Take a closer look at the successes and challenges of free trade around the world.
North America scores the highest among trade groups on the George W. Bush Institute-SMU Economic Growth Initiative’s Scorecard with a 76.3 (B+). When weighted by GDP, the strength of the U.S. economy brings the score up to 90.5 (A).
Canada, Mexico, and the U.S. together outperform the world’s other major regions on the Scorecard – including the European Union, APEC in Asia, and the Pacific Alliance in Latin America. The three parties to the North America Free Trade Agreement (NAFTA) agreed to modernize and replace NAFTA with the U.S.-Mexico-Canada Agreement (USMCA) that went into effect July 1, 2020. Notably, USMCA was updated to include the latest intellectual property and digital commerce provisions. However, changes to rules of origin in certain manufacturing sectors may constrain supply chain decisions, replacing free-market latitude with rules and regulations that will be defined and enforced by government agencies. View North America integration data.
Within the Scorecard’s six categories, North America’s highest score is for investment environment (73.9), followed by business environment (69.1) and legal system and property rights (67).
North America’s trade environment score has decreased since 2007, largely driven by a substantial drop in the score of the U.S. – which fell from 85 in 2007 to 63 in 2020. This can likely be attributed to increased security measures in the U.S. over this period. Despite an emphasis on free trade, security procedures at customs and border checkpoints in response to September 11, 2001 have increased the cost and complexity of trading with and travelling to the U.S. However, the World Bank reports that the time and cost of border compliance, documentary compliance, and domestic transport within the overall process of exporting or importing a shipment of goods has increased substantially in all three countries over the past ten years. As a result, North America’s average percentile rank on the World Bank “trading across borders” indicator has fallen from 75% to 60% over the past decade. This decline signals the need for the three countries to invest more in digitization, targeted development and coordinated pre-screening programs at the borders. As the effects of the COVID-19 pandemic linger, these needs will only grow more urgent.
In the Bush Institute-SMU Economic Growth Initiative’s Scorecard indicators, the U.S. excels in higher education and training, financial market development, innovation and sophistication, and labor market efficiency. Canada shines when it comes to measures of primary education, property rights protections, credit and labor markets, and financial stability. Mexico rates highly on the ease of obtaining credit, and its investment environment has improved markedly over the past decade thanks to recent far-reaching economic policy reforms in sectors including energy and telecommunications. However, recent interference and arbitrary regulations initiated by the Mexican government suggest that these market-opening reforms may be subject to retreat.
Overall, investment environment is North America’s highest score, and it signals the region’s success at attracting and protecting cross-border investment – thanks in part to agreements such as NAFTA and USMCA. To maintain its score, the region must continue to preserve the free movement of goods, services, capital, and labor, along with effective mechanisms to resolve investor disputes that may arise.
There is also room for improvement. All three nations are plagued by low scores in the macroeconomic environment, where North America receives its lowest score of 57.3. Specifically, the U.S. must reduce fiscal deficits and indebtedness to restore confidence in its long-term macroeconomic outlook. Above all else, Mexico needs to improve rule of law, strengthen institutions, and reduce corruption. Mexico’s score for legal system and property rights has decreased considerably since 2007 – indicating that attempted reforms have been ineffective. In Canada, company spending on research and development is lagging, and non-tariff barriers still impede trade in some industries such as dairy.
One of the Asia Pacific Economic Cooperation Forum’s (APEC) core strengths is having the North American economies as members. However, the absence of the U.S. from major regional trade pacts diminishes the forum’s potential.
APEC encompasses 21 economies that together make up roughly 60 percent of the global economy. Merchandise trade between APEC economies accounts for about 35 percent of the world’s total merchandise trade. North America contributes 46 percent of APEC’s GDP, and China contributes 27 percent.
APEC receives a B (70.5) on the Bush Institute-SMU Economic Growth Initiative’s Scorecard, and its score rises to 74 when weighted by GDP. APEC performs above-average on each of the six key Scorecard metrics.
