Chapter 9: The Way Forward
Since the end of World War II, the goal of U.S. trade agreements has been to eliminate barriers to international trade to the greatest extent possible in order to promote economic efficiency and consumer benefit, as called for by Western economic theory. As a result of these U.S. trade agreements, there have been enormous reductions of trade barriers and steady expansions of the trade rules to cover a wide range of nontariff barriers, services, and even the protection of intellectual property. The United States and other countries have benefited greatly from the resultant expansion of world trade.
However, today there are two major problems with the United States’ trade agreements program. First, the international trade rules developed in previous rounds of negotiations have significant gaps, and some neomercantilist countries have taken advantage of these loopholes to pursue commercial policies that injure the U.S. economy. Second, after a dozen years multilateral negotiations under the World Trade Organization (WTO)—the so-called Doha Development Round—have failed. The United States has free trade agreements (FTAs) in effect with twenty other countries, but seventeen of these are with small economies, and these agreements have only very minimal commercial benefit for the United States. The United States needs a strategy that will promote its commercial and foreign policy interests and strengthen the global trade system.
The law of comparative advantage—one of the fundamental pillars of modern economic theory—holds that total global welfare will increase under conditions of free trade, and that even if one nation maintains trade barriers, other nations may still benefit from reducing their own trade barriers. Consumers will benefit from lower prices as tariff s are reduced, and producers will be forced to become more efficient to meet international competition. However, economists note some very important caveats to the basic theory of comparative advantage, and these caveats are too often ignored by policymakers.
One caveat is that the law of comparative advantage assumes that trade is basically balanced and that any deficit or surplus is temporary or at least cyclical. If a country has a long-term structural deficit, as is the case for the United States, it means that the country is importing some products and not exporting other products where it actually has a comparative advantage.[1] The result is reduced economic output and a loss of employment opportunities.
A second important caveat is that countries can create comparative advantage in some products. The original theory expounded by David Ricardo assumes constant or increasing costs as production expands. However, in today’s complex economy, the costs of production for many products, such as automobiles and semiconductors, decline as production increases. This means that for these products, countries can play an important role in creating comparative advantage. For example, a neomercantilist country might impose trade barriers to allow domestic producers to take advantage of the home market until sufficient market size can be obtained to be cost competitive, or it might provide subsidies to enable domestic producers to expand production and move down the cost curve. Or the country might maintain an undervalued currency that acts as both an import barrier and a subsidy and is perhaps the most egregious form of protectionism.
And a third important caveat is that the multilateral reduction of trade barriers under the WTO is generally preferable to trade liberalization as a result of a bilateral or regional FTA. Reducing or eliminating trade barriers between just a few countries may actually be a move away from trade based on global comparative advantage if the agreement leads to more trade diversion than trade creation. (A bilateral or regional FTA leads to trade diversion if members of the FTA expand their sales to a partner because of the tariff preference, thereby displacing a more efficient nonmember that has to pay the duty.)
Bilateral and regional FTAs also have cumbersome rules of origin, which are generally different in each agreement and which are often explicitly designed to increase trade diversion to benefit the parties to the agreement at the expense of nonmembers. Rules of origin that differ from one agreement to another mean that a country’s products may qualify for duty-free treatment when exported to a partner in one of its bilateral agreements but not qualify for duty-free treatment under other agreements. In addition to this loss of efficiency, it is expensive for firms to track compliance with these rules of origin, and this also reduces global efficiency.
With these three caveats in mind, we look first at the huge U.S. structural trade deficit, which is caused partly by defective U.S. domestic policies and partly by the neomercantilist practices of some of the United States’ trade partners, such as maintaining an undervalued exchange rate and taking advantage of other loopholes in the world trade rules.
Then we consider what should be the U.S. strategy toward trade agreements in the current context of a failed round of multilateral negotiations—the Doha Development Round—under the WTO. How can the negotiations for a Trans-Pacific Partnership trade agreement and for a Trans-Atlantic Trade and Investment Partnership further the United States’ commercial and foreign policy interests? And how can America help revive the multilateral trade system and move back toward trade based on the most-favored-nation (MFN) principle?
The U.S. Trade Deficit
As described in chapter 4, the U.S. deficit in goods and services trade has increased enormously over the past thirty years, from $12.1 billion in 1980 to $560 billion in 2012. In 1980, the United States’ deficit in goods and services trade equaled about 0.5 percent of its gross domestic product, rising to just under 6 percent in 2005 and 2006 before falling during the global financial and economic crisis of 2008–9 to just under 3 percent in 2009. More recently, as the U.S. economy has been slowly recovering and demand for imports has been increasing, the U.S. deficit has been rising again and in 2012 equaled 3.6 percent of the nation’s gross domestic product.
Economists, of course, generally focus on the current account, rather than the more narrow trade balance, when analyzing a country’s international balance. However, the other items combined that make up the United States’ current account except for goods and services, such as earnings on investments or foreign aid, have a slight positive balance. Because the United States’ deficit in goods and services trade is far larger than its surplus on the other items, it has a large deficit in its current account, which equaled $475 billion in 2012, about three-fourths the size of the deficit in goods and services trade by itself.
