The Cato Review of Business & Government
William A. Niskanen is chiarman of the Cato Institute and was
a member of the Council of Economic Advisoers from 1981 to 1985.
U.S. trade policy turned sharply protectionist during the Reagan years. Moreover, all of the new trade restraints imposed were initiated or approved by the administration, despite a general endorsement of free trade in its public rhetoric. The cost of trade protection to American consumers was about $65 billion in 1986, an increase of nearly 100 percent since 1980. About one-quarter of the products imported by the United States are now subject to trade restraints, an increase form about one-eighth in 1980. Since no major trade legislation was enacted until the Omnibus Trade Act of 1988, this deterioration in U.S. trade policy was implemented largely without any major changes in trade law. The Reagan administration must bear the primary responsibility for this record. This article addresses the following questions: What happened to U.S. trade policy and why? Where do we go form here?
Only a brief summary of the major trade cases during the past eight years in needed to convey the scope and nature of the administration's import policies.
Automobiles. Following a campaign pledge that "one way or another the deluge of [Japanese] cars must be slowed while our industry gets back on its feet," and the introduction of a Senate bill that would sharply limit the import of Japanese cars, the Reagan administration pressured the government of Japan to impose a "voluntary export restraint" (VER) on car exports to the United States. The agreement limited exports to 1.68 million cars through March 1982. To counter congressional pressure for a " domestic content" bill, the Japanese maintained this limit for two more yuears, then increased it to 1.85 million cars in the fourth year. Although the Reagan administration did not ask the Japanese to renew the export agreement in 1985, the government of Japan, for its own reasons, has maintained an annual limit of 2.3 million cars since that time.
The gains accruing to the two nations under this agreement have been predictable, if lopsided. For Japan, the agreement increased prices and profits of Japanese auto firms, increased their relative sales of higher-value cars, increased their production in the United States, and increased the control of the Ministry of International Trade and Industry (MITI) over their auto industry. (See Arthur T. Denzau, "The Japanese Automobile Cartel," Regulation, 1988 Number 1.) The U.S. auto industry got higher prices, profits, and employment, and American consumers got to pick up the tab-about $5.8 billion in 1984, or about $105,000 per job saved in the domestic industry. (These estimates of consumer losses, and those for the industries below except steel, were made by Gary Hufbauer, Diane Berliner, and Kimberly Elliot.)
The VER with Japan was entirely "extralegal" in that it was not authorized under U.S. law or under the General Agreement on Tariffs and Trade (GATT). It nevertheless set an unfortunate precedent for the administration's response to most other major trade eases.
Textiles and Apparel. As a candidate, Reagan also pledged to "relate" the growth of imports of textiles and apparel to the growth of domestic sales. In response to this pledge the administration decided in 1981 to renew the MultiFiber Agreement (MFA) in a form that would meet this goal. (The MFA, an outgrowth of the "short-term" cotton agreement of 1961, is a complex system of quotas set by the industrial countries on textile and apparel imports from developing countries.) The continued growth of imports led the administration to broaden the products covered by these quotas and to change the country-of-origin rules.
For the exporting countries the effects of these measures were similar to those of the auto quotas: increased prices, profits, and government control of their textile and apparel industries- The United States got increased prices and profits and a slower decline in employment in the domestic firms. The cost to American consumers was about $27 billion, or about $42,000 per job saved in the domestic industry.
For three decades the United States has been the prime mover in establishing a worldwide cartel for textiles and apparel sales, the only commodity group (other than agriculture) that is exempt from the normal GATT rules. The primary effect of the Reagan measures was to increase the scope and cost of this cartel.
Steel. In response to a 1982 petition by the steel industry for antidumping penalties and countervailing duties against imports of carbon steel from European firms, the administration arranged for VERs for steel. Under the agreements, steel imports from Europe were limited to 5.5 percent of the U.S. market, and a similar limit was placed on pipe and tube imports. Negotiations were initiated to achieve similar limits from other countries. The quotas established under the agreement were independent of the amount by which a country's or a firm's products were determined to have been dumped or subsidized; an "unfair trade" case was thus transformed into a general limit on European steel exports to the United States, irrespective of the extent to which individual firms had been charged with unfair trade practices.
