Dynamics and Complexity: Do Free Trade Agreements create uncertainties for companies' operations?

Dynamicsand Complexity: Do Free Trade Agreements create uncertainties for companies'operations?

There are many uncertainties faced every day for a company’soperation anywhere in the world. Operating globally increases these uncertainties, and the associatedcomplexities of free trade are a prime example of these uncertainties. 

The GATT of 1947 helped start the trend towards freetrade.  The principle mission of thistreaty was for each member nation to open markets equally to all other membernations.  This began a most favorednation status among nations and eventually was replaced by normal traderelations.  Much of these agreements, andtreaties were incorporated into the WTO. Many nations could circumvent these global treaties by entering intobilateral agreements like a Preferred Trade Agreement or Free Trade Agreement(Daniels, et al, 2009).  Free trade isoften negatively cited as a cause of the widening gap between the wealthy andthe poor, and strengths and weaknesses of trade agreements can alter stabilityof a developing nation (Xirinachs, 2008).

These bilateral arrangements create uncertainty forcorporations.  The static and dynamiceffects caused by free trade open or divert trade from various markets.  If a company is not able to predict andrespond quickly, it may find itself in an uncompetitive region in terms oflabor or tariffs (Daniels, et al, 2009). An unexpected agreement in a regioncould cause a dynamic shift allowing for an economy of scale that makes a firmmore or less competitive. This type of uncertainty is part of the impact freetrade has.

The expansion of the European Union has led to uncertainty forcompany operations there.  The EU hasexpanded rapidly and has allowed other nations to join that are lesseconomically robust to join.  This allowsfor shifting labor from areas of high labor costs to areas of low laborcosts.  While this level of change canwork for a company, it is hard to predict the end result of immigration andlabor pool mobility in advance (Daniels, et al, 2009).  In addition, proposed member Turkey posesmovement, and security uncertainty for the entire EU. 

Nations like the United States use treaties like NAFTA for itsown political agenda.  Trade sanctionsand treaties are a strategic means for a government to influence itsagenda.  In the case of NAFTA, the USimposed stricter labor and environmental mandate on Mexico.  Competing nations like China, at present donot have clauses for sustainability. These uncertainties caused many firms to close up shop in Mexico withthe increased pressure for higher wages and sustainable manufacturing to moveto the Asian markets where labor is also cheap and there are no environmentalmandates (Daniels. et al, 2009).  Asfactor mobility theory suggests, the FDI and MNE followed the low wages and lowcosts and shifted production there.  Manytreaties are influenced by labor unions, and Political Action Committees.  These lobbyist groups spend big bucks toinfluence lawmakers and policymakers to vote a certain way.  Often a firm will find itself at odds with apolitical agenda of the government or more likely a PAC and its stakeholders(Jackson and Engel, 2003).  Opening upfree trade often comes at a cost to other industries; the groups with the mostto loose are often the most outspoken against the free trade (Daniels, et al,2009).

A Trade agreement like NAFTA forces companies to reshape theirstrategies to adapt to the changing environment (Baer, 1991). In addition, freetrade in developing areas like Africa and South America are subject to theuncertainty of political movements, war and national agenda that can disruptbusiness operations (Daniels, et al, 2009).

Another source of uncertainty related to free trade isexchange rates.  While products can crossborders with little tarrifs and quotas, there is always the specter of currencyexchange rates.  In the case of Mexico,it does over 50% of its exports with the US and the value Peso versus theDollar has varied greatly since NAFTA (Grube and Samata, 2003). Thisuncertainty can cause firms to adjust foreign direct investment orconsideration of operations in a particular country. Trade agreements ofteneliminate the  welfare effects of atariff and a quota in an imperfectly competitive market when demand isuncertain and policy must be chosen before the uncertainty is resolved Chen andHwang, 2006). Excessive fluctuations in exchange rates often influence tradeflows. Theoretically, increased uncertainty may increase or decrease the volumeof trade, or leave it unchanged. NAFTA has caused increased volatility hasshort-term effects on the trade flows of most industries but that the long-termeffects are significant (positive or negative) for only one-third ofindustries. Most of the significant effects are negative rather than positive.  This effect leads to uncertainty for firmsthat operate in and around these areas (Bahmani-Oskooee and Hegerty, 2008).

Overall, freetrade, while more often beneficial, does increase a firms operatinguncertainty. It has become clear that a simple focus on tradeliberalization as a formula for growth and poverty reduction is simplistic.Most high performing nations have integrated with the world economy by usingunorthodox approaches to trade reform, which combine relatively long periods ofreasonable protection for domestic industry with the establishment of tradetreaties and arrangements such as investment incentives.  These varied programs can cause uncertaintyand are a challenge to predict the impact of. The design of trade policy overtime is critically important for growth and stability. So is finding the rightway to combine trade liberalization with other public policies aimed atstrengthening infrastructure, human capital, innovation, or enterprisedevelopment (Xirinachs, 2008).

References

Baer, M.D. (1991). North american free trade. Foreign Affairs, 70(4),132-144

Bahmani-Oskooee, M., & Hegerty, S.W. (2009). The Effects ofexchange-rate volatility on commodity trade between the united states andmexico. Southern Economic Journal, 75(4), 1019-1044.

Chen, H., & Hwang, H. (2006). Tarrifs versus quots under market priceuncertainty. Review of World Economics, 142(1), 181-194.

Daniels, J. D., Radebaugh, L. H., & Sullivan, D. P.(2009). International Business (12 ed.). (S. Yagan, Ed.) Upper Saddle River,NJ: Pearson Education, Inc.

Grube, B.T., & Samanta, S.K. (2003). Effects of exchange rateuncertainty on mexican foreign trade. Multinational Business Review, 11(2),3-1

Jackson, D., & Engel, S. . (2003). Friends don't let friends vote forfree trade. Political Research Qurterly, 56(4), 441-449.

Salazar-Xirinachs, J.S. (2008, Spring). When Free trade does not reducepoverty and inequality. Americas Quarterly, 59-68.