There are several major problems with the United States’ large structural current account deficit. The most immediate, as described in chapters 4 and 8, is that it represents a loss in U.S. economic output and reduced employment. Additionally, most economists believe that at some point in the future America’s continued trade deficits will become unsustainable. Much of the United States’ debt to finance its current account deficit is held by just a few countries, primarily China and Japan. At some point these countries may decide to no longer accumulate dollars or they may be unable to continue purchasing U.S. debt.
The risk that this would pose to the U.S. economy is vividly described by Daniel Drezner:
Any decision by the major central banks to sell off dollars would make it impossible to finance the current account deficit at current price levels and interest rates. Under this worst-case scenario, a run on the dollar could commence. A drastic fall in the dollar’s value would fuel inflation at home as the prices of imports shot up. The Federal Reserve Board would in all likelihood ratchet up the short-term federal funds rate in order to stanch outward capital flows. The result would be severe stagflation—higher prices combined with decreased output. At a minimum, such a move would trigger a severe economic slowdown.[2]
As described in chapter 4, the United States’ large current account deficit is partly caused by the neomercantilist trade practices of some other countries, which take advantage of loopholes in the trade rules, and partly by its own policies. U.S. policies that contribute to the nation’s trade deficit include a low national savings rate exacerbated by consistent federal budget deficits, fiscal and monetary policies that do not encourage household savings, and a corporate tax structure that discourages companies from repatriating profits earned overseas.
Because of the U.S. corporate tax code, many multinational companies choose to keep their profits overseas, rather than bring them back to the United States to give to shareholders or invest in United States–based production. U.S. companies such as Cisco, Microsoft, Bristol-Myers Squibb, and GE have more cash overseas than they have had for decades—an estimated $213 billion in 2012 for all U.S. companies.
This element of the United States’ tax policy is in direct opposition to some elements of its policy regarding trade agreements. In particular, trade negotiators have pushed for access for direct investment by U.S. companies in both the WTO services agreement and the investment provisions of U.S. bilateral agreements. However, significant benefit for the U.S. economy from these provisions only occurs if the companies repatriate their profits. Fixing the United States’ budget and tax problems will put the country on a much stronger footing as it seeks to close the loopholes in the trade rules that permit the beggar-thy-neighbor trade practices that damage its economy.
Mind the Gap: The Exchange Rate Loophole
Manipulation of foreign exchange rates is the most egregious tool used by neomercantilist countries. The founders of the General Agreement on Tariffs and Trade (GATT) recognized the potential for currency manipulation to undermine the trade system, but to date negotiators have not successfully addressed this gap in the rules.
In an outsanding analysis by C. Fred Bergsten and Joseph E. Gagnon of the Peterson Institute, eight economies are listed as the most significant currency manipulators: China, Denmark, Hong Kong, South Korea, Malaysia, Singapore, Switzerland, and Taiwan. The report also notes that Japan “has been an occasional manipulator in the past but has not intervened recently.”[3]
Because of its size and history of manipulating its exchange rate, China is the focus of concern by most analysts today. In its semiannual report on exchange rates released on November 27, 2012, the U.S. Treasury noted that China’s currency is “undervalued by between 5 and 10 percent on a real effective basis, as of July 2012.”[4] Though a considerable improvement from the extent of Chinese undervaluation of the past decade, this still represents a significant trade distortion. The report also notes that “China’s official foreign exchange reserves remain exceptionally high compared to those of other economies,” and it says that it is important that the Chinese government move toward greater disclosure of its activities in the currency market.[5]
The Chinese government pegs the renminbi to the dollar and maintains an undervalued rate by purchasing an average of $1 billion to $2 billion in the foreign exchange markets every day. As a result, China has accumulated foreign exchange reserves of some $3.3 trillion, of which about $1 trillion is in U.S. Treasury bills. China, of course, is home to half of all the people in the world living on less than $2 per day, and its leaders deliberately undervalue the exchange rate to boost exports in order to promote China’s economic development and alleviate poverty.
Although the main focus today is on China, currency manipulation is not a new problem. In 1971, the United States believed that some other nations were pegging their currencies below the market value of the dollar to gain a trade advantage. President Richard Nixon imposed a 15 percent import surcharge, which was only removed after Germany, Japan, and other countries revalued their currencies. And then the problem resurfaced again in the mid-1980s, particularly with regard to Japan and some European currencies. At that time, the U.S. Congress threatened to impose an across-the-board import surcharge, which led Japan to agree to revalue the yen by some 80 percent and the Europeans to allow their currencies to appreciate by some 50 percent in the so-called Plaza Accord of 1985.
As noted in chapter 2, Article XV of the GATT specifies that members should not take exchange rate actions that “frustrate the intent of the provisions of this Agreement,” and the International Monetary Fund’s Article IV states that members should “avoid manipulating exchange rates . . . in order . . . to gain an unfair competitive advantage over other members.” However, the WTO/GATT is to accept all findings of statistical fact presented by the IMF, and the IMF for its part has never taken action on exchange rate issues. The result is a huge gap in the international rules.