In response to a 1983 "escape clause" petition from the specialty-steel industry, the administration imposed a set of tariffs and quotas on imports of selective specialty-steel products. Total steel imports, however, continued to increase, primarily from countries not included in these agreements. When another such petition was filed by the steel industry in 1984 and a bill was introduced to limit all steel imports, the administration decided to seek VERs from all major steel exporting countries, it sought to limit total imports of finished steel to 18.5 percent of the U.S. market as well as to limit imports of semi-finished steel. Strong U.S. demand and a delay in negotiating and implementing these VERs, however, reduced their short-term effects; between 1984 and 1986, total steel imports declined from a peak of 26.4 percent of the U.S. market to 23 percent.
Together these measures effectively created a worldwide cartel of steel exporters to the United States, increasing the prices and profits of firms receiving quotas and increasing government control of these firms. The U.S. steel industry experienced higher prices and profits and a slower decline in employment. The annual cost to American consumers was about $6.5 billion, or about $750,000 per job saved in the domestic industry! Since steel is a major input to other products, these measures also reduced the international competitiveness of other American industries.
Semiconductors. In 1986 the semiconductor industry petitioned to impose antidumping duties on imports of general-purpose memory chips from Japan. The price of Japanese chips was higher in the United States than in Japan, but was lower than the cost of Japanese production as estimated by the U.S. Department of Commerce. As in the 1982 steel case, the administration chose to negotiate a broad agreement with the exporting country, rather than to impose the duties authorized by law. Under pressure from the U.S. government, the Japanese government agreed to set a floor price on memory chips sold in the United States equal to the "fair market value" (as determined by the Commerce Department), to set a similar floor price on sales in third countries, and to promote an increase in the sales of U.S. chips in Japan. In the absence of this agreement the United States would have no authority to impose the latter two conditions. In 1987 the administration determined that Japan had not met the second and third provisions of this agreement (although it would not reveal the data on which it based this determination). It then imposed 100 percent tariffs on $300 million worth of other Japanese imports. In fact, the government of Japan had already ordered a substantial reduction of chip production to reduce the large inventory being sold in third countries; it also had implemented several measures to promote the sale of foreign chips in Japan. Although the administration later determined that Japan had ceased "dumping" in third countries, it maintained the punitive tariffs on a reduced set of products to induce Japan to increase the U.S. share of its chip market.
In effect, the semiconductor agreement created a two country memory-chip cartel. Combined with steady demand growth, the agreement led to a sharp increase in the price of memory chips in both Japan and the United States, from $2.50 in early 1986 to $5.50 in March 1988. Since chips are a major input in the production of computers, the agreement will reduce the international competitiveness of the much larger computer industries in both countries.
Other cases. There was no consistent pattern in the administration's handling of other trade cases. On the one hand, the administration established (in 1981) a system of quotas on sugar imports to maintain the domestic sugar price; these quotas were progressively tightened and later extended to the import of food products containing even minimum amounts of sugar. As of 1984, the domestic price of sugar was about four times the world price-the highest effective tariff on any legal product-at a cost to American consumers of about $1 billion. The administration also set a high temporary tariff on large motorcycles (in 1983) to protect about 2,000 jobs in one company; it requested (in 1986) VERs on imports of machine tools from four countries, after rejecting two prior petitions for restraints under different sections of U.S. law; and, during the sensitive early negotiations on the U.S-Canada free-trade agreement in 1986, the administration imposed substantial tariffs on imports of cedar shingles and softwood lumber from Canada.
On the other hand, the administration rejected or removed trade restraints on three products. The administration rejected petitions (in 1981 and 1985) to continue or reimpose quotas on footwear. It rejected a petition (in 1984) to limit copper imports because of the adverse effects on the much larger copper products industry. And it convinced Congress (in 1986) to delete the "manufacturing clause" in copyright law that required most books and magazines to be printed and bound in the United States in order to receive U.S. copyright protection (a provision that dated from 1891). The footwear and printing industries are the only industries for which trade restraints are now substantially lower than in 1980.
