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August 26, 2013

What Free Trade With Europe Will Mean

Some sectors will thrive on more trans-Atlantic trade

Negotiation over the ­creation of the Transatlantic Trade and Investment Partnership, designed to reduce barriers to commerce between the United States and the 28-member European Union, got an unusually quick start in July, when the first meeting was held in Washington. The sides set a November 2014 target for reaching at least a preliminary agreement, and it looks like the deadline will hold. This contrasts sharply with the Trans-Pacific Partnership Agreement, where talks have been ongoing since 2010, without a deal in sight. Given the current economic conditions in Western Europe, as well as the kind of benefits the sides will get from TTIP, it is in their interests to conclude an agreement promptly.

Controversial Pacts

It is one of the fundamental precepts of economic theory that trade, investment and commercial ties benefit the economies of all trading partners over time, regardless of their relative strengths and level of development. Most mainstream economists therefore support tariff reductions and easing of regulations and other non-tariff barriers, since free trade leads to greater efficiency, higher economic growth, more wealth creation and more, better paid jobs. U.S. business is also by and large in favor of free trade.

The U.S. currently has free trade agreements with 20 countries, but most of them are small economies mainly exporting agricultural commodities, natural resources and garments sewn for U.S. retailers. The exceptions—Canada, Australia and South Korea—are industrial economies with wages and regulations comparable to those in the United States. But when Mexico, a large and poor economy, joined the North American Free Trade Agreement in 1994, the move was steeped in controversy on both sides of the border. Even now, nearly 20 years after NAFTA took effect, detractors blame it for everything from the disappearance of U.S. manufacturing jobs and the rise of illegal immigration to the loss of livelihood by small farmers in Mexico.

TTIP is a very different deal than NAFTA since it involves two markets of a roughly similar size and structure, where one side will not be able to undercut the other with low wages or lax labor, health, workplace safety and environmental regulations. The U.S. and E.U. are already the world’s largest trading partners, protective tariffs having already been slashed or eliminated; the U.S. exports over $450 billion worth of goods and services to the E.U., making it the largest single market for American exports. Investment flows are even larger, and the two sides have investments in each other’s markets valued at around $4 trillion. Overall, according to the Office of the U.S. Trade Representative, 13 million jobs in the U.S. and Europe depend directly on transatlantic business ties.

With trade flowing relatively freely, negotiations will focus on easing various non-tariff impediments to trade and investment, in particular on harmonizing regulations, making them more transparent and reducing the cost of compliance to businesses.

The Near Term

While some economists believe that TTIP will give greater advantages to the U.S.—because tariffs in many industries are higher in Europe and regulations tend to be more restrictive, fragmented and protectionist across a range of member states—the European Commission in Brussels sees a greater benefit accruing to the E.U. Cutting tariffs would increase output in Europe by $140 billion annually by 2018, and in the U.S. by over $90 billion. A 2009 study by the Dutch consulting firm ECORYS, undertaken on behalf of the European Commission, estimated that eliminating tariffs and non-tariff barriers would increase GDP in Europe by 0.7% annually and in the U.S. by 0.3%.

However, these statistics do not take into account the situation in Europe following the outbreak of the 2010 euro-zone government debt crisis, which pushed the region into a deep and protracted recession. Consumer demand across the euro-zone has been slashed, declining especially steeply along the southern periphery of the continent. In Spain, retail sales are down by nearly 20% since 2010.

In mid-2013, the recession in the region appeared to have eased, or at least consumer confidence reached a 16-month high and unemployment inched lower. But economists warn that even if these are the first green shoots of a Europe-wide recovery, it is going to be long and sluggish. Fiscal policy has to remain restrictive for fear of spooking bondholders once more, lending conditions are still tight and the number of unemployed is still at record highs and growing in some countries.

Consequently, Europe’s industries and companies will benefit if they can increase their exports to the U.S. market, especially in light of a stronger consumer-driven recovery in the U.S.

European Cars

The European market for motor vehicles has been decimated by the government debt crisis, which came fast on the heels of the 2008–09 global financial debacle in which automotive sales also suffered. In the first half of 2013, new car registrations in Europeshrank by 6.7%, and unit sales were at their lowest level since 1993. Mass market carmakers, especially France’s Renault and Peugeot, which rely on European markets for sales, have been reeling. Italy’s Fiat has maintained profitability only because it owns Chrysler, and both GM and Ford have been spilling gallons of red ink in their European operations.

If TTIP goes through, its impact on the automotive industry will be staggering and it will reach far beyond Europe’s and America’s borders. The two regions account for nearly one-third of global automotive production and slightly more than that in automotive sales worldwide—and even more so in dollar terms, since their rich consumers tend to buy more expensive vehicles. Almost two-thirds of cars and trucks on the road today ply American and European highways.

Initially, at least, Europe’s auto industry could be a huge winner while U.S. auto makers will likely take a back seat. Bilateral automotive trade between the U.S. and Europe, which includes vehicles and components, stands at nearly $60 annually. It is the largest single component of bilateral trade.

Moreover, even before the euro-zone slump, trading in vehicles and parts was mostly one-way: Ford and GM source their products at their European plants, so that the Detroit Big Three export few vehicles to Europe. But European automotive manufacturers, on the other hand, still mostly manufacture their vehicles at home and ship them internationally.

American Dynamism

Given soft economic conditions in the euro-zone, benefits to U.S. companies and American GDP will be much slower to accrue. But even in the automotive industry they will be tangible. For example, while European automakers pay 2.5% on cars that they export to the United States, EU tariffs are higher. The recent revival of U.S. carmakers, including Chrysler, indicates that U.S. cars and SUVs will soon start growing market shares in various export markets, including Europe.

The sectors where U.S. companies will benefit strongly from TTIP are electronics, office equipment, finance and insurance, which together should add to America’s bottom line around $9 billion by 2018.

While this will only boost U.S. exports to Europeby 2%, harmonizing regulations with the 28 European states should benefit smaller companies. Currently they lack resources and international expertise to deal with regulatory red tape across EU countries. Eliminating this aspect of international trade will be particularly welcome to high-tech startups in such areas as information technology, engineering, renewable energy and electric battery technology. Such companies tend to be more dynamic; they create most jobs, breed entrepreneurs and help the U.S. maintain its leadership position in innovation. Consequently, while over the near term crisis-plagued Europe should be more strongly incentivized to achieve an agreement on a transatlantic free trade zone, the greatest long-term gains will go to the U.S.

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