Close, but no Cigar: Bilateral Trade Pacts and Free Trade

In a recent speech [1] by George W. Bush delivered to the Organisation for American States (The Washington Post, 18 April 2001), the U.S. President reiterated his nation's commitment to pursue open trade 'at every opportunity'. Whilst the motivation behind seeking a removal of trade barriers is a laudable one and should be encouraged, the method by which this is effected - bilateral trade agreements - is a veritable minefield and deserves to be approached carefully.

Economists have long argued for the need to promote free trade; the basic principles of comparative advantage - that countries that engage in trade are able to specialise in what they are able to produce relatively better and hence reap the benefits of mutual exchange - still hold true today, at least in most situations [2]. However, in an evangelistic drive to tear down trade barriers, one must not immediately assume that any step towards trade liberalisation is necessarily a positive one. Indeed, academic opinion on this issue is decidedly mixed, with some economists (notably, Fred Bergsten from the Institute for International Economics) holding the belief that bilateral, or more generally, regional trade agreements are stepping stones to eventual multilateralism; and others (such as T. Srinivasan of Yale and Jagdish Bhagwati of Columbia) insisting that they are stumbling blocks.

The main economic arguments underlying support for free trade lies in the static gains - the so-called 'trade creation' argument - where due to tariff reductions, imports from a partner displaces less efficient local production, as well as the dynamic gains - including, but not limited to, the spur to growth and productivity that free trade agreements engender. Stacked against these are the equally convincing counter-arguments centred on trade diversion effects (of tariffs, either explicit or implicit, imposed on nations not a party to the agreement), and the complex web of costs imposed due to the need to observe rules of origin, where the free trade agreements signed require substantial shares of a good to originate in the member country.

As such, the gains from being part to a bilateral free trade agreement are far from clear. 'Open regionalism' - touted as the panacea to ensure such agreements tip the scales towards the side of welfare gains - have ambiguous effects on overall welfare since formal calculation of the costs of rules of origin are difficult to ascertain; moreover, the determination of endogenous factors such as the amount of trade diversion can never be predicted with any amount of certainty. These uncertainties prompt the need to re-examine our common assumptions on the need to promote free trade at all costs. Indeed, such costs may well be too high, especially when we are ill informed regarding the full and final economic consequences of bilateral trade agreements.

Why, then, do governments continue to seek an agenda for bilateral trade pacts, when the evidence - both theoretical and empirical - remains so murky? In order to distil the aims behind the Bush declaration, there is a need to look beyond the simple economics and into the political economy arguments surrounding the issue.

Foremost would be the need to send - as a credible signal - the commitment of the U.S. to free trade, and, concomitantly, the need for regimes opposed to unfettered trade flows to rethink their antagonistic stance. It is, after all, in the interests of all nations to engage in a multilateral trading platform that will yield increased benefits for all. Through this leadership move, the U.S. can not only placate political pressure groups at home (most significantly, the business lobby that is so closely affiliated with the president) but concurrently establish a stable core of pro-trade nations from which future multilateral movements draw from.

The danger signals here would be that arising from excluded parties - 'second track' nations that might find themselves behind in the trade liberalisation curve. There is a very real risk of alienating members that are currently already members of NAFTA or the wider FTAA, since bilateral agreements would imply the need for these excluded members to be more fastidious about the practice concerning rules of origin, and possibly even resentment, due to the implicit branding that these economies - whether through circumstance or by choice - are somehow not quite 'ready' for the big stage of globalisation. Worse, accusations could arise that since the administration is preoccupied with bilateral trade negotiations, their attention and interest in pursuing the more encompassing multilateral undertaking is somehow diminished.

How, then, should nations respond? Whilst there is no clear-cut answer, perhaps the best way forward would be a concerted effort by these lead nations to push through trade negotiations at the multilateral level. Of course, this is easier said, but much can be achieved if these principal economies lay aside some of their more astringent demands from the developing nations - one thinks of paternalistic labour laws and extreme environmental strictures in particular - and kick-start the stalled international trading process. On the part of the excluded members, less criticism and more effort in moving their own nations towards trade liberalisation would be in order. In the final analysis, only with the co-operative endeavours of all nations will we move toward a world without trade restrictions, one that would lead to increased welfare for all.


'US to Pursue Bilateral Trade Pacts', The Washington Post, 18 April 2001

Speech by U.S. President George W. Bush to the Organisation for American States, Washington, DC, 18 April 2001. Online:


1. Students of international trade theory would note that there are special cases - in particular, in the large country case - where a country's welfare may actually be improved by the imposition of an optimal tariff rate. This is however theoretical issue and is hardly contentious in most practical considerations.

2. The full text of the Bush speech can be obtained from the OAS website,

This article is unpublished.