U.S. Trade Policy in the Wake of Doha: Why Unilateral Liberalization Makes Sense

Presented at a Cato Hill Briefing in Washington, DC on July 20, 2006.

Introduction

I want to talk about a controversial subject: unilateral trade liberalization.

Some people would say it’s akin to unilateral disarmament – that we’d lose all of our leverage to encourage others to liberalize.

Others would say it’s a nice theory, but impossible politically. Perhaps. I’m not dissuaded from advocating it yet.

While there is still a small glimmer of hope that trade negotiators will achieve a major breakthrough in the languishing Doha talks, I rather doubt that will happen in a timely manner.

There is a lot of finger pointing as to who is to blame for the Round’s failures. Look, there’s plenty of blame to go around, if you want to call it blame.

The bottom line is that there simply isn’t enough interest across enough countries in real trade liberalization at this point in time. Or perhaps more precisely, there isn’t enough interest in trade liberalization that commits countries to new rules and requirements.

Doha’s likely failure does not reflect a wholesale rejection of the merits of trade liberalization. I think many countries are willing to reduce their barriers, but to varying degrees and with greater flexibilities.

It’s not a secret that countries that are more open to trade grow faster than those that are relatively closed. This is not some abstract economic theorem in search of adherents; economists of all political persuasions will agree to that. Most countries recognize that commercial engagement with the rest of the world is an economic imperative.

Just look at the trends: there were only 23 original contracting parties to the GATT in 1947, but 127 members of the WTO in 1995 (that figure is now 149).

In 1995 there were about 70 bilateral and regional agreements in effect; today there are more than 225.

In the nearly 60 years since the original GATT, industrialized countries have lowered their tariffs from 40 to 4 percent. Developing countries have followed a similar trajectory.

Most countries appreciate the necessity of international engagement. There is just a vast disparity of ambition at this point. I believe many governments don’t want to relinquish their prerogatives to change course, if the political pressure to do so becomes too strong.

So, how do we deal with this disparity of ambition? This is a major problem that besets the whole concept of multilateral reciprocity, which is the premise of the Doha Round.

When we’re dealing in this construct of a single undertaking, where liberalization in ag is conditioned upon liberalization in industrial tariffs, which is conditioned on services liberalization, which is conditioned on changes to antidumping and other rules, there is no escaping an outcome that at best reflects the lowest common denominator of ambition and at worst produces nothing – or worse than nothing, which would be a deterioration in respect for the current rules of trade and growing disdain for decisions of the WTO dispute settlement system.

Why should more ambitious countries accept an outcome that reflects the lowest common denominator of ambition? And for that matter, why should countries that are reluctant, for whatever reasons, to undertake ambitious liberalization be pressured to do so? Well, it doesn’t have to be that way! It’s not an all or nothing exercise.

These precise conditions, where countries recognize the benefits of trade liberalization but a disparity of ambition makes meaningful commitments impossible, are precisely the conditions that call for leadership from a big country. Not rhetorical leadership. Not cheerleading. But leadership through action.

But We Don’t Need Negotiations to Liberalize Trade

We don’t need negotiations to liberalize trade. We don’t need the consent of other countries to remove our own trade distortions and energize the U.S. economy.

Trade barriers and subsidies are foremost matters of domestic budgetary and economic policy. Domestic reform does not require international trade agreements.

All by itself – without need of foreign consent – the U.S. Congress can show its support for American businesses, consumers, and taxpayers by pursuing a policy of unilateral trade liberalization.

Tariffs and quotas and other protection and distortions are not assets to be relinquished only in exchange for better access abroad. They are not assets at all. They are liabilities that raise the costs of production for U.S. producers and the cost of living for American consumers, and they are especially burdensome for lower‐​income families.

Thus, the most compelling case for dismantling protectionist barriers and subsidy programs is not that they are “concessions” that will buy U.S. exporters access to foreign markets.

The best reason is that it would be incontrovertibly good for the U.S. economy, regardless of what other countries do with respect to their own trade barriers.

In other words, we don’t need a Doha Round to achieve the U.S. objectives of the Doha Round. Unilateral liberalization will bring better opportunities for U.S. business, greater choice and lower prices for consumers, and greater opportunity for the developing world to partake of the benefits of the global economy.

Removing barriers unilaterally could also go a long way toward advancing foreign policy objectives by breaking the links – both real and perceived – between U.S. trade policies and economic hardship in the developing world. Unconditional access to the U.S. market could foster goodwill toward the United States at a time when antipathy toward U.S. policies is growing.