The administration's export policies are best described as inconsistent. The administration removed the embargo on grain sales to the Soviet Union but imposed an embargo on the sale of U.S. equipment and U.S.-licensed equipment made in Europe for the natural gas pipeline from the Soviet Union to Europe. After a protest from European governments, this embargo was removed. For foreign policy reasons the administration imposed selective embargoes on trade with Poland, Libya, Nicaragua, Syria, and, in response to strong congressional pressure, South Africa. Several times the administration proposed reducing funding for the Export-Import Bank while simultaneously agreeing to increase subsidies on agricultural exports. The administration did not ask Congress to remove the bans on exporting logs or Alaskan oil, or the requirement that 50 percent of all government-financed agricultural exports be carried on American ships. American firms still lack clear guidelines on the export of defense-related technology that are consistent with the rules affecting sales by other Western nations. For many years the federal government has promoted the export of some products and restricted the export of others, with little apparent rationale. For the most part, this is still the case.
At the same time, however, the administration stepped up pressure on other governments to open their markets to U.S. goods. The general tactic was to threaten limits on their exports to the United States in order to induce them to reduce their limits on U.S. sales in their markets. The Reagan administration initiated 10 such cases during its first term and 22 such cases after September 1985, when trade policy became markedly more aggressive. These measures had some success. Japan reduced or eliminated tariffs on aluminum products, cigarettes, and leather products, and substituted high tariffs for very restrictive quotas on beef and citrus. Korea reduced its barriers on U.S. movies and television programming. Taiwan opened its market to beer, wine, and cigarettes. Europe reduced restraints on imports of corn and citrus. And so on.
But this tactic, by its nature, risked imposing substantial costs on the United States, both in terms of higher U.S. trade barriers and an erosion of our bargaining leverage on more important issues. For example, in response to a loss of corn sales to Spain and Portugal upon their joining the common market, the administration threatened to impose a 200 percent tariff on imports of selected alcoholic beverages and agricultural products from Europe. The escalation of this dispute was only narrowly averted. Threats of steep U.S. duties on European spaghetti and fancy pasta sold in gourmet groceries became even more tangled, with the European Community retaliating against U.S. walnuts and lemons, the U.S. delaying concessions on semi-finished steel, and Europe imposing duties on U.S. fertilizer, paper products, and beef tallow. One might hope that America's limited leverage with major allies would be focused on more important issues, such as our shared defense burden. Threatening to impose costs on both U.S. consumers and foreign producers in order to increase the benefits to U.S. producers, generally over trivial issues, may turn out to be a game of Russian roulette.
Congress also bears substantial responsibility for the deterioration in U.S. trade policy during the Reagan years. Although little trade legislation was approved until 1988, a large number of trade bills were introduced, and a few were passed by one or both houses. Heading off these bills became the administration's primary internal rationale for its own protectionist actions.
During Reagan's first term Congress was stepping up pressure for protectionist trade legislation, but its signals were still mixed. Congress overrode a veto to extend the manufacturing clause of the copyright law, but subsequently allowed this provision to expire. Twice the House approved a bill that would have required domestic production of up to 90 percent of the value of all cars sold in the United States, but on both occasions the bill died in the Senate. A more general Trade and Tariff Act was approved in 1984, after an extraordinary effort by William Brock (the U.S. Trade Representative in the first tenn) to delete most of the small protectionist provisions. This act strengthened the authority to retaliate against unfair trade practices, broadened the definition of injury in escape clause cases, and included a small number of minor protectionist provisions; on the other hand, it reduced tariffs on about 100 products, extended the Generalized System of Preferences on imports from the developing nations, and provided authority for bilateral negotiations for free-trade agreements with specific nations.
Trade policy turned more aggressive in the second term. In 1985 the House passed a bill to tighten the quotas on textile and apparel imports and the Senate passed a similar bill, adding protection for the copper and footwear industries that had been denied relief by the president; this bill, however, was subsequently vetoed. In 1986 both houses began to develop comprehensive trade bills, focusing on trade authority and rules rather than on specific products. The general thrust of these bills was to broaden the conditions that would be defined as unfair trade practices, restrict the presidential authority to deny trade relief, and (for a few goods and services) to require a "reciprocal treatment" of U.S. sales in foreign markets and foreign sales in the U.S. market. Two years of deliberations on this legislation culminated in the Omnibus Trade Act of 1988, the 1,000 page trade bill passed by large margins in both houses. The president's response to this legislation was remarkable. He first vetoed the bill, objecting primarily to a provision requiring early notice of plant closings and substantial layoffs. When Congress responded by passing a separate plant closing bill, the president endorsed the trade bill and chose not to veto the plant closing bill.
