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A world divided by trade deals?

The President-Elect of the United States, Donald Trump has promised to scrap the Trans-Pacific Partnership once he takes office. The TPP was set to be a monumental deal which was set to change global trade, however, now, this may not happen. In his piece for The Gateway of India Dialogue compendium in June 2016, Leon Berkelmans discusses the fragmentation of global trade. This piece has been published separately.

The Gateway of India Geoeconomic Dialogue will happen on 13-14 February 2017.

What sort of endgame does President Obama see in the push he and others are making for mega-trade deals? Will the endgame be a world where global rules are streamlined under a U.S. model, along the lines of the Trans-Pacific Partnership (TPP)? Or will it be a fragmented scenario, where China and deals such as the Regional Comprehensive Economic Partnership (RCEP) write the rules for one part of the world, while the U.S. writes them for another? Clearly Obama would prefer a U.S.-centric trade model, but a fragmented one cannot be ruled out.

We may be able to seek answers in the academic literature. Important papers have been written, from a theoretic and an empirical perspective, on whether preferential arrangements eventually lead to global free trade. Unfortunately, the literature offers few definitive answers. Theoretically, Harvard professors Philippe Aghion, Pol Antràs, and Elhanan Helpman find that preferential agreements can either be building blocks or stumbling blocks toward global free trade, depending upon the model’s features. [1]

Empirically, studies can be found that go either way.  Limão finds that tariff reductions agreed to by the U.S. under multilateral negotiations are smaller if the good is imported under a preferential agreement; this is consistent with the stumbling block thesis. [2] On the other hand, Baldwin and Jaimovich find that preferential trade agreements are in some sense contagious—if a given pair of countries signs an agreement, others are more likely to do so; this is consistent with a building block effect. [3]

Meanwhile, as the scope of the mega trade agreements expands, consolidating such deals has become more complicated. New “21st century agreements” often contain provisions on items such as competition law, anti-corruption, and environmental protections, which are in large part new. For example, a key feature of U.S.-driven agreements, whether they are bilateral or mega-regional, is strong intellectual property (IP) protections. This typically locks signatories into protections similar to U.S. law, which contains more robust provisions than WTO standards.

Little theoretical support is available for the inclusion of strict harmonised IP standards in trade agreements. This is because, unlike many goods and services, intellectual property is non-rivalrous. Gene Grossman of Princeton University and Edwin Lai of the Hong Kong University of Science and Technology have written about this in a paper titled ‘International Protection of Intellectual Property’. [4] They studied the theoretical underpinnings of harmonising intellectual property and concluded: “…harmonisation of patent policies is neither necessary nor sufficient for global efficiency.” They found that harmonisation shifts gains from the users of intellectual property to the producers.

Moreover, the stronger intellectual property protections that are included in trade agreements are unlikely to encourage innovation. There is a body of economic literature arguing that existing intellectual property protections inhibit innovation, [5,6] as efforts by companies are diverted toward protecting monopoly rights and away from research and creation. In a notable example from 1991, Bill Gates wrote “[i]f people had understood how patents would be granted when most of today’s ideas were invented, and had taken out patents, the industry would be at a complete standstill today.” [7]

Will the U.S. template, with its emphasis on IP, be acceptable to other countries? So far it hasn’t seemed to hurt the U.S.—other countries have been willing to sign preferential agreements with America. But the really tough nuts like China and India are still left to crack.

It is hard to see China signing onto these U.S.-influenced IP protections anytime soon. India was opposed to the stronger intellectual property protections that formed a part of the founding of the World Trade Organisation—its concerns included the restrictions IP would impose on medicines. However, at the time of singing in 1994, India acceded under the threat of being left out. [8] India has since shown it will hold up WTO negotiations if it is unhappy with the outcomes, as it did in 2008 during the “breakdown ministerial,” [9] and would conceivably hold up efforts to multilateralise further expansions in IP protections.

So it is unlikely that large emerging countries will embrace the U.S. template.

Perhaps, instead of the TPP, the RCEP, a proposed free trade area including both India and China, will form the basis of a multilateral deal. It will presumably reflect a trade agenda in line with the needs and vision of emerging economies.

