October 24, 2017 11:21AM

The Use and Abuse of “Reciprocity” in Trade Policy

One of the big demands of the Trump administration is that trade, and trade agreements, must be “reciprocal.” Their concerns about reciprocity are misplaced, and miss the point about why we open our markets in the first place. Sure it’s great when other countries also open their markets, but there is more to be gained from unilateral opening than no liberalization at all. Frédéric Bastiat explained this peculiar desire for reciprocity in Economic Sophisms, where he wrote:

There are people (a small number, it is true, but there are some) who are beginning to understand that obstacles are no less obstacles for being artificial, and that we have more to gain from free trade than from a policy of protectionism, for precisely the same reason that a canal is more favorable to traffic than a “hilly, sandy, difficult road.” 

But, they say, free trade must be reciprocal. If we lowered the barriers we have erected against the admission of Spanish goods, and if the Spaniards did not lower the barriers they have erected against the admission of ours, we should be victimized. Let us therefore make commercial treaties on the basis of exact reciprocity; let us make concessions in return for concessions; let us make the sacrifice of buying in order to obtain the advantage of selling.

People who reason in this way, I regret to say, are, whether they realize it or not, protectionists in principle; they are merely a little more inconsistent than the pure protectionists, just as the latter are more inconsistent than the advocates of total and absolute exclusion of all foreign products. 

This principle applies not just to border measures such as tariffs, but also to internal measures such as government procurement. Closing our procurement market to foreigners ignores the value of greater choice and competition. Politicians tend to oversell the advantages of selling (exports) over buying (imports), and incorrectly frame imports as a loss and exports as a gain. In fact, increased competition from foreign firms bidding on government contracts can get more value out of taxpayer dollars by increasing efficiency and gains in quality. 

Nonetheless, if people are going to make these demands for reciprocity, they should at least have some reasonable basis for determining whether there is, in fact, reciprocity. To paraphrase a famous line from the Princess Bride: They keep using that word, but it does not mean what they think it means. A recent demand from the Trump administration in the NAFTA renegotiation, related to government procurement, distorts the concept of reciprocity beyond recognition. Here’s a Politico report on Commerce Secretary Wilbur Ross’ remarks on the subject: 

Ross was pressed on whether he thought the U.S. proposal on government procurement access was fair, given that it might result in less market access for Canada and Mexico than is granted to other countries through the WTO.

The U.S. proposal would cap Mexican and Canadian access to U.S. government projects at the combined total access those two countries provide to U.S. firms.

“It’s very good faith, our market is 10 times the size of either of those markets, so if you gave equal percentage market share we’d be giving them 10 for one, how is that good arithmetic?” Ross said. “It is actually to the benefit of the parties because it is the cumulative total of two economies rather than the individual one.”

Ross said the proposal helps address “one of the fundamental flaws, the president feels and I agree, that exists in NAFTA to begin with.”

“The fact is we think it was absurd in general to give away 10 times as much market access as you are getting back,” he said.

Ross’ view appears to be that, in order for there to be reciprocity, the Canadian, Mexican, and U.S. procurement markets should all be open to foreign competition in the same nominal amounts. So, to take an illustrative example, if $10 billion of U.S. procurement is open to foreign competition, $10 billion of Canadian procurement and $10 billion of Mexican procurement should also be open. In his view, that is fair. And just to be nice, he says the U.S. will offer the combined amount that Canada and Mexico offer, so the U.S. will offer $20 billion. See, more than fair, right?

No, not at all! What he leaves out is that the differing size of the economies has an impact on outcomes. The share of the procurement market that each country has open to foreign competition is much different when the nominal amounts are the same, with a far smaller portion of the U.S. market open. And because the U.S. economy is much bigger, the United States has more companies that can compete for contracts. So, if Canada opens up $10 billion of procurement to foreign competition, the U.S. is going to grab a big chunk of that. By contrast, if the U.S. opens up $10 billion (or even $20 billion) to foreign competition, Canada won’t take very much. The result is that the approach Ross is pushing won’t lead to reciprocity. Rather, with the nominal amount of market access the same, and the U.S. economy so much bigger, there will almost certainly be more sales by U.S. companies than by Canadian companies.

If you want to get somewhere close to reciprocity (again, not that we’re advocating it), the way to do so is to open up a percentage of the procurement market to foreign competition. For example, each country could open up 10% of its procurement contracts. This is roughly the approach governments usually take now. Opening up procurement markets on a percentage basis is the best way to get us to a result where roughly the same amount of procurement contracts flow in both directions.

Ross doesn’t like the current approach, saying that the U.S. has given away “10 times as much.” But we haven’t, for the reasons noted: There are fewer Canadian and Mexican companies, so they don’t have the same ability to compete for procurement contracts. 

Adding additional restrictions to the government procurement market, which is valued at $4.4 trillion annually, will be a step in the wrong direction. If the U.S. undertakes measures to further restrict its procurement market, it will be equivalent to a self‐​inflicted wound. It may also be inevitable that other countries will follow suit, reducing international business opportunities for both foreign and U.S. firms around the world.