Inside Story

Lessons from the Australia–US Free Trade Agreement

The agreement delivered few, if any, of the benefits promised by its advocates, writes John Quiggin, but its adverse consequences have also been more limited than many critics predicted

John Quiggin 22 November 2010 3813 words

With the Doha round of trade negotiations in limbo since they broke down in mid-2008, increasing attention has been paid to the possibility of negotiating trade agreements among a more limited number of states. The United States, in particular, vigorously pursued bilateral trade agreements under the Bush administration. The Obama administration is now promoting a regional, Asia-Pacific trade agreement, known as the Trans-Pacific Partnership Agreement, which would be an expansion of an existing agreement between Brunei, Chile, New Zealand and Singapore to encompass Australia, Peru and Vietnam, and perhaps other countries in the region.

With those negotiations resuming on 6 December, it’s useful to consider what lessons can be learned from existing trade agreements undertaken between the United States and its trading partners. This article focuses on the best-known of these, the Australia–United States Free Trade Agreement, or AUSFTA.

AUSFTA was negotiated in 2004 against the background of a close political and personal alliance between the Australian prime minister, John Howard, and the US president, George W. Bush. The Australian government had been among the strongest supporters of the Iraq war and, while both sides denied the existence of any quid pro quo, there was a widespread feeling on the Australian side that Australia’s status as a close ally should be reflected in the negotiation of an agreement.

The resulting political dynamic gave the Australian government a large stake in the successful conclusion of an agreement. On the US side, by contrast, the issue was primarily one for trade policy specialists, including the large and powerful agricultural lobby groups that sought to limit market access for competing products.

A second asymmetry arose from the different starting points of the two countries. Following several decades of unilateral reductions in tariffs and quotas, Australia retained only minimal intervention affecting international trade in goods. The main elements were a general 5 per cent revenue tariff on imported goods and slightly higher tariffs on motor vehicles, textiles, clothing and footwear. The latter items were in the process of being phased out.

Australia’s approach to international trade negotiations had been to lead by example, in the hope of promoting multilateral liberalisation. As founder of the Cairns Group of agricultural exporting countries, Australia sought to promote reform of the interventionist policies adopted by most food-importing countries, particularly the United States and the European Union. By contrast, the United States maintained a longstanding tradition of intervention in domestic and international agricultural markets, formalised in Farm Bills passed at intervals of about six years since the mid 1960s. The elements of most interest to Australia are restrictions on imports of sugar, beef and dairy products, and subsidised exports of corn and wheat.

In addition to its interventionist agricultural policy, the United States has made liberal use of anti-dumping and emergency assistance provisions to protect domestic manufacturers. A notable instance was special protection for the steel industry introduced by the Bush administration but abandoned after retaliation by the European Union. In international negotiations, the United States has adopted the “bargaining chip” approach, seeking to obtain the largest possible concessions from other countries while offering the smallest possible concessions itself.

Under the Bush administration, the US abandoned multilateral agreements of all kinds, including trade agreements, in favour of bilateral agreements. As well as maximising the disparity in bargaining power between the parties, the bilateral strategy encouraged even more hardline use of bargaining chips. Any concession made to one bargaining partner would embolden others in future, so the need to minimise concessions was even greater.

As a result of these asymmetries, the actual terms of the agreement were considerably less favourable than those anticipated by the Australian side. In particular, there was no increase in access to the US market for Australian sugar, and only modest improvements for beef. These were the most salient elements of a generally lopsided deal, in which the United States maintained substantial barriers to Australian imports while gaining not only the removal of nearly all traditional trade barriers, but also influence over a wide range of Australian domestic policy institutions.

When the agreement was finally announced, it included extensive clauses relating to the operation of the Pharmaceutical Benefits Scheme, or PBS, and to enhanced protection for the owners of drug patents. The Australian government presented this outcome as a victory, however, arguing that the United States had demanded a right of appeal against adverse decisions from the Pharmaceutical Benefits Advisory Committee, but had received only a non-binding review.

The AUSFTA was signed on 18 May 2004, and the US Congress ratified the agreement with large majorities in both houses. In Australia, however, provisions relating to the PBS and to intellectual property created substantial controversy. When the implementing legislation for the agreement was passed by parliament, it incorporated an amendment, proposed by the Labor Party, designed to prevent a possible abuse of patent law through “evergreening” – a device by which patent-holders may extend the effective life of patents through trivial modifications to existing drugs. It was feared that evergreening, in combination with the increased protection for US patent-holders provided under the agreement, might reduce the availability of cheaper generic drugs and thereby increase the operation costs of the PBS.