Ironically, the immediate problem with China’s currency regime could have been resolved when China joined the WTO; as noted in chapter 2, at the insistence of the United States, the draft protocol on China’s accession to the WTO would have required that China bring its foreign exchange regime into conformity with the obligations of the IMF. Unfortunately, the IMF staff forced the deletion of this provision on the grounds that such a provision was the IMF’s jurisdiction, not the WTO’s.[6]
So today the United States has two problems: the immediate one regarding currency manipulation by a number of countries, and the more fundamental problem that there are no effective rules on exchange rates. With regard to China, some progress has been made. In 2005, China pledged to allow the renminbi to appreciate about 5 percent a year, and today it is about 25 percent higher than it was then. Most economists would argue that it is in China’s own interest to allow the renminbi to continue to appreciate. First, China is facing a problem of inflation; wages are rising about 10 to 15 percent a year, and there has been a precipitous rise in housing prices. Former premier Wen Jia-bao said that “the biggest problem with China’s economy is that the growth is unstable, unbalanced, uncoordinated, and unsustainable.”[7]
A stronger renminbi would help curb Chinese inflation, and it would raise living standards in China. Additionally, the dollar will likely depreciate over time, given the United States’ huge current account deficits, and this means that by buying dollars to maintain its undervalued currency, China is basically investing in a declining asset. Thus it is not surprising that China has recently been trying to diversify its exchange holdings to include other currencies and gold. A reason that China has not moved faster is that Chinese leaders are concerned that too rapid appreciation of the renminbi would sharply curb exports and result in political instability.
Nonetheless, the fact is that the process is too uncertain and is moving too slowly. So how should the United States proceed in order to protect its own vital interests?
The United States actually has significant leverage in pressing for a solution with China. First, of course, it could follow the same approach of 1971 and 1985 and threaten or impose an across-the-board import surcharge on countries that consistently maintain an undervalued currency.
Another approach to increasing its negotiating leverage would be to unilaterally intervene in global currency futures markets to bid up the renminbi—in essence, the mirror image of the way that China maintains an undervalued renminbi.[8]
So why has the United States not adopted either of these measures to press China to revalue its currency? There are two answers to this question: The first is the lack of a consensus among economists as to whether China’s undervalued renminbi—and the overvalued dollar—is in the
United States’ interest; and the second is that the United States has important foreign policy interests in resolving this issue in a less confrontational manner.
Some economists argue that because the renminbi and other currencies are undervalued in relation to the dollar, the United States is able to purchase more foreign goods for every dollar than it would be able to do if the dollar were valued at a competitive rate. This benefits importers and consumers. However, as we have seen, it hurts U.S. producers and workers, and this injury is significantly greater than the benefit to consumers. Furthermore, the undervalued renminbi reduces overall global welfare, because it represents a movement away from trade based on comparative advantage.
There is a critical distinction between a strong dollar that has a favorable exchange rate with other currencies because the U.S. economy is strong compared with an overvalued dollar that is artificially high because of U.S. fiscal and monetary policies or because other countries buy
U.S. Treasury notes as protection from global insecurity or because other countries deliberately undervalue their currencies to gain a competitive advantage. An overvalued dollar in these conditions artificially expands U.S. imports beyond the level that would exist under comparative advantage, and similarly it reduces U.S. exports.
The second reason why the United States has not been more forceful on this issue is that it has important foreign policy interests in ensuring that a commercial dispute with China does not create significant enmity that could damage long-term relations between the two nations. Very
aggressive unilateral action by the United States would be viewed as extremely antagonistic by its trade partners.
An Approach to Developing Rules on Exchange Rates
Although this is not the time to designate China or another country as a “currency manipulator,” the United States cannot allow this issue to continue to fester because it is critical to its long-run economic health and indeed the health of the international trade system. Therefore, the United States should take a two-track approach to developing effective rules on exchange rates. Under the first track, the United States should take the issue of ineffective rules on currency manipulation to both the WTO and the IMF. In fact, Brazil has already proposed that the WTO undertake a work program to consider the relationship of exchange rates and international trade. In Brazil’s view, the “WTO could and should . . . deal with the effects of [currency] fluctuations and misalignments.” Among other things, this work program should “define methodologies to assess currency misalignments.”[9] The United States should vigorously support this Brazilian proposal.
However, agreeing on general principles to identify unfair currency manipulation will be difficult. In the analysis by Bergsten and Gagnon noted above, four criteria are listed that may identify a country that is unfairly manipulating its currency: (1) The country’s foreign exchange reserves must exceed six months’ worth of its goods and services imports, (2) its foreign exchange reserves must have grown more rapidly than its GDP, (3) its current account must have been in surplus on average since 2001, and (4) its per capita gross national income must be at least $3,000.[10] Though these criteria are a good starting point for consideration, it will take some time to gain an international consensus as to what constitutes unfair currency manipulation.
