Broadly put, economics deals with the allocation of scarce resources in order to best maximise utility. In the case of a country the utility focus is on its production of all goods which in turn is measured by its financial position in world markets, i.e. the level of wealth that it generates for the country. A Production Possibilities Frontier (PPF) graph (Fig 1) can be used to show the maximum production of goods that a country can achieve given its limitation of resources and current technology. A combination of goods outside of the curve, e.g. point C is not possible, while one under the curve (e.g. point A) means that the economy is underperforming, in other words is not using all of its resources efficiently (as in the case of point B). A final point to note from this graph is that an increase in production of one good will result in an opportunity cost in production loss of another good.
It will be shown that if countries do trade freely amongst themselves then not only will they be able to break through their PPF but they will also be able to do so at reduced costs. Given this fact, the question as to why governments appear to resist opening their markets to free trade and competition will also be answered.
Basic Economics and Trade Barriers
Consider the Supply-Demand curve in figure 2. Assuming that there is no foreign trade, there will be a price and quantity equilibrium (Pe, Qe) where the domestic supply (Sd) and demand (D) intersect. Suppose now that foreign exporters enter the market and that they can supply the product at the world price of Pw (which is lower than Pe). As the new supply is a world supply, its supply curve will be horizontal (i.e. perfectly elastic) since it won’t be affected by the relatively small consumption of its new market (Mankiew, Bandyopadhay & Wooding, 2007). As can be seen, this will drive the domestic supply down to Q1 but demand up to Q2. Not only does this result in the consumer of the domestic market being able to purchase more at a lower price but it is also possible that this imported quantity of Q2-Q1 may very well result in the PPF of the domestic market being exceeded.
As a result of the price reduction, domestic suppliers will no longer be willing to produce as many goods meaning that labour will be laid off and in some cases businesses might even close. In order to try and protect their domestic industries, Governments may impose an import tax (called a tariff) on the foreign product. Figure 2 once again shows what will happen. This will cause Sw to move up vertically by the amount of the tariff to Swt. Sure more domestic producers are prepared to supply the goods and revenue of FGÃ-DG is generated for the government. However consumer surplus (difference between what consumers are prepared to pay and what they have to pay) shrinks by the amount represented by area âˆ†ABC to that of the area of âˆ†ADE. There is also a dead weight loss (inefficiencies between marginal benefit and cost) represented by area âˆ†FGH+âˆ†EDB. The result also includes domestic consumers having to pay more expensive prices as well as the possible souring of relations with a county’s trading partners who in turn might impose tariffs on goods coming into their own country.
Although governments use trade barriers (like tariffs) to protect their own domestic trade, it can be seen from the above that this does not produce efficient markets that are beneficial to both consumer and producer. A better way would be for countries to have free trade but then trade with each other based on their comparative advantages. Consider the following, New Zealand and Malaysia can each produce both dairy products and petroleum. New Zealand can however produce dairy products at lower opportunity cost than Malaysia while Malaysia can produce petroleum at a lower opportunity cost than New Zealand. If New Zealand therefore produces more dairy (but less petroleum) while Malaysia produces more petroleum (but less dairy), the two counties will be able to not only achieve a greater combined output of each product (at a lower cost) but they will be able to supply each other’s demands for the alternate product. While this may enable them to exceed their PPF it also makes them dependant on each other and therefore vulnerable should future disagreements arise.
Malaysia is New Zealand’s eighth most important export destination; larger than either India, Germany or Singapore.(NZMAF, 2009) In spite of this trading between the two countries is not as efficient as it should be as a result of the duties that exports from New Zealand to Malaysia attract ($12.6 million in 2008, NZMAF, 2009). As New Zealand is trading with Malaysia anyway, it makes sense to work at removing these barriers so that each country can increase the quantity of their product exported while keeping prices at the lowest possible market price. This not only benefits the consumers in each country but will also continue to stimulate growth in each of the industries as demand grows. As far as this particular RTA goes, New Zealand kiwifruit, meat, wool, dairy, fish, forestry products, liquid milk, some steel lines, some paints and varnishes as well as a number of plastic products stand to benefit from the elimination of tariffs as result of this agreement. This represents a broad cross-section of New Zealand industry and there for will not only have a positive effect on the GDP but also should affect many New Zealanders directly.
