Wednesday, 5 November 2014

Why Europe needs to take TPP seriously

There's no point any longer in pretending: The geo-economic race over the Asia-Pacific is now on - and in the open.

Will the TPP coalition declare victory at the next week's APEC summit – and steal the show from the Chinese host? Is there enough time for Amari and Forman to resolve their issues? Could China mount a counteroffensive in the form of a "breakthrough" on RCEP (a jab at the US, who is not invited), or its own FTA with Korea (a jab by Premier Li and President Park, who are only united in their common animosity for PM Abe)? 

Beijing APEC media center canteen features two panicked deer butting heads. Somehow fitting. 

Pan-Asian trade deals are now high politics and prime time entertainment rolled into one. It's the burning issue for commerce ministers everywhere – except in Brussels, still deep in introversion and shellshocked over TTIP. But Europe always took TPP with a pinch of salt, questioning whether TPP is even feasible, having failed its own attempt for a pan-Asian trade deal. Indeed, it's far from certain that there will be any FTA entertainment in Beijing next week. But what if the Trans-Pacific Partnership (TPP) is not a doomed initiative – and what if it will actually make inroads into modern trade problems? 

Our new policy brief looks to this what if. The Asia-Pacific region is de facto the world’s centre of economic gravity, rapidly turning into the world’s fastest growing consumer market. TPP (or RCEP, if it ever comes into fruition) will indeed change the competitive relation between EU and US firms, as far as access to this market is concerned.

The negotiations now include Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the US, and Vietnam. Influential actors, including South Korea, Philippines, Taiwan, Thailand, (and even China) have formally or informally shown their interest in joining the negotiations. There is no reason to doubt that TPP is the new standard-setter in the Asia-Pacific region – current signatories represent 60% of world trade, which is the same level as GATT in the 1980s:
  • The TPP will be the first ‘competing’ economic integration large enough to make a negative impact on Europe. To put it rather bluntly – for every dollar the US economy gains thanks to TPP, the EU will lose a dollar (or 1.03 to be exact).
  • In the long-term, there will be further negative effects on the economic fundamentals – a drop in investment, productivity and competitiveness; TPP also presents a 'deadly threat' to EU agricultural exports to the TPP countries, as my friend Patrick Messerlin likes to puts it.
Europe negotiates bilaterally with some TPP countries, but has no strategy equivalent to the TPP. 
  • The ongoing EU negotiations with Canada, Japan, Malaysia, Vietnam and TTIP have been facing "difficulties" due to the political urgency and industry support given to TPP. 
  • The TPP even add pressure on EU’s existing FTAs with countries such as Mexico and Chile, with whom only old-styled FTAs are in place.
  • Australia and New Zealand are currently not being addressed at all, despite being part of both RCEP and TPP.
Obviously, EU trade policy (our ersatz foreign policy in Asia) cannot be underpinned by TTIP and plurilateral initiatives alone. 

#ECIPEdebates: ISDS in TTIP – Should it stay or should it go?

In his reply to our latest #ECIPEdebate, Simon Lester - trade policy analyst at Cato Institute - expresses the feeling that many of us share on the issue of ISDS.The inclusion of the mechanism in TTIP is likely to induce a surge in the number of cases across the Atlantic, given that currently only a handful of European countries have signed a BIT with US. Yet, the presence of ISDS in the agreement is essential to avoid “trouble”.

First of all, the inclusion of an investor protection mechanism in the TTIP negotiations falls under the Council mandate given to the Commission. Questioning its presence in the agreement, therefore, jeopardizes the Commission credibility as a trade policy negotiator.

Secondly, a golden opportunity for addressing the flaws of the current ISDS system would be missed. The European Commission has stated clearly that it wants to improve the system by making the investor protection rules clearer, more transparent and impartial than they are today. If the ISDS is simply excluded from TTIP, then the nine BITs between US and individual Member States would remain in force, and the problems emphasized in the public debate will not be addressed.

