EU Monitor

European integration

January 24, 2017

Coping with mixed feelings

What future for European trade policy?

Author

Patricia Wruuck

+49 69 910-31832

patricia.wruuck@db.com

Editor

Barbara Böttcher

Deutsche Bank AG Deutsche Bank Research Frankfurt am Main

Germany

E-mail: marketing.dbr@db.com

Fax: +49 69 910-31877

www.dbresearch.com

DB Research Management

Stefan Schneider

It is hard to overstate the importance of trade policy for Europe.The EU28 is the largest trading bloc, the top trading partner for about 80 countries worldwide and ranks 1stfor in- and outbound investment.

EU agreements to foster trade (and investment), however, have sparked mixed feelings more recently given the backlash against globalisation as well as EU- internal controversies over the power to strike such deals. Nonetheless, free trade agreements (FTAs) are going to remain important for the years to come.Their key advantage is flexibility. The question of a post-Brexit arrangement with the UK is just one case in point.

A wide-ranging network of FTAs support the Union's trade ties and forms a key element of its trade strategy. At present, the EU has 44 agreements in place with more than 60 countries across the globe. The share of EU trade covered by FTAs could soon exceed the 40% mark, with new agreements being concluded or entering into force, e.g. with Singapore, Vietnam, Canada or Japan.

The EU's FTAs vary substantially, depending on partners and policy priorities. Trade agreements are about more than reducing barriers to commerce.

Historically, they have served as a policy instrument to strengthen bilateral ties between partners and can also be used to promote policy principles or values.

"New generation trade agreements" with new challenges: New generation trade accords go beyond traditional tariff reductions, including issues like services trade, intellectual property or investment. This reflects the rise of global value chains and multilateral disciplines in some areas being less advanced.

Arguably, these issues are particularly relevant for the EU but the new type of trade accords also come with new challenges.

Reconciling the European system of multi-level governance and internal sovereignty sharing with negotiating new generation FTAs remains a key issue. Yet, the EU's ability to conclude trade deals is also contingent on political support. Rising scepticism about globalisation means, that (potential) distributional effects of FTAs and their (potential) interaction with national legislation, is going to feature more prominently throughout negotiations and in the public debate.

FDI dispute resolution has proved one of the most controversial points in recent trade negotiations. A more thorough reform of investment governance could help to address some of the issues with the current system. The EU and Canada have recently made the case for reform but an overhaul of the current system would require substantive global cooperation.

The Trump campaign questioned the usefulness of current trade agreements. Actions following words could easily trigger a slew of legal challenges ‒ both domestic and at the WTO ‒ and cause serious economic damage.

Back in the spotlight: Trade policy

The EU in global trade: Growth in interconnectedness during past decade 1

In EUR bn 2000

1500

1000

500

0

2005 2007 2009 2011 2013 2015

EU exports-goods EU imports-goods EU exports-services EU imports-services

Sources: European Commission, Eurostat

Trade policy has never been uncontroversial. However, 2016 brought it back in full spotlight with (fears of) globalisation seeming to reshape politics in developed economies.

Free trade agreements (FTAs) have come particularly under fire. Challenged by anti-globalisation protests and called into question in election campaigns, the future of trade accords like TTIP or NAFTA currently look uncertain. At the same time, the global trading system may well be in for a new round of trade deals,

e.g. if the UK opts for restructuring its trade relationships with the EU and other countries via FTAs.

As for the EU, the seesaw about CETA showed some of the issues that far- reaching trade agreements are facing. These are both legal and political, including questions such as the scope of the Union's trade policy competence, what issues trade accords can and should address, the public perception of (EU) trade negotiations and some FTAs in particular.

Stable trade relations with its partners are key for an advanced economy like the EU, its consumers, and companies and FTAs can play a vital role in supporting ties. In fact, the certainty they can add is (all the more) valuable in times of high (political) uncertainty. Yet, EU trade policy risks being caught up between domestic and global challenges at the moment.

The key domestic issue is ensuring support for common trade policy - both among the public and EU member states. Notably, this includes better communication of EU trade policy, its rationale, implementation and results as well as strategies to address the disruptive effects of trade (and the fears thereof). Globally, the EU has been trying to reconcile its bilateral and regional agenda with support for the multilateral trading system. The latter looks likely to be further tested in the coming years, e.g. due to looming trade disputes between key players - take for example the recent challenge of the US and the EU over methodologies for antidumping duties by China - or countries prioritizing bilateral goals over multilateral commitments. While the EU has a well-developed FTA network and agenda to fall back on, some of the most difficult issues in its FTA negotiations, e.g. the investment dispute settlement, could be easier to address - internally and externally - with a stronger multilateral framework.

