Trade’s Real Enemy is Regulation

Free trade has brought countless benefits over the past two centuries. It allows for specialisation among nations that has brought down the cost of living for people the world over. Unfortunately, it is now in peril. 

Mercantilism – the idea that exports are good and imports are bad – is back in fashion. Populist politicians around the world rail against jobs lost to other countries and demand punitive tariffs. Trade megadeals like the Trans-Pacific Partnership and Transatlantic Trade and Investment Partnership are dead or dying. 

Frustrated displaced workers look for a cause of their woe. As a result, trade gets blamed for problems caused by regulation.

Yet we may still see some positive developments that will increase freedom and the benefits from trade. It depends on politicians’ willingness to give up control.

That’s because trade’s enemy number one is something politicians love: regulation. Trade leads to what Joseph Schumpeter called “creative destruction” – old industries and companies that can no longer compete disappear, giving way to more beneficial and creative industries and businesses. 

Heavy-handed regulations impede that creative process. Labour regulations, for example, may help someone hold on to an existing job. But when that job is rendered obsolete by competition, that same person will find it much harder to find a new job because those same regulations make hiring more expensive. Companies are not formed and economic opportunities are missed. Frustrated displaced workers look for a cause of their woe. As a result, trade gets blamed for problems caused by regulation.

That gives cover to politicians looking to protect domestic industries from increased foreign competition. They use regulation as a sort of backdoor tariff. If you cannot charge a tariff on imports, you can effectively ban them by imposing onerous regulations that erode other nations’ competitive advantage – in a phenomenon called “non-tariff barriers”. 

Reduced regulatory burdens would enable greater economic growth by allowing creative destruction to give many countries’ economies a necessary shake-up.

A widely accepted approach for addressing non-tariff barriers has been to negotiate increasingly complex trade deals, trading off a barrier on one side for one on the other, and “harmonising” regulations across borders. The problem is that harmonisation has generally meant ratcheting up regulatory requirements to meet the most onerous among an agreement’s parties.  

This led to a global trade regime that cannot accurately be called free. The big trade deals are really about managed trade, with politicians and bureaucrats setting the parameters for trade. Non-tariff barriers have been a major issue of contention in negotiations of the General Agreement on Tariffs and Trade (GATT) and its successor, the World Trade Organisation.

The European Union took harmonisation of non-tariff barriers to unprecedented levels. The EU created a customs union in which most trade within the union was subject to the same regulations. However, the union also acted as a giant non-tariff barrier to the rest of the world. For example, African countries desperate to sell their agricultural produce in Europe found themselves unable to do so because of the dictates of the Common Agricultural Policy. World trade found itself segmented into regional blocs such as the EU and the North American Free Trade Agreement.

These regional blocs have done little to gain popular support for even slightly liberalised trade. The problem has been the impact of domestic regulations on various industries. Americans who have lost manufacturing jobs to Mexico or China now find themselves in a job market where 25 per cent of professions require occupational licensing, a major barrier to starting your own business. With the annual cost of regulation on the US economy approaching $2 trillion, fewer small and medium­-sized businesses are being created, and historically it has been those businesses that have provided new jobs. 

Mercantilism – the idea that exports are good and imports are bad – is back in fashion.

Yet there is a way forward for trade policy. Even a vocal free trade sceptic like President Trump has said that he is open to a free trade agreement with a post-Brexit Britain. Other advanced economies such as Canada, South Korea and Australia have said the same. If these agreements go back to the original premise of GATT – “a substantial reduction of tariffs and other trade barriers … on a reciprocal and mutually advantageous basis” – it could be possible to negotiate trade agreements based on mutual recognition of regulatory systems, rather than regulatory harmonisation.

Such trade deals would help advance not more regulation, as is the case with harmonisation, but less onerous regulation as a result of competition. Moreover, if a principle were to be set that countries that meet certain minimum but exacting standards for stable business environments could join the club, it would encourage economic liberalisation in other areas worldwide. Requirements should include recognition of private property rights, strong rule of law and contract protection. Meanwhile, reduced regulatory burdens would enable greater economic growth by allowing creative destruction to give many countries’ economies a necessary shake-up.

Such a new world trade order is plausible, but it would require a radical change of approach from developed world governments. With that in mind, the first thing Theresa May should do after her likely re-election in June is to call a meeting of her allies to discuss how such a “GATT 2.0” could help spread the benefits of world trade.