Although previously enthusiastic about the agreement, representatives of the US government were strongly critical of the amended legislation. As a result, the United States delayed certification of the Australian legislation, a step required for the agreement to come into force. This resistance is indicative of the importance to the US administration of the protection of intellectual property in pharmaceuticals and the perceived threat to intellectual property posed by interventions such as the PBS. Pharmaceutical companies in the United States and elsewhere have long been critical of the PBS, claiming that it does not provide an adequate return for the investment in research and development required to develop new drugs. Conversely, the debate over the agreement in Australia highlighted the importance placed by political actors and the public on the preservation of the PBS in its current form.

The AUSFTA came into force on 1 January 2005.

What it did

The agreement removed most tariffs and barriers to Australian imports of US goods, but made no change in US restrictions on imports of sugar from Australia and only modest and gradual changes with respect to imports of beef and dairy products. More importantly, no changes were made to the US Farm Bill, under which US agricultural producers benefit from a complex set of subsidies and the resulting enhanced supply is dumped on world markets. Not only was the general system of subsidies unaffected (it would perhaps have been utopian to hope for broad-based reform), but it appears there was not even any commitment to avoid the use of export subsidies that directly harm Australian exporters in particular markets. Indeed, it appears that the issue of the Farm Bill was not even raised in the negotiations. The most important distortions of agricultural trade practised by the United States were unaffected by the AUSFTA and were, in effect, endorsed by Australia’s signature to the agreement.

As the New York Times editorial of 14 February 2004 observed:

The deal with Australia is a huge setback in the process of liberalising global agricultural trade. Poor nations whose only viable exports are agricultural goods are hampered by excessive protectionism. And by making a deal with Australia that leaves out sugar, Washington has jeopardised chances for meaningful progress on a hemispheric Free Trade Area of the Americas, and the latest round of negotiations at the World Trade Organization. As part of this effort to lower trade barriers, developing countries are rightly insisting that rich nations stop subsidising their farmers and open up their markets to competition.

The agreement sends a chilling message to the rest of the world. Even when dealing with an allied nation with similar living standards, the administration, under pressure from the Congress, has opted to continue coddling the sugar lobby, rather than dropping the most indefensible form of protectionism. This will only embolden the case of those around the world who argue that globalisation is a rigged game.

The success of the United States in retaining agricultural import restrictions means that these policies can be reused as bargaining chips in negotiations for a Trans-Pacific Partnership Agreement.

The impact of the proposed free-trade agreement on services was limited. Although there were some provisions in both Australia and the United States that discriminate against non-citizens, these were relatively modest. Moreover, some of the most important policies of this kind, such as restrictions on airline services, were excluded from the scope of the agreement. However, energy, water and public transport services were included.

On the other hand, the protections extended to investors were substantial. In effect, the agreement precluded Canberra from applying any conditions on US investors in Australia that would not be applicable to domestic investors (or vice versa). There was an exception for investments worth more than A$800 million (indexed from the time of the agreement), for which foreign investment review procedures remained permissible.

Given the dominant role of the United States as a source of investment capital in Australia, the effect was to implement, on a bilateral basis, measures that incorporated much of the Multilateral Agreement on Investment proposed by OECD members in the 1990s. This agreement was abandoned as a result of community opposition in many countries.

The agreement also included numerous provisions aimed at expanding the scope of intellectual property rights and strengthening the protection accorded to holders of those rights. The “strong IP” agenda behind these provisions has been consistently advocated by the US government, and equally strongly criticised by economists and advocates of internet-based innovation.

Prior to the agreement, Australia had a relatively short copyright term by international standards (copyrights expired fifty years after the death of the author), while the United States had one of the longest (ninety-nine years after the author’s death). The AUSFTA required Australia to extend its copyright term to seventy years after the death of the author, but did not require any change from the United States, or preclude further extensions of US copyright protection. The agreement also extended patent protection, and required legal enforcement of digital rights management systems, implemented in the United States by the Digital Millennium Copyright Act.

Predicted effects

Discussion of the proposed AUSFTA showed a sharp divergence among official estimates of the likely effects, those put forward by mainstream economists, and those of non-economists concerned with specific aspects of the agreement. The official estimates were highly optimistic, in some respects more so than those of the organisation set up to promote the agreement. Conversely, the critics predicted a range of potentially disastrous outcomes. The predominant view among mainstream economists, meanwhile, was that the costs of the agreement outweighed the benefits, but that the likely net impact was small.

In the lead-up to the AUSFTA, the Department of Foreign Affairs and Trade commissioned the Centre for International Economics to analyse the economic impacts of a likely agreement. The Centre reported benefits of around A$4 billion, largely because of the benefits assumed to flow from improved access to the US sugar market. When the agreement was announced, with no improvement in access for sugar, the Centre prepared a new analysis that, surprisingly enough, showed even larger benefits. The loss of sugar access was more than offset by the inclusion of highly speculative assumptions about a reduction in the cost of capital.

