Dimensions: 6'' x 9'' 141 pages AEI Press  (Washington) Publication Date: June 1995 Paperback ISBN: 0-8447-3889-1 Price: $ 12.95 Add to Cart   Examination Copies

June 1995
American Trade Policy: A Tragedy in the Making
By Anne O. Krueger

This book is a study of the dangers to American productivity and living standards of the shift in recent years away from an open multilateral trading system toward bilateral trade agreements. The author is professor of economics, Stanford University, and 1996 president of the American Economic Association. A summary of the book follows.

The increasing integration of the world economy has been a hallmark of economic advancement over the past two centuries. As costs of transport and communications have fallen, economic interactions between distant people, which were earlier limited to occasional shipments of low-volume, high-value goods, expanded first to trade in durable commodities, such as food-stuffs, and then to daily air shipments of specialized parts and components, and even perishable foods and fresh-cut flowers. As that has happened, the importance of the open multilateral trading system has increased; but, so too, has the visibility of foreign competition.

In the nineteenth century, Britain led the world in establishing the international economic system. When British hegemony diminished and the system broke down in the period before World War II, it was American leadership that led the world toward trade liberalization in the postwar period.

In the early postwar years, international trade policy was seen largely as a matter of U.S. foreign policy. As Europe and Japan recovered from the war, however, the importance of trade to the American economy increased and trade policy came increasingly to be formulated by Congress, the branch of government most susceptible to the pressure of special interests.

Over the years, American trade policy has gradually drifted toward an approach to trading relations in which there are strong bilateral elements. This present approach is gradually undermining the open multilateral trading system that has been serving the global economy so well. Should that system weaken, the entire globe will suffer.

Evolution of the International Trading System

Ever since Adam Smith first elucidated the ways in which decisions made by individuals in a market setting can serve the social good "as if by an invisible hand," the case for free trade has been clear: it makes no sense to produce goods at home if they can be purchased more cheaply abroad and exchanged for one's domestic production. The historical record since Smith's time provides clear evidence of ways in which an open economy best suits countries desirous of maintaining or improving their international competitiveness and living standards.

Long before the Industrial Revolution, Europeans traded for spices and other exotic products with partners as far away as Asia. But trade really began to flourish in the eighteenth and nineteenth centuries, as transport costs fell and Great Britain adopted a policy of free trade. During the latter part of the nineteenth century, other industrial countries followed the British example.

The growth of trade and the increasing integration of the international economy continued throughout the nineteenth century and up to World War I. For the next thirty years, however, the international economy suffered severe dislocations, the most devastating of which was the Great Depression. One of the intensifiers of the Great Depression was the 1930 Smoot-Hawley act, which raised U.S. tariffs to extremely high levels and encouraged other countries to do likewise.

Up until the end of World War II, most countries relied on high tariffs and bilateral trading arrangements in part as a residual from the traumatic 1930s. As it became clear that the Allies would emerge victorious in that conflict, the American and British architects of the postwar economic era created the International Monetary Fund and the International Bank for Reconstruction and Development, subsequently known as the World Bank. The General Agreement on Tariffs and Trade (GATT) was established in 1947 to resolve disputes between trading nations in an open multilateral trading system. These institutions, it was hoped, would lend stability to the international trading system and prevent a recurrence of the downward spiral that had started with the Smoot-Hawley tariff.

Successive rounds of multilateral trade negotiations beginning in the late 1940s have reduced the level of tariffs and removed many impediments to trade. The thirty years following the creation of the GATT were the most prosperous in history, although the liberalization of world trade was confined largely to the industrial countries and to trade in nonagricultural commodities.

Administered Protection

Since the 1970s, U.S. trade policy has become increasingly schizophrenic, emphasizing "free trade but fair trade." On some occasions, the United States will support an open multilateral trading system. At other times, however, it uses the rhetoric of "fair trade" as a screen behind which to follow protectionist practices. Although the United States has not abandoned its commitment to the GATT (and now to its successor, the World Trade Organization), a series of recent decisions has shifted U.S. trade policy away from an almost exclusive reliance on multilateral procedures to a much greater reliance on bargaining bilaterally with individual countries or small groups of trading partners.

Over the years, U.S. trade laws have increasingly acquired protectionist overtones, leading many to term the operation of those laws "administered protection." Threats of administered protection have all but forced trading partners to accept other bilateral measures, such as voluntary export restraints, to avoid harsher trade remedy alternatives. By the mid-1980s, the United States was the largest single user of administrative trade law remedies.

U.S. trade law has long contained provisions for trade remedies when domestic industries or the American government can demonstrate the use of unfair practices by foreign governments and firms. Over time, however, Congress has made it easier for firms to prove that they are victims of unfair trade practices, while restrictions on presidential discretion to reverse such findings have increased. If these trends continue, there would appear to be only two possibilities as to the future evolution of administered trade. Nations could agree on an international code for "competitive" practices, presumably under the aegis of the WTO. Or an increasing number of other countries might adopt administrative procedures similar to those of the United States. Doing so would greatly increase the possibilities of retaliation and counterretaliation and would further undermine the multilateral trading system.

American policy has been to support the open multilateral system through the GATT and the WTO, while pursuing closer ties with like-minded trading partners through regional arrangements. Simultaneously, the United States has enacted legislation instructing the U.S. trade representative to deal bilaterally with some trading partners over certain issues. While some bilateral relations are inevitable and even desirable, far too much of the U.S. negotiating posture in recent years has shifted toward confronting trading partners individually.

