Liberal economists tend to say that free trade means that governments should not impose barriers of trade. These barriers could be tariffs or non-tariff barriers such like quotas and different standards which regulate market access. Free trade negotiations thus aim to reduce tariffs and quotas, reduce bureaucracy, and harmonizing standards.

Many of these market regulations or standards have their background in various forms of market failure. Their task is e.g. to internalize external costs (or to regulate activities which produce externalities), to mitigate problems of information asymmetry e.g. in case of consumer protection, or to establish countervailing power, e.g. in case of labor standards. All that is not distortive in the sense of allocation efficiency, in contrast, it should promote market efficiency, and could incentivise market participants to seek for better solutions. The design of these rules and standards  – though being influenced by political bargaining and interest groups – can be seen as a democratic outcome: the open and liberal society decides to which extent and in which way they wish to come up with these various sorts of market failure. These rules determine the mode how markets are working in order to achieve an overall desirable outcome – not only the desired bundle of goods but also the way how production, market exchange, (re-) distribution, working conditions etc. are organized. Recall, that all that are choice consequences where individuals have preferences about. This illustrates that market regulations, also for cross-border transactions, should empower people to make better informed choices, reduce externalities and the role of imbalanced power and to take responsibility for the consequences – not bossing individuals around.

Liberalism implies that people are aware of the choice consequences and take full responsibility of them. This requires that prices reflect all social costs, and that customers are well informed about choice consequences. Many agents would like to take responsibility about social and ecological conditions of production of the goods they are purchasing. In Global Value Chains, information about these consequences are usually dispersed and not fully reflected in the prices. Thus, with increasing globalization, information asymmetry increases, too. The price system in a market economy should reflect social opportunity costs and willingness to pay. Hence, the question whether globalization fosters or reduces allocative efficiency, is not easy to
answer.

What happens in case of trade between countries with different, i.e. lower standards or more lax regulations? The country with stricter standards will have – in tendency – a comparative disadvantage for all activities which are regulated more strictly. These activities are out-sourced or off-shored, and consumers buy the imported goods at lower prices. However, they could know that they are indirectly contributing to externalities and social imbalances in other countries. But if their decisions are guided predominantly by prices, they are less able to express their willingness to pay for proper production conditions. An example might be child
work or hazardous working conditions. People decided for good reasons to prohibit child work – in their country. Whether they indirectly promote child work in other regions via their consumption behavior is a choice consequence they cannot be sure about. Imposing environmental taxes for internalizing externalities leads to comparative advantages of other countries for producing dirty goods. Introducing labor standards create comparative advantages of other countries for labor-intensive goods, and so forth.

The common wisdom of trade theory that “aggregated” welfare increases due to specialization and trade is easy to prove for a „represwentative“ consumer who is purely self-interested: her welfare depends only on the amount and variety of consumed goods, and the bundle of goods is increasing due to trade. From a political economy point of view, if consumer’s or voter’s preferences are also reflected in the way of regulation and standards, it is by no means clear whether welfare has increased. This is one of the problematic issues of many free trade agreements: the negotiations are often intransparent and massively influenced by minority lobbying groups. Public support of free trade arrangements require an open dialogue, information disclosure, and participation in discussion. This would reduce campaigning activities against free trade agreements by other lobbying groups which are often seen as ill-informed. However, the main participants and lobbyists of past trade agreements are sometimes ill-informed as well, e.g. when declaring that environmental and consumer protection issues are “not economic issues” and should thus not be prioritized. (That’s an example of the widespread misconception that first we have to „make business“ in order to have the money to finance all that social and environmental bling-bling – this is the opposite of informed economic reasoning.)

For a reduction of tariffs or quotas or bureaucracy there is usually a broad consensus. The “harmonization” of regulations and standards, however, is highly debatable. Proponents of free trade see these differences as a barrier to trade. The opponents see an undermining of the democratically legitimated rules how to cope with these various forms of market failures according to the voter’s preferences. In many cases a “harmonization” means that the lower standard is made effective, and a further improvement of standards or adaption to the preferences is much more difficult as the consent of the other country is necessary (supranational law). Therefore, the voters do not experience an extension of their “freedom”, the “free” trade agreement might limit or reduce their freedom to take responsibility of their choice consequences and the future design of the rules. The “free” in free trade should not be trivialized to freedom to choose among a larger variety of (cheaper) goods or the freedom to
make more money. This would not have much to do with the ideas of liberalism.

These are not ideological or left-winged arguments, it is a very simple implication of economic reasoning, based on Pareto efficiency criterion and theory of allocation in a market economy plus some arguments from Public Choice. Therefore, free trade agreements between countries with different attitudes and preferences is an ordoliberal challenge if the goal is to maintain or even extend freedom. It is by far less simple than just “abandoning trade barriers”. It has to address the question how individuals can decide about the design of rules which govern their life conditions according to their preferences. And how they can keep control of that in a globalized world with multilateral and regional agreements.

The free trade negotiation process should carefully deliberate publicly about differences of standards. If harmonization isn’t desirable, the national standards prevail. If national standards evolve, all suppliers and consumers are affected in the same way. Thus it is not legitimate that foreign investors have privileged rights to appeal against changing policies (such privileges are justified only in case of very weak institutions if FDI should be promoted). Both governments should make clear arrangements how to deal with important cross-border externalities such as greenhouse gas emissions. For example, both sides could agree to consider a joint de-carbonization strategy which imposes improved standards of cleaner production. In case of e.g. different carbon taxes, traded goods should be border-taxed so that the carbon embodied in traded goods is taxed in a non-discriminatory way compared to the locally produced goods. Improvements of regulations should not be hindered by international treaties but supported by them. Thus, free trade agreements could become a vehicle to globalize improved environmental and social standards. It could be expected that with such an agenda there would be by far less resistance against globalization and free trade. And it would be a step towards a modernization, i.e. de-trivialization of the term “liberal” in economic policy.