Thirdly, the exclusion of ISDS from trade and investment agreements would put additional pressure on national courts, which might not have the necessary expertise to deal with these cases. The arbitration tribunals are in fact constituted ad hoc for each individual case and comprise highly specialized arbitrators.

Fourthly, as stated in a recent ECIPE paper, bringing the case in front of a national court might put the national policy itself on trial, while arbitration does not require the State to withdraw or change the measure that violated the investment agreement.

Finally, the EU should be consistent in its request to include ISDS in the agreements it is negotiating. Excluding the mechanism from TTIP would put the EU in the awkward position of having to differentiate between countries whose quality of the legal system is considered sufficient to protect its investors and countries that it does not trust. Alex Berger - researcher at the German Development Institute – has replied to our debate by pointing out that such an exclusion from TTIP would not necessarily impede the EU from including the mechanism in the on-going negotiations of EU-China investment agreement.

This is probably true – given China’s interest to increase protection for its steadily rising investment in the EU –  but it does not necessarily apply to other third countries with whom the EU is (or plans to) negotiate. Moreover, the issue is not only about third countries, but also about those European countries that are brought to court under intra-EU BITs. Three quarters of all cases against EU countries since 1987 have been filed by another EU country, and in 2013 only one of the cases against EU countries was brought by a non-EU investor (from Turkey). How could it be acceptable that the same national courts of certain European countries are considered to offer “sufficient legal protection” vis-à-vis the United States but not vis-à-vis other European Member States?

German stubborn opposition to the inclusion of ISDS in trans-Atlantic trade agreements relies on the consideration that “US investors in the EU have sufficient legal protection in the national courts”. Quite surprising to hear such a statement from the country with the highest number of BITs in the world and which has led the opposition to Czech Republic request to terminate intra-EU BITs only few years ago. Germany is acting in its self-interest showing no willingness (and even opposition) to a modernization of the system and at the same time taking advantage of this mechanism – only in 2013 Germany has initiated four cases against Czech Republic.

These inconsistencies pose a serious threat to EU's credibility in the international trade policy arena. It is hard to expect the world to take Europe seriously if it accepts the request to exclude ISDS from certain agreements while at the same time the number of intra-EU cases keeps soaring. If Member States are not willing to cooperate for a serious improvement of the system, then they should terminate all their BITs with other EU countries.

Tuesday, 28 October 2014

Behind global trade statistics

Do you sometimes wonder about the world trade statistics, published by the WTO? Behind the headline numbers, there is a lot to explore ….

Until 1995, when the GATS was added to the corpus of trade rules, there was no official recognition of services trade. There was of course awareness among those who handled balance of payments data – and at the IMF in particular – that cross border financial flows took place; but these covered a wider area than just trade. In London the trade component was called “Trade in Invisibles”.

Now, in 2014, it is well established that a country’s overall trade performance is the result of both goods and services trade.  However, “not many people know” what the connections are between the two flows, and how the data is compiled, and the size of the two respective flows. Increasingly the statistical experts argue that trade in services is ‘embedded’ in the data for trade in goods because the transaction value includes a service component (design, transport or marketing costs). So, the services data is systemically understated.           

Goods data are put together from the customs returns: what we used to call, rather quaintly, customs collections. They represent primarily the value of imports and exports, duty paid, and sometimes there is additional data on weight. But even in the 1960s we referred to data as FOB (free on board) – meaning as delivered to the ship - or CIF (carriage, insurance, freight) which recognised that service elements such as transport and insurance had already entered into the value of the transaction.
Services data on the other hand are collected from the financial flows through the banking system, and that includes government business (foreign aid, capital flows) as well as commercial flows.
In advanced economies goods trade tends to be around 4-5 times larger than services trade (the UK is the exception at 2.5:1), while countries with less developed service economies such as China are around 8:1 and more.  Here the exception is India whose services figures are one third of the goods figures.

