5 February 2019

The U.S. Is Fighting a 21st Century Trade Battle Armed With a 1930s Mindset

The United States may score some successes in persuading its trade partners to reduce their tariffs, but its current strategy fails to address the fact that tariffs are not the biggest limiters of U.S. exports. 

Ultimately, nontariff barriers such as health and safety regulations and intellectual property rights present greater obstacles to trade in the contemporary world than tariffs do. 

With the United States focused on tariffs, its exporters could soon face greater difficulties as competitors in Canada, the European Union, Asia and elsewhere gain access to more markets thanks to comprehensive free trade deals that eliminate more important nontariff barriers. 

Can turning back the clock to the 1930s achieve a 21st-century trade win? That might be the question on everyone's lips as the White House aims to significantly increase presidential authority over U.S. tariffs by asking Congress during next week's State of the Union address to pass the Reciprocal Trade Act. The name of the bill itself echoes perhaps the single most consequential trade act in U.S. history, the Reciprocal Trade Agreements Act, which President Franklin D. Roosevelt signed in 1934 to help the United States recover from the Great Depression.

Congress is certainly in no mood to give the current occupant of the White House, Donald Trump, more power to impose tariffs on other countries, but Trump's strategy and aims in using the existing act highlight the White House's focus: balance trade through bilateral negotiations and tariffs. The problem for Washington is that the situation in the 21st century is not that of the 1930s, as tariffs are no longer the most important barriers to modern trade. Instead, everything else is: investor rights guarantees, health and safety regulations, intellectual property protections, digital trade regulations, and voluntary standards. And focusing on tariffs as a policy goal may mean that the United States misses the boat on concessions on those issues.

More importantly, the Trump administration's push for increased trade barriers has spurred the rest of the world to strive for comprehensive agreements that avoid dallying on tariffs in favor of addressing more significant nontariff barriers. This raises the next question: By focusing simply on bilateral trade balances, tariffs and obstructing imports, does the United States risk losing out?

Reciprocity: A Carrot and a Stick

The concept of reciprocity in trade has been around for centuries; whereas feudal lords once offered access to their markets in exchange for "reciprocal" access to another market, now countries do. Over time, this concept has become inextricably linked to that of "most favored nation," in which a country extends any concessions it makes to a third country to its "most favored" partners as well on a conditional or unconditional basis. For example, if the United States granted the United Kingdom most favored status as part of a trade deal before proceeding to sign a more expansive trade agreement with France, it would then have to extend similar concessions to London (subject to the exact nature of their bilateral deal).

For most of history, reciprocity and most-favored-nation clauses have centered on one thing: tariffs. In the trade wars of the 19th and early 20th centuries, average tariff rates would often run above 50 percent. When Roosevelt signed the 1934 trade act, he ended Washington's postwar economic isolationism and made it a vanguard of trade liberalization in an otherwise protectionist global environment. In so doing, the United States offered to liberalize its tariffs for any country that was willing to do the same for Washington. 

By 1940, the United States had signed deals involving 21 countries. After World War II, Washington helped enshrine this concept — and unconditional most-favored-nation deals — in the General Agreement on Tariffs and Trade and, eventually, the World Trade Organization (WTO). The United States encouraged other countries to join these pacts for strategic purposes, dangling the prospect of access to the U.S. (and Western European) markets to lock them into the U.S.-led world order. Since the end of the 1980s, however, this strategy has no longer proved politically tenable amid the aftermath of the Cold War, a ballooning U.S. trade deficit and the decline in U.S. manufacturing jobs.

The White House's operative perspective is trade protectionism, rather than trade liberalization; as a result, it's very much a case of "lower your tariffs, or I will raise mine."

With his focus on trade deficits and tariffs, Trump's view on reciprocity reflects this. Unlike many of his predecessors, the president has explicitly sought to disconnect trade deals from a global, strategic point of view, arguing that such perspectives have hurt American workers. On the Reciprocal Trade Act, the White House's operative perspective is trade protectionism, rather than trade liberalization; as a result, it's very much a case of "lower your tariffs, or I will raise mine." Accordingly, the act would allow the president to increase a tariff on another country's good to the same level that that country charges for the same U.S. product. Ultimately, Trump's dominant view of reciprocity is focused on the details, the actual tariffs and the outcome, all in a bid to ensure equal trade volumes in both directions.

Bipartisan legislation to reduce Trump's power is currently winding its way through Congress, meaning the Reciprocal Trade Act is almost certain to be dead on arrival in the lawmaking body, yet the president can still utilize other tools to realize more of his vision of reciprocity.

So far, the White House has creatively used Section 232 of the Trade Expansion Act of 1962 and Section 301 of the U.S. Trade Act of 1974 to pursue his goals on the matter, explicitly linking a Section 232 investigation on cars to the European Union's tariffs on vehicles. (Brussels charges 10 percent on imported vehicles, while Washington maintains a 2.5 percent tariff on foreign-made automobiles.) 