While this work is under way in the WTO and hopefully the IMF, the United States should press to have enforceable rules in both the Trans-Pacific Partnership (TPP) and the Trans-Atlantic Trade and Investment Partnership (TTIP) that address currency manipulation. Two countries that have been identified by Bergsten and Gagnon as currency manipulators, Malaysia and Singapore, and also Japan, which has a history of manipulating its currency, are in the TPP negotiations. Because of this and because this is a complex issue that will take some time to address, it is likely that only limited progress can be made in the TPP. However, it should be possible to agree that (1) members will not seek to gain a commercial advantage by manipulating their currency; (2) members will ensure transparency with regard to their interventions in the foreign exchange market; and (3) members will commit to immediate consultations in the event that a member country has concerns with a TPP partner’s actions with regard to the exchange rate.
In the TTIP, it should be possible to make greater progress on this issue. The European Union has also been injured by exchange rate distortions and will likely be more open to developing effective rules on currency manipulation. In addition to what might be agreed on in the TPP, in the TTIP it might be possible to define unfair currency manipulation and make it fully subject to the dispute settlement mechanism.
Responding to Trade Distortions and Barriers
In addition to currency manipulation, countries can take a number of other trade actions to tip the trade field in their own favor at the expense of their trade partners. Sometimes these policies are in violation of WTO rules, and sometimes they take advantage of loopholes in existing rules and are not technically in violation, although the policies may contradict the spirit of the trade rules, which are intended to promote competition based on comparative advantage.
The piracy of intellectual property is a particular area where a number of countries tolerate practices that disadvantage U.S. commercial interests. For example, a study by the U.S. International Trade Commission estimated that the piracy of other company trademarks, copyrights, and patents by Chinese companies resulted in losses of approximately $48.2 billion in 2009 to U.S. firms.[11] Some of China’s and other countries’ practices would likely be found to be in violation of WTO commitments in the event of a dispute settlement case, and the United States should continue to aggressively pursue these cases. However, many of these practices involve inadequate enforcement of the country’s own existing laws; and unfortunately the requirements of the Trade-Related Aspects of Intellectual Property Rights agreement for enforcement are vague and pursuing dispute settlement cases would be difficult. Here, the United States needs to negotiate tighter rules regarding enforcement.
Some examples of other loopholes in the international trade rules:
• The services code (the General Agreement on Trade in Services, GATS) only covers specific commitments to which countries have agreed and have notified to the WTO, and countries are free to implement whatever policies they chose to in areas that have not been notified. China, for example, only allows twenty foreign films a year to be shown, and this is not in violation of China’s GATS commitments; similarly, foreign financial services and insurance firms are largely blocked from the Chinese market.
• The WTO rules on investment allow for a range of domestic subsidies and practices, and a number of countries have given large subsidies to attract foreign investors. Singapore gave Intel $10 billion in tax subsidies, free land, and so on to establish a plant there; and a number of U.S. states give tax incentives to new investors (although the states have funding problems and cannot provide large subsidies). China requires foreign car companies to from a partnership with a Chinese automaker if they want to do business in China.
• Competition policy is not addressed at all by international trade rules. Some countries have business structures that can have the impact of excluding foreign competition; Korea’s chaebol system and Japan’s keiretsu system consist of families of companies in different business segments that give preferential purchasing to other family members and sharply limit the ability of non-national firms to compete.
If there are domestic U.S. producers that are seriously injured by these or other practices, there will be an adverse impact on U.S. employment and production. Some models that some economists use to predict trade effects assume that any capital idled by this lost production or workers who have lost their jobs are instantly reemployed. However, this is usually not the case. Capital and labor often are not fungible. Workers who have lost their jobs in one industry due to imports often do not have skills that are readily transferable to other industries, and equipment that has been idled often cannot be readily redeployed to make other products. Further, if injury occurs in an industry with decreasing costs of production, the firm or industry can suffer permanent long-term damage as the foreign competitor gains global market share, thereby reducing its costs for later penetration of the global market.
So how should the United States respond to the practices of its trade partners that injure an industry? First, if the practice appears to violate an existing rule, of course, the response should be to bring a dispute settlement case. Although a number of companies and congressmen argue that the United States should be more aggressive in using the WTO dispute settlement mechanism (DSM), the United States has actually been one of the more aggressive countries in bringing disputes to the WTO. For example, the United States has brought eleven cases against China and won eight of these (four were settled before a WTO decision), with the other three pending. However, the DSM is somewhat time consuming because the industry first must persuade the administration to file the case and then it has to wait the year or year and a half for the WTO to render a decision. And even once a decision has been rendered, it may be some time before the offending country changes its practices, and occasionally the country will decide to maintain the practice and provide other compensation that benefits another industry.
Second, as an alternative to a dispute settlement case or in parallel with one, it often is possible to offset the injury to the United States’ domestic economy from the trade practices of other countries by taking domestic policy actions. For example, China imposed restrictions on the exportation of rare earths, which are critical to the production of many high-technology products, such as cell phones, ostensibly on the grounds that this was necessary to protect the environment. However, because China produces 97 percent of the world’s supplies of rare earths and because
China did not impose any restrictions on domestic producers, many saw this action as a blatant attempt to gain a commercial advantage by disadvantaging foreign competitors to Chinese industry. Accordingly, the United States, the EU, and Japan filed a dispute settlement case in the WTO against China’s export restraints.