Table 1. Leading countries in world trade: combined table goods and services

This table gives many other indications of strengths and weaknesses:
·         The top four countries in goods – US, China, Germany and Japan, in that order -  are also the top four overall;  but they are in a different order in services trade (Japan lower).
·         The next three countries are in shifting positions:  NL is fifth in goods, UK is seventh, but overall it is reversed – UK # 5 and NL # 7, largely due to the UK performance in services.
·         As you go down, there are non-G 7 countries appearing:  Korea, Hong Kong, Belgium and Russia among others.  India is # 15 in goods and # 13 overall – good services performance.
·         The top 15 countries in services are the same as the top 15 in goods, with one exception: Russia falls out, and is replaced by Spain.
·         Mexico is well placed for trade in goods, but so weak in services that it is outside the combined table of top 20.
·         Just below the top 20 group is a mixed group of advanced economies (Australia, Taiwan, Switzerland, Poland and Sweden) and emerging countries (Brazil, Thailand, Malaysia and Indonesia).

Another feature of these tables is that they indicate trade deficits. These are most commonly quoted in the media as trade deficits in goods: countries such as US, Japan, France, UK and Canada have deficits in goods, while China, Germany and Korea lead those with a trade surplus. On the other hand China and Germany have a deficit in services, while US, France and UK have a surplus. Strange world...

Friday, 24 October 2014

Why Italy fails and Swedish economists are smug

Our friends at Bruegel posted a nice piece called "Why does Italy not grow?" which I missed when it was first published (until a chronically sleep-deprived friend posted it on her Facebook). The post compares how France and Italy underperform in terms of GDP compared to Sweden – and Swedish economists love to gloat, and talk about our model that rest of the world would embrace - if they knew what's good for them.

Well, my very Swedish persona digresses – in any case, the authors correctly point to three factors why Italy fails – the huge gap on innovation measured in number of international patents (the poor returns of R&D in  France and Italy is something I've pointed out in some of my sector studies); low levels of education in the workforce, and inflexible labour markets that created a huge youth unemployment that pushed its bright young things to move abroad (some of them works in our office; and no, Italy – you can't have them back).

However, the authors fail to mention an important point: Italy did not deregulate its markets (especially on services), which had tremendous downstream effects, creating inefficiencies across the whole economy. Here's a graph on services restrictiveness from the OECD that says a thousand words.

(in case you're looking for Italy somewhere in the middle, try on the far-far-far right)

The problem with Italy however, is that country is so simply so divine that you will forgive it for all its flaws – or to quote my favourite line in Where Angels Fear to Tread: There is something majestic even in the bad taste of Italy.

Friday, 17 October 2014

Competition authorities should listen to Jean Tirole

by Maria Salfi

The recent Nobel Prize winner in Economics, Jean Tirole, has brought very important contributions to economics – and competition policy authorities should take on some of the key conclusions from his research.

In Industrial Organization, every model analyzing how firms interact with each other in a static and/or dynamic contest is based on some assumptions such as perfect market competition, the number of firms in the industry, homogeneous or heterogeneous preferences of consumers, constant (increasing or decreasing) return to scale. Moreover firms are treated as acting in the same way in different industries and there is little differentiation about the nature of the industry. All the analysis that has been done for years on how industries work and how firms interact with each other has potential to change. Tirole’s work differentiates between industries and takes into consideration the fact that firms can act in a different manner depending on the industry they are in. What are the implications for the competition authorities?

First of all, past cases in which firms would have been accused of unfair competitive behavior would have a different outcome now. During the presentation of his work at the Royal Swedish Academy of Sciences, Tirole made a clear example. Newspapers give away information at a very low price in order to acquire market share and increase advertising revenues. What at first can be perceived as a predatory behavior by the press firms, it is actually not. There is clearly a trade off between price and market share/advertising revenues. According to this line of reasoning, the context does matter. Different rules should then be applied to different industries and each case should be investigated individually.

