4 Conclusions

Throughout this book, we have referred to international agreements on trade, including multilateral agreements such as the GATT and WTO and regional agreements such as NAFTA. In this chapter, we have explored the rationale for these agreements more carefully, and discussed areas other than trade—such as labor standards and the environment—that these agreements encompass.

The first issue we addressed is why international agreements are needed at all. The answer is that there are strong temptations for countries to use tariffs for their own benefit, or to avoid adopting environmental regulations, as occurs when countries do not face the costs of their own global pollutants. In these situations, countries have an incentive to use tariffs or not regulate, but when all countries act in this manner, they end up losing: the outcome can be high tariffs or high pollution. This outcome can occur because the countries are in a “prisoner’s dilemma” in which the Nash equilibrium leads both parties to act in ways that seem right taken on their own but result in a poor outcome (i.e., both use tariffs or pollute). International agreements are needed to avoid these bad equilibria and restore a free-trade or low-pollution outcome.

A second issue we have addressed is that halfway steps toward the complete use of markets (as with complete free trade) can also have bad results. We found that such an outcome was a possibility with regional trade agreements, also called “preferential trade agreements,” if the amount of trade diversion caused by the agreement is more than the amount of trade creation. Because preferential trade agreements provide zero tariffs only to the countries included in the agreement but maintain tariffs against all outside countries, they are a halfway step toward free trade. Countries that are not members of the agreement are worse off from being excluded. We have also shown that such agreements might make the member countries worse off, too, because the lowest-cost producers can be excluded from the agreement.

Another case in which a halfway step toward open markets can make countries worse off is with the overharvesting of resources. We have argued that in the absence of property rights for an exhaustible resource such as fish, opening countries to free trade can lead to even more harvesting of the resource, to the point of near extinction or extinction. That outcome is bad for the exporting country, at least, and illustrates a negative externality in consumption. So free trade in the absence of well-defined property rights can lead to losses. Economists think of this case as opening one market (i.e., free trade between countries) without having a properly functioning market for the resource (no property rights). Viewed in that way, the overharvesting of an exhaustible resource is similar to trade diversion in a regional trade agreement, since the trade agreement also opens one market (i.e., free trade between member countries) without having complete free trade (tariffs are applied against the nonmember countries). Both overharvesting and trade diversion are bad outcomes that arise in settings in which markets are not functioning properly.

Finally, we have argued that actions by consumers, unions, and firms to improve labor standards and the environment are important. Such actions, including the protests at the 1999 WTO meetings, have made a difference in the rulings of the WTO in environmental cases: although environmentalists have lost some battles at the WTO, some observers believe they have won the war. We can also expect that such actions make a difference to the labor standards enjoyed by workers and the environmental safeguards used by firms.