In parallel to this dispute settlement case, the United States could take domestic policy actions to offset the Chinese restrictions. As a case in point, a U.S. mine, the Mountain Pass Mine in California, ceased mining rare earths in 2002 because of weak demand and delays in environmental reviews. The United States could speed up the environmental review process of such a mine without weakening its protection of the environment, and it could even provide subsidies to reopen the mine. Other possible U.S. actions could include providing greater incentives for research into substitute materials for rare earths, promoting the recycling of products such as cell phones that use many of these minerals, and stockpiling vital minerals.
Third, the United States could seek to enter into negotiations with the country imposing the barrier or distortion. As a spur for such bilateral negotiations, the United States could take a unilateral action of its own that limits the other country’s access to the U.S. market to be used as leverage to launch bilateral negotiations. For example, in the rare earths case, America could refuse to license the export of liquefied natural gas to China until China removes its export barriers on rare earths.
Needed: A New Negotiating Strategy
The WTO Doha Development Round of multilateral trade negotiations has essentially failed, although it may be possible to reach agreement on a few elements, particularly trade facilitation, at the December 2013 Ministerial Meeting. There are a number of reasons for failure, including the sheer complexity of trying to reach an agreement among more than 150 countries and the WTO’s governance structure, which gives each member veto power over an agreement.
A major cause is the fundamental disagreement between the developed countries and the advanced developing countries—particularly China, India, and Brazil—over the level of obligations to be assumed by these emerging economic powerhouses. Although they are home to extensive poverty, these advanced developing countries have an enormous impact on the trade system and their trade partners. The major test for the trade system in the coming decade will be how to integrate these nations into a trade system that enjoys support in the developed countries and that still respects the legitimate needs of these nations to continue economic development.
The fundamental concept of a world trade system based on MFN rules is still valid. The founders of the trade rules after World War II believed that trade blocs had contributed to the political frictions that led to the war. Additionally, economists believe that bilateral and regional agreements often cause trade diversion away from trade based on comparative advantage, whereas multilateral agreements allow all WTO members to compete within the same rules-based system. Accordingly, MFN is one of the fundamental principles of the trade rules. However, bilateral and regional trade arrangements have proliferated, and today the MFN system is almost the exception rather than the rule.
The Organization for Economic Cooperation and Development sums up the pros and cons of multilateral versus bilateral trade agreements well:
Multilateral trade rules provide the best guarantee for securing substantive gains from trade liberalization for all WTO members. Nevertheless, . . . [regional trade agreements] have allowed groups of countries to negotiate rules and commitments that go beyond what was possible at the time multilaterally. In turn, some of these rules have paved the way for agreement in the WTO. . . [However], there are concerns that the proliferation of RTAs could create problems of coherence and consistency in trade relations, put developing countries at a disadvantage when negotiating RTAs, and generally divert negotiating resources and energy from multilateral negotiations.[12]
Although multilateral negotiations are preferable to bilateral negotiations, the fact is that this genie is out of the bottle, given that 354 bilateral and regional trade agreements were in force as of January 2013, according to the WTO, and the United States’ trade competitors are eagerly pursuing additional agreements. A strategy that can eventually put the FTA genie back in the MFN bottle is badly needed.
In the early 1980s, when faced with the reluctance of the developing countries in the GATT to launch a new multilateral round of trade negotiations, the then–U.S. trade representative, William Brock, considered a concept he called “GATT Plus.” This would have been an arrangement between countries that were willing to undertake additional liberalization and expanded obligations beyond GATT provisions in exchange for greater market access to their GATT Plus partners. In essence, this would have been a two-tier system in which all GATT members would honor GATT liberalization and trade rules, and then a subset of GATT member countries would have additional rules and freer trade among themselves.
The intent was twofold. First, it was to promote the economic benefits of trade liberalization to the greatest extent possible given international political realities at the time; and second, it was to put pressure on the recalcitrant countries to adhere to the new GATT Plus system at a later date. When the Uruguay Round negotiations were finally launched in 1986, this idea was dropped.
However, perhaps it is now time to consider the concept of a “WTO Plus” system. Under this approach, countries willing to strengthen the trade rules regarding currency manipulation, state-owned enterprises and other loopholes in the current rules, and to develop rules for the new issues such as digital commerce and regulatory coherence would negotiate an FTA among themselves that would supplement the current WTO system. The negotiations for the TPP agreement and the TTIP could provide the basis for developing such a WTO Plus system.
This approach, which may well be the current U.S. strategy, would represent a temporary further movement away from MFN; however, the intent would be to create a system that other countries would join in the future or that could form a basis for a future multilateral WTO trade round. Because of the huge size economically of the TPP and the TTIP, trade diversion that might be caused by either agreement would be minimal.
