Published daily by the Lowy Institute

Douglass North and the Trans-Pacific Partnership

Douglass North and the Trans-Pacific Partnership

Now that the terms of the Trans-Pacific Partnership (TPP) have been agreed, the participant countries have to decide whether to ratify the deal. In assessing the benefits, where might we turn for guidance on the economics?

First thoughts might go to David Ricardo, father of one of the few ideas that economists largely agree on: comparative advantage. Countries should produce the things they do best, and trade these for things they do less well. The key insight is that countries should trade internationally, even if they are better at doing everything (they have 'absolute advantage') than their trading partners. 

The policy message is that countries should abandon tariffs and quotas and open up their markets for international trade.

This is, more or less, what Australia has done. Over 90% of Australia's imports have tariffs of 5% or less. We've done this largely unilaterally, believing it to be in our own self-interest. Can't we now just rest on our laurels, while urging other countries to follow our virtuous lead?

Economists might believe this, but they have never persuaded either the public or the politicians. The WTO has struggled in vain for the past decade to make progress at the multilateral level.

So-called Free-Trade Agreements (FTAs) such as the TPP have been the response to this failure. These are preferential agreements, so Ricardo's simple free-trade dictum doesn't apply. There is trade diversion (imports may not come from the cheapest source). Nevertheless the TPP will push some of our partners, over time, towards some reduction in quota restrictions on our agricultural exports. And having 12 TPP members (accounting for one third of world trade) reduces the trade diversion, compared with bilateral FTAs.

Thus, viewed from Ricardo's vantage point, the TPP is not ideal, but it might be the best that can be done in an imperfect world.

The main issues are however, elsewhere, in the high-level 'platinum standard' rules that the TPP imposes on participants. Most of these rules are not closely related to international trade. [fold]

We can't object to the idea of rules, per se. Ricardo's free trade took place in a fantasy world, where cloth merchants met wine traders and agreed on price, quality, payment terms, delivery date and then everyone kept their side of the bargain. Transaction costs were ignored. In the real world, enforceable rules are needed to ensure markets work well. If there are not enough rules, uncertainty and asymmetric information raise transaction costs. If there are too many rules (or the wrong ones), there is a dead-weight cost to transactions; too much 'red tape'.

Thus we need more than Ricardo's 'free market'. But what rules are needed, who makes them, and in whose interests? 

For academic guidance on this, we might draw on the work of economic historian Douglass North (who died last week, aged 95). One of his best-known studies examined the self-imposed rules that developed between long-distance merchants during the revival of trade in the late middle ages.

North's interest was in generalising from this experience, analysing the evolution of rules of conduct. He called these 'institutions' — 'the humanly devised constraints that shape human interaction' — and likened them to the rules of sporting games.

For North, the rules evolved out of social interaction (often by the participants) rather than being imposed by governments, and in response to perceived needs. Whether a particular set of rules persisted or evolved over time depended on whether they served the objectives of the participants. 

So where does the TPP fit into North's view-of-the world? If Australia had been writing the rules from scratch to foster our international economic interaction, does the TPP represent the set we would have devised?

We're an intellectual property net importer, so have little national interest in strengthening the current IP rules, perpetuating the misconception that innovation is best fostered by awarding monopoly rights to the innovator. The same goes for foreign investment dispute resolution. As a major capital importer, we are entitled to think our own domestic laws should be enough to protect foreign investors. Labour laws, environmental issues, corruption, the role of state-owned enterprises and free capital flows are all issues we might best handle with our domestic laws and practices, which might or might not coincide with TPP requirements. In short, while acknowledging the desirability of rules-based international order, these are not the rules we would have prioritised.

Just as in football, we now have the opportunity to sign up for this TPP code which is a less-than-perfect fit with the way we would like to play. One strong incentive to sign is that this is the 'only game in town', at least at the moment. If we don't join, the TPP partners will be off playing with their own set of rules, including some which divert trade away from us. On top of this, economics isn't the only consideration: the TPP is part of our overall relationship with America.

So we will sign up. This should not, however, be the end of the story. Douglass North's narrative analyses why some 'institutions' are persistent (unchanging) while others evolve. Two paths of evolution are open. 

The first is to expand TPP membership, starting with China and Korea, but going on to include Southeast Asia and India. The biggest advantages come from enlarging the number of participants playing by the same rules.

The second is to align the rules more directly with the practical needs of international trade. The TPP rules are unlikely to evolve much, but there are opportunities outside the TPP for rule-making (and rule simplification). In the longer term, the more operational focus of the ASEAN-based Regional Comprehensive Economic Partnership (RCEP) might offer us more advantages, more analogous to Douglass North's trade-facilitating rules. It is moving slowly but is more focused on our region, where our greatest trade potential lies. 

The ultimate advance would entail moving away from competing codes, towards a 'world game' where everyone plays with the same rules. International trade would benefit from both the TPP's high-level behind-the-border rules and the detailed operational facilitation that is at the heart of the RCEP.

You may also be interested in