No Nafta and it's splat for Gatt

'NAFTA - We hafta,' says President Clinton, who faces the second key congressional test of his presidency when the House of Representatives votes on the North American Free Trade Agreement on Wednesday.

Having scraped through the budget debate with only a couple of votes to spare in the summer, there was considerable doubt whether the President would stake his prestige on pushing Nafta through a basically hostile Congress - especially since the Democratic party's main union funders are also vehemently opposed to the free trade deal.

Mr Clinton was deliberately ambiguous about Nafta in last year's election campaign, but it is to his credit that he has now decided to throw the weight of the presidency on the right side of the debate. At first sight, the issue seems unimportant - Mexico's economy is only about one-twentieth the size of the US economy, and trade barriers between the two countries are already low. (Canada, which is also a party to the deal, already has a free trade agreement with the US, and does almost no trade with Mexico.)

Furthermore, it is difficult to understand why there is so much hostility to the deal north of the Rio Grande. Mexican tariffs on imports from the US average 10 per cent, while American tariffs on Mexican goods average less than 5 per cent. Consequently, when tariffs disappear (over the space of a decade, according to the deal), the US should gain more than Mexico.

Several reputable economic studies - I exclude those used by the amazing Ross Perot - have confirmed the deal will result in a small net gain in employment in the US.

So why the fuss? The explanation lies in the fact Nafta is a litmus test of America's attitude towards free trade in general, and towards the Uruguay Round of Gatt in particular. A defeat for Nafta will leave the US's trade strategy in ruins and its foreign policy searching for new leads.

Any European eavesdropper on the Nafta debate will be struck by how peripheral the European Union has become to many Americans. Supporters of Nafta unashamedly see the deal as crucial in ensuring US hegemony over Latin America, and it is indeed obvious the process of economic reform in the Latin countries will be set back immeasurably by a rebuff from Congress.

In addition, many Americans, including some in the Clinton camp, view Nafta as a prototype for a much larger free trade area, stretching across the Pacific Ocean towards Japan and the rest of Asia.

Nafta failure would stymie this vision. Of more immediate importance to those of us in Europe, it would also make it less likely that a Gatt deal could be concluded by the 15 December deadline set for the negotiations in Geneva. Even with a Nafta success, Gatt could run into trouble.

There are at least a dozen major issues still to be settled, ranging from the reform of the common agricultural policy in Europe, to the opening up of Japanese rice markets and the access of financial services into Asia. Even the question of tariffs between the developed economies remains contentious, despite the apparent agreement at the Tokyo summit in July.

Two ingredients are needed to ensure success. The first is time - an even more precious commodity now that the Americans have in effect absented themselves from Geneva pending the Nafta decision. The second is goodwill and a willingness to compromise. The real problem which would be created by Nafta rejection would be that the US negotiators would feel much more restricted in the concessions they could make in the inevitable last-minute sessions of Gatt horse-trading.

STUMBLING BLOCK

Too many concessions, the American negotiators would suppose, could mean the defeat of the implementing bill for the Uruguay Round in Congress next year. But too few concessions would allow the French in particular to portray the US as the main stumbling block to a deal. And if they could do this, there would be less chance of the Germans being willing to muscle the French into accepting the Blair House agreement on agriculture.

This is why several European governments will be glancing anxiously towards Washington on Wednesday.

On most calculations, it is the EU - and this includes France, incidentally - that gains most from a further shift towards free trade.

According to a much-quoted recent study by the Organisation for Economic Co- operation and Development and the World Bank, the EU would make a gain of 1.4 per cent of its GDP in the year 2002 if the Uruguay Round succeeds, whereas Japan would gain 0.9 per cent and the US only 0.2 per cent. (The Asian 'tigers', incidentally, would gain most, with a jump of 2.6 per cent in GDP.) Furthermore, since these gains would supposedly come from supply-side factors - in particular, a superior allocation of resources across economies as world prices become less distorted by tariffs and subsidies - there would be no adverse inflationary effects from this extra GDP growth.

In fact, in some European countries with particularly rigid labour markets, there are grounds for thinking inflation might actually be lower if a Gatt agreement is reached.

The French point out - with some justification - that these gains are unlikely to be forthcoming quickly, or indeed to be possible at all without accepting considerable short-term dislocation and unemployment as industrial restructuring takes place.

Furthermore, it is absurd to suggest that a supply-side improvement of this type will do much to help the world out of recession. That has been entirely caused by a deficiency of nominal demand - a shortage of spending rather than supply capacity.

Nevertheless, a Gatt deal would be worth having, if only because the alternative could, if politicians are sufficiently foolish, involve slipping back into a world of recrimination and rising protection.

My own belief is that this is unlikely to be a black-and- white affair. If there is no overall Gatt deal by 15 December, it is likely that a more modest deal could be signed, or that countries could agree to describe the failure as a further postponement of the deadline.

Nevertheless, the efficacy of Gatt as a means of settling disputes - already extremely shaky - would be further damaged, and there would probably be an acceleration of the recent tendency for world trade to split into three protected blocs - the EU, North America and East Asia.

CONFIDENCE CRISIS

The graph is based on a recent study by the London Business School of the effects of an increase in European and American tariffs worth 10 percentage points on all imports. (The Japanese are assumed not to retaliate.)

According to the model, the level of world GDP in 1997 would be depressed by about 1 per cent relative to the base case, while the world price level increases by 1.2 per cent.

Although these effects may seem to be quite small, they are an unmitigated bad thing, and both effects are still rising as the simulation ends. What is more, these calculations make no allowance for the drop in business confidence that a world trade war could cause.

The world will continue to spin on its axis if the Gatt round fails. There will be no return to the slump conditions of the 1930s (which were not primarily triggered by the spread of protection in any case). But to return to Mr Clinton's slogan - Nafta, they hafta, or it's splat for Gatt.

And that matters.