President Donald Trump believes international trade agreements such as the World Trade Organization are a bad deal for the United States. He fails to see how these agreements provide the rules that govern international commerce.
The WTO and other regional free trade agreements create more certainty for global businesses, expanding investment at home and abroad. These agreements also increase the flow of products and services across borders. Consumers can buy less expensive items and have a greater variety.
Since the end of World War II, U.S. leaders have striven to open the global economy. These efforts have resulted in a free flow of goods, services and investment. The United States and the rest of the world have benefited from these changes. The Peterson Institute for International Economics estimates that the United States real GDP was $2.6 trillion, or $20,000 per household, higher in 2022 because of international trade.
Trump’s trade policy actions will blow up the post-World War II trade consensus and system. During the first Trump administration, he blocked the appointment of judges who sit on WTO dispute tribunals. He started a trade war with China. He learned little from these ineffective policies. Trump II is doubling down on unilateral policies that will weaken established international agreements and make the United States less prosperous.
Why are agreements such as the WTO so valuable and worth keeping? Up until now, members of the WTO have abided by the established rules of the game. When violations or disagreements occurred between countries, they did not act unilaterally. Instead, they dealt with trade disagreements through the established resolution process. The president’s approach to international commerce will decapitate a system that has worked for years.
As was pointed out years ago by Nobel Prize-winning economist Edward Prescott, a significant problem facing businesses is that economic policies, such as taxes, regulations and tariffs, can change after decisions to invest or enter a market are made. These unexpected policy changes affect the profitability of businesses, often negatively. For global companies, trade agreements help reduce the uncertainty surrounding trade and international investment.
Trade organizations such as the WTO and preferential trade agreements allow governments to commit to a set of rules. In a sense, they tie their policymaking hands, reducing policy uncertainty and resulting in higher levels of international commerce and economic growth.
The free international movement of goods and assets increases a country’s standard of living. Suppose today’s government announces it will follow a free trade policy to help the economy grow. Under that free trade regime, domestic and foreign businesses make profitable investments that expand their engagement in the international economy. Now, suppose a new government argues it can improve the economy by imposing import tariffs. Some past investment decisions may become unprofitable but cannot be changed or are costly to change.
If businesses had known about this change in trade policy at the time they were making their decisions, they may have made a different choice. In an environment where domestic and foreign businesses are unsure about a country’s future international economic policies, global business expansion will decline. The result is depressed exports, imports and investment, which slows economic growth. What is needed is a credible way to commit the country to a long-term free-trade policy, reducing international economic policy uncertainty.
One way to reduce uncertainty over international economic policies is to form international trade agreements. The WTO requires a member country to commit not to raise tariffs above a certain binding level set by the organization. In return, the other members of the WTO agree to keep their tariffs at or below the same binding levels.
WTO membership imposes policy discipline and a set of rules to resolve international policy disagreements. Those rules serve as a device to commit to a policy of lower trade restrictions. They are binding commitments about the future course of trade policy. These commitments should promote more credible international economic policies, which would lower economic policy uncertainty and expand trade.
Agreements that lower barriers to trade will expand trade. One careful study by Scott Baier and Jeffrey Bergstrand found that bilateral trade flows will double in the 10 years after a free-trade agreement, providing convincing evidence that trade agreements do increase trade flows.
Rather than fixating on trade imbalances that are unrelated to tariffs, the president should focus on the more stable economic environment that trade agreements create, which promotes prosperity.
Robert Krol is an emeritus professor of economics at California State University, Northridge. He wrote this for InsideSources.com.
