners of the US retaliated with tariffs of their own, including Spain, , Switzerland, , Italy, Australia, New Zealand, and Cuba.4 Accordingly, like the reversals of the 1830s, the US passed the Reciprocal Act in 1934 to give the executive arm of government more leverage to make trade deals that are in the interest of the nation (US) rather than the import-competing economic and political interests of individual US legislators. The philosophical and institutional shifts of the Reciprocal Act were important then and now. The shifts suggest that: (i) the Congress was incapable of making trade deals that were consistent with national rather than limited interests, and (ii) that the executive arm of government must find ways to expand trade in the interest of the nation. The institutional shift was never provided with contractionary or insular intent. The expansionary theme resonated in the 1940s when the world came together to form the General Agreement on Tariffs and Trade (GATT), now the (WTO). Competitive devaluation and beggar-thy-neighbor policies had necessitated the agreement to promote freer international trade. That is, after the Second , restrictive trade policies, including currency manipulation, were contracting global trade and diminishing human welfare to such an extent that it became necessary to open up markets for freer trade and the improvement of human welfare. The average tariff among industrial nations was reduced from approximately 50 percent, after WW II, to approximately 5 percent by 2006 (Elwell, p.6). After the 1940s, the dimensions and articles of trade significantly increased to include services and intellectual property. The contemporary service sector has assorted categories, including insurance, shipping, banking, legal matters, educational provisions, e-commerce, and data processing, for which commitments or trade agreements are essential to promote international trade. Therefore, those who participate in trade agreements have tremendous leverage to mitigate the discontents and disputes that are certainly going to emanate from international transactions and the development of newer sectors of international trade. As far as the Trans Pacific Partnership (TPP) is concerned, the service sector is expected to generate welfare gains amounting to approximately $79 billion, which will offset some manufacturing losses. US trade with TPP countries was more than $1.6 trillion in merchandise in 2014 and more than $273 billion in services in 2013 (Fergusson et al, p.12.). Nevertheless, the nontariff restrictions on services (barriers to trade) are generally sophisticated and extremely difficult to quantify for comparative analysis or dispute resolution. This difficulty makes transparency and trade agreements all the more essential. Contemporary trade agreements also deal with a wide range of issues beyond those of the General Agreement on Trade in Services (GATS) and Trade-Related Intellectual Property Rights (TRIPS), both of which are creatures of the Uruguay Round of

4 See Irwin, pp.144-183, for foreign retaliatory responses or measures. 74 Warburton, C.E.S. Trade Treaties and Deglobalization Negotiations (talks). The history of trade talks is instructive, because the talks have consolidated the bases of trade agreements, which are intended to ensure freer and nondiscriminatory trade patterns. Some eventful negotiations followed the implementation of the GATT: The Kennedy Round (1964-1967), The Tokyo Round (1973-1979), and The Uruguay Round (1986-1994). In 1999, a Seattle (Washington) Round (1999) abysmally failed, but it nurtured hopes of resuscitation in Doha, Qatar. The uneventful or moribund Doha Round (2001-) has dashed the hopes for multilateral trade agreements but favorably increased those of bilateral and plurilateral ones. The march to deglobalization is nothing new. It became louder and insidious after the 1990s as many groups organized protests to disrupt trade talks that were becoming much more polarized and contentious. The divergences of interests, including growing income inequality, poverty, and environmental degradation, between rich and poor nations proved to be irreconcilable in a multilateral setting. The negotiations opened the door for protests by human rights activists, environmentalists, consumer-rights advocates, organized labor (unions), anti-immigrant [nationalist] groups, animal-rights activists, and anarchists.5 One of the problems with multilateral organizations may well be the size of their membership and the multiplicity of economic interests for which agreements are sought. Models of multilateralism and consensus are a rarely well managed for substantive results. Though frictions became much more apparent after 1990, negotiations began to flounder in the 1980s and the movement towards bi- and pluri-lateral trade agreements gained momentum. The US signed the first regional trade agreement in 1982 and it started to negotiate a free trade agreement with Israel in 1983. These agreements were largely in reaction to multilateral treaty failures and the growing protectionist threats from other areas of the world.6 The literature has an eclectic array of discussions on globalization and structured trade, ranging from the beneficial results to the adverse effects of globalization on deficits, economic growth and human welfare. A cross section of these discussions can be found in the writings of Stiglitz (2002), Bhagwati (2004), Wolf (2004), Elwell (2006), Stiglitz (2007), Romalis (2007) Warburton (2010), Warburton (2016b), Guisan (2013), and Prahan et al. (2016), to list a few. Some of the socio economic implications of globalization for Africa can be found in Warburton (2011, 2016). The central conclusion of Guisan is that industrialized countries should ensure that their foreign trade policy is compatible with domestic development by avoiding strong and unsustainable trade deficits. The most recent study of Pradhan et al. investigates the relationships between trade openness, foreign direct investment, financial development, and economic growth in 19 Eurozone countries over the period 1988– 2013. Using a panel vector error-correction model (VECM), the study finds that the conintegrating variables support the theory that a combination of openness in the real and financial sectors have fostered financial and economic development, and elevated the prospect of foreign direct investment in the Eurozone region. Increasing inflows of foreign direct investment have propelled economic growth to strengthen the role of

5 See Pugel, p.165. 6 See the 2007 World Trade Report, pp179-197; see also Ostry (1997). 75

Applied Econometrics and International Development Vol. 17-1 (2017) financial development and international trade in the short-run. While controversies abound in the literature, it is a widely accepted principle that international trade is unavoidable and that it can be conducted within a legal framework. With obvious asymmetries of benefits, nations have generally favored access to markets so that they can sell their products and services, because trade can be mutually beneficial rather than destructive. This paper provides additional dimension to the trade literature by analyzing the interaction of multiple variables in the context of dynamic changes in the US economy and the changing comparative advantage of the US in the global economy. The next section discusses the legal and economic bases for freer trade.

