The Philosophy of Free Trade

It is fair to say that IEA's latest paper "A trade policy for a Brexited Britain" took a bit of a battering. Unfortunately the paper makes some fundamental errors in arguing that Britain will keep zero-tariff access to the EU market by default.  Under WTO MFN (Most Favoured Nation) rules, by default Britain will face the EU's common external tariff.

This is a shame, because the paper read wells as a philosophical case for classically liberal free trade. We are reminded that Adam Smith's great insight was that consumers should be prioritised over producers. Tariffs are recognised as a self-harming import tax that increases consumers prices and input prices for manufacturing. Free trade reduces market distortion and brings greater efficiency & productivity. Workers move up the value chain and increase their earnings. Trade should be correctly understood as a mutual benefit, not erroneously viewed as a zero-sum game - protecting producer interests is ultimately counter-productive.

Hence international trade negotiations should be based on promoting the consumer interest and confronting producer protectionist instincts, rather than attempting "tit-for-tat" exchange of concessions. While Multilateral Free Trade (MFT) is the ideal, Unilateral Free Trade (UFT) can still bring considerable benefits - Hong Kong and Singapore are cited as successful modern examples of UFT.

Critics will say that nowadays non-tariff barriers are the main concern, not tariffs. Actually, the IEA paper agrees, stating (on page 10): "But tariffs have come down over the years and non-tariff barriers are now much more important." I suspect what really irks the critics is the IEA identifying regulatory harmonisation as the source of many non-tariff barriers. Personally, I found myself in broad agreement with the points made.

Modern trade deals are attempts to harmonise all sorts of regulations beyond trade. The 5,000 pages long TPP is described as "weighed down by numerous non-trade provisions aimed at appeasing non-trade special interests". Historically, trade was seen as a means to open and strengthen friendly ties between countries - allowing for an exchange of ideas and development of mutually beneficial policies in other areas. Withholding trade as a means to impose policies on third countries seems to be fundamentally illiberal to me.  Surely, a more liberal way to achieve these policy goals is via international treaties and organisations (e.g. ILO for labour regulations, UNEP for environmental regulations etc.) - which are based on consensus and willing opt-in, not compunction.

Moreover, I wholeheartedly support mutual recognition over regulatory harmonisation. Harmonisation creates "one-size-fits-all" regulations with all the attendant problems. Rather than avoiding a "race to the bottom", the result is often "lowest common denominator". Enforced homogeneity leads to a higher risk of catastrophic failure - think Irish potato famine for an example of how disastrous homogeneity can be.

By contrast, mutual recognition allows a choice of regulatory regimes and regulatory competition - allowing room for innovation and discovery of best practice and cost effectiveness. This will always beat regulations imposed in a "top-down" manner by regulators with limited information/experience and subject to capture by special interests. Philosophically, this is a choice between the wisdom of technocrats versus the wisdom of crowds - between central planning and a dispersed and diverse market approach.

Moreover, mutual recognition allows countries with differing regulatory regimes to still enjoy the benefit of trade. Mutual recognition agreements by definition are an agreement to recognise that regulatory objectives have been met via a different routes. Furthermore, use of recognised international standards (as per WTO TBT agreement article 2.4) allows the for recognition of regulatory equivalence. I would also emphasise that regulatory co-operation to minimise non-tariff barriers is an important aspect of a trade relationship.

Unfortunately, the EU does not seem to follow a philosophy geared to free trade. Brussels is the perfect example of a plutocratic ivory tower bureaucracy.  Its secretive lobbying system all too often falls prey to special interests - ranging from the German automobile industry (emissions  scandal)  to well-heeled executives of NGO's (Non Government Organisations).

The EU Single Market is essentially a regulatory union, enforced by supranational regulatory harmonisation handed down from Brussels. The EU acquis is exported as a means of extending Brussels control - it has precious little to do with trade liberalisation.

Worse still, the often EU insists on harmonisation in its trading relationships with third countries. Typically, the EU requires harmonisation well beyond trade, straying into areas like human rights and demanding political action as a price for trade. Where does this end ?  In the future will the EU start insisting on specific social policies as a pre-requisite to enjoying tariff-free Camembert ?

Critics of the paper are right to point out that the EU does not get to choose over whether to apply tariffs to Britain as a third country. But it is also true to say that a straightforward agreement to continue zero tariffs takes no real negotiation and Britain will be happy to agree. Even with respect to non-tariff barriers, Britain starts from a position of 100% harmonisation and there is no good reason why  the EU should not agree Mutual Recognition or Equivalence. Indeed, international treaties to which the EU is party "encourage" members to enter such agreements.

Britain will adopt a Free Trade philosophy - the key question is does EU want to join in ?