28 January 2018

Trade Profile: The U.S. Struggles to Break Its Fetters

Global trade is changing. The kinds of multilateral agreements that characterized the postwar years have stalled over the past two decades, prompting countries and economic blocs to try to negotiate smaller deals with fewer partners. Nations and blocs have more leeway under this new model to negotiate the trade agreements that best suit their interests and to avoid those that don't. Now, more than ever, the future of international trade depends on a country or bloc's defensive interests, offensive interests and underlying factors of production. Our fortnightly Trade Profiles aim to break down these factors to facilitate an understanding of where global trade stands today and where it's headed.

In the 17th installment, we focus on the United States.

Economic Background

More a continent than a country, one nation has held pride of place in the global trading system for most of the last century: the United States. Since World War II, the United States has been central to underpinning a system that has spread to encompass the whole world as it reduces trade barriers and reciprocity. This centrality has not only extended to leadership on trade but also to the use of the U.S. dollar in global payments and central bank reserves. Despite its preeminence in the global trading system, the United States periodically has chafed against the bonds that hold it in place. Under the leadership of U.S. President Donald Trump, the country is now staging the latest iteration of these periodic rebellions — an uprising that puts the whole structure of international trade at risk.

For the first century of its existence, the United States essentially was split in half between a south that championed free trade and a north that espoused protectionism. The fledgling manufacturing hubs of the North struggled to cope with external, chiefly British competition, precipitating demands for tariff protection, while the South enjoyed great advantages in cotton (a crop that accounted for 61 percent of U.S. exports alone in 1861) and tobacco production. As a result of these impressive export figures, the South became staunch advocates of free trade. The struggle for the country's economic future was fierce, but proponents of protectionism gained the upper hand in the latter half of the 19th century because of westward territorial expansion that incorporated new states that favored protectionism, as well as the American Civil War, which resulted in the South's military defeat and a loss of political power that would last several decades. Ultimately, these developments combined to ensure that the young country became a largely defensive player that maintained uniformly high tariff barriers.

The United States, however, underwent profound economic change toward the turn of the 20th century. Thanks to infrastructure improvements, population growth and the discovery of new raw materials, the United States succeeded in fulfilling its immense potential, overtaking the United Kingdom to become the world's economic powerhouse between 1870 and 1929. From 1870 to 1913, the U.S. share in global manufacturing rose from 23 percent to 36 percent; in contrast, the British share dropped from 32 percent to 14 percent. Between 1895 and 1929, the U.S. portion of global manufactured exports leapt from 4 percent to 18 percent (aided by World War I, which largely sidelined the country's European competitors). But while some areas of U.S. manufacturing had become immensely competitive, former areas of strength in agriculture and textile manufacturing had begun to fade, reigniting calls for greater protectionism. Political intransigence soon snuffed out the fledgling attempts by those wishing to liberalize U.S. trade policies so that the country could benefit from its new-found export power, as demonstrated in 1930 by the notorious Smoot-Hawley Tariff, which resulted in a sharp rise in average tariffs during the worst of the Great Depression.

The deleterious effects of the Depression and World War II, however, helped usher in a modern global trade system that owed much of its existence to the United States. In 1934, President Franklin Roosevelt laid the foundations for a lasting policy shift within the United States by wresting control of trade from the perennially protectionist Congress via the Reciprocal Trade Agreements Act. Eleven years later, the United States emerged from World War II, its second global conflict in three decades, with an economic output that accounted for half the world's shattered economy. Wishing to avert more such disasters, the superpower took advantage of its commanding position to actively shape its surroundings and foster stability via a new financial system. Placing itself at the center, the United States developed a system whose foundations rested on a new gold standard tied to the dollar and featured new, robust institutions such as the International Monetary Fund and the World Bank. Although a similar institution for global trade proved too ambitious at the time, the United States spearheaded the creation of the General Agreement on Tariffs and Trade (GATT) in an effort to reduce trade barriers around the world. Now the axis on which the global economy turned, the United States used its preeminent position to encourage free trade and reciprocity for all.