Current U.S. bilateral and regional FTAs have several provisions that many other countries strongly oppose. If the TPP and TTIP are to become templates for future multilateral negotiations, these provisions must be handled in a way that meets the legitimate concerns of current and prospective U.S. trade partners. If the prospect of joining these agreements is to be attractive to other trade partners in the future, U.S. negotiators must avoid the temptation to muscle through provisions not in its partners’ interest in order to gain support from U.S. special interests. As noted above, the particular provisions that many U.S. trade partners have found objectionable are those on intellectual property protection for pharmaceuticals that go beyond the WTO provisions; the investor-to-state dispute resolution mechanism; the maintenance of trade-distorting agricultural subsidies; and the restrictions on the use of capital controls by developing countries, which limit their ability to deal with currency speculation. These provisions have to be dealt with in a way that will not discourage other countries from joining these agreements at some point in the future.
The major problem confronting the world economy today is the enormous imbalance in trade between the United States, and to a lesser extent Europe, with the major Asian nations, particularly China and Japan. The United States and EU basically have minimal barriers to imports, whereas Japan and China have extensive barriers that limit imports and foreign investment. Additionally, the United States and the EU have very low levels of savings compared with China and several other Asian countries. These enormous imbalances undermine support for liberal trade policies in the west and threaten the stability of the international system.
If done correctly, the TPP and TTIP can be important mechanisms for addressing these imbalances. If Japan uses the TPP to actually eliminate its trade barriers and open its market, over the long term that would put its economy on a more solid footing. The same would be true for China if it should decide to adhere to the TPP sometime in the future.
However, many are skeptical that Japan, or at a later date China, will actually open its market. Japanese policymakers will face enormous opposition from its agricultural sector to eliminate trade barriers and its barriers in the industrial side are deeply entrenched in domestic policies, including its business structure.
If the TPP and TTIP are not constructed correctly, they will exacerbate the already precarious world trade system. These agreements need to address the potential for currency manipulation, and they need to close many of the loopholes in the current system. Even more important, adherents to these agreements need to open their markets and remove barriers to imports.
A Return to a Multilateral System
Even if successful, the TPP and the TTIP cannot address three major trade problems. First, these agreements would not include most of the WTO members, and particularly all the world’s poorest countries, which now will be at an even greater disadvantage in exporting to the TPP and
TTIP nations. Second, these agreements will not include effective rules that limit the enormous subsidies that the United States, EU, and others give to their agricultural sector; these subsidies distort world trade and are not in the United States’ national economic interest. And third, the mishmash of differing rules of origin between these agreements and all the FTAs that have been negotiated will still be in place, and these will add to inefficiencies in the trade system.
However, the TPP and TTIP can be a mechanism to return the trade system to one based on MFN trade in either of two ways. First, other WTO countries can join these agreements, provided they commit to the additional disciplines, thereby expanding the number of countries participating in the WTO Plus agreements. Second, and more important, would be to launch a new round of multilateral trade negotiations at a future date. Many trade experts question whether a future WTO multilateral round is feasible, and certainly it will be difficult to launch a future round. But given the importance of multilateral negotiations, the effort should be made, using the TPP and TTIP agreements as a template.
Reducing the developed countries’ tariff s on nonagricultural goods has been the centerpiece of multilateral trade negotiations since the Kennedy Round, including the recent Doha Development Round. However, U.S. and other developed-country tariffs on nonagricultural goods are now so low—with a few but significant exceptions—that further reductions would only have minimal consumer and economic benefits. Today, the tariffs that generally have the greatest commercial effects are developed-country agricultural tariffs and the tariffs of the advanced developing countries on all products.
If the advanced developing countries—particularly China, Brazil, and India—continue to refuse to make significant cuts in their tariffs on products of interest to U.S. exporters, the traditional formula approach to reducing tariffs would again be doomed to failure. The United States’ industrial firms would oppose reducing U.S. tariffs, even though they are relatively low, without gaining real access to the large markets of the advanced developing countries.
Although a formula reduction of tariffs should not be the centerpiece of a future trade round, tariff s should be on the table. Though the United States’ average tariff rate is low, it does have some high tariff s that could be reduced significantly, and these concessions could be in its broader economic interest and would be important negotiating chips to gain access to other important markets. For example, the United States has a tariff equivalent to about 800 percent on ethanol, which adds to domestic transportation costs and hurts the consumer. The U.S. International Trade Commission estimates that eliminating this duty would increase U.S. welfare by $1.5 billion.[13] This concession would be important to Brazil and would be a very important bargaining chip. Similarly, reducing U.S. barriers on sugar would benefit downstream industries; the International Trade Commission estimates that this would increase welfare by $49 million.
Other areas where the United States has high import barriers that could be used as bargaining chips flagged by the International Trade Commission include dairy products, sugar, canned tuna, tobacco, textiles and apparel, footwear, costume jewelry, writing instruments, ball and roller bearings, tires, handmade tools, and ceramic tile.
The United States also has some important objectives for gaining tariff reductions from its trade partners. For example, one area is technology. The Information Technology Agreement, as noted above, now has seventy-four signatories; and some important countries, such as Brazil, are not signatories. Eliminating tariffs on information technology products worldwide would benefit U.S. exports, and also be in the interests of all importing countries, because information technology has become an integral building block for many other industries. Another example is environmental goods and services; eliminating trade barriers on these products would benefit both the environment and U.S. exporters.