Only a few provisions of the Omnibus Trade Act are likely to be trade-expanding: the president is granted special authority to negotiate the new GATT round; the rules affecting U.S. business practices in other countries are made more realistic; tariffs are reduced or eliminated on many products for which there is no U.S. source; and the "windful profits" tax on U.S. oil is repealed. These provisions came at a very high price, however.
The primary problem with the act is that it represents a unilateral U.S. declaration of the rules of trade. It reverses 40 years of U.S. leadership toward a set of trade rules to which all parties agreed. In effect, the United States has told the rest of the world, "Play by our rules or we will not buy your products"; in the name of reducing unfair trade by other countries, the United States changed the rules of trade by an unfair process. One should not be surprised by strong foreign opposition to this act or by the prospect of other countries applying unilateral rules to the United States.
One creative instrument of trade policy initiated during the Reagan years was the bilateral free-trade agreement with selected countries. A free-trade agreement with Israel was approved in 1985, for example, and a broad agreement with Canada, our largest trading partner, has recently been approved. A "framework agreement" with Mexico, our third largest trading partner, will provide guidance for future trade negotiations. Such agreements have been considered with other countries.
Bilateral free-trade agreements promise to increase the benefits of trade to each participating country. In addition they expand the dollar-bloc free-trade area, which can provide leverage- perhaps our only substantial leverage-to achieve a desirable outcome from the new round of GATT negotiations. The United States entered these negotiations in 1986 with an ambitious agenda to broaden GATT rules to agriculture, services, and investment. The prospects for this round, however, are not encouraging. The Europeans have strongly resisted the elimination of trade-related agricultural subsidies and are more concerned about completing the integration of the European Economic Community. And most countries have been provoked by the more aggressive U.S. trade policy of recent years. In the absence of creative leadership, the world trading system may well devolve into regional trading blocs with higher barriers to trade among blocs-a sad outcome for an administration that was once committed to "improvements and extensions of international trade rules."
The Political Economy of Trade Policy
What explains the substantial change in U.S. trade policy during the Reagan years?
First, when the Reagan administration came to office, it had no strong, consistent convictions on trade policy. Indeed, the president and other key officials never resolved the tension between their public pro-market rhetoric and their private pm-business sympathies. The initial statement of the Reagan economic program barely acknowledged the international dimensions of economic policy. One paragraph described how the proposed policies were expected to improve international conditions, but there was no mention of the principles that would guide our economic relations with other nations. Increased spending for defense and business investment was a major objective of the initial program, but there was no recognition that these measures would have a substantial effect on the real exchange rate and the trade balance.
Fortunately the administration developed a more comprehensive statement of U.S. trade policy in mid-1981. The primary theme of this statement was "free trade, consistent with mutually accepted trading relation." It committed the administration to five specific trade policy objectives which, given the economic conditions anticipated in 1981, would have been a satisfactory and sufficient frame work for trade policy. Unfortunately these conditions did not prevail.
Second, adverse economic conditions in the early 1980s-the long recession and the rapid increase in the exchange rate and trade deficit-led strong pressure, in combination with some 1980 campaign commitments and controversy within the administration, led to numerous breaches in the announced trade policy.
Third, even after the economy rebounded, the increasing disparity between the announced trade policy and the developing trade record was resolved by changing the official trade policy, rather than by correcting the record. In 1985 a draft speech prepared for the president that would have renewed his commitment to free trade was revised, under the auspices of White House Chief of Staff Donald T. Regan, to conclude that "if trade is not fair for all, then trade is 'free in name only." The major element of Reagan's new Trade Policy Action Plan was the initiation of a series of actions against "unfair" trade practices by other governments, including practices not covered by existing GATT rules. This unilateral definition of fair trade policy of the first term and set the stage for the broader U.S. definition of fair trade in the trade bills being developed by Congress. This change in policy was roughly coincident with the appointment of Clayton Yeutter as the new U.S. Trade Representative and with Secretary of the Treasury James A. Baker III's Plaza Agreement for coordinated action to devalue the dollar, which signaled a more interventionist policy on a range of international economic issues.