Perhaps surprisingly, APEC’s two lowest scores are trade environment (60.2) and investment environment (61.7). Since its inception, APEC’s primary goal has been to promote investment and free and open trade across the region. APEC has achieved marked success in this regard, with free trade agreements such as NAFTA, USMCA, and the Pacific Alliance emerging among its members. However, China and Russia both score in the D range on the investment environment indicator for maintaining prohibitions or significant restrictions on foreign investment in key sectors. APEC economies that do not have free trade agreements with each other, such as the U.S. and China, have engaged in tariff wars over technology transfer requirements and domestic subsidies to industries – subsidies which the U.S. argues have distorted trade. APEC’s next lowest score is on macroeconomic environment (62.1), where it is weighed down by unsustainably high government debt and deficits in two of its largest economies: Japan and the U.S.
The APEC model provides North America with food for thought when it comes to its focus on underlying competitive drivers, including health, food security, innovation, and human capital, as well as its detailed work to deepen integration in key sectors, such as energy, transportation, automotive, and chemicals. View APEC integration data.
Two massive new trade deals may determine the ultimate success of APEC. Eleven APEC economies have signed the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). CPTPP significantly reduces trade and investment barriers, calls for competitive neutrality between state-owned and private businesses, and includes advanced standards on intellectual property protection. Notably, CPTPP does not include the two largest APEC economies: the U.S. and China.
China spearheads the recently-signed Regional Comprehensive Economic Partnership (RCEP) trade agreement. RCEP includes key U.S. partners such as Australia, New Zealand, Japan, and South Korea, among others, but excludes North America.
CPTPP receives an un-weighted score of 73.2 (B) on the 2020 Scorecard, compared to a 68.1 (B) for RCEP. In part, this is because RCEP includes a larger number of developing countries. In 2019, the GDP per capita at purchasing power parity (current international dollars) for the RCEP group was $18,161, compared to $29,210 for the CPTPP group. Un-weighted, CPTPP outscores RCEP on all six of the key Scorecard metrics. Two of CPTPP’s largest leads are on the trade and investment environment metrics – and these leads will likely only grow as CPTPP fosters standards of market liberalization absent from RCEP.
CPTPP and RCEP are competing models for shaping transpacific trade in the 21st century. The absence of the U.S. from these forums puts it at a disadvantage as the rules of global trade may be heavily influenced by China.
Despite lingering uncertainty around the terms upon which the United Kingdom will exit the EU, the European Union (EU) maintains its B on the Scorecard.
The EU is the result of decades of integration among its 28 Member States. Within the EU’s Single Market, goods, services, people, and capital move as if in a single country. The European fund for strategic investments targets key areas for competitiveness, including infrastructure, development of the energy sector, and education and training. EU ministers have set goals to enhance the functioning of the Single Market by focusing on integration in energy, transport, and services, and by fostering digital commerce. View European Union integration data.
Although its scores across the six key Bush Institute-SMU Economic Growth Initiative’s Scorecard metrics have fluctuated over the last thirteen years, the EU’s overall grade has held steady at a B. When weighted by GDP, the EU’s grade is still a B, but its overall average score rises from 69.3 to 73.2.
Among the six key Scorecard metrics, the EU scores highest on legal system and property rights, health and education, and trade environment – a reflection of the European commitment to social development and frictionless movement of goods and people across borders. The EU scores lowest on the macroeconomic environment indicator (50.3). Over the past decade, the EU has endured multiple sovereign debt crises as countries – including Greece, Portugal, and Spain – have struggled to constrain public debt in the face of growing unemployment and deflating property values. The crises stem, in part, from the fact that the members of the eurozone share a common currency, but are free to set their own budget, tax, and pension policies. Therefore, when a eurozone country becomes overleveraged and faces default, more disciplined and faster-growing countries, like Germany, are called upon to extend credit in order to preserve monetary stability in the eurozone.
The EU's oftentimes cumbersome regulatory regime weighs down its members individual business environment scores. For example, by protecting domestic producers, the EU reduces their incentive to be innovative and flexible. An oftentimes cumbersome EU regulatory regime also makes it difficult to start a business. For this reason, Germany, the EU’s largest economy, only ranks in the 29th percentile on the World Bank’s indicator for ease of starting a business. Furthermore, it scores a pedestrian 56 on the Bush Institute-SMU Economic Growth Initiative’s investment environment indicator.