3. Trade agreements of the USA

International trade agreements are creatures of economic necessity and . In effect, despite the pockets of resentment against such agreements, they generally conform to the expectations of international trade law. The Vienna Law of Treaties (VLT) stipulates some generic properties of conventional law that should provide some assurances when nations embark on trade negotiations. Domestic laws are insufficient preconditions for violating treaty provisions (Article 27) and treaties conflicting with the peremptory norms of international law are intolerable or invalid, because of their derogations (jus cogens) (Article 53) from the prescriptions of international law. However, the adherence to treaties is limited by fundamental changes in unanticipated circumstances (rebus sic stantibus) (Article 62). Trade treaties are normally constructed as instruments of general international law and they are variously consistent with the agreements of pertinent international legal instruments. Derogations from the provisions of the WTO agreements are impermissible and nations are obligated to ensure that discrepancies in treaty arrangements are rectified to be consistent with the prescriptions of general international law. These principles, which are also principles of the International Labor Organization (ILO), the United Nations (UN), and the Universal Declaration of Human Rights, include: human rights, sustainable development, and sanitary and phytosanitary conditions.7 The WTO’s sanitary and phytosanitary (SPS) measures address issues that are protective of the lives of humans, animals and plants. The implementation of SPS provisions is often times contentious and controversial, but the provisions are hardly without recognition of the pacific settlement of trade disputes. Harmonization of municipal laws with public international law is an important requirement of international treaties. This means that all parties to a treaty are expected to ensure that their domestic law is consistent with their declared international obligations; failing which, the international obligations are generally considered to be peremptory.8

7 See the WTO Agreement on the Application of Sanitary and Phytosanitary Measures, Articles 2 through 5 and Articles 8 through 10; see also Warburton (2016a), pp.154-158. For international law on sustainable development, see Warburton (2016a), pp. 434-517; see also Trebilcock et al, pp.293-308. All sanitary and phytosanitary measures must conform to international standards, guidelines or recommendations. 8 See SPS Agreement Article 3; see also the Vienna Law of Treaties Articles 27, 46, and 53. “A State may not invoke the fact that its consent to be bound by a treaty has been expressed in violation of a provision of its internal law regarding competence to conclude treaties as 76 Warburton, C.E.S. Trade Treaties and Deglobalization Accordingly, treaties are deficient when they insufficiently the expected or reasonable standards of international law. The deficiencies of trade treaties are increasingly becoming threats to economic integration (trade-related aspects of globalization). Notwithstanding, prompt disapproval of regional trade arrangements (RTAs) can also be occasionally associated with the lack of familiarity with international trade law, its essence, or the legal and economic reasons for the RTA negotiations in the first place. Apart from the convincing economic arguments that are projected by Figure 1, RTAs give the members of regional organizations cheap access to foreign markets without agonizing over of the Most Favored Nations (MFN) mandate of the WTO Agreement.9 In 1992, the North American Free Trade Agreement (NAFTA) was concluded and subsequently ratified by the US, Canada, and Mexico. Actually, several regional trading blocs have been arranged over the years, including MERCUSOR, a customs union of four Southern-cone countries—, Brazil, Paraguay, and Uruguay— that was established under a 1991 treaty, the (CARICOM) of fifteen states and five associates (established in 1973), the Association of South East Asian Nations (ASEAN), consisting of Thailand, Indonesia, Malaysia, the Philippines, Singapore, Brunei, Cambodia, Lao, Vietnam, and Myanmar (established in 1967), and the Common Market for Eastern and Southern Africa (COMESA) (established in 1994 and expanded to include countries in North and Northeastern Africa ). Though the economic reasons for the existence of FTAs and RTAs are compelling, trade arrangements are increasingly coming under attack, especially after Brexit and the Trans Pacific Partnership (TPP) initiatives. Notably, it should be recalled that FTAs or RTAs must not be conflated with currency unions. Plurilateral and multilateral unions increase the propensities to generate trade-creating benefits, because of the greater leverage to import goods from cheaper sources as market outlets are expanded. Yet, the issues of human rights and sustainable development are increasingly becoming relevant to corporate profits. Invariably, trade negotiations are unproductive when legal issues involving the use of economic resources are not given adequate consideration at the outset. This reality circumscribes contemporary FTA negotiations and their sluggish completions. Fortunately, there are some preliminary and existing multilateral models that can be perfected to address human rights issues. For example, the Canada-Panama labor cooperation agreement does not allow for the suspension of trade concession as a resolution of labor dispute. Rather, a dispute settlement panel is empowered to develop an “action plan” to remedy a dispute. If and when an offending party fails to implement a plan of action, a monetary penalty capped at $15 million could be imposed.10 Dispute settlement mechanisms are integral components of trade agreements that are designed to open up markets while resolving volatile and sticky trade issues that invalidating its consent unless that violation was manifest and concerned a rule of its internal law of fundamental importance.”(VLT, Art. 46). 9 The MFN clause is a nondiscriminatory clause that outlaws discriminatory or preferential treatment in the conduct of international trade. That is, tariffs must be equitable for all members of the WTO without quid pro quos, except when countries are members of a common union; see General Agreement on Tariffs and Trade (GATT, now WTO) Articles 1 and XXIV. 10 See Fergusson et al, p.39. 77