In the decades after World War II, liberalization occurred on a global scale — though chiefly among the Western powers. The United States led successive GATT rounds that resulted in the large-scale decrease of tariff barriers, while European powers and Japan used their new access to the U.S. market, as well as postwar reconstruction funds provided by Washington, to rapidly regain their economic strength. By the 1970s, however, the United States no longer dominated the globe sufficiently to underwrite the financial system. As a result, President Richard Nixon severed the dollar's link with gold in 1971, allowing currencies to float freely while producing lasting changes in the global trading system. With capital freed to roam, it rapidly flowed into the United States in the form of investment, driving up the dollar and correspondingly reducing the competitiveness of U.S. manufacturing. Ultimately, the decision created a trade deficit and rekindled protectionism in the country.

Other aspects of the transforming U.S. economy also contributed to the growth of the country's trade gap. While traditional industrial goods often related to iron and steel drove U.S. production in the 1800s, high-tech industries such as computing, aircraft manufacturing, pharmaceuticals and Hollywood became transnational moneymakers in the subsequent century. As the fetters came off capital, international finance acquired greater importance, and U.S. investment banks soon spread their influence around the world. In effect, the value drivers of the U.S. economy shifted from the heavy, older industries of Pennsylvania and Ohio to high-tech and intangible sectors often clustered on the West Coast — such as computing and movies in California and aerospace in Washington. But with increasing value now held in intellectual property, which does not cross borders in a sale, the shift only served to harm the United States' trade balance.

The resulting increased trade deficits of the 1980s seized the U.S. Congress with protectionist fever, prompting the passage of the Plaza Accord to weaken the dollar. At the same time, the country also increased unilateral actions against other countries, particularly Japan, which allegedly had taken advantage of the United States. The moves were indicative of the U.S. dissatisfaction with the global system, and the unilateral actions taken outside the GATT framework threatened to undo the entire multilateral trading agreements the United States had been instrumental in creating after World War II. Instead of unraveling, however, the system adapted to better suit U.S. wishes. The final GATT negotiation round (1986-1994) in Uruguay resulted in the creation of a trading institution that policymakers had failed to realize in 1947, the World Trade Organization (WTO). The WTO assuaged several U.S. concerns: Whereas the GATT had been a loose agreement lacking powers of enforcement, the WTO boasted a dispute settlement mechanism that could impose fair punishments, theoretically removing the need for unilateral action. At the same time, the United States and other countries signed new agreements regarding matters such as intellectual property to better assuage U.S. concerns.

But in the quarter century since the conclusion of the Uruguay Round, the trends that precipitated U.S. dissatisfaction have continued unabated — or even increased. China joined the WTO in 2001, giving the world's biggest-ever export juggernaut greatly enhanced access to the U.S. market. A stronger dollar and weaker yuan facilitated a consumerist boom in the United States in which goods poured into the country from China and elsewhere, swelling the U.S. current account deficit to 5.1 percent of GDP in 2007. These global imbalances eventually contributed to the 2008 economic crisis, although the recession's consequences reduced the U.S. current account deficit to the 2.5 percent level, where it has remained. Of greater worry for the United States, however, is the continuing deterioration in its net international investment position, a measure of the differential of foreign assets held by the United States and U.S. assets held by foreigners. In 2016, the United States possessed the world's biggest deficit – a totaling eight times more than Spain, the country with the second largest gap.

These events have culminated in a new phase of U.S. discontent with the status quo. The global superpower is once again objecting to its circumstances, and Trump's administration has made the reduction of the trade deficit a primary goal. The United States is thus revisiting its major bilateral trading pacts in an attempt to reduce the largest deficits via negotiation; in so doing, it has dusted off some of the unilateral trade remedy mechanisms that it last used in the 1980s. The country has also directly challenged the WTO by refusing to ratify appointments for the appellate body – a stance that could leave the WTO unable to arbitrate in international trade disputes.

Such initiatives could bear one of two consequences. The first could usher in a repeat of the 1980s, when the global system was reconfigured to address U.S. complaints. Like the 1980s, however, it is impossible to imagine a reconfigured situation that would reverse the overall trends. As the source of global reserve currency at the center of a global system that is predicated on the free flow of capital, the United States cannot escape trade deficits, and a refashioned global system would only forestall a subsequent rebellion at the system's inherent conditions. The second scenario would represent a major rupture in which the United States successfully resolves its trade deficit problems by fomenting enough disruption to the global system that the status quo can longer prevail. Such an option would entail the emergence of deep fragmentations in trading arrangements and the erection of new barriers and controls to the current free flow of capital, goods and services. In such a fragmented world, the United States — instead of being the foundation on which its peers conduct business — would merely become the first among equals.
Trade Strategy

Offensive Interests

The United States is the world's largest exporter of services. The sector accounts for 78 percent of the country's GDP and more than 80 percent of employment. So, there is great motivation for the United States to negotiate the removal of barriers to further increase its services exports.