Notwithstanding debatable flaws, the EU free trade platform is vital for manufacturing powerhouses that source regionally and export globally. Once again, Germany serves as a prime example. Germany exports nearly as much as the U.S., even though its economy is less than a fifth the size of the U.S. economy. In a pattern similar to North American supply chains, German automakers source metals, parts, and manufacturing services from other European countries, most notably the Czech Republic, Hungary, Poland, and Slovakia. The EU agreement does more than support free trade in Europe. It gives a country like Germany the ability to profitably maintain manufacturing excellence on the global stage while fostering economic development in neighboring countries.
The EU approach to integration transfers sovereignty to supra-national political institutions, which the North American model does not. The UK’s decision to leave the EU seems to suggest that the North American approach may be more politically sustainable.* Indeed, since Great Britain announced its intent to leave the EU, the EU’s trade environment score has fallen from 74.5 to 72.3 amidst the uncertainty.
That being said, sustained cohesion in the EU provides benefits that extend far beyond Europe. The U.S. alone ships about $917 million in goods to the EU every day (including the UK). For U.S. exporters, it is much simpler and less costly to deal with one set of EU duties and standards instead of dozens of country-specific regulations. A comprehensive free-trade agreement between the EU and U.S., such as the proposed Trans-Atlantic Trade and Investment Partnership (TTIP), could benefit North American and European businesses** and would add to the free trade agreements Mexico and Canada already have with the EU.
*Note: Because the UK decision to leave the European Union did not take effect until January 2020, the UK is still included as part of the EU in the 2020 edition of the Bush Institute-SMU Economic Growth Initiative Scorecard.
**Studies suggest that an agreement like TTIP could increase GDP for the EU and U.S. by 2 percent each. Shortly after its implementation, it could add 350,000 jobs in the U.S. and 1 million jobs in the EU.
Internal challenges persist in the five Central American countries and the Dominican Republic, but their free trade agreement with the U.S. offers a foundation for economic advancement.
Signed in 2004, the United States-Dominican Republic-Central America Free Trade Agreement (U.S.-DR-CAFTA) eliminated most tariffs and other trade barriers on products and services passing among Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua, and the United States. Designed to increase U.S. market access, foster direct investment, promote regional economic integration in Central America and diversify Central American exports, U.S.-DR-CAFTA was the first free trade agreement between the U.S. and a group of developing countries. The region covered by the agreement is the second-largest Latin American export market for U.S. producers, behind only Mexico. View U.S.-DR-CAFTA integration data.
Since 2007, the five Central American countries and the Dominican Republic have shown improvement on the Bush Institute-SMU Economic Growth Initiative’s Scorecard investment environment indicator, rising from 35 to 40 (on average). This improvement coincides with U.S.-DR-CAFTA commitments that remove barriers to private investment and create common standards and regulatory oversight for financial institutions in Central America and the Dominican Republic.
Central America and the Dominican Republic score lowest on the Scorecard measure of legal system and property rights (24.2). In particular, they rank near the bottom of the world on ease of starting a business, enforcing contracts, resolving insolvency, and paying taxes. For the economies to fully realize gains from free trade, they must create regulatory environments that provide certainty and legal recourse to businesses.
Other indicators most in need of improvement include business environment (24.8) and health and education (35.8). Underinvestment in infrastructure and a large, persistent informal economy weigh down the business sector in the region. In Central America, less than 2 percent of GDP is dedicated currently to physical infrastructure, and just 5 percent of digital connections are 4G. On the education front, gang infiltration of schools prevents many students from finishing secondary or high school.
The recent surge of Central Americans seeking asylum in the U.S. reflects the struggles that endure in the region. Specifically, the Northern Triangle countries of El Salvador, Guatemala, and Honduras continue to battle gang violence, drug trafficking, and corruption, all of which constrain potential investments. However, as domestic conditions improve, U.S.-DR-CAFTA provides an opportunity for Central America and the Dominican Republic to produce and invest together with North America.