Applied Econometrics and International Development Vol. 17-1 (2017) must conform to settled positions of international trade law. Analogously, environmental provisions in U.S. FTAs have evolved over time to use the multilateral framework as a paradigm for FTA dispute resolution. Revised NAFTA provisions added an affirmative obligation to abide by multilateral environmental agreements (MEAs) while following dispute settlement mechanisms to resolve environmental disputes. To capture some of the salient economic arguments of freer trade arrangements, consider Figure1 in the Annex. 4. Trade agreements, comparative advantages and sustainable development Comparative advantage is an intuitive theory that was originally formulated by to explain why nations use their abundant and cheap resources to specialize in the production of those goods that they can cheaply produce for exports. Implicitly, nations should import those goods that are relatively expensive to produce domestically. By using relatively scarce and expensive economic resources to produce goods, nations will inefficiently produce goods that they should otherwise import. The rationale behind such a theory of trade was further clarified in 1936 when defined Ricardo’s trade theory in terms of the production possibilities and opportunity costs confronting nations. That is, there are economic consequences that are associated with the imprudent use of scarce economic resources when productive and competing alternatives are improperly considered. The basis of comparative advantage has never been a static precondition for trade, because development and scientific changes reconfigure the productive infrastructure for the production of tradeable goods and services. Scientific changes will cause once abundant and cheap factors to become relatively expensive and comparatively less attractive. As such, workers will be displaced as scientific progress and trade take hold in any society; especially in societies that care about the merits and realities of sustainable development. It is worth noting that comparative advantage is a production and consumption theory that does not explain the normative preconditions for the distribution of output or national income. Alternatively, the theory of comparative advantage cannot prescribe how the benefits (profits) of international trade should be distributed or reinvested; such a decision has to be made by policy makers and business managers.11 Public policy makers and business managers must decide whether those who are unemployed and priced out of markets, for whatever reason, should be abandoned for starvation or given an opportunity to earn income. The alternative will be to wait for income to magically trickle down to the unfortunate or poor via the invisible hand of God or an imaginary sublime mysticism (a moral issue with economic implications). The societal decision that is made will ultimately determine the intensity with which people will embrace acerbically xenophobic and hostile attitudes toward scientific

11 Economists generally disagree on the diagnosis for normative problems, except of course that they can use productivity, income disparities, and changes in the general price level as benchmarks or indicators of favorable or unfavorable normative occurrences like equitable (fair) income distribution. Yet, normative conditions are not extraneous to the realities of economic outcomes. For example, low disposable income is positively correlated with low consumption. Naturally, increases in disposable income—for whatever normative reason—must be positively correlated to higher consumption. 78 Warburton, C.E.S. Trade Treaties and Deglobalization changes, sustainable development, and international trade. Is US trade influenced by comparative advantage and dynamism? In 1996, hourly US manufacturing cost was pretty high, surpassed only by Germany and Japan for the countries considered in Table 1. For the sake of simplicity and relevance to US trading interests, only major trading partners of the US (including prospective TPP members) have been considered for analysis in this paper. Hourly manufacturing cost was extremely low in Mexico.12 This suggests that some US manufacturing production can be done more efficiently in Mexico for relatively cheaper cost, even with intra-industry trade. In effect, Mexico had some comparative advantage and trade creating opportunities. The NAFTA agreement was formulated around the opportunities for cheap markets and cost of production. The evidence suggests that by the early 2000s, NAFTA generated more than diversion (Pugel, p.264). Table 1: Hourly International Manufacturing Costs 1996-2012 ($US) 1996 2000 2004 2008 2012 % Change United States* 22.47 24.96 29.31 32.78 35.67 59 Canada* 18.62 18.33 23.67 32.06 36.59 97 Mexico* 3.05 4.70 5.26 6.47 6.36 109 Germany 33.22 25.41 37.72 47.53 45.79 38 Japan* 23.67 25.02 25.27 27.48 35.34 49 Australia* 19.17 16.45 26.75 35.91 47.68 148.7 New Zealand* 12.11 9.0 14.78 19.15 24.77 105 Singapore* 11.93 11.71 13.20 18.87 24.16 102.5 Notes: Top 5 trading partners are Canada, Mexico, , Germany, and Japan. 1996 is base year for percentage change.* Prospective TPP Members. Source: U.S. Bureau of Labor Statistics, International Labor Comparisons, August 2013. However, by categorizing the articles of trade, Romalis (2007) found evidence in favor of when it comes to textiles and clothing products from Asia. Recalling the fundamental arguments of Figure 1, trade creating opportunities exist in Asia. Increased in the NAFTA countries led to the failure of high-cost Canadian factories and the opening of low-cost ones. Additionally, increased competitive pressures and export propensities compelled Canadian firms to innovate and produce better products via improved production methods. By the early 2000s, it is estimated that welfare gains in Mexico, Canada, and the US amounted to 2, 1, and 0.1 percent of GDP respectively. As a result of the productivity gains, Canadian manufacturing increased by about 14 percent more than it would have been without the FTA. While US imports from Mexico grew faster than US exports to Mexico during 1993-2013, US exports to Mexico still grew faster than US exports to other countries.13 As should be expected, NAFTA created structural unemployment in the US economy; especially among workers in the import-competing sector, including apparel, field crop, furniture, and product assembly. Small farmers who produced corn (maize) suffered losses while Mexican exporters of fruits and vegetables gained income. Yet, income losses have not been peculiar to the US.