Pros and Cons of Reciprocity

I am not arguing that reciprocity‐​based agreements have no place. They have obviously played an important role in the story of trade liberalization.

Multilateral or bilateral reciprocity can produce widespread benefits. Agreements to dismantle more barriers in more countries can be more liberalizing than the commitment of one country to unilateral reform.

The fewer obstacles there are to the free flow of goods and services throughout the world, the greater the potential for economic growth. Agreements can facilitate the consolidation of domestic reform and lock countries into commitments that become difficult to reverse (NAFTA example).

They can also help prevent backsliding. U.S. WTO commitments, for example, might prove the prevailing argument against protectionist considerations like the Schumer‐​Graham bill, which calls for a 27.5% tariff against all Chinese imports unless and until China revalues its currency to Congress’s liking.

Also, international trade negotiations can carry a certain gravitas that can be tapped by reform‐​minded constituencies to overcome resistance to liberalization on the part of entrenched domestic interests. Prospects for reform that are in a country’s best interest, but are opposed by politically powerful domestic constituencies, can improve when external pressure is harnessed and brought to bear.

My point is that reciprocity‐​based negotiations are not costless and can run into deadends, as I believe is the case with Doha.

First, reciprocity reinforces the fallacy that import barriers are assets to be dispensed with only in exchange for similar measures abroad. That misperception can and does retard the liberalization process in countries that are already inclined toward liberalization.

The idea that elimination of barriers already under consideration might be viewed as desirable by current or prospective negotiating partners can change the perception of those barriers from burdensome liability to negotiating chit.

Although agreements might help to consolidate and buffer domestic reforms from subsequent political motivation to backtrack, negotiations could cause countries to recoil from reforms they might otherwise undertake. Countries may be more willing to liberalize when they do it on their own terms, knowing that if push comes to shove they can reverse course.

Trade negotiations also feature an asymmetry of negotiating power between and among participants. While there are important benefits to having more leverage, there are also responsibilities and burdens.

As the world’s largest economy, the United States has a lot of negotiating leverage. But its positions are often perceived – or can be distorted to be perceived – as heavy‐​handed.

We’ve heard from developing countries and the NGO’s that purport to represent their interests throughout the Doha negotiations, accusations of U.S. arm‐​twisting and bullying.

Many have alleged that the negotiating process is the exclusive domain of a few rich countries, and that proposals are presented on a take‐​it‐​or‐​leave‐​it basis, and do not reflect concerns of smaller countries.

This asymmetry requires – in perception if not in reality – that the United States assume a greater share of the responsibility for the consequences of any agreement. So, if a trade agreement fails to deliver the advertised benefits expeditiously to the smaller, poorer countries – even if that failure may be attributable to purely domestic policy errors unrelated to the agreement, then the agreement, and by extension the United States, is to blame.

Whether that is a fair conclusion is irrelevant. The point is that by insisting on reciprocity, the United States exposes itself to the fallout from any adverse consequences or short‐​term adjustment costs that are likely to be incurred.

That to me can seriously undermine U.S. foreign policy and security objectives.

Trade policy is potentially a shiny carrot in a quiver full of foreign policy sticks. By opening our markets unconditionally, we not only reap the economic rewards but we might engender some good will toward the U.S. But by insisting on even a small degree of reciprocity, trade policy is no longer perceived as that shiny carrot, but rather as another bludgeon through which the U.S. expresses its hegemony.

Economic Benefits of Openness

Much research on the benefits of trade liberalization affirms a conclusion of a 2001 IMF paper, which states: “Although there are benefits from improved access to other countries’ markets, countries benefit most from liberalizing their own markets.”

I site several studies from different sources in my paper, and I believe Will has his own figures to share with you.

Import competition boosts productivity and living standards by inspiring a shift in resources away from activities in which Americans are less productive toward activities in which we are relatively more productive. It also extends family budgets, increases quality and choice, raises average productivity, and reduces the costs of production for U.S. manufacturers.

This year’s Economic Report of the President contains data comparing trends in overall consumer prices (including prices of non‐​traded goods and services) to the trend in import prices.

Real prices for highly traded goods fell considerably between 1997 and 2004: audio equipment (-26%), TV sets (-51%), toys (-34%), clothing (-9%). In contrast, real prices for largely nontraded products increased: whole milk (+28%), butter (+23%), ice cream (+18%), peanut butter (+9%), and sugar (+9%).

In addition to their suppressing effects on prices, imports allow consumers to benefit from a wider variety and better quality of products and services.

