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Bilateral free trade agreements have been the major means of opening markets over the last decade, but they have been attacked on two fronts. Critics of trade liberalization dislike them for obvious reasons. However, some advocates of trade liberalization also dislike them because they are seen as distracting from the goal of worldwide free trade. This latter group tends to misinterpret what free trade agreements do and the broader benefits they can bring.

This study aims to explore those broader benefits through an in-depth look at the case of Peru. In particular, it seeks to shed light on some of the debates about free trade agreements by asking what the Peruvians sought to achieve through the FTA. Were they seeking new access to the United States market? Or were they using the agreement as a vehicle to strengthen economic and governance reforms?

Although these explanations have been offered for FTA participants around the world, there are some reasons why Peru offers a particularly interesting application. Not only did Peru suffer through past periods of economic mismanagement and poor governance, but the current President, Alan Garcia, previously presided over one of the worst episodes. The FTA with the United States offered one of the only ways that the Peruvian government could commit itself credibly to pursuing a broad range of better policies. Further, if we are interested in what countries hoped to achieve in pursuing an FTA, Peru offers the freshest set of expectations available, still untainted by much subsequent experience with the operation of the agreement.

A major focus of this study is the extent and means by which FTAs function as a means of committing to better governance. Some of this is embodied in the agreement itself, with chapters covering investment and dispute resolution. Some of it comes from the signal it sends about the government's beliefs and priorities. One of the failings of the academic literature has been a tendency to approach FTAs as a mere reciprocal lowering of tariffs. There is a practical reason for this approach: it is very difficult to model systematically the other things that an FTA does. While there are alternative approaches in the literature reviewed below, they tend to be broad and empirical, without firm theoretical foundations. A case study offers an opportunity to address familiar liberalization questions, but also to delve into some of the subtler questions that have yet to be well-addressed in the literature.

The study suggests that Peruvians were far more interested in locking in economic reforms and attracting investment than in gaining new market access or moving the terms-of-trade in their favor. They saw the FTA as an integral part of broader economic reform and as a springboard to liberalization with the rest of the world.

In some ways, the Peruvian case is ideal for disentangling the different effects of FTAs which are expounded in the academic literature. Most notably, Peru already had virtually tariff-free access to the U.S. market through the U.S. preference measures.

It is not a perfect natural experiment, however. Peru benefitted greatly from a worldwide commodities boom that was contemporaneous with pursuing and signing the FTA with the United States. That is an important part of the backdrop to the story about learning and the dynamics of trade liberalization that is taken up later in the paper.

Peru sheds light on the central schisms in the trading world today. The World Trade Organization reached an impasse in 2008, in part over the proper rights and obligations of advanced developing countries. Those obligations have historically been low in the WTO and high in FTAs. The different branches of the U.S. government reached an impasse over the desirability and impact of FTAs--Peru was the last to pass before this rift brought action to a halt.

The next section reviews some of the major hypotheses in the literature about why countries pursue FTAs and what those agreements do. Section 3 offers some background on Peru's economic history and the role that trade has played. It also describes
the key features of the U.S.-Peru Trade Promotion Agreement (PTPA). Section 4 reports the findings of a series of interviews with Peruvian former officials, academics, and businessmen. It uses those interviews to consider the hypotheses of Section 2 as well as to explore some novel arguments about the political economy of trade agreements. Section 5 concludes.

This is the first paper in the Working Paper Series on Development Policy.

Philip I. Levy is a resident scholar at AEI.