12 According to the BLS, compensation costs include direct pay, social insurance expenditures, and labor-related taxes. 13 See Pugel, pp. 264-265. 79

Applied Econometrics and International Development Vol. 17-1 (2017) The deficiencies of NAFTA, emanating from the original construction of the agreement, led to supplemental agreements with Mexico to cover workplace and environmental standards. The harmonization of laws and respect for international law are indispensable attributes of the implementation of successful trade agreements. Between 1996 and 2012, hourly manufacturing cost in Canada and Mexico increased by 97 and over 100 percent respectively. The increases, which include social insurance expenditures, and labor related taxes, were relatively greater compared to that of America (see Table 1). In 2012, US hourly manufacturing cost exceeded those of prospective TPP countries like Singapore, New Zealand, and Japan; but the cost in Australia exceeded that of the US. Trade agreements have the potential of increasing foreign direct investment (FDI) into FTAs. So-called “tariff factories” relocate into FTAs in order to take advantage of preferential treatment that is not extended to non-members of an FTA. By so doing, foreign investors create investment and employment opportunities in the low-cost producing countries. Many Asian manufacturers using Mexican assembly plants switched to North American suppliers for their assembly plants input and others, notably from Japan and Korea, arranged for their home country suppliers to join them in production in Mexico (Folsom, pp. 81-82). Under the Rules of Origin, which provides exemptions from tariff under specific conditions, some goods like autos and light trucks are given preferential tariff treatment if approximately 62.5 percent of the vehicles are produced in the free-trade area. The “trilateral merchandise trade, as measured by the total of each country’s imports from its other two NAFTA partners, amounted to over USD $1.0 trillion – more than a threefold increase since 1993. In 2015, NAFTA partners represented 28 percent of the world’s GDP with less than 7 percent of the world’s population. Since the implementation of NAFTA, the North American economy has expanded. The combined gross domestic product (GDP) for Canada, the U.S. and Mexico reached USD $20.7 trillion in 2015. Canadian merchandise exports to the United States grew at an annualized rate of almost 4.6 percent between 1993 and 2015. Canada’s bilateral merchandise trade with Mexico nearly reached CA$37.8 billion in 2015. Some 78 percent of Canada’s total merchandise exports were destined to … NAFTA partners in 2015. Total merchandise trade between Canada and the United States more than doubled between 1993 and 2015. Trade between Canada and Mexico has increased over 8-fold over the same period.”14 Similarly, “between 1993 and 2015, Mexico-Canada merchandise trade grew 8- fold to almost CA$37.8 billion in 2015, showing an average annual growth rate of 10.1 percent. Services trade between Canada and Mexico has increased six-fold during the

14 See Global Affairs Canada, http://www.international.gc.ca/. Benefits were also derived from trade in services and investment. “Canada-U.S. trade in goods and services in 2015 reached close to CA$881 billion. Canada is the second-largest market for U.S. services exports with Canada-U.S. services trade nearly reaching over CA$122.8 billion in 2015, a 205.1 percent increase since 1993. The United States was the number one destination for Canadian merchandise exports in 2015, and was Canada’s largest supplier of merchandise imports. Canada is the main foreign supplier of energy to United States (Mexico is 4th), and was the largest cumulative source of foreign direct investment (FDI) into the United States.” (op cit.); see also Villarreal and Fergusson. 80 Warburton, C.E.S. Trade Treaties and Deglobalization NAFTA period, to nearly $3.9 billion in 2015. …The enhanced economic activity and production in the region have contributed to the creation of jobs for Canadians with one in six jobs in Canada related to exports. With the addition of nearly 5.2 million net new jobs during the period from 1993-2015, Canada’s unemployment rate … decreased from 11.4 percent (1993) to 6.9 percent (2015).”15 In 2014, Canada was the leading market for U.S. exports, while Mexico ranked second. The two countries accounted for 34 percent of total US exports in 2014 (Villarreal and Fergusson, p.10). Though the partial effects of trade can be reasonably estimated, the total effects of trade agreements are normally tedious to estimate, because of the volume of trade, economic shocks, and changes in other exogenous variables that are generally presumed to be invariant. For example, exchange rates affect net exports just as economic booms or will affect the movement of resources and finished products across international boundaries.16 The evidence suggests that NAFTA also created opportunities for US exporters. Consequently, trade does not necessarily generate monolithic and disastrous incidents that prevent innovation and economic growth. In the period following the life and times of , several economists have attributed the improvement in US manufacturing to specialization and economies of scale. For example, Hufbauer and Schott (2005) observe that the US auto industry became more globally competitive through the development of supply chains. They attribute much of the increase in US- Mexico trade to the reorientation of manufacturing and assembly plants to specialization and economies of scale. Hence, supply chains have been increasingly crossing national boundaries to perform manufacturing work wherever it is most efficient to do so. The successes and disappointments of the NAFTA experiment are largely consistent with the core arguments of Figure 1 and the trade theory of economics. For quite some time, while consumers and some businesses benefited from NAFTA, displaced workers did not get urgent relief for losing their import-competing and related jobs. The sluggish response to the undesirable outcomes of trade conventions has determined the litmus test for the efficacy of subsequent trade agreements. If not for anything, trade agreements provide sufficient reasons why policy makers should proactively think about prospective structural unemployment, diversification of articles of trade, and secured high-skilled jobs that cannot be outsourced. At the time of this writing, the newer jobs in the US provide opportunities for reducing unemployment, reducing the cost of production (generating efficiencies), and increasing industrial and profits (Warburton, 2017). Does the TPP hold any promise for the US economy? The TPP should not be misperceived as a contrived and extraordinary trade agreement. Its existence will generate expected economic benefits that are consistent with the circumscribing economic theories of similarly situated trade agreements of the past. Passage of the TPP is particularly propitious for the US economy, because the macroeconomic conditions of the US have fundamentally changed to accommodate

