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International Economic Models: Free Trade in the Pacific Rim and Beyond

Jason D. Edinger, CFA

Surveying the global economic landscape, we see signs of increased divergence and separation at every turn.  As the U.S. economy grinds along at only a moderate pace, the Eurozone economy appears ready to break out of its recent anemic state, helped by the European Central Bank’s bond-buying program, and surging exports on the back of a weak euro. Looking further east, we see China’s growth slowing to its lowest level in six years, but still healthy at greater than 6 percent, just as the Japanese economy emerges from malaise and grasps at new hope for improved growth.

On this backdrop, President Barack Obama is engaged in a legislative process that would bring many of these economic regions closer together, and at the same time provide potential benefits to investors in both U.S. and overseas markets.  In what has been dubbed the most progressive trade bill in history, President Obama is pushing Congress to pass the Trans-Pacific Partnership (TPP), a multilateral trade agreement involving the U.S. and 11 other nations in the Pacific Rim. The goal of the TPP is to liberalize multinational trade in the region while also promoting domestic reform for its partner nations, with a particular emphasis on labor, environmental, and other social issues. The program was publicly announced in November 2009, and has been under negotiation since its inception, only recently making national headlines as the President has gone on the offensive, promoting the deal to shore up support on both sides of the aisle.

At its core, the TPP is truly historic in its breadth and depth. One of the most ambitious free trade agreements ever presented on the world stage, the TPP is being hailed as the pathway to unlock future growth between countries within the pact and deepen economic ties between these nations. Key features of the bill include:

  • Comprehensive market access: the elimination of tariffs and other barriers to the free flow of goods, services, and investment across countries;
  • Full agreement among all participating nations: facilitation of production and supply chains among TPP members;
  • Cross-cutting trade issues: reinforcement of favorable trade terms via regulatory coherence, increased competitiveness and business encouragement, addressing small- and medium-sized company issues, and broad economic development via market liberalization and improvements in regional investment; and
  • New trade challenges: promoting investment and development of new products, technologies, and innovation to address emerging trade issues as they arise.

The TPP represents a natural extension of the Trans-Pacific Strategic Economic Partnership (TPSEP), a trade agreement that was originally negotiated between several Pacific countries in 2006. Based on common interest and deepening relationships in the region, the original treaty laid the groundwork for many of the key features to the TPP described above (expansion and diversification of territory, eliminating trade barriers, and fair competition, to name a few).

The TPP is expected to augment these basic economic principles with stronger, more enforceable features that will not only legislate trade and business laws between participating nations, but also include labor, environmental, and human rights articles that have been conspicuously absent from previous trade agreements.  Although in principle the TPP is a free trade agreement, many of the provisions in the bill are concerned with non-trade matters that affect the daily lives of the people residing in participant nations. These non-trade issues include food safety, intellectual property, internet rights, medical and healthcare costs, financial regulation and oversight.

In order to see the TPP passed and signed into law, President Obama first secured Trade Promotion Authority -- so-called “fast track legislation” – in June, as we noted in the July quarterly Investment Commentary.  Fast track status allows the executive branch to expeditiously submit trade agreements directly to Congress for straight, “yes or no” votes – not allowing for congressional debate or amendment. The brainchild of President Nixon in the 1960s, fast track legislation has been employed off and on over the decades, having been used in 16 of the hundreds of U.S. trade and commercial deals proposed during the time period. After months of political rhetoric, back and forth voting, and procedural roadblocks, trade promotion authority was passed in both houses of Congress, green-lighting a larger discussion and eventual approval vote on the TPP.

Despite this progress, President Obama has encountered resistance from both sides of the political aisle, and notably within his own party.  Many of the most-vocal and best-organized Democratic groups strongly oppose the larger TPP.  This includes labor unions like the AFL-CIO, who claim the TPP threatens American job security in the same way that North American Free Trade Agreement (NAFTA) did decades ago.  Concerns include the potential endangerment of American jobs by low-wage foreign competition, as well as the possible enforcement to widening domestic income inequality.

Taken on the surface, these allegations are serious and grave. But when the onion is peeled back a layer, it should be noted that the U.S. already maintains free trade pacts with several TPP countries, including Australia, Canada, New Zealand, Singapore, and others. Many of these countries are not low-wage nations, so the argument that TPP would result in the U.S. losing jobs to lower-wage countries does not have merit. If anything, the TPP could result in foreign markets opening their doors to U.S. labor in greater volume.  A great example is Japan, where compensation in the manufacturing sector is slightly higher than here in the U.S.

At its core, the TPP is a trade agreement, and, importantly, one that could enhance the fundamental picture for investors across global asset classes. Trade amongst people and nations is a natural instinct, laid out and upheld in the great economic theories of history, including works by classical economists Adam Smith and David Ricardo. From the law of comparative advantage to the benefits of diversification and competitiveness to economies of scale, it is widely understood and accepted in economic circles that liberalized international trade benefits nations who participate in it. While a debate about how such a free trade system should work and be structured is beyond the scope of this article, we would argue here that, if adopted, consumers within the TPP nations will undoubtedly benefit from freer trade, as will the countries themselves.

Freer trade would result in pressure to keep prices of domestic goods and services low, a drastic increase in the variety and quality of goods and services from which the consumer can choose, and the promotion of international investment and entrepreneurship as the fear of government intervention in markets is relaxed and eventually removed. Additionally, negative externalities should be dramatically reduced as the costs of protectionism are increasingly burdensome and far outweigh the benefits. Although all governments regulate foreign trade to a certain extent, the degree to which that regulation can be reduced should result in benefits to global consumers and producers. After all, the economic goal of trade and commerce is to deliver the greatest good to the greatest number of people.

From a geopolitical standpoint, the TPP is regarded by supporters as a means for the U.S. to sustain its position as economic and political leader in the area. In the decades after the ink dried on the Bretton Woods Treaty in 1944 (a global system of monetary policy and exchange rate management), the U.S. was the dominant player on the global stage, able to dictate many of the rules of the road, both economically and politically. Undoubtedly, this has been beneficial for the U.S. and its citizens. However, in recent decades, U.S. leadership in the region has grown increasingly fragile as China has emerged as an economic juggernaut.   While China’s rise in the world should continue to benefit the world’s economies, ours included, it is important to the U.S. and other countries that the economic and political rules are fair, and open competition is promoted for all players in the Pacific.  The TPP is one important element to that end.

With respect to RINET’s mandate as prudent allocators of capital across global asset classes, we believe a successful TPP bill could be beneficial to client portfolios over the medium and longer terms. The TPP is well representative of RINET’s global investment philosophy, in which we feel that all asset classes and markets – not just those in the U.S. - should be investigated and scoured to find the best investment opportunities. Many different countries stand to benefit from the TPP’s passage.

In the coming weeks and months, there will be challenges to the successful passing of the TPP.  Almost certainly, the current dissension on both sides of the political aisle foreshadows the struggle to come.   We feel, however, that the TPP has a good chance to become law.  We will watch with interest as this landmark multinational legislation is further discussed, debated, and potentially enacted.