Despite steady improvement since 2007, China receives a C with an overall score of 46.4 on the Bush Institute-SMU Economic Growth Initiative Scorecard.
Significant legal and regulatory reforms followed China’s entry into the World Trade Organization (WTO) in December 2001. Since 2007, the country’s Scorecard rating for legal system and property rights has improved from 38.4 to 56.6. However, the investment environment score (34.9) remains China’s lowest among the six key Scorecard indicators, and China’s trade environment score (37.9) has shown only small improvement since 2007. This may reflect a plateau after partial implementation of its WTO commitments.
China has pursued an aggressive bilateral free trade agreement strategy in recent years, and it leads the newly signed Regional Comprehensive Economic Partnership (RCEP), a trans-Pacific trade agreement that rivals CPTPP and excludes North America. In contrast to the openness of North America, China still imposes a variety of market restrictions.
China continues to prop up uneconomic state-owned enterprises over private companies in many sectors, fails to provide adequate intellectual property and other legal protections for foreign businesses, and maintains regulatory barriers to market access. In response to these restrictions, a tit-for-tat trade war has emerged between the U.S. and China, with both countries imposing tariffs on imports. There is a potentially significant opportunity here to reduce trade barriers, but an equally great risk that the parties become dug-in over a sustained period of time. This could severely hinder transpacific trade, investment, and growth in both countries, with implications for the global economy as a whole.
Major investments by the Chinese government in health and education are paying off, reflected by the 26-point increase in China’s score in this category since 2007. China’s macroeconomic environment score has declined markedly in the past few years – falling from 53.1 in 2017 to 36.7 in 2020. After experiencing nearly 11 percent annual GDP growth over two decades, China’s high rate of growth is showing signs of leveling off. In response, the Chinese government has cut taxes to try to stimulate growth and has urged local governments to reign in mounting debts. All the while, China is spending aggressively on infrastructure projects in Asia, Europe, and Africa – through its Belt and Road Initiative – with an aim to increase political and military influence abroad, expand markets for Chinese exports of goods and services, and reduce excess capacity in Chinese industrial sectors.
Buoyed by openness to trade and private investment, the Pacific Alliance scores a 55.2 (C+) on the Bush Institute-SMU Economic Growth Initiative Scorecard.
Formally launched in June 2012, the Pacific Alliance is a relatively young trade group, but it has become a significant counterpoint to Mercosur in Latin America. Currently, the Pacific Alliance accounts for nearly 37 percent of Latin America and the Caribbean’s total GDP, 54 percent of the region’s exports, 54 percent of the region’s inward foreign direct investment stock, and 35 percent of the region’s population.
Within the Bush Institute-SMU Economic Growth Initiative’s Scorecard six categories, the Pacific Alliance scores highest on macroeconomic environment (63), investment environment (59.8), and trade environment (57.4). In particular, scores for investment environment and trade environment have trended upward during the past decade, as countries such as Mexico have opened their economies to private investment and pursued trade pacts with partners from around the globe. Notably, Mexico is a member of both USMCA and the Pacific Alliance. However, Mexico’s economy represents a much larger share of the Pacific Alliance, accounting for 60 percent of its combined GDP.
Excluding Chile, members of the Pacific Alliance continue to perform poorly on measures of legal system, property rights, and judicial effectiveness. For the alliance to crystallize its market-opening agreements, its member countries must reduce the pervasiveness of crime, corruption, and violence. To improve its score, the Pacific Alliance could strength judiciary system across the alliance, which would provide even more certainty for investors looking to enter a region with untapped potential.
With an aggregated population of approximately 229 million, the Pacific Alliance is actively working to increase the number of business professionals and students in its member countries. The Pacific Alliance has pursued deep and innovative forms of integration , such as enabling the free flow of capital among its members and combining its members’ financial markets into one stock market. It is also exploring the idea of a dedicated fund to channel pension fund investment into cross-border infrastructure projects.