15 Op.cit. 16 See also Villarreal and Fergusson (2015). 81

Applied Econometrics and International Development Vol. 17-1 (2017) low-cost energy and technology sectors that are structurally well positioned for greater global economic integration and sustainable development. In fact, the new energy revolution is a secured source of employment and income. Yet, adverse infrastructural stagnation and inaccessibility to new and improved job markets are still retarding the realization of potential economic performance. Apart from the infrastructural linkages to job markets, it is estimated that a $1 billion incremental spending on infrastructure could generate approximately 13,000 new jobs.17 Unlike the conditions that predated NAFTA, new sources of employment are trending upwards and the real sector of the US economy is appropriately poised to favorably respond to globalization and sustainable development. The inherent and changing comparative advantage of the US economy will be briefly alluded to in the next section and more fully explored in “International Trade and Industrial Recovery in the US,” published by Warburton (2017). The TPP is a proposed regional free trade agreement (FTA) among 12 countries: Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the United States, and Vietnam. In the wake of moribund multilateral trade talks, the negotiating partners have the potential of covering a wide array of topics that will include newer participants in the effort to attain higher standards of trade. Market penetration into the Asia-pacific region is important, because the region contains 40 percent of the world’s population and produces nearly 60 percent of global GDP. Additionally, the region has the fastest growing economies of the world and it is estimated that the negotiating partners of the TPP, including Canada, Mexico, and Japan, absorbed about 40 percent of US trade in goods in 2012.18 Recalling Figure 1 and its ensuing discussions, a fundamental aspiration of FTAs is the commitment among their members to eliminate tariff and non-tariff restrictions. In 2013, it was estimated that the current average most-favored nation tariff (MFN) for the TPP countries vary from 0 percent to about 10 percent.19 High levels of tariff make it difficult for some US businesses to compete in the Asian markets. The dynamism of trade and the development of new articles of trade make it essential to develop regulatory coherence for supply chains (the continuum from production to consumption, suppliers, manufacturers, and retailers), and state-owned enterprises or policies. Accordingly, the proposed agreement deals with investment agreements that do not include some potential members. For example, Williams (2013) reports that though investment agreements exist with Australia, Canada, Chile, Mexico, Peru, and Singapore, no such agreements exist with the other TPP members. The Rules of Origin (ROO), defining the sources of inputs and final product for preferential tax treatment, are beneficial to members of a trade area. The domestic content requirement creates opportunities for foreign investment and domestic employment. Fergusson et al. report that negotiators have agreed that inputs produced in any TPP country may be cumulated so that a product produced with components

17 See US Department of Transportation, http://www.fhwa.dot.gov/policy/otps/pubs/impacts/. 18 See Williams; see also Fergusson et al, and Fergusson and Vaughn 19 See Fergusson et al, p.16-17. 82 Warburton, C.E.S. Trade Treaties and Deglobalization made in multiple TPP countries can be claimed as originating within the TPP region and therefore be eligible for preferential treatment.20 Since the US has consistently incurred trade deficits with the TPP countries (see Table 2), it is sensible to reduce the cost of imports and expand the export capacity of the US. Apparently, while the US has performed reasonably well in the service sector, its performance in the goods sector is discouraging. “The U.S. services trade surplus with TPP countries has steadily increased over the past decade while the U.S. goods trade deficit fell… sharply during the and has yet to reach its pre-recession levels. In services, the U.S. trade surplus has increased from $33 billion in 2002 to $78 billion in 2011. In goods, the U.S. trade deficit in 2012 of $155 billion was slightly less than the deficit in 2002 of $167 billion, and significantly less than the peak deficit in 2007 of $247 billion.” (Williams, p.4). The dominant driver of increasing import cost and trade imbalance is crude oil, which is a major import from both Canada and Mexico, and a cost accelerant for trade deficit with the TPP countries. Williams reports that when trade in crude oil is discounted, the US actually had an overall trade surplus in goods and services with the TPP countries in 2011. The problem with the production and sale of crude oil is that it is both expensive and environmentally degrading. Cost-effective alternative sources of energy stimulate innovation, production, employment, and preservation of environmental resources. Improvement in the provision of services—an area of comparative advantage for the US—requires structured trade arrangements for more benefits to be realized. Table 2: US Trade Imbalance with TPP Countries (2000-2015, $US millions) Japan Malaysia Vietnam Singapore Brunei Australia 2000 -81,555 -14,630.9 -453.8 -1372 -227.5 6,044.4 2001 -69,021.6 -12,982.6 -592.8 2,651.8 -295 4,452.7 2002 -69,979.4 -13,665.3 -1814.8 1,415.5 -240.7 6,606.1 2003 -66,032.3 -14,526.1 -3231 1,422.5 -385 6,673.9 2004 -76,236.5 -17,328.7 -4169.8 4,027 -357.9 6,412.4 2005 -83,323.1 -23,224.4 -5438 5,356 -513.1 8,246.3 2006 -89,721.8 -24,089.1 -7,466.4 6,057.4 -502.1 9,341.7 2007 -84,303.7 -20,948.3 -8,729.7 7,224.9 -265 10,563.2 2008 -74,120.4 -17,786.5 -15,690.5 11,968.7 -2.8 11,629.8 2009 -44,669.5 -12,879.3 -9,190.6 6,526.9 58.6 11,587.8 2010 -60,080.2 -11,821.4 -11,162.4 11,581 112.3 13,221.7 2011 -63,128.2 -11,512.9 -13,172.6 12,166.5 161 17,383.3 2012 -76,455.9 -13,117.1 -15,644.8 10,291.3 71.3 21,594.6 2013 -73,337.9 -14,272.1 -19,614.2 12,822.1 541.1 16,851.1 2014 -67,628.6 -17,495.1 -24,882.7 13,570.9 517.3 15,984.7 2015 -68,921.5 -21,693.5 -30,932.2 10,204.6 114 14,141.8 Source: US Census Bureau Agreements on trade in services expand the commitments to the General Agreement on Trade in Services (GATS), especially in light of the dormancy of the Doha Round. A high priority for the United States in its negotiations of bilateral and regional free trade agreements has been increased market access for service providers; especially