The EU's trade position

Europe plays a key role in world trade. Altogether, the EU28 is the largest trader in goods and services. With EUR 2,388 bn it ranks 2ndin imports (US: EUR

2,522 bn) and takes the top position for exports (EUR 2,603 bn, followed by China with EUR 2,258 bn).1

EU total trade in goods increased by 57% from 2005 to 2015 and - albeit from a lower basis - services surged by 94%. Notwithstanding the growth in absolute volumes, the EU's share in world trade, 14.7% for trade in goods and 22.2% for

trade in services in 2015 compared to 17.5% and 24.1% in 2005 respectively, slightly declined due to a mix of domestic and external factors.2 Shares for the US are similarly lower than 2005 while China's role in world trade has clearly

1 Volumes for trade in goods and services excluding intra-EU trade, 2015. Source: European Commission, Eurostat (2016).

2 Domestic factors include demography and the effects of the financial and economic crisis. External factors include the growing importance of emerging economies in world trade, notably China which

increased its trade substantially since the country entered the WTO in 2001.

Three largest traders worldwide 2

In EUR bn (2015), for EU: trade with extra EU28 6000

5000

4000

3000

2000

1000

0

EU US CHN

Total goods Total services

Sources: European Commission, Deutsche Bank Research

increased during the past decade (14.9% trade share for trade goods, i.e. + 6 pp compared to 2005, and + 4.7 pp for trade in services bringing the share to 9.1%).

Similarly, the EU28 is a key source of and destination for global investment. In 2014, it ranked first in inbound investment with a total of EUR 118.9 bn in inflows and EUR 96.1 bn in outflows (2ndto the US which recorded outflows of

EUR 253.6 bn). Foreign direct investment in the EU (2014: EUR 4.583 bn) makes up for about 26% of global FDI stocks and investment in European firms in other parts of the world (EUR 5.749 bn) amount to more than a third of global stocks.3

The quick glimpse at trade and investment figures emphasizes the EU's global interconnectedness. As a bloc, the EU28 is the top trading partner for about

80 countries worldwide and the 2ndmost important partner for another 40.4A wide-reaching network of trade agreements and investment treaties that has developed over decades supports these connections.5

The EU's trade agreements

At present, the EU has 44 trade agreements in place with more than 60 countries across the globe.6 In addition, five accords have been finalised but are not yet being applied (with East African countries, Ecuador, Singapore, Vietnam and West Africa).

FTAs: More and broader scope

3

FTAs aim to reduce tariffs and non-tariff barriers (NTBs) between partners. While strengthening ties, economic integration is less advanced than in aCustoms Union (also requires common external tariff) or aCommon Market with free movement of capital, labour and people and (some) harmonisation of policies.

During GATT (1948-1994) members notified 124 regional trade agreements (on trade in goods). Since 1995, about 400 arrangements for goods and services have been notified.

WTO members currently have 19 customs unions and 238 FTAs in force (total regional trade agreements: 431).

FTAs can vary considerably in terms of scope and ambition, particularly for issues beyond tariffs. Services have increasingly formed part of trade agreements and by now the majority of physical agreements cover both goods and services. In addition, FTAs have been including elements that are only partly or not covered by WTO rules.

Sources: WTO (2016), Deutsche Bank Research

Trade agreements are flexible instruments and their content reflects relations with and priorities of the EU and its different partners. Basically, EU trade policy distinguishes between three types of accords7, i.e.

  1. Partnership and Cooperation Agreements - which leave customs as they are and provide a general framework for bilateral and economic relations, for example with African and Caribbean partner countries.

  2. Customs Unions - which eliminate duties with the respective trading partner and establish a joint tariff for foreign imports, for example with San Marino and Andorra or the Customs Union with Turkey (for trade in goods).

  3. Association Agreements, Stabilisation Agreements and (Deep and Comprehensive) Free Trade Agreements and Economic Partnerships - which remove or reduce customs tariffs in bilateral trade, for example with South Korea (FTA), Canada (deep and comprehensive FTA) or Serbia and Albania (both with Stabilisation and Association Agreements).