As the issuer of the global reserve currency, the United States has long harbored worries that other countries are using undervalued currencies to outcompete it on the global stage. U.S. policymakers previously have accused Japan and China of engaging in such behavior, and Washington operates a three-pronged mechanism with a biannual report to determine whether a country is actively manipulating its currency to the detriment of U.S. interests.

Related to the issue of currency, the United States has expressed ire that other countries are undercutting it by maintaining lower wages. To combat such concerns, the country has encouraged the adoption of higher labor standards in other countries, a demand that has the added benefit of satisfying humanitarian concerns. As a result, the United States often encourages emerging countries to permit unionization to empower foreign workers and raise labor costs in trade competitors.

E-commerce is prominent in current international trade negotiations, as the sector has grown rapidly across the globe, including in the United States. The country, home to key brands such as Amazon and eBay, is pursuing the implementation of international rules to both regulate and protect these companies as they pursue cross-border activities. Unlike many developing countries, the United States advocates the removal of barriers to data movement across borders.

Defensive interests

Because of its high relative wages, the United States has struggled to compete in the global market in low-end manufacturing, as textiles and steel production have moved to countries like Japan and China as each advanced up the value chain. The U.S. automotive industry, which frequently produces larger models that are less attuned to an increasingly climate-conscious world, has often lost out to German and Japanese management and supply chain innovations, meaning others have outcompeted U.S. manufacturers both abroad and, to an extent, in the United States as well. But as times change in the automotive industry, the appearance of more technological components in self-driving cars should benefit the United States. Accordingly, the sector could one day return to being an offensive interest.

Like most of the pioneers of industrialization, the United States is no longer dominant in the sectors that were integral to that development process. The coal and steel sectors, traditionally clustered around Pennsylvania, have struggled to compete with subsequent upstarts such as Germany, Japan and China.

Crossover interests

As a global leader in innovation, the United States stands on the cutting edge of technological advancements, making it highly protective of intellectual property developed within the country. For the United States, there are two primary issues regarding intellectual property. The first centers on the risk that the United States will not be able to receive fair recompense for its intangible assets in cases such as the pirating of Hollywood movies or the reproduction elsewhere of pharmaceutical products whose patents have expired. In these cases, the United States seeks to police the activities of external actors to ensure they respect U.S. intellectual property rights and to extend the duration of the rights. The second issue involves the potential diffusion of U.S. intellectual property to rival countries, especially China, which has a history of requiring U.S. companies to share intellectual property in order to enter the Chinese market. The United States would like to see the abrogation of such requirements.

The United States also has a complex relationship with agriculture, where it is offensive in some commodities and defensive in others. At present, the United States is especially strong in soybeans, wheat and feed crops, but it is shifting away from bulk commodities toward high-value products such as live animals, fruits and vegetables, and more processed goods. Sugar remains a defensive interest, while there are dairy products on both sides of the ledger.

The country is home to a multitude of multinational companies that conduct many investments abroad, meaning Washington is intent on protecting such investments. The United States' offensive trade policy can thus extend to both reducing barriers to investment, often in emerging markets, and creating and enforcing investor-state dispute settlement (ISDS) mechanisms to protect U.S. companies from foreign government action. The mechanism is a double-edged sword, however, and the United States is concerned about protecting its own sovereignty from ISDS challenges, making this a crossover interest.

An additionally complex area centers on government procurement. While the United States constantly urges other governments to open up their contracts to external competition, the country also maintains its own powerful Buy American program.

Finally, there is the vexed issue of aircraft manufacturing – a success story for U.S. industry that is responsible for the country's highest trade surplus by far. However, the sector is a recipient of substantial government investment, and the United States has simultaneously defended its own subsidies while also accusing peers, particularly the European Union, of unfairly supporting their domestic industries.

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