20 See Fergusson et al, p.34. 83

Applied Econometrics and International Development Vol. 17-1 (2017) financial services including, insurance and banking, legal services, private educational services, telecommunication services, express delivery, e-commerce, and data flows.” (Fergusson et al, p.18). Table 2: US Trade Imbalance with TPP Countries (cont.) (2000-2015, $US millions) N. Zealand Canada Mexico Chile Peru 2000 -110 -51,897.4 -24,577.3 191.5 -335.2 2001 -88.7 -52,843.8 -30,041.4 -376.9 -279.7 2002 -468.4 -48,165 -37,145.9 -1,175.7 -376.8 2003 -555.4 -51,671 -40,648.2 -990.4 -710.2 2004 -895 -66,479.9 -45,170.2 -1,126.3 -1,600.6 2005 -563.1 -78,485.6 -49,861 -1,530.8 -2,809.8 2006 -3,101.4 -71,781.9 -64,531.5 -2,979.3 -2,953.6 2007 -3,096.4 -68,168.7 -74,795.9 -850.7 -1,151.8 2008 -636.9 -78,341.6 -64,721.5 3,661.4 370.5 2009 -399.2 -21,590.4 -47,762.3 3,396.3 695.5 2010 56.7 -28,380.2 -66,321 3,889.2 1,506.2 2011 413.5 -34,033.3 -64,584.9 6,917 1,736.9 2012 -208.3 -31,612.5 -61,718.5 9,406.5 2,930.3 2013 -261.4 -31,748.7 -54,601.6 7,131.2 1,993.4 2014 273.5 -36,460.8 -55,408.3 7,062.1 3,976.4 2015 -661.7 -15,546.6 -60,662.8 6,672.7 3,672.3 Source: US Census Bureau Other significant issues to be addressed in contemporary trade agreements include government procurement policies, agriculture, intellectual property, and environmental issues. The United States, a member of the WTO’s plurilateral Government Procurement Agreement (GPA), has pursued the inclusion of government procurement policies in its FTAs. Among TPP partner countries, only Japan, Singapore, and New Zealand (2014) are members of the GPA. Government procurement policies force governments to patronize domestic production in the form of hidden subsidies that limit the access of foreign competitors to domestic markets. Agriculture is a very sensitive issue, and all nations tend to be protective of their agricultural sector for strategic and other reasons. As such, nations tend to develop offensive and defensive trade policies that minimize the volume of trade. However, many in the US agricultural sectors (agribusiness/food manufacturing sectors) will welcome access to markets in commercially significant countries with which the United States does not have an FTA (i.e., Japan, Malaysia, and Vietnam). On the defensive side, the US sugar industry is opposed to providing additional access to the U.S. sugar market, while the US dairy industry has offensive and defensive interests that extend beyond tariffs and market access.21 Threats to intellectual property rights discourage innovation. The preservation of intellectual property right gained prominence during the Uruguay Round of talks and the US has increased the protection of its intellectual property interests within the framework of FTAs. The broader blueprint for such protection include: (i) the application of existing IPR protection to digital media, and (ii) negotiation of trade agreements in terms of IPR that reflects a standard of protection that is similar to that

21 See Fergusson et al. pp. 21-22. 84 Warburton, C.E.S. Trade Treaties and Deglobalization required by US law. The harmonization of standards, which transcends the level of protection offered by the Trade-Related Aspects of Intellectual Property Rights (TRIPS) Agreement, requires further negotiations and agreements. For example, the United States has sought to have its partner countries sign the World Intellectual Property Organization’s (WIPO’s) Performances and Phonograms Treaty, an agreement to which Brunei, New Zealand, and Vietnam are not parties.22 It must be recalled that the general economic results of trade agreements also depend on a variety of exogenous factors, including the degree of liberalization that is tolerated by any agreement, the current and potential levels of growth among the trading partners, political stability, and exchange rate volatility (currency valuation); the factors that are not explicitly considered by partial equilibrium analysis. Yet, “the TPP appears significant given that the TPP would be the largest US FTA by trade flows ($727 billion in US goods exports and $882 billion in imports in 2014), and the TPP negotiators have expressed their intent to achieve a ‘comprehensive and high- standard’ FTA that will broadly liberalize regional trade and investment.” (Fergusson et al, p.10). By momentarily discounting tariffs, non-tariff barriers, and crude oil prices, it is worth exploring the performance of the US dollar in the Trans Pacific region. Without any arrangement for freer trade, is the US dollar competitive in the region? Consider Loretan’s (2005) proposal (Equation 1) for estimating the nominal effective exchange rate of the US dollar relative to the currencies of US trading partners: wj,t N(t)  e  I  I *  j,t  t t1   ; (1) j1 e, j,t1  where It-1 is the value of the index at time t-1 (reference period), e j,t and ej,t-1 are the prices of the US dollar in terms of foreign currency j at times t and t-1, wj,t is the weight of currency j in the index at time t, N(t) is the number of foreign currencies in the index at time t and ∑ j wj,t =1. The evidence suggests that after 2010 the trade weighted exchange rate of the dollar started to lose competitiveness in the region.23 With the exception of Brunei, Singapore, Chile, Peru, and Australia, the US ran successive trade deficits with the TPP countries from 2000 to 2015 (see Table 2).24 The US trade surpluses reflect increased capacity for trade in nonferrous metals metal ores, petroleum, apparel, pharmaceuticals and medicines, computer equipments, and semiconductors and electric components. The appreciation of the dollar and relative lack of access to Pacific markets could only worsen the with the TPP countries as the US consumption cost increases. The trade imbalances also suggest that foreign absorption is weak, partly because of the lack of reciprocal trade agreements.