Finally, trade policy became a major focus of the special interest demands for government benefits. While the total demand for such benefits may be roughly constant, several major changes in economic policy during the Reagan years-specifically the substantial reduction in real spending on discretionary programs, continued economic deregulation, and broadening of the tax base in the Tax Reform Act of 1986-reduced the special benefits distributed by other means. The large budget deficit continues to constrain the potential to distribute special benefits through the budget and tax code. This is likely to create continuing demands for special benefits through trade policy (as well as through new types of economic regulation such as mandated benefits).
While the administration rationalized its major protectionist actions and, ultimately, the shift in its announced trade policy as necessary to had off even more aggressive measures by Congress, the outcome of this strategic retreat was not satisfactory. For the first time since World War II the United States added more trade restraints than it removed. Although U.S. pressure led to some reduction in trade-distorting practices, it also consumed political capital that continues to be important in GATT and other international forums. And the Omnibus Trade Act of 1988 ended a half-century of U.S. leadership toward a more open world trading system based on mutually accepted rules of trade.
The Prospects for U.S. Trade Policy
Where do we go from here? For the next several years U.S. trade policy is likely to be increasingly aggressive-despite a sustained economic recovery, a declining trade deficit, and a sharply lower foreign-exchange value of the dollar. Both presidential nominees, George Bush and Michael Dukakis, endorsed the Omnibus Trade Act while generally supporting free trade. Congress is in an ugly mood, both about foreign trade practices and foreign investment in the United States. The Omnibus Trade Act, best described as "procedural protectionism," invites an increasing number of petitions for trade practices. Since the president and the U.S. trade representative still retain a measure of discretion. My own judgment is that the prospects for the new GATT round are not encouraging, unless the United States develops an effective strategy to break the logjam on agricultural issues.
We now need to develop a longer-term strategy to preserve and extend free trade. Supporters of free trade have been too defensive for too long-opposing or trying to limit new trade restraints, but rarely proposing reductions in trade restraints. This is no-win strategy. When we win, it is a draw; when we lose, the scope and level of trade restraints are increased. What is needed is an offensive strategy to reduce trade restraints, both in the United States and abroad, with the hope of shaping the perceptions that will affect U.S. trade policy well into the next century.
What might be the elements of such a strategy? The following general approaches should be considered.
First, and most important, we need to regain the moral and economic high ground for free trade. The fundamental moral case for free trade, both within nations and between nations, is based on the principle of consent. The most important role of government is to secure the rights of individuals to make consensual arrangements across national borders. The economic case for free trade is that it increases the combined income of the affected nations and, except in rare conditions, also increases the income of each nation. This perspective on international trade is now more threatened than at any time in the post war years.
Many supporters of free trade, unfortunately, became too involved in the narrow politics of current issues to recognize the power of ideas in shaping legislation. During the past decade, however, three of the more important changes in U.S. economic policy were the result of a convergence of elite opinion, across parties and without any significant popular pressure. These changes were the substantial reduction of domestic economic regulation, the Gramm-Rudman-Hollings deficit reduction process, and the Tax Reform Act of 1986. We need to reassert the moral and economic case for free trade so that, at some point in the future, free trade will be similarly recognized as an idea whose time has come.
Second, we need to support measures, both in the United States and abroad, that reduce the U.S. trade deficit. A trade deficit is of no particular concern when domestic investment is unusually high. The current U.S. trade deficit, however, is the result of conditions that are neither sustainable nor desirable: the unusually low level of U.S. saving net of government borrowing. In effect, the U.S. trade deficit is providing the net inflow of goods and services to permit an unsustainable level of private consumption and government spending. There is no prospect for changing the direction of U.S. trade policy until these conditions are changed.