Globalization: 60 Years On

But pursuing this strategy will be a tall order in a world that has been transformed since World War II. Prior to the 1950s, most international trade centered on raw materials, agriculture or some light industrial goods. Supply chains were not deep; while global multinational corporations existed, they were active in only a handful of industries and regions. Furthermore, government regulatory bodies were generally weak, exercising only a modicum of oversight over safety, sanitary and environmental issues. In such a world, tariffs dominated trade negotiations.

Today, however, tariffs are no longer the key issue. Supply chains are globalized, complex and deep. Multinational corporations have obtained investment protection, while multilateral treaties are becoming increasingly important. Technical barriers to trade resulting from health, safety and other regulatory standards have become increasingly sophisticated. Meanwhile, digital and e-commerce trade, as well as electronic privacy, are front and center in trade discussions — particularly between developed countries — but forcing countries to harmonize these issues has proved difficult since it necessitates amendments to domestic laws on regulatory issues. 

In terms of global trade, tariffs are hardly an issue anymore. In 2017, the average applied tariff rate (weighted by goods imported) was just 2.59 percent worldwide. The European Union's average was just 1.79 percent, while the U.S. rate was 1.66 percent. Exceptions do exist, as evidenced by the European Union's higher tariff on cars than the United States, but Washington also charges a lot more on trucks than Brussels does. By squabbling over a few decimal points to obtain a lower tariff for certain industries, politicians certainly score a few points at home, but their measures are hardly bringing down nontariff barriers.

Still, U.S. tariff threats have succeeded in driving other countries to the negotiating table, although it is not clear how long Washington intends on negotiating new deals. Trump clearly wants trade victories before 2020 elections to show that his heavily criticized trade strategy is working. As a result, he is likely to pursue two avenues — one that increases barriers on imports to protect U.S. workers, and the other that reduces tariffs on U.S. exports — even if that could tie the hands of American negotiators who want to address more difficult structural issues. In the end, reducing others' nontariff barriers is a pertinent goal, but it's not an aim that lends itself to a tweet.

As I've argued before, Trump's end goal is to reduce the trade deficit, primarily by restricting imports. Thus far, he has not lifted a single tariff that's been imposed on his watch — including the steel and aluminum tariffs on Canada and Mexico, even though Ottawa, Washington and Mexico City have signed a new continental free trade deal. This means that America's trading partners are likely to limit their concessions simply to tariffs and certain exports, eschewing any compromise on more important structural issues. To be sure, there will be some focus on nontariff barriers and some deals on sector-specific agreements, but they won't be as comprehensive as possible. On this front, the European Union provides a good case in point: In an effort to avoid a 25 percent tariff on its automobiles, the bloc is offering a trade deal in which it removes tariffs for the industrial sector instead of reopening more comprehensive Transatlantic Trade and Investment Partnership (TTIP) talks that would have reduced nontariff barriers on both sides. The union is willing to ultimately discuss nontariff barriers, but Trump wants a quick win, and time is not on his side. Whatever the case, the United States under Trump is unlikely to make significant strides in gaining market access — and allowing market access — on a host of issues. 

In the end, reducing others' nontariff barriers is a pertinent goal, but it's not an aim that lends itself to a tweet

Protectionism in a Globalized World

Although multilateral talks to reduce trade barriers involving all WTO members have slowed to a crawl, countries other than the United States have shown a renewed interest in signing more trade deals to compensate for Washington's current protectionism. A trade pact between the European Union and Canada went into effect last year, while a similar deal between the European bloc and Japan will go into effect on Feb. 1. On a multilateral level, the Trans-Pacific Partnership might have failed because of the U.S. withdrawal, but the defunct deal's remaining members — including Japan, Mexico and Canada — signed their own agreement, which came into force at the end of 2018. These deals not only tackle tariffs but also touch on many of the deeper issues beyond them. 

The upshot is that the United States is worse off than many of its competitors when trying to access key markets. Take, for example, its immediate southern and northern neighbors; as a result of the new United States-Mexico-Canada Agreement (USMCA), companies that set up shop in Mexico or Canada can export via preferential trade agreements to the United States, the European Union and Japan — three of the four largest markets in the world. Firms operating solely in the United States, however, don't have easy access to either the European bloc or Japan. Washington is discussing trade deals with both Brussels and Tokyo, but Trump's focus on restricting imports and reducing tariffs suggests that the White House will prioritize concessions on those issues, meaning that U.S. companies will still face nontariff barriers in those markets, even if the countries finally sign trade deals. And given the complexity of the contemporary, globalized world's supply chains, those nontariff barriers and labeling harmonization issues will loom ever larger.

Naturally, U.S. trade lawyers and career professionals at the Office of the U.S. Trade Representative are well-aware of the significance of these nontariff barriers. What is unclear, however, is whether they will have sufficient time to negotiate complex agreements on these issues or whether they will receive orders to deliver a quick — if pyrrhic — political victory. The U.S. political system has driven the president to focus on trade deficits and tariffs, but the United States is likely to find that such a focus is incompatible with the structure of modern trade deals. The conundrum thus leaves Washington with a trillion-dollar question: Can it adapt its trade strategy before it's too late?

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