22 Op.cit. 23 The currencies considered are the , the Malaysian ringgit, the Vietnamese dong, the dollars (currencies) of Singapore, Brunei, Australia, New Zealand, and Canada; the Mexican and Chilean peso; and Peruvian nuevo sol. The author’s computations are reported in Figure 2. Trade weights can be distorted because exports may include the cost of diverted added value rather than direct shipments, but they give a reasonable indicator of the value of the currency of a country relative to that of its trading partners. 24 The US trade surplus reflects increased potential for trade in the region. 85

Applied Econometrics and International Development Vol. 17-1 (2017) In general, after a recovery of average trade volumes in the 1980s, the average volume of trade for the US has trended downwards from 1990 to 2015 (see Figure 3). However, between 2005 and 2010, export growth in goods and services has exceeded import growth without undue protections. Has the US confronted the challenges of globalization? Is globalization actually working for the US? Figure: 2: US Trade Weighted Exchange Rate (WER) for 2000, 2005, 2010 and 2015

Data Source: US Census Bureau and www.ofx.com

Figure 3: US Export and Import Growth 1965-2015 (5-year Rolling/Moving Average)

Data Source: US Census Bureau 5. Manufacturing revival and sustainable trade agreements Some adjustments to the industrial sectors of the USA and changing comparative advantages have increased industrial employment and income without diminishing freer trade. This finding will be discussed more fully in Warburton(2017) as an extension of this paper. The central argument to be made is that trade and industrialization have dual causal relationships that are good for employment and sustainable development. However, one of the main issues in international trade agreements is whether trade can be conditioned to be sustainable, as to say compatible with the increase of real wages, employment and industrial production per head over extended periods of time. Free trade of goods and services within the NAFTA has other important positive effects. It has contributed to the creation of employment in Mexico and the diminution of emigration. Since Mexico is a potential market for many goods and services produced in the USA, if NAFTA can increase development in Mexico it can synergistically contribute to development in the USA. 86 Warburton, C.E.S. Trade Treaties and Deglobalization 6. Concluding Remarks International trade is about increasing the wealth and welfare of nations when nations take advantage of their comparative advantages to promote international exchange of goods, services, and assets. Nations can only maximize their collective welfare when they conduct international transactions within an orderly or lawful framework. The structured framework requires negotiations, because nations have both divergent and mutual interests in trade. The evidence in this paper suggests that the US economy is poised to benefit from economic integration, because newer sources of energy are creating dynamic comparative advantages, reducing poverty, and stimulating growth and sustainable development. The structural change puts the US in a position to maintain long-term competitiveness in the global economy, meaning that the US must engage other nations to create markets for services and finished goods. Trade negotiations have become the only obvious way to foster adherence to the key provisions of international trade law and all trade negotiations must be sensitive to human rights for their smooth and successful implementation. References Bhagwati, J. (2004). In Defense of Globalization. New York, NY: Oxford University Press. Elwell, C.K. (2006). Trade, Trade Barriers, and Trade Deficits: Implications for US Economic Welfare. Washington, DC: Congressional Research Service. Folsom, R.H. (2008). NAFTA and Free Trade in the Americas. St. Paul, MN: Thomson-West Fergusson, I.F. & Vaughn, B. (2011). The Trans-Pacific Partnership Agreement. Washington, DC: Congressional Research Service. Fergusson, I.F., McMinimy, M.A. & Williams, B.R. (2015). The Trans-Pacific Partnership (TPP) Negotiations and Issues for Congress. Washington, DC: Congressional Research Service. Government of Canada. (2016, December 12). North American Free Trade Agreement (NAFTA). Retrieved December 30, 2016, from http://www.international.gc.ca/trade- agreements-accords-commerciaux/agr-acc/nafta-alena/info.aspx?lang=eng Guisan, M.C. (2013). Macro-Econometric Models of Supply and Demand: Industry, Trade, and Wages in 6 countries, 1960-2012. Applied Econometrics and International Development, 13(2), 19-26: downloadable at http://www.usc.es/economet/aeid.htm Hufbauer, G.C. & Schott, J.J. (2005). NAFTA Revisited. Washington DC: Institute for . Irwin, D.A. (2011). Peddling : Smoot-Hawley and The . Princeton, NJ: Princeton University Press. Loretan, M. (2005). Indexes of the Foreign Exchange Value of the Dollar. Federal Reserve Bulletin, 2, 1-8. 87