Instead of the approach of reducing tariffs through formula cuts, negotiators might consider a request-offer approach, as was used before the Kennedy Round. For example, the United States could ask Brazil to eliminate its duties on information technology products in exchange for the United States eliminating its tariffs on sugar. Or a sector approach might be possible in which the participating countries all agree to eliminate trade barriers in the sector.
Agricultural subsidies should definitely be on the table. As we saw in Chapters 2 and 4, the United States gives substantial subsidies to domestic farmers, and reining these in would be in the broader U.S. national interest. Many of these subsidies go to farmers with annual incomes greater than $250,000—something that is hard to justify at a time when the United States is experiencing the largest income inequality since 1928. Some aspects of these subsidies have been found to be in violation of America’s WTO commitments; for example, the United States is paying Brazil $148 million annually as compensation for continued U.S. subsidies on cotton.
Some elements of the United States’ agricultural subsidy program, of course, are important. The agricultural sector is critical to the nation and farming is an inherently risky business. In negotiations, the United States would have to retain the right to provide subsidies that serve its national interest, such as countercyclical payments in bad years.
Strengthening and reform of the trade rules could be on the table. From the United States’ perspective, rules on exchange rates must be developed and enforced, and the loopholes that allow countries to pursue beggar-thy-neighbor policies need to be fixed.
Conversely, several of the United States’ trade partners object to some of its practices, such as the way it administers antidumping actions. Provided that the antidumping or countervailing duty only offsets the original distortion, then from an economic theory perspective these duties basically restore trade based on comparative advantage and should not be viewed as “protectionist.”
However, several countries believe the U.S. administration of dumping and subsidies agreements goes beyond offsetting the distortion and is protectionist. In fact, the United States has lost a number of WTO dispute settlement cases regarding U.S. administration of the antidumping statute.[14]
The United States has resisted proposals for negotiations on these rules because a number of politically powerful industries depend on the antidumping and countervailing duties provisions for protection against import surges. However, it might be politically possible to make some changes to U.S. antidumping practices if rules regarding currency manipulation and competition policy were developed, and safeguard actions were once again made a viable policy option. Certainly this is an area that could be explored to see if negotiations on rules might be possible.
Services is another area that needs to be effectively addressed in a future multilateral round. In the Doha Round, services were approached on a request-offer basis, similar to the way negotiators approached tariff negotiations in the first five rounds of GATT negotiations, and the results were similar—very minimal. In the next round, instead of a request offer approach, services might be negotiated using a sector approach. In each sector under negotiation, the negotiators might have additional objectives in addition to seeking to gain access for exporters. The following two examples indicate the possibilities for negotiation in the medical and transportation sectors.
Costs are a major concern in the medical sector in the United States, and a properly structured negotiation might help reduce costs in a way that did not lessen the quality of care or create unemployment in the United States. A number of operations can be performed more cheaply in some other countries, but few Americans can take advantage of this because health insurance programs, including Medicare, are limited to a certified practitioner in the United States, and most other countries have similar restrictions. Mattoo and Rathindran of the World Bank estimate that extending health insurance coverage to overseas care for just fifteen types of tradable treatments could produce savings for the United States of more than $1 billion a year even if only one in ten American patients travels abroad.[15] The United States might only make this concession of allowing Medicare to cover treatment in designated hospitals to specified countries that had facilities comparable to its own and only in exchange for concessions of interest to the United States.
Costs are also a major concern in the transportation sector. As noted in chapter 4, transportation costs now are a larger factor in international trade than are developed-country tariffs on nonagricultural goods, and these costs are particularly onerous for developing countries. The transportation sector is highly protected in most countries, but some liberalization could reduce these high costs. The major reason progress has not been made in this sector is that the United States has been unwilling to put its major barrier on the table, which is the Jones Act. This legislation limits shipping in American waters to United States owned and crewed vessels, and it was designed to protect the American shipping industry. However, today there are only about 3,000 or 4,000 workers affected by the Jones Act, which now applies principally to the shipment of Alaskan oil to the mainland, and eliminating this law could reduce the costs of shipping Alaskan oil to U.S. consumers.
Conclusion
The United States’ trade agreements policy is only part of its total trade policy, and its trade policy is only one of many critical national policies for ensuring its prosperity and more harmonious world relations. At this point, however, the United States’ policy on trade agreements is stuck, unable to contribute to either its domestic economic needs or its foreign
policy objectives.
Following are some key steps that the United States should take to reenergize
its trade agreements policy:
• The lack of rules on exchange rates is a cancer eating away at the global trade system. Policymakers have long recognized that currency manipulation can be the most unfair trade practice of all, yet this issue has only been addressed sporadically and ineffectively. The
United States needs to launch negotiations to fix this problem as its top priority.
• The United States needs to recognize that the neomercantilist practices of other countries can cause unacceptable damage to the U.S. economy. It thus needs to develop a mechanism to identify when its important interests are at stake, and then to develop a strategy to protect these interests, either through domestic actions or bilateral or multilateral negotiations.