The United States is a large trading nation whose trade is generally more important to its trading partners than is their trade to the United States. Because U.S. tariffs are bound under the GATT, however, resort to threats of administered protection has provided a means by which U.S. trade officials can bargain bilaterally with and impose their will on their foreign counterparts. The administration can profess its commitment to free trade, while hinting that Congress will impose protectionist remedies unless other nations comply with U.S. demands.

NAFTA and the Multilateral Trading System

For the first twenty-five years of their existence, the trade laws of the European Community were consistent with the open multilateral system because external trade liberalization was proceeding apace with the internal removal of trade barriers, except for agriculture. NAFTA, and any successor Western Hemisphere free trade agreement, can similarly evolve in a way that strengthens the open multilateral system--or weakens it.

The GATT principles permitted uniform, across-the-board, preferential trading arrangements so long as they did not reduce member countries' trade with the rest of the world. From the birth of the GATT until the early 1980s, virtually all trends in the international economy were toward greater global integration. Preferential arrangements appeared to be adjuncts to the multilateral system. Then, in the early 1980s, the USTR announced that the United States would support agreements for further trade liberalization through the GATT but would also enter into preferential trading arrangements with countries that wanted to go beyond that agreement.

In the mid-1980s, Canada and the United States concluded the negotiations that led to the establishment of the U.S.-Canada Free Trade Agreement in 1989. A few years later, Mexico announced that it too would seek to negotiate a free trade agreement with the United States.

Immediately, several questions were raised. Would Mexican entry reduce the value of the concessions Canada had obtained in the already negotiated U.S.-Canada Free Trade Agreement? Would the United States negotiate free trade agreements with other Latin American countries to gain preferential access to their markets, while each trading partner would have access only to the (admittedly large) U.S. market? If countries acceded to the free trade agreement sequentially, would there be successive rounds of trade diversion? After discussing those issues, Canada, Mexico, and the United States finally decided to enter into three-way negotiations to formulate NAFTA. Following ratification by the three governments, the agreement took effect on January 1, 1994.

It is too early to tell whether NAFTA will evolve into a Western Hemisphere free trade agreement in a "GATT-plus" manner. Given the American propensity for bilateralism, economists have several concerns for the future of the multilateral system. Some fear that the free trade agreement is really a way of exporting American administered protection to third countries. Others contend that the free trade agreement is drawing American support away from multilateralism or that, in basing free trade agreements on regional considerations, signatories will have little or no incentive to participate in "GATT-plus" arrangements. Finally, if countries negotiate free trade agreements separately with each new entrant, there are enormous possibilities for legal discrepancies among rules between different pairs of countries.

A Strengthened Multilateral System or Increased Friction?

With the signing of the Uruguay Round agreement, the world faces an opportunity for expanding the gains from trade that have spurred economic growth since World War II. The establishment of the new WTO will lead to further tariff reductions, a more effective and speedier dispute settlement process, and agreements on other aspects of trade that will go far to assuage the earlier American concern that unilateral action was necessary because of the absence of international agreements covering those issues.

From a broad perspective, trade policy is an important part of U.S. foreign relations. It does not require idealism to believe that the United States loses respect and influence in the world when it takes unilateral actions that are inconsistent with previous commitments and that harm other countries. There may be occasions when it would be in the U.S. self-interest to take particular actions with respect to trade policy, even if they were deemed detrimental to the U.S. economic interest. Nonetheless, it is in the U.S. self-interest to pursue its legitimate concerns with respect to trading partners' practices through international forums and under international agreements, insofar as possible.

The fundamental fact is that U.S. national economic interests lie largely in the pursuit of free trade. In recent years many of the trade debates in the United States have lost sight of that point, as particular groups seek trade interventions for all sorts of reasons. Perhaps the most legitimate concerns relate to declining industries, where productivity is rising rapidly, demand is rising slowly, and imports are increasing (and exports decreasing). Sympathy for workers who may become unemployed is often a powerful political argument in support of protection. In the cases of automobiles, steel, and textiles and apparel, however, employment has decreased despite protection. To be sure, there can be legitimate concerns with income distribution and the fate of the relatively unskilled. In virtually all such instances, however, one can readily demonstrate that there are cheaper ways of achieving one's social goals.

A second type of appeal for trade policy intervention has come from some high-tech industries, such as the semiconductor industry. Here advocates argue that the industry must survive in the United States because of its importance to further productivity gains across a range of industries. That argument, too, must invoke considerable skepticism: any country whose industries must rely on higher cost or lower quality products than foreign competitors' surely inflicts great harm on its national economy.

Farm groups have been another special interest seeking protection. As with other pleas for intervention, the government can show sympathy for farmers without resorting to protection. Deficiency payments for farmers and negotiations for multilateral liberalization of agricultural trade are far superior to increased protection as solutions to the problems of agriculture.

Viewed from any perspective--foreign policy concerns, national economic interest, or sympathy for the plight of a particular group--there are good reasons for questioning the efficacy of protectionism and other bilateral or unilateral trade interventions. Nonetheless, schizophrenia in American trade policy continues. The United States could achieve much by removing some of the practices that most disturb its trading partners and that derogate from the multilateral system. Should the United States persist in its bilateral and protectionist policies, the system that has contributed most to the world's postwar prosperity will inevitably be affected. The United States (and, indeed, the world) is fortunate that the damage to the global system caused by protectionist policies to date has been limited. It is time for the United States to reassert the importance of multilateral approaches and to provide its strong support for the open multilateral trading system.