However, I suspect the prospects of globalising this sort of deal are also poor. If efforts were made to expand the deal, it is difficult to see the U.S. signing on to something that lacks bite in the 21st century areas, like IP, it holds dear.

Perhaps fragmentation is the most likely outcome. But an even more consequential possibility is lurking in the current configuration of deal-making.

As of writing, passage of the TPP through the U.S. Congress is uncertain. In a sign that is not promising for its prospects, no major presidential candidate has endorsed the deal. If the Congress does not ratify the TPP, then what does the world look like?

It will still look fragmented, but perhaps not neatly carved up between a U.S. sphere and a non-U.S. sphere. And this brings up more questions. For example, if the TPP stalls, could this make it more difficult to finalise the Translatlantic Trade and Investment Partnership (TTIP) between the European Union and the U.S.?

If the U.S., which has championed the TPP, cannot ratify the agreement, it will also signal a clear failure of America’s global leadership. It will be another example of the country’s leadership credentials being spoiled in the Indo-Pacific—other examples include its long-delayed ratification of International Monetary Fund reform, and its mishandling of the Asia Infrastructure Investment Bank, when the U.S. unsuccessfully attempted to prevent allies from joining.

A common thread in all these instances is the U.S. Congress. It held up the IMF reform, and any proposal for AIIB membership would face enormous difficulties in getting the required votes (although the farce of attempting to prevent allies signing on had nothing to do with the Hill).

Similarly, the U.S. Congress could stop the TPP cold in its tracks. Connelly has argued that Congressional gridlock has hindered U.S. policy toward the Pacific because it had few champions in either house in recent years. [10] He suggests that new leaders need to be cultivated. The U.S. would do well to take note.

Leon Berkelmans is the Director of the International Economy Program and the G20 Studies Centre at the Lowy Institute. Prior to this, he was a Senior Manager at the Reserve Bank of Australia, where he worked on the Chinese and Indian economies, investment, trade, and financial markets. Leon has also worked at the Federal Reserve Board of Governors in Washington D.C. He has a PhD in economics from Harvard University.

The Gateway of India Dialogue was co-hosted by Gateway House and the Ministry of External Affairs on 13-14 of June 2016. The 2017 conference, The Gateway of India Geoeconomic Dialogue will be held on 13-14 of February 2017.

This article was exclusively written for Gateway House: Indian Council on Global Relations. You can read more exclusive content here.

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[1] Aghion, P., Antràs, P. and Helpman E., “Negotiating free trade”, Journal of International Economics, vol 73, no 1, 1–30, 2007.

[2] Limão, N.,” Preferential Trade Agreements as Stumbling Blocks for Multilateral Trade Liberalization: Evidence for the United States.” American Economic Review, vol. 96 no. 3, 896-914, 2006.

[3] Baldwin, R. and Jaimovich, D., “Are Free Trade Agreements contagious?”, Journal of International Economics, vol 88, no 1, 1-16, 2012.

[4] Grossman, G., and Lai, E., “International Protection of Intellectual Property”, American Economic Review, vol. 94 no. 5, 1635-1653, 2004.

[5] Boldrin, M. and Levine, D., Against Intellectual Monopoly, (Cambridge,Cambridge University Press, 2008).

[6] Tabarrok, A., Launching the Innovation Renaissance: A New Path to Bring Smart Ideas to Market Fast( TED Books, Kindle Edition, 2011).

[7] The New York Times, A Patent Lie, Lee, T, 9 June 2007, <http://www.nytimes.com/2007/06/09/opinion/09lee.html?_r=0>.

[8] Panagariya, A., India, the Emerging Giant, (New York, Oxford University Press, 2008)

[9] Brookings Institution, The Nine-Day Misadventure of the Most Favored Nations: How the WTO’s Doha Round Negotiations Went Awry in July 2008, Blustein, P., 5 December 2008, <http://www.brookings.edu/research/articles/2008/12/05-trade-blustein>

[10] Lowy Institute for International Policy, Congress and Asia-Pacific policy: Dysfunction and neglect, Connoelly, A., 2015, <http://www.lowyinstitute.org/publications/congress-and-asia-pacific-policy-dysfunction-neglect>