The primary responsibility for reducing the U.S. trade deficit, of course, must rest with the United States. The several types of measures that should be considered include reducing the remaining biases in our tax system against private saving, reducing the growth of government spending for both services and transfer payments, and, only if politically necessary, increasing taxes to reduce the growth of private consumption.
It is important to recognize that measures by other governments to increase their private consumption, defense spending, or domestic investment would also reduce the U.S. trade deficit. As a rule, and in contrast with many U.S. government officials, I am most reluctant to pressure other governments to change their domestic policies. In the case of defense spending, however, the current U.S. share of our common defense is disproportionate. The United States now spends about 6.5 percent of GNP for defense-about twice the share by our NATO allies and about five times the share by Japan. Our disproportionate share of the burden of providing the common defense is, in effect, one of our largest exports-but one for which we arc not compensated. For various reasons the United States is likely to reduce its overseas military forces during the next decade, forcing the governments of Europe and Japan to reassess their own contribution to the regional defense against the continuing Soviet threat. An increase in defense spending by Europe and Japan that matches the reduction of U.S. defense spending would reduce the U.S. trade deficit by more than the amount of the shift in the defense burden. This is a complex issue but one that cannot be avoided by pretending it does not exist.
Third, we need to force the political pressures for U.S. trade restraints through the formal processes authorized by U.S. trade law and the GATT. Many of the U.S. trade restraints implemented since 1980 have been extralegal "voluntary" export restraints under which other governments have agreed to avoid a formal action under U.S. trade law. My own judgment is that the acquiescence of other governments, particularly Japan, to these restraints has been most shortsighted because it induced the United States to impose other such measures. The scope of U.S. trade restraints, I believe, would have been narrower if other governments had resisted U.S. pressure for such extralegal restraints.
Fourth, we need to broaden the use of bilateral free-trade agreements. Bilateral agreements serve two objectives: they broaden the dollar bloc of free-trade agreements in the absence of a more general agreement under GATT; and they put substantial pressure on the Europeans (who have expressed considerable concern about being left out of such agreements) to broaden and strengthen GATT in the current negotiations.
My views on this issue were reinforced by hearing the French agriculture minister's proposal (in the Chirac government) for cartelizing the world's major cereal exporters. The current European position on agricultural trade threatens to undermine any prospect for success of the GATT round unless the United States presents a credible threat of walking out of these negotiations. The GATT may increasingly become an instrument of managed trade, unless the United States presents a credible alternative framework for world trade-even if that alternative is less desirable than some conceivable multilateral arrangement. The U.S. bilateral initiatives should not be regarded as a threat to GATT but as part of a strategy to achieve a successful negotiation of a broader multilateral arrangement.
Finally, at some stage, we need to make the case for reducing the scope of U.S. trade law. My suggestions are the following:
Such changes would channel pressures for trade restraints primarily through two existing sections of U.S. trade law, sections 201 and 232. Section 201 authorizes trade restraints when an increase in imports has been the major cause of injury to a domestic industry. This provision has the advantage of permitting the president to consider the interests of consumers and other industries in determining whether to approve or modify a recommended trade restraint, and requires compensation of the exporting country. Section 232 authorizes trade restraints when an increase in imports would threaten the industrial base necessary for national security. Even Adam Smith acknowledged that "defense is more important than opulence."
The process and criteria for approving trade restraints under these two sections of U.S. trade law are wholly consistent with GATT, and these sections have not been subject to substantial abuse.
In summary, we can develop a long-term strategy to preserve and extend free trade. This will require intelligence, a sense of realism, a commitment to principle, and considerable patience. Alternatively, we can simply respond to political pressures for new trade restraints and allow the world trading system to continue to deteriorate. The future of U.S. trade policy and of the world trading system depends on the outcome of this choice.
Selected ReadingsHufbauer, Gary, Diane Berliner, and Kimberly Elliot. Trade Protection in the United States:
31 Case Studies. Washington, DC: Institute for International Economics, 1986.
Richman, Sheldon. "The Reagan Record on Trade: Rhetoric vs. Reality" (Policy Analysis No. 107). Washington, DC: The Cato Institute, 1988.
Volokh, Eugene. "The Semiconductor Industry and Foreign Competition" (Policy Analysis No. 99). Washington, DC: The Cato Institute, 1988.
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