Second, consumers should be taken into consideration. If the assessment of a merger or a monopolistic behavior are a priori considered detrimental for society it is then counterproductive. There are cases in which consumers have actually been harmed by a competition authority’s decision. Monopolies usually arise because they are the most efficient firms in the industry and it is not necessarily harmful for consumers.

Competition authorities can now utilize a solid tool to improve society. The definition of fair competition might then be reformulated, taking into consideration the real consequences and the effects that the competition authority’s decision can have on the market and on consumers.

Tuesday, 14 October 2014

Cracking the mainstream notion of fiscal competition

by Maria Salfi

There is a general widespread notion within the European Union that a lower corporate tax rate can harm society. In fact, the European Commission strongly advises the EU’s member states to raise the rate until a certain threshold – about 30% - and to harmonize the tax among countries. A lower corporate tax rate leads to a lower return in government revenues and therefore a lower public goods’ provision for society. Corporate tax rate can be used as a fiscal tool in order to attract capital and labor because firms have an incentive to relocate in a country where the tax rate is lower.

According to the figure below, the corporate tax rate differs across EU countries. Newly member states tend to have lower tax rate compared to countries such as France, Italy or Germany which are characterized by a rate of 30% or more. Being the EU’s average tax rate 21%, half of the member states are actually below or equal to the average (Estonia and the United Kingdom are two examples). 

                                       Source: KPMG

However there are some misleading ideas about the role of the corporate tax rate in society and about the popular “race to the bottom” argument. Although the economic literature widely investigates fiscal competition and its impact on society and it strongly affirms that firms relocate where tax is lower and that it can indeed lead to a lower supply of public goods, the economic models date back to the 80s such as Zodrow and Mieszkowski (1986) or late 90s such as Keen and Marchand (1997). Empirical literature is quite more recent nonetheless it reports controversial results.

Yet, the general public looks at only one side of the coin. First of all, firms are influenced by different factors when relocating to a country - and corporate tax rate is only one of them. According to Ernst and Young (2004), firms look at 18 main factors[1], where corporate tax rate occupies only the 11th place on the list. Second of all, following the argument that a low tax rate will attract multinationals, it leads to a larger tax base. Since a higher amount of firms relocate in one country, the tax base is enlarged and the government can re-balance the tax return although the tax rate is lower. Third, harmonization of the tax rate will not necessarily lead to welfare gain. Countries will find another tool to enhance fiscal competition. In fact, fiscal competition’s studies often forget that corporate tax is not the only tool that countries can use to attract capital and labor: public spending can be used in a similar way to achieve similar results.  Government can indeed increase public spending in certain categories in order to attract firms. Generally speaking, a country investing in domestic infrastructure will not only benefit society and domestic industries per se but also foreign firms which will want to relocate to profit from the business environment, causing an agglomeration effect.  Nonetheless governments should be careful when allocating public revenues since using public expenditure as a fiscal tool can provoke a shift in the supply of public goods. Infrastructure expenditures could be increased at the expenses of social spending. 

[1] The factors are: domestic market, transport logistic infrastructure and telecommunication network, flexibility of employment regulations, local labor skills level, availability of sites, cost of land and regulations, R&D quality and capacity, potential productivity gains, labor costs, corporate taxation, access to financial investors, aid and support measures from public authorities, specific treatment for expatriate executives or corporate headquarters, transparency and stability of the regulatory environment, social climate, language and culture, quality of life.  

Sunday, 12 October 2014

Railways derailing EU-Japan talks?

By P. Messerlin
Professor Emeritus at Sciences-Po Paris and Chairman of the Steering Committee of the European Centre for International Political Economy (ECIPE) Brussels

Since the mid-2000s, the EU has made the opening of public procurement markets one of its key priorities in the WTO and in the bilateral agreements it negotiates with the US and Japan.