Trade agreements are about more than reducing barriers to trade. They are a policy instrument to strengthen bilateral ties between partners and can also be used to promote certain principles or values (e.g. environmental protection or animal health). FTAs are typically based on the idea of reciprocal liberalisation. However, Economic Partnership Agreements do not necessarily require (immediate) reciprocal market opening from partners, reflecting their history as an attempt to promote economic development through trade. Some trade accords are part of broader political agreements, e.g. association agreements.

The EU's trade agreements are quite heterogeneous, reflecting characteristics of trading partners' economies, bilateral trade ties as well as their dates of negotiation and conclusion. Notably some of the older agreements are currently undergoing modernisation.

3 See European Commission, Eurostat (2016).

4 See European Commission (2015).

5 Other factors are of course the EU's geographical position and the multilateral trade system of which the EU and its member states have formed part.

6 Source: European Commission, DG trade. Dec. 2016. This includes different types of agreements. Accords with country groups are counted as one.

7 Source: European Commissionhttp://ec.europa.eu/trade/policy/countries-and-regions/agreements/

Trade agreements are not all alike

Trade agreements can be classified in different ways, ranging from age or partner country characteristics, the degree of market access they foster, the type of trade they cover, whether they require reciprocal market opening, and potentially also looking at more political elements they include.8 Breadth of trade

Do trade agreements really increase trade?

4

The short answer is "yes" on average - but not all trade agreements do so to the same extent (see e.g. Baier/Bergstrand 2007, Baier et.al 2007 and Kohl 2014).

One explanation for varying impact is the heterogeneity of agreements for example in terms of design, institutional quality etc.

Different characteristics of accords can also affect the credibility of commitments.

Handley and Limao (2015) find that credible preferential trade agreements can increase trade even if applied barriers are already low and that agreements can play an important role in removing uncertainty about future trade policies which in turn spurs export investment.

Source: Deutsche Bank Research

accords is easier to capture than depth. In the first case, issue areas (e.g. goods, services, intellectual property) that are typically addressed in different chapters, can serve as one proxy.9 Depth is more elusive: Some trade agreements for instance contain provisions to somewhat open up labour or

capital flows bringing it closer to a common market. Also, accords can contain provisions and set up fora for dispute settlement or establish policy dialogues in

certain areas, which can be a way to foster closer cooperation.

A recent distinction is between "classic" trade agreements which mainly focus on liberalisation of trade in goods and "new / 2ndgeneration accords" which cover areas beyond trade in goods, such as services, intellectual property or rules for investment. While still seeking tariff reductions in some areas, a key focus is the reduction of non-tariff barriers. Basically, the 2ndgeneration accords are broader and deeper, the recent agreement with Canada (CETA) being one example for this type of agreements.

Agreements on trade and investment tap very different worlds

While trade and investment are (ever more) closely linked, particularly through global value chains, it is worth pointing out some distinctions between agreements on trade compared to the area of investment. First, the basic goal of rules in the two areas differs. Rules for trade originally aimed at smoothing flows of goods by reducing protection at the border (thereby encouraging trade) whereas arrangements for FDI are about protecting property rights of foreigners within another country's borders (thereby attracting investment). In practice, things are more complex but the different origins still show in today's debates.

Second, the degree of multilateralisation and institutionalisation is more advanced for trade.

GATT and later the WTO have provided a relatively advanced multilateral framework for trade relations and have reached broad membership and coverage of global trade (by now 164 WTO members, with exchange among them accounting for more than 94% of global merchandise trade and 97% for

services10). The issue here has always been to reconcile bilateral and plurilateral trade deals with(in) the multilateral system.

Trade agreements aim for privileged market access for the countries doing an agreement. Yet for GATT/WTO most favoured nation (MFN), i.e. that countries cannot discriminate between trading partners and that special favours granted to one need to apply for all members, is a core principle. WTO provides for exceptions from MFN for regional trade agreements provided that they meet the conditions specified in GATT and GATS. This is relevant for example for the

tariff part of negotiations as the rules stipulate that "substantially all of trade" must be liberalised.11

8 For example establishing regular policy dialogues in a particular area.

9 Beyond issue areas the approach to market opening (negative or positive list) is a factor to consider for breadth and depth.

10 Membership includes the EU and member states. Trade shares excluding intra-EU trade, 2014. Source: WTO.

11 See WTO for further information on regional trade agreements in the world trading system and

Matsushita (2010) for further discussion.

Deutsche Bank AG published this content on 24 January 2017 and is solely responsible for the information contained herein.
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