• The United States’ trade agreements program has both contributed to the speed of globalization and been driven by globalization. However, its domestic policies have not kept up with today’s globalized world. Among other steps, it needs to recognize that its huge federal budget deficit has contributed to its trade problems, and it needs a tax system that promotes its global competitiveness.
• There is a fundamental disagreement between the developed countries and the advanced developing countries—such as China, India, and Brazil—over the appropriate trade obligations for these countries. Though these countries have enormous domestic poverty, the trade system needs to recognize that some of their practices can cause unacceptable injury to their trade partners.
• Negotiations for the TPP and the TTIP could be vehicles for establishing a WTO Plus system, provided that the United States negotiates a template for these agreements that establishes effective rules regarding neomercantilist practices and eschews special interest provisions that are not in the interests of our trade partners. Such a WTO Plus system would both open markets for countries willing to accept strengthened trade rules and put pressure on nonparticipating countries to further open their markets and adopt similar rules in a future multilateral trade round.
• Over time, the United States needs to move back to a trade system based on MFN trade rules rather than bilateral and regional trade agreements that provide favored access for members at the expense of nonmembers. As the United States negotiates the TPP and TTIP, it needs to lay the groundwork for a new multilateral trade round under the WTO’s auspices.
U.S. trade agreements have an important role to play today in promoting both its commercial and foreign policy interests, just as they have since the 1930s. It is time for America to make some modifications in its approach to negotiating its trade agreements to meet the current and likely future realities of globalization.
[1] The United States also had a trade deficit in the nineteenth century, but that financed investment and could be repaid at a later date. Its current deficit finances consumption of imported television sets, cars, etc.
[2] Daniel W. Drezner, U.S. Trade Strategy: Free Versus Fair. Critical Policy Choices Series (New York: Council on Foreign Relations, 2006), 47.
[3] C. Fred Bergsten and Joseph E. Gagnon, Currency Manipulation, the U.S. Economy, and the Global Economic Order (Washington, D.C.: Peterson Institute for International Economics, 2012), 2.
[4] U.S. Department of the Treasury, “Report to Congress on International Economic and Exchange Rate Policies,” November 27, 2012, 13.
[5] 5. Ibid.
[6] This incident is reported by Independent Evaluation Office of the International Monetary Fund, IMF Involvement in International Trade Policy Issues (Washington, D.C.: International Monetary Fund, 2009), 59.
[7] Quoted from a report of March 2007 news conference during the National People’s Congress, according in an article by David Ignatius in the Washington Post, March 11, 2010.
[8] The recent “quantitative easing” by the U.S. Federal Reserve does result in a devaluation of the dollar. Brazil has strongly protested against U.S. quantitative easing precisely on these grounds, namely, that it puts Brazil’s exporters at an unfair trade disadvantage.
[9] World Trade Organization, “The Relationship between Exchange Rates and International Trade,” WT/WGTDF/W/68, November 5, 2012, 2.
[10] Bergsten and Gagnon, Currency Manipulation, 5.
[11] U.S. International Trade Commission, China: Effects of Intellectual Property Infringement and Indigenous Innovation Policies on the U.S. Economy (Washington, D.C.: U.S. International Trade Commission, 2011), xiv.
[12] Organization for Economic Cooperation and Development, “Environment and Regional Trade Agreements, 2007,” 13.
[13] U.S. International Trade Commission, “The Economic Effects of Significant U.S. Import Restraints,” August 2011, http://www.usitc.gov/publications/332/pub4253.pdf.
[14] Jan Woznowski, the former director of the WTO Rules Division, notes that one of the reasons the United States has lost WTO disputes is that the WTO Appellate Body has ignored a provision in the Uruguay Round Anti-Dumping Agreement, which specified that panels must accept “the investigating authorities’ evaluation of the facts if proper and unbiased, even though the panel might have reached a different conclusion. Furthermore, if a panel finds that a relevant provision of the agreement is subject to more than one permissible interpretation, the panel should find the measure to be in conformity with the agreement if it rests upon one of those permissible interpretations.” Jan Woznowski, “Anti-Dumping Negotiations in the GATT and the WTO: Some Personal Reflections,” in Opportunities and Obligations: New Perspectives on Global and US Trade Policy, edited by Terence P. Stewart (Amsterdam: Kluwer Law International, 2009), 106–7.
[15] As cited by Joseph François and Bernard Hoekman, Services Trade and Policy, Working Paper 903 (Linz: Department of Economics, Johannes Kepler University of Linz, 2009), 24.
Chapter Updates
Chapter 1: U.S. Trade Policy in Crisis
Chapter 2: America's Trade Agreements
Chapter 3: Trade Agreements and Economic Theory
Chapter 4: Trade Agreements and U.S. Commercial Interests
Chapter 5: Foreign Policy: The Other Driver
Chapter 6: Economic Development: A Missed Opportunity
Chapter 7: Uneasy Neighbors: Trade and the Environment
For more information or questions contact William Krist at william.krist@wilsoncenter.org