Applied Econometrics and International Development Vol. 17-1 (2017) Ostry,S. (1997). The Post-Cold War Trading System. Chicago, IL: The University of Chicago Press. Pugel, T.A. (2016). International Economics (6th ed.). New York, NY: McGraw Hill. Pradhan, R.P., Hall, J.H. & Nair, M. (2016). Trade openness, foreign direct investment, and finance-growth nexus in the Eurozone countries.” Journal of International Trade and Economic Development, 1-25. Romalis, J. (2007). NAFTA and CUSFA Impact on International Trade. Review of Economics and Statistics, 89(3), 416-435. Stiglitz, J. (2002). Globalization and its Discontents. New York, NY: WW Norton & Company Stiglitz, J. (2007). Making Globalization Work. New York, NY: WW Norton & Company Trebilcock, M., Howse, R. & Eliason, A. (2013). The Regulation of International Trade (4th ed.). New York, NY: Routledge. US Department of Transportation (2017, January 4). Employment Impacts of Highway Infrastructure Investment. Retrieved January 4, 2017, from http://www.fhwa.dot.gov/policy/otps/pubs/impacts/ Villarreal, M. A. & Fergusson, I.F. (2015). The North American Free Trade Agreement (NAFTA). Washington, DC: Congressional Research Service. Warburton, C.E.S. (2011). Globalization and Monetary Convergence: Independent or Dollarization? In House-Soremekun, B. & T. Falola. (Eds.). Globalization and Sustainable Development in Africa (pp. 213-232). Rochester, NY: University of Rochester Press. Warburton, C.E.S. (2010). International Trade Law and Trade Theory. Journal of International Trade Law and Policy, 9(1), 64-82. Warburton, C.E.S. (2016a). The Delicts and Criminal Laws of International Economic Relations (2nd ed.). New York, NY: McGraw Hill. Warburton, C.E.S. (2016b). Merits and Demerits of Globalization. In E.L. Wonkeryor (Ed.), Globalization and its Implications for Africa (pp.115-130), Cherry Hill, NJ: Africana Homestead Legacy Publishers. Warburton, C.E.S. (2017). International Trade and Industrial Recovery in the US. Regional and Sectoral Economic Studies, Vol. 17-1, http://www.usc.es/economet/rses.htm Williams, B. R. (2013). Trans-Pacific Partnership (TPP) countries: Comparative trade and economic analysis. Washington, DC: Congressional Research Service. Wolf, M. (2004). Why Globalization Works. New Haven, CT: Yale University Press. WTO(2007). World Trade Report. Geneva, Switzerland: World Trade Organization.

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88 Warburton, C.E.S. Trade Treaties and Deglobalization

Annex

Imagine that the US has nine major trading partners (countries), Xynobia, Bygonia, Xanada, Patria, Freedomia, Myopia, Polis, Poveria, and Insula, and that the trading partners offer widgets for sale. For a start, the US can impose a nondiscriminatory tariff of $ 0.50 cents per unit (above the market rate) on the imports of widgets from Xynobia, Bygonia, Xanada, Insula, and others, because there is no trade agreement or international obligation to prevent such a tariff. The tariff is nondiscriminatory. At the very high price, US consumers will be willing and able to consume 50 thousand units of widgets at any given time. The higher and inefficient price of $1.75 per unit will encourage domestic producers to produce 30 thousand units of widgets. However, the producers are not guaranteed access to foreign markets where prices are competitive and access is restricted, because of external tariffs and nontariff barriers (NTBs); meaning that US producers must heavily rely on domestic consumption when output is high and imports are very low. To increase the welfare of US consumers, US policy makers can form a bilateral trade union with the less efficient Freedomia. The bilateral union with Freedomia reduces the markup and import cost by 25 cents, which is still expensive and noncompetitive even without a tariff. That is, it is rather costly to produce widgets in Freedomia relative to Myopia, Polis, Poveria, and Patria without a tariff. The new trade arrangement increases imports from 20 thousand units (50k-30k) to 40 thousand units (60k- 20k). Notably, some amount of unemployment is likely to occur, because of the decrease in domestic production from 30 thousand units to 20 thousand units and the increase in imports. The increase in imports reduces price from $1.75 per unit to $1.50 per unit, thereby increasing consumer welfare or surplus, because US consumers 89

Applied Econometrics and International Development Vol. 17-1 (2017) can now increase their consumption by 10 thousand units at a lower price when domestic wages are stagnant; triangles ACD and BEF approximate US . It must be noted that the bilateral union is suboptimal if additional gains can be derived from trade arrangements. That is, by ignoring Myopia, Polis, Poveria, and Patria (a plurilateral arrangement), trade is diverted. The exclusion of these countries from unionization means that the US is still importing at a higher price of $1.50 per unit when it can actually produce and import widgets at a cheaper price of $1.25 per unit. In effect, the US policy makers can actually increase the welfare of US consumers and eliminate the trade diversion represented by rectangle DEGH if they can include Myopia, Polis, Poveria, and Patria in a trade agreement. It is probably apparent by now that the controversial partial equilibrium analysis of Figure 1 might not necessarily be a very reassuring proposition for freer trade. The partial equilibrium model endogenizes price changes and the production and consumption of widgets but not the exogenous levels of unemployment, nominal wages, and policy responses. By presuming that the exogenous variables are not susceptible to disturbances (ceteris paribus), we can direct our attention to the effects of trade policy on the demand [for] and supply of widgets. RTAs cause unsavory unemployment results, which can be long-lasting, when public policies become insensitive or inadvertent responses to structural changes that emanate from trade agreements. However, trade arrangements should not be evaluated solely on the basis of the unemployment that they are momentarily going to generate. The value of net gains or losses, efficient production, and readjustment to structural changes that necessitated the agreements in the first place, must also be evaluated. So, what should be done with the [structurally] unemployed workers? Do countries face changing comparative advantage as time progresses into the distant future? Should any economy remain in a steady state when offering articles of trade? These are just some of the pertinent questions that are essential to understanding the dynamism of the global economy. Progressive nations are hardly content with unchanging articles of trade, or articles of trade that cannot penetrate foreign markets. Without recalibration or innovation, factors of production are susceptible to obsolescence. Therefore, workers need to be prepared for structural changes and forward looking opportunities in a dynamic world.

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