Another positive side effect is that as Malaysia enters into agreements with other countries, New Zealand will automatically benefit from these agreements. This is because of the reciprocal Most Favoured Nation (MFN) condition in the agreement. This condition ensures that all trading countries are treated equally amongst themselves. Beside the trading benefits, there are also benefits in areas like:
Environment – this covers agreements over exhaust gases , sewage, noise control and environmental protection,
The benefits of an RTA are only as good as the RTA itself. In this regard, the MNZFTA has some shortfalls. As a result of religious, safety or environmental concerns, Malaysia has kept tariffs on some eighty-eight products (NZMAF, 2009). Also certain products have kept tariff rate quotas; liquid milk being one of these, (NZMAF, 2009). An obvious concern would be that as markets open up, countries start to become more dependent on each other for the products they consume. This can put one country at the mercy of another should the politics of the time change for the worse. Besides domestic industry protection, this is another strong reason why many governments may implement a certain level of protection in their markets. It may cost more but gives them a greater sense of security.
Multilateral trade initiatives and RTAs
Multilateral trade incentives involve a number of parties and are therefore generally more difficult to finalise than that of a RTA between a few countries. Furthermore, the requirements needed to meet the World Trade Organisation’s (WTO) acceptance are more stringent than those required by a Regional Free Trade Agreement (RTA). Firstly, a WTO backed resolution for a particular agreement can only be passed if there is full agreement between all members. Also (since the Uruguay round of the WTO) quotas are not permitted (WTO website); this technically makes the Tariff Rate Quotas (TRQs) on New Zealand’s liquid milk, in the MNZFTA, illegal. Although the WTO would not sign off on such an agreement, they do allow it as they see it as part of a transitioning period to a truly free market i.e. they see it as a step in the right direction.
An economically compromised agreement is still better than no agreement. As a result, countries that enter into such RTAs are able to more quickly reach agreement on goals that they wish to achieve and then specify the process and timeframes on how they will bring them into WTO compliance. In the case of the MNZFTA, this agreement allows certain goals to be achieved quicker than they will be under the AANZFTA agreement e.g. faster tariff elimination. It also allows for “greater cooperation and dialogue on a range of economic issues of common interest” (NZMAF, 2009, p. 14).
Given the growth in business transactions and investments between New Zealand and Malaysia it makes sense that a business that wants to expand into Malaysia (and its surrounding regions) would welcome such an agreement as the MNZFTA. Firstly the MNZFTA levels the playing fields for all those involved ensuring that everyone is subject to agreed and transparent rules. This not only results in free and fair trading but also gives all parties security and stability for the long term. This is particularly true in the areas of environmental and labour compliances. As the MNZFTA covers these areas, producers in both countries will be affected by the same constraints and costs, putting them on an equal trade footing with respect to these issues.
The MNZFTA will also give New Zealand businesses a competitive edge over those countries that are not part of the agreement. While preferential treatment is frowned on by the WTO it will definitely help New Zealand businesses to expand into the Malaysian market. Also as more nations enter these sorts of agreements, the MFN condition will eventually result in all being treated equal.
This agreement also helps lay a foundation on which to build a future FTA for the whole Asia Pacific region. Thus this agreement may ultimately open the way for a New Zealand business in Malaysia to expand beyond Malaysian borders.
Although hard to calculate, administrative costs in protected markets may equal up to 15% of the value of the goods traded (OECD, 2005). This together with the added tariffs (which drive export sales down) results in unnecessarily high costs for the supplier. Trade agreements reduce these hidden costs (making things cheaper for the supplier). As a result of reduced or removed tariffs, prices fall, demand increases and the supplier is able (and willing) to export more.
Free trade may put stress on domestic markets as growing competition competes for market-share. At the same time though it also forces domestic markets to restructure and become more efficient.
Trade barriers like tariffs are used by governments to protect domestic industries which in turn secure citizens’ employment. They are also used to strengthen national security. That said it has been shown that markets are more efficient when they are allowed to interact freely without government interference. It also makes it possible for poorer or smaller countries to use their comparative advantages to not only better their positions but also to contribute positively to global economies.
WTO agreements and FTAs provide the framework (both implementation and legal) within which companies can safely open up, and trade with each other, now and in the future. Besides addressing economic issues these agreements also strengthen global relationships and address ethical and environmental concerns.
Since New Zealand’s trade with Malaysia continues to grow it makes sense to engage in a RTA (or FTA) with them as this will not only reduce costs to New Zealand businesses (and consumers) but also increase their already growing trade. Although never perfect the benefits of these agreements far outweigh the concerns.