Misusing Trade Agreements – Econlib

But why all these extra clauses? The general idea behind trade agreements is to champion trade liberalization, which can usher in a plethora of benefits—from stimulating long-term economic growth to attracting foreign investments and even sparking institutional reforms. As economist Russell Sobel posits, an open trading environment is often the spark that ignites enhanced economic freedom. The argument is simple: by liberalizing trade, nations can diminish corruption or foster ethical behavior. This reduction can stem from either formal institutional reforms (think laws and regulations) or informal shifts arising from increased business interactions with countries perceived as less corrupt.

Starting with the US-Morocco Free Trade Agreement in 2004, the U.S. began embedding transparency and anti-corruption measures in its trade agreements. These stipulations compel trading partners to legislate against both active and passive bribery. By 2015, the European Union joined the fray, advocating for anti-corruption clauses in free trade deals. Amy Fuentes argues that these provisions can significantly diminish demand-side corruption, particularly when foreign entities or officials are the ones pursuing bribes.

However, despite the potential upsides of increased free trade, corruption can act as a formidable barrier to economic growth, especially in developing nations. Global estimates place the cost of bribery at about one trillion dollars annually—roughly five percent of the world’s GDP. Corruption stifles both immediate economic transactions (often “greasing the wheels”) and longer-term growth prospects. Jac Heckelman and Benjamin Powell suggest that in environments where economic freedom is stifled, corruption can ironically serve as a means for entrepreneurs to navigate regulatory red tape, effectively bypassing restrictive policies. Yet, as nations evolve, such corrupt practices often morph into inefficiencies that impede sustainable economic development, akin to “sand in the wheels.”

In this discussion, Michael Munger introduces the concept of a “political Coase theorem,” suggesting that corruption can serve to lower transaction costs and improve efficiency in the face of ineffective economic institutions. The catch? Public officials are unlikely to relinquish their power or the perks of corruption for the uncertain promise of collective betterment. Munger concludes that corruption, rather than being purely irrational or inefficient, is a result of a pervasive transitional gains trap. Gordon Tullock elaborates on this notion, explaining that once rent-seeking behavior sets in, the resultant rents become entrenched over time, making it costly to remove the policies that birthed them. Thus, corrupt officials may be resistant to reforms that would enhance their own welfare at the cost of the capital they’ve accrued through corruption.

Research by Omer Gokeekus and Yui Suzuki indicates that increased trade openness between the European Union and African nations—fostered via the Cotonou Partnership Agreement—has the potential to mitigate corruption. Notably, this agreement predates the EU’s adoption of anti-corruption clauses.

What about other regions? In our recent study with Taylor Crawford, we delve into the impact of U.S. trade agreements on corruption within Latin American nations. With 20 countries currently holding trade agreements with the U.S., 11 of which are in Latin America—a region notorious for its erratic and corrupt regimes—this is a fertile ground for analysis. We specifically investigate whether the level of corruption differs between Latin American countries that have entered into trade agreements with the U.S. and those that haven’t.

It’s worth noting that anti-corruption initiatives between the U.S. and other nations aren’t a new development. The Foreign Corrupt Practices Act (FCPA), enacted by Congress in 1977, specifically targets U.S. businesses that engage in bribery of foreign officials. It differentiates between “corrupt payments” and “facilitating payments,” where the latter—payments made to expedite standard processes—may escape penalties. However, the FCPA doesn’t address foreign officials who attempt to solicit bribes.

The limitations of the FCPA have spurred calls for embedding transparency and anti-corruption provisions within free trade agreements, a practice the U.S. pioneered in 2004, quickly followed by the EU and Canada. These anti-corruption clauses necessitate that countries revise their laws to meet the treaty’s standards. Formal laws, or what Gerard Roland refers to as fast-moving institutions, can be modified swiftly by centralized authorities. Yet, the real challenge lies in enforcement. Frank Brown and Amy Fuentes point out that enforcement rests largely on the willingness of the foreign country, and many Latin American nations have shown little resolve in this area.

Conversely, slow-moving institutions such as social customs and norms evolve gradually. Peter Boettke, Christopher Coyne, and Peter Leeson advocate for the concept of institutional stickiness: for formal institutions to succeed, they must be rooted in compatible informal institutions and cultural contexts. Consequently, for formal anti-corruption laws to be effective, they must align with the informal institutions and the pervasive culture of corruption.

The intersection of free trade and corruption raises the question of whether trade agreements that exist within transitional gains traps can sufficiently lower transaction costs to mitigate corruption. Could participation in a trade agreement encourage moral integrity, reward virtuous behavior, and elevate ethical standards, as suggested by scholars like Langrill, Storr, and McCloskey? Ultimately, does engaging in a trade agreement with the U.S. contribute to a decline in corruption over time?

Our findings challenge the assumption that entering into a trade agreement with the U.S. leads to reduced corruption in Latin American countries. In fact, trade agreements featuring anti-corruption clauses seem to correlate with increased corruption, as per metrics from the International Country Risk Guide and the Global State of Democracy corruption indices. A closer inspection of these corruption metrics indicates that bribery within the executive branch may be the principal factor at play. Given that the anti-corruption clauses directly target bribes, they might not yield the intended outcomes.

This observation aligns with Richard Epstein’s argument favoring simple rules over complex regulations for fostering market efficiency. When the U.S. attempts to impose intricate regulations through trade agreements, the involved countries may struggle to enforce them, potentially resulting in heightened corruption as they seek to navigate this complexity. Furthermore, this notion resonates with Holcombe and Boudreaux’s assertion that increased regulation tends to exacerbate corruption. If anti-corruption clauses lead to the creation of more regulations, they could inadvertently produce the opposite effect intended. Thus, while trade can spur economic growth and enhance freedoms, the imposition of complex regulatory frameworks through trade agreements could dampen some of the otherwise positive outcomes.

Moreover, if anti-corruption clauses fail to effectively curb corruption, the transaction costs associated with negotiating these clauses—and other provisions like environmental regulations—could outweigh the benefits of focusing solely on promoting free trade. The public choice theory, unfortunately, has largely been overlooked in discussions regarding Latin America. The role of governments in combating corruption through trade, while neglecting the rent-seeking behaviors and transitional gains traps tied to corruption, raises the question of whether we are expecting too much from trade agreements.