EU-Mercosur agreement is a new approach to trade policy – 07/14/2023 – Market

Next week, leaders will meet at the first EU-Latin America summit in a long time. The most important item on the menu is the trade agreement between the European Union and Mercosur, a trade bloc made up of Brazil, Argentina, Paraguay and Uruguay. The agreement was closed in 2019 after years of negotiations, but has yet to be ratified.

Most of the blame for this lies with Europe, where two forces prevented its completion – one traditional and one much more recent. The traditional one is agricultural protectionism. The newest, and far more interesting, is the EU’s move beyond what we might call standard trade liberalization to include new elements in trade agreements – in this case, environmental and climate requirements.

Mercosur countries agreed on climate and environmental provisions – intended to protect the Amazon from deforestation – but European green policy dominated the process. Brussels was pressed to request additional provisions to make the green aspects of the deal legally binding. It is these extra commitments that Brazil, in particular, has resisted.

We should not expect a breakthrough in the Mercosur agreement at the summit, but we can expect some political meeting of minds that will allow a final agreement to be sealed soon. But today I am less concerned with the details of the green provisions than with the principle behind them and how it reflects an entirely new approach to trade policy.

What is new is that trade agreements have come to include not only specific products (and to some extent services) but also the methods by which they are produced. The EU-Mercosur agreement’s attention to deforestation is just one of many examples.

The same agreement contains a provision that eggs will only receive favorable import treatment if they have been produced in compliance with EU animal welfare standards.

The EU isn’t alone: ​​when the US renegotiated the old NAFTA trade deal with Canada and Mexico, it only extended tariff reductions to cars produced by labor paid above a certain value.

Unconventional considerations are also not pursued solely through bilateral trade agreements. The EU is using unilateral trade policies too, such as a carbon border tax on imports from countries with less stringent emissions regulations than the bloc’s, or human rights requirements in European companies’ global supply chains. A new EU law banning the import of palm oil from cleared forests has suspended its trade talks with Malaysia and Indonesia.

All of these new trade rules are examples of identical products being treated differently depending on the production method. This is legally controversial, or at least new, as David Henig explained in a Borderlex column a few weeks ago. Traditionally, treating identical products differently has been seen as a sign of protectionism, to be justified with the exceptions permitted by international trade rules.

Interestingly, the same tension exists in US law, where the Supreme Court has just upheld California’s animal welfare restrictions on sales of pork products produced in other states. Likewise, Henig suggests that legal refinements are possible to allow consideration of production methods while preventing protectionism.

I agree, but I’m more concerned about the economy than the law. What economic justification is there for these extra conditions in trade if we believe that there are generally gains in voluntary economic exchanges?

One answer is “externalities” – free trade is not always efficient, so it must be a little less free to achieve greater efficiency. Carbon tariffs can be an example of this: without them, domestic carbon regulations simply shift polluting production abroad –“carbon leakage”–, with the result that the pollution remains the same, but the products are more expensive.

But two things about this answer bother me. The first is that the externality argument does not easily generalize to other areas (European chickens would not be less protected without an animal welfare clause in the Mercosur agreement). The other is that it takes for granted that there is a trade-off between free trade and these other considerations.

I think there is another, more ambitious argument for including unconventional considerations in trade policy, based as much on economic efficiency as on pro-trade liberalism. It is this: modern consumers themselves distinguish between identical goods that are produced in different ways. Today, many people are directly concerned about whether a product is produced ethically – say, without the use of child or slave labor – or in a way that threatens the environment. A T-shirt made from cotton from the Xinjiang concentration camps is simply a different product than ethically produced cotton.

Furthermore, the mix of goods and services of the digital revolution means that “methods of production” do not end when a good is sold. For many consumers, a car that spies on you by sending data about your behavior to a manufacturer in a different jurisdiction is a different product than one that doesn’t.

There is a small but important economic research literature on “procedural usefulness”, the idea that we care not just about the results we achieve, but the ways in which those results are achieved. Here is an initial contribution. It’s a topic I’m particularly interested in because my own PhD was an extensive discussion of why and how economics should take process-dependent preferences into account. (For those interested, the published version included a mathematical model of process dependency, an experiment demonstrating that people care about processes separately from outcomes, and a philosophical argument for why it’s perfectly rational to do so.)

Since people care about production processes, it is a mistake to think that taking them into account violates free trade. Free trade cannot mean forcing consumers to accept the substitution of a product they prefer for another that they consider inferior due to the way it was produced. Of course, there is a need to guard against protectionism – arguments about production methods can be made in bad faith. But this is no different from other product rules, such as banning the import of lead-based paint toys, for example.

Free traders have nothing to be ashamed of accepting rules about production methods into trade policy. We can and should be confident that the new approach to trade policy is here to stay.

Translated by Luiz Roberto M. Gonçalves