In this context, the Japan-EU negotiations are crucial because they raise all the key problems to be faced. First and foremost, they involve firms with very different legal and economic status. Most of the EU railways companies are public, subject to very limited competition and deeply in debt. The Japanese railway market is competitive, consists of a mix of a small number of relatively small public companies and many totally private companies, including a number of former Japan Railway companies which have been privatized).  In particular, the three largest Japanese railways companies which represent 60 percent of the whole EU28 rail passenger market are totally private and profitable.  It took some time in Europe to realize these key differences.  The reason for the healthy situation in Japan is that, since the Meiji era, the Japanese railways companies have worked as true urban planners—connecting their tracks and large stores—something that the EU railways companies have started to do only a decade or so ago (and at a very small scale with their very limited station spaces).

Of course, this situation means that it is impossible to include private firms under public procurement rules. However, an option could satisfy both negotiating partners: a “railways” chapter with a public procurement section covering most of the EU rail companies and the few Japanese firms of similar statute and with a private section covering the private Japanese firms and the (possibly increasing number of) EU firms of similar statute. Drafting different but equivalent concessions for the two sections is not be so difficult because the Japanese rail sector is as large as the whole EU28 sector and because a progressive and balanced deal could be expressed on a firm by firm basis (individual private Japanese rail passengers firms and individual state-owned EU rail firms).

Such a simple solution seems currently rejected by a few vested interests—led by the French railway equipment company Alstom. Opposition by vested interests is not a new thing in trade negotiations. But this one is particularly astonishing for five reasons.

First, France has massive offensive interests in getting a Japan-EU agreement concluded. For instance, such a deal is the only insurance policy to protect her agrifood exports in Japan (Japan is the 3rd export market in the world) against the conclusion of the Trans-Pacific Partnership which includes all the key competitors of French agriculture (Australia, Canada, Chile, the US, New Zealand). Bowing to Alstom means creating huge troubles for the French farmers and agrifood business.

Second, French consumers need more competition in the rail equipment. SNCF has been able to buy French because of massive subsidies. The bad state of the French public finance means that such a mechanism is out of reach for a very long time. And SNCF will not be allowed to raise its prices for political reasons. The only option for SNCF—and the host of French commuters using daily local and inter-city trains—is to get better deals when buying its equipment. This situation is not new: it happened with Air France buying Boeing aircraft.

Third, the Japanese rail passengers companies have the same problem than SNCF: getting cheaper equipment thanks to more competition. It happens that the Japanese equipment market is huge. For instance, the three major private Japanese rail companies own 23,000 electric railcars, whereas SNCF owns 3,000.

Fourth, the GE-Alstom deal has induced some commentators to talk about Alstom as leading a future “Trainbus”—a term making a reference to Airbus. Such a perspective needs clarification. Airbus has never aimed at being a “national champion” in European closed markets. Rather, it has chosen to face international competition and to make the necessary industrial alliances to operate successfully in worldwide markets. A Trainbus which would try to keep the EU rail equipment markets closed is certain to be on a collision course with not only SNCF but also with all the EU rail companies of passengers and cargo transport, on behalf of the 400 billions of passengers-kilometer in the EU 28.

Last but not least, the golden market for the next two or so decades is the Chinese market. For instance, in 2012, there have been 145 billion passenger-kilometers of fast-speed trains in China, compared to 51 in France and 79 in Japan. This market is much too big for Alstom alone. Alstom needs to join forces with rail equipment companies which enjoy a great reputation in Asia and which know already well the Chinese markets. Japanese firms are the only ones to master these two cards.  As a result, the “railway” chapter of the Japan-EU agreement should include  “cooperation” aspects enhancing the EU-Japan industrial alliance, in particular at the third countries including China.

So, why to make troubles when the pros and cons are so clear? Is it the traditional French trade negotiation strategy that consists in playing the “naughty kid” up to the last minute in order to get a few short-term advantages—at the costs of building long-term resentment among our EU partners and in the rest of the world? Or, is it the incapacity of the French government to make the French national interest prevail over narrow vested interests?