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Next week, leaders will convene for the first EU-Latin America summit in quite some time. The primary focus of the meeting will be the trade agreement between the EU and Mercosur, a trading bloc consisting of Brazil, Argentina, Paraguay, and Uruguay. Although the deal was agreed upon in 2019 after years of negotiations, it has yet to be ratified. The delay in finalizing the agreement can be attributed to two key factors in Europe: agricultural protectionism and the EU’s newfound emphasis on environmental and climate demands in trade deals.
While the Mercosur countries agreed to climate and environmental provisions aimed at protecting the Amazon from deforestation, European green politics have taken precedence. Pressure from Brussels has led to calls for additional provisions to make the environmental aspects of the deal legally binding. Brazil, in particular, has been resistant to these extra commitments. Although a breakthrough is unlikely at the summit, there is hope for a political consensus that will pave the way for a final agreement soon.
However, my focus today goes beyond the specifics of the green provisions and delves into the underlying principle behind them. This reflects a completely new approach to trade policy. Trade deals are no longer limited to specific products and services; they now encompass the methods of production as well. The EU-Mercosur deal’s emphasis on deforestation is just one example. The agreement also includes a provision stating that eggs will only receive favorable import treatment if they adhere to EU animal welfare standards. The EU is not alone in this approach. When the US renegotiated the old NAFTA trade deal with Canada and Mexico, it extended tariff reductions only to cars produced by labor paid above a certain amount. Non-traditional considerations are also being pursued through unilateral trade policies, such as the carbon border tax on imports from countries with less stringent emissions regulations and requirements on human rights in EU companies’ global supply chains. Additionally, a new EU law banning imports of palm oil from cleared forests has impeded trade talks with Malaysia and Indonesia.
These new trade rules demonstrate that identical products can receive different treatment based on their production methods. This approach is legally controversial, as treating identical products differently has often been associated with protectionism. However, legal refinements could potentially strike a balance between considering production methods and preventing protectionism, as highlighted by David Henig in a recent Borderlex column.
From an economic standpoint, the question arises: what is the rationale for imposing these extra conditions on trade if voluntary economic exchange generally leads to gains? One possible answer lies in externalities—situations where free trade is not always efficient and needs to be slightly restricted to achieve greater efficiency. An example of this is carbon tariffs, which prevent pollution from shifting abroad due to lax regulations and result in higher-priced goods. However, this answer has limitations. The externality argument does not easily apply to other areas, and it assumes a trade-off between free trade and other considerations.
I propose a more ambitious argument for including non-traditional considerations in trade policy—one that is grounded in economic efficiency and pro-trade liberalism. Modern consumers themselves differentiate between identical goods produced in different ways. Many individuals care about whether a product is ethically produced or environmentally sustainable. For instance, a T-shirt made with cotton from concentration camps in Xinjiang is fundamentally different from one made with ethically sourced cotton. Furthermore, the blending of goods with services in the digital age means that production methods extend beyond the point of sale. Consumers consider a car that tracks their behavior and transmits data to a manufacturer in a different jurisdiction to be distinct from one that does not.
There is existing economic research on “procedural utility,” highlighting the importance of both outcomes and the processes by which they are achieved. This topic aligns with my own research during my PhD, which emphasized the need to account for process-dependent preferences in economics. It is clear that because people care about production processes, taking these processes into account does not violate the principles of free trade. Free trade should not force consumers to accept inferior products that differ from their preferences due to production methods. Of course, precautions must be taken to prevent protectionism, but rules regarding production methods in trade policy are no different from other product rules, such as prohibitions on toys with lead-based paint. Free traders should embrace rules on production methods and have confidence in this new approach to trade policy.
Other notable reads include Erik Nielsen’s analysis of the convergence between Italian and German borrowing costs and Gideon Rachman’s podcast featuring Anu Bradford, the author of the term “Brussels effect” and a proponent of regulating artificial intelligence. If you prefer reading over listening, you can always refer to the transcript of the podcast.
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