The big gains in this second modelling exercise came from two main sources. The first are the so-called “dynamic gains” from liberalisation, which are little more than a pious belief held by advocates of free-market reform. These gains have no basis in neoclassical economic theory and no real supporting evidence. The second supposed gain was derived from the idea that capital market liberalisation will reduce the equity risk premium and therefore increase economic welfare. Again, these projections lacked any credibility. The policy changes proposed under the free-trade agreement were tiny by comparison with the floating of the dollar and the associated removal of exchange controls over the 1970s and 1980s, not to mention the concomitant domestic liberalisation. Yet there was no convincing evidence that these larger changes had any net effect on the risk premium for equity. Australian regulators who have to use a risk premium in estimating the cost of capital have looked at this issue repeatedly, and none has yet been willing to base decisions on the assumption that the risk premium for equity has declined recently, relative to the twentieth century as a whole.

By contrast with the optimistic predictions prepared for the Australian government, a study undertaken by the International Monetary Fund found that a free-trade agreement with the United States would shrink the Australian economy by 0.03 per cent per year and increase the bilateral trade deficit.

Independent analyses, such as that of Philippa Dee, generated much smaller estimates, in the order of A$100 million each year for the goods trade component of the agreement. Taking account of the uncertainties involved in all such projections, it would be difficult to reject the hypothesis that, assessed in terms of standard neoclassical trade theory, the costs and benefits of the agreement to Australia will be approximately equal, and that the net benefits will be approximately equal to zero.

The second issue considered by independent analysts concerned the relative desirability of bilateral and multilateral agreements. Proponents of multilateral processes, such as Ross Garnaut and Bill Carmichael, were strongly critical of the agreement, and argued that it would undermine both the World Trade Organization and prospects for improved trade relationships with Asia.

Supporters of the agreement, such as Alan Oxley, on the other hand, argued that the failure of the Doha round of World Trade Organization negotiations showed that multilateral processes could not be relied on to produce progress towards freer trade, or alternatively that bilateral and multilateral agreements were complements rather than substitutes. In addition, they pointed to the alleged dynamic benefits of closer integration with the US economy. Summing up the independent economic studies of the AUSFTA, a research note for the Australian Parliamentary Library found that four out of five studies predicted negative effects.

The economic issues were familiar from past debates. But the agreement also attracted critical attention from a wide range of actors, including writers, health policy professionals and actors in the literal rather than metaphorical sense of the term, whose concerns and interests had not previously been impinged upon by trade policy. Most of these concerns were related, in one form or another, to the issue of intellectual property.

The most extreme critique, by Linda Weiss and others, was called How to Kill a Country: Australia’s Devastating Trade Deal with the United States. The polemical title of this work reflected the heated atmosphere of the debate and also, perhaps, the marketing requirements of a popular book on a complex issue that remained topical for only a few months.

The outcomes

At least viewed from the Australian side, the AUSFTA has produced few of the expected benefits. And, while there have been some notable negative effects, they too have been relatively modest. The hyperbolic claims of How to Kill a Country have not been borne out, and the AUSFTA has played only a relatively marginal role in Australian public policy.

A survey undertaken by the Australian Industry Group revealed general disillusionment with the agreement. According to the group:

The survey found that five years after implementing the much heralded Australia–US FTA, the US market remained difficult for Australian exporters. Almost 80 per cent of respondents said the FTA was not very effective in improving export opportunities, and 85 per cent said it had failed to help in setting up an operation in the US. As for improving access to US government contracts, 87 per cent rated the FTA’s effectiveness as low or having no effect.

These subjective impressions are confirmed by statistical measures of the outcomes. As Rodney Tiffen observes:

Australia’s exports to the US in the five years to last year grew by only 2.5 per cent, compared with double-digit growth for exports to all the major Asian trading partners. Since the signing, America has slipped from third to fifth among Australian export destinations, overtaken by Korea and most recently India.

Moreover, between 2004 and 2009, the bilateral trade gap in America’s favour grew even larger. Australia’s imports from America have grown much more quickly than its exports to America. According to US data, the gap in America’s favour grew from US$6.4 billion to US$11.6 billion.

The Parliamentary Library’s Michael Priestley also notes the deterioration in the trade balance, observing, however, that “it is unclear whether the widening trade deficit with the US and the decline in manufactured exports to the US can be attributed to the AUSFTA or to the lagged effect of the strong Australian dollar beginning in early 2004, or to a combination of both of these factors.”

