Economists, unlike politicians, are often sceptical about the extent of any net benefits of free trade agreements. Economists are often concerned that such agreements may result in trade diversion rather than trade creation, due to the application of different tariffs on imports from different countries. Consequently, they would be more accurately described as being “preferential” rather than “free” trade agreements.
Politicians, on the other hand, like to sign these types of agreements as they provide “announceables” that look substantial and provide an opportunity for fanfare and media coverage.
However, even if the net gains to Australia won in a free trade agreement are minimal, our research shows they can still be worth signing as a form of insurance against a future rise in protectionist tendencies.
The use of the term insurance in this case means the ability of one government to both bind and restrict the choices of subsequent governments. This applies to all countries that form part of the agreement as well as their successors.
The bias in recent agreements signed by Australian governments is to build in measures more favourable to economic openness. Similar measures have been taken by other countries in the the Asia Pacific. Many countries are fearful of being isolated from a growing new world order comprised of a complex web of preferential trade agreements.
Possible future recessions or depressions could provide momentum for protectionist policies, although the world was fortunate this did not happen during the global financial crisis. Neo-classical theory of trade liberalisation emphasises the importance of comparative advantage. It assumes a flat world where there is little intervention or distortion caused by government.
Whereas, the history of international relations tells a different story of concern and doubt within domestic polities about the intentions of other nations. In creating more preferential trade agreements, governments may well be seeking insurance against future protectionism.
The controversial Investor State Dispute Settlement (ISDS) mechanisms - where investors may take action in an international court against a country’s jurisdiction if it believes it is being denied access to markets - can be thought as a form of insurance against the possible future incentive for sovereign states to appropriate foreign investment.
Including such agreements offers investors from all countries greater surety that there investments will not be confiscated without compensation. Agreements can be crafted in such a way to safeguard the government’s ability to legislate in the public interest on matters such as health, environment, cultural heritage or safety.
The former Labor government accepted the Productivity Commission’s 2010 recommendation against including investor state dispute mechanisms in trade agreements. But the current Coalition government is more open to them. The newly signed South Korea-Australia FTA contains ISDS mechanisms; the Japan-Australia FTA does not.
The current compensation claim by tobacco giant Philip Morris challenge against Australia’s plain packaging laws under the Hong Kong bilateral investment treaty is testing these type of issues. Notably, Philip Morris moved its ownership to Hong Kong, which enabled it to be able to take advantage of this particular investment treaty.
A preferential trade agreement is an interesting device to respond to the governance challenge of how best to manage openness to international trade and investment flows. It provides some surety for governments in their international relations on trade, and in domestic public policy to bind and restrict the actions of future governments, or at least change the playing field for future governments.
For international investors such agreements, where they include provisions for dispute resolution, create new opportunities for binding future sovereign governments.