Free Trade!

The sun rises over the Atlantic at Virginia Beach. Freer trade across the ocean may soon dawn, too. Photo by Brendan Hoffman/Getty Images.

The global economy just took two big steps toward freer trade, with China and Switzerland signing a free trade agreement (FTA) on Saturday and the US and EU starting free-trade negotiations Monday. Though these aren’t instant economic fixes for anyone involved, they should provide additional tailwinds for global stocks and be longer-term economic positives.

Combined, analysts estimate both deals will eventually boost global trade by over $400 billion. Swiss-Chinese trade totaled $26.3 billion last year and is on pace to top $40 billion in 2013. As tariffs on Swiss luxury goods and Chinese textiles and shoes phase out, trade should rise further. Exporters on both sides likely boost profits, while consumers enjoy cheaper goods and broader choices. The Transatlantic Trade and Investment Partnership (TTIP) likely brings even bigger gains. Currently, the US and EU have the world’s largest trade relationship, with $2.7 billion crossing the ocean daily. Since tariffs on most of this are already ultra-low, the biggest rewards come from removing administrative barriers, including procurement policies, incompatible regulatory standards and subsidies. Right now, transatlantic red tape can cost firms as much as tariffs, if not more—and it disincentivizes trade. For example, many automakers opt against exporting certain models rather than comply with conflicting environmental and safety standards.

Removing these barriers would be huge over time, but potential sticking points like EU restrictions on genetically modified food and meat washed in chemicals, US bans on raw milk products and both sides’ sensitivity over pharmaceutical and auto safety standards could hold things up. Financial regulation may be another stumbling block. Both sides want to liberalize financial services, but this likely requires harmonized rules. The EU has proposed establishing a US-EU “super regulator” to ensure consistent standards, but the US is wary. If they agree to a regulator in principle, they could spend years wrangling over bank capital standards, the EU’s limits on banker bonuses, the UK’s fuzzy plans to make “reckless misconduct in the management of a bank” a criminal offense, the forthcoming financial transaction tax and other similar items. Even where rules coincide in spirit, like the US’s Volcker Rule, the UK’s Vickers Rule and similar EU plans to ring-fence retail and investment banking, they differ significantly in practice. Finding common ground will be no small task.

That’s just one reason we’d caution folks against getting too jazzed over the economic benefits in the near term. Overall, huge regional trade agreements are slow at best and often stall. The US-EU deal likely has a better chance than the failed Doha round of world trade talks, but it will take time. Both sides want a deal done by next autumn so US midterm elections and the new European Commission appointments can’t get in the way, but that seems optimistic considering the Trans-Pacific Partnership is in its 17^th round of talks since 2010 and NAFTA took 6 years to negotiate. Even if TTIP moves swiftly, it won’t take effect overnight. Trade barriers likely fall over a number of years so businesses can have time to adjust to increased competition—a typical political concession. Switzerland and China, for example, will phase out tariffs over 10 years. Economic gains will come, but not overnight.

Yet FTAs can lift equity markets in the near term. Though global GDP may not fully reflect these deals for years, stocks aren’t solely a function of GDP. Equities move largely on investors’ expectations of future earnings—and the prospect of freer trade can boost expected profitability. Stocks likely move before trade barriers fall as investors anticipate new revenue streams, more streamlined costs and higher business investment. Equally important, free trade progress can boost investor sentiment, perhaps offsetting some jitters over the EU and China’s ongoing solar spat and other tiffs. As long as the world keeps trending toward freer trade overall—something stocks typically love—the occasional protectionist threat needn’t knock the bull off course.