These outcomes are hardly surprising. The Howard government’s desperation to produce a result allowed the Bush administration to impose an agreement heavily weighted in favour of the United States. The available evidence suggests that, as regards international trade in goods and services, the outcomes for Australia have been negative, as predicted by most independent economists. Certainly, there is no sign of the benefits predicted in the studies commissioned by the Australian government.

Some of the adverse effects feared by critics of the AUSFTA have not come to pass. Eli Lilly used the appeal provisions of the agreement regarding decisions by the Pharmaceutical Benefits Advisory Committee in relation to Forteo, an osteoporosis drug, which had been rejected for listing under the PBS (except for a limited set of cases) four times. The appeal was unsuccessful, however, and the decision of the PBS was upheld. Following further studies, Forteo was listed in May 2009.

Thus, while the appeal mechanism may be of some marginal benefit to pharmaceutical companies, it has not fundamentally changed the operation of the Pharmaceutical Benefits Advisory Committee. More generally, the PBS remains a central feature of Australian health policy. Policy changes aimed at cost containment have allayed concerns about the sustainability of the scheme, and criticism from pharmaceutical companies regarding the prices paid and criteria for listing have been ineffectual.

On the other hand, as noted by Pat Ranald, Tom Faunce and Ruth Townsend in No Ordinary Deal, the agreement set up a joint Medicines Working Group that has pushed for changes to medicines policy. The creation of a new “F1” class of medicines exempt from reference pricing was one outcome of this process.

In relation to intellectual property, the additional restrictions imposed by the AUSFTA and other international agreements have been relatively ineffectual in the face of a general shift in sentiment against strong intellectual property rights and the effective breakdown of most prohibitions on copying material. Recent moves by the Australian government to raise the thresholds to patenting and to exempt experimental activities from patent restrictions are indicative of the trend. On the other hand, the investment provisions appear to have some real bite, notably in restricting protections that governments might seek to impose in the process of privatisation, such as limits on foreign ownership and requirements to provide employment in regional areas.

On at least one occasion, the extra bite of the AUSFTA proved counter- productive to the goal of limiting public intervention in the economy. Snowy Hydro, an electricity generation company jointly owned by the Commonwealth, NSW and Victorian governments, was a candidate for privatisation. In view of the political unpopularity of privatisation, it has been common for governments to attach a range of conditions on employment and ownership. Under the terms of the AUSFTA, however, the capacity to impose such conditions is strictly limited. Ranald notes that a proposed limit, restricting foreign ownership to 35 per cent of shares, was judged to be in contravention of the agreement. The inability to impose such conditions, and thereby allay some sources of public concern, was one reason for the abandonment of the proposed privatisation.

A notable feature of this case is that a bilateral agreement between Australia and the United States sharply constrained policy options, even though there was no reason to suppose that the restrictions were directed at US investors in particular. It seems unlikely that the US government would take the provisions of the agreement with Australia, or the provisions of a Trans-Pacific Partnership Agreement, into account when formulating policies directed primarily at incoming investment from, say, China.

THE AUSFTA has delivered few, if any, of the benefits promised by its advocates. On the other hand, its consequences have been more limited than many critics predicted. The PBS remains intact, although the agreement has strengthened the push to raise returns to pharmaceutical companies. Attempts to advance a strong intellectual property agenda on the basis of the agreement have generally been unsuccessful, and there has been some liberalisation of intellectual property rules in relation to fair use and other exemptions.

Perhaps the most important general lesson to be learned is that the effects of an international trade agreement depend, to a large extent, on the political context in which the agreement is applied. In the political context of the 1980s and 1990s, a market liberal policy agenda, focused on privatisation and deregulation, was dominant in most developed countries, but nevertheless faced significant resistance. International agreements such as those associated with the World Trade Organization and the World Intellectual Property Organization provided a powerful tool for governments seeking to overcome such resistance. Even where community mobilisation was sufficient to defeat proposed agreements, as with the failed Multilateral Agreement on Investment, many of the provisions were implemented piecemeal, in ways that avoided public scrutiny.

By the time the AUSFTA came into effect in 2005, though, enthusiasm for market liberalism had waned. In the place of a consistent program of market-oriented reform, a pragmatic approach has emerged. The scope of government intervention has been expanded in some areas and reduced in others, depending on assessments of the political, economic and social costs and benefits.

Rather than using the provisions of the AUSFTA to advance an agenda of privatisation and deregulation, as was widely expected, the Howard government adhered to the letter of the agreement, but was not, in practice, much constrained by its provisions. The Rudd government took a similarly pragmatic approach, which its successors seem likely to continue.

This means that discussion of the proposed Trans-Pacific Partnership Agreement should not be seen primarily as the venue for stand-alone campaigns against (or for) a particular text. Rather, the discussion needs to be placed in the context of long-term debates about the interaction between trade policy and such issues as employment rights, environmental protection and intellectual property. •