Americans also benefit as producers, investors, and workers when access to imports in improved. U.S. producers need imported raw material and components to lower their own costs of production. And competition for their final goods inspires greater efficiencies, exposes them to international best practices, and ultimately helps to raise productivity. When productivity rises, wages and profits tend to follow suit, benefiting workers and investors.

Through all these channels, imports help U.S. industries remain competitive at home and abroad and help the economy to grow and living standards to rise.

The benefit of better access to imports for U.S. producers translates into better access to foreign markets. Trade liberalization at home reduces costs in the supply chain, which renders businesses more competitive abroad. And when foreigners have better access to the U.S. market, they have the opportunity to earn more dollars.

The income effect on their sales in the U.S. has a measurable impact on their demand for U.S. products. As imports have increased year‐​after‐​year over the past several years, so have exports. Last year, more than $900 billion of U.S. production was exported.

In my paper, there are some charts that reflect a correlation between import growth and export growth. We tend to export more to countries from which we import more. That should make sense.

Import restrictions raise the costs of production to U.S. producers and are ultimately akin to restrictions on exports.

By raising the costs of production and by depriving foreigners of sales opportunities in the U.S., import barriers force U.S. exporters to try and sell at higher prices to foreign customers with less income.

Lower input prices mean lower production costs, which enable U.S. companies to sell more competitively abroad to customers who have greater income because of their access to the U.S. market.

But you may say, as members of Congress like to say, that the U.S. economy is already wide open. What more is there to liberalize?

Overview of U.S. Trade Barriers

Sure, average tariff is only 1.4%, which is relatively low. And, about 70 percent of all U.S. imports entered the market duty‐​free in 2005.

But those averages obscure certain facts – as averages tend to do.

The 1.4% average reflects the fact that products with low or no duties tend to be imported more than products subject to higher duties. That skews the average lower.

The average nominal tariff, which is just a straight average of all the product‐​specific tariff lines is closer to 4.9%, reflecting a range of 0 – 350%.

Many of the products subject to above‐​average tariffs are necessities, like clothing, footwear and food products (including ag products).

Products in Chapters 61 and 62 of the tariff schedule, which covers all imports of apparel and clothing accessories are the most heavily taxed at around 11.5%, which is a rate 8‑times higher than the overall average.

While imports of apparel and clothing accessories accounted for only 4.3 percent of total import value in 2005, duties collected on these products accounted for nearly 35 percent of all duties collected by U.S. Customs.

Lobbyists for the U.S. textile industry and their representatives in Congress like to claim that our trade agreements and preference programs provide the world’s clothing producers with duty‐​free access to the U.S. market.

But the fact is that fewer than one‐​third of those shipments entered the U.S. duty‐​free last year. That’s a pretty strong indictment of the rigid rules of origin and the exorbitant costs of complying with the terms of those agreements.

Table 1 in my paper highlights some of the other products that are subject to high tariffs: other textile products, footwear, and food products feature prominently.

The costs of those duties are borne most significantly by lower‐​income Americans because many of those products are necessities for which demand is not very price elastic. Accordingly, lower income families devote higher proportions of their budgets to these items.

Products subject to high rates of duty are also the products that are most likely to be produced and exported by developing countries. And that burden is also reflected in the tariff and trade data.

It is of know relevance to exporters in Macau, Cambodia, Bangladesh, Sri Lanka, Pakistan, and Vietnam that the average applied tariff in the U.S. is 1.4%.

What matters to them is that their exports are subject to duties ranging from 6 to 12 times higher than that average.

What matters to them is that, although their exports constitute a small fraction of total U.S. imports, their shares of U.S. duties collected are substantial. Combined, those six poor countries account for 1 percent of total U.S. import value, but 9 percent of total duties collected.

Table 2 in my paper provides the breakout. There you will see that the average rate of duty applied to OECD countries is 0.8%, and nearly three‐​quarters of rich country exports enter the U.S. duty free.

But Macau’s duty rate is almost 17 percent, and only 2.7% of her exports enter the U.S. duty free.

Cambodia’s exports are subject to almost 16 percent duties, and less than 2 percent enter the U.S. duty free. The story is the same for many developing countries.

The U.S. tariff system is regressive. Lower‐​income Americans and workers in poor countries bear the biggest brunt of its bite.

U.S. protectionism goes well beyond perverse tariff peaks to include import quotas, antidumping measures, anti‐​subsidy measures, government subsidies, rules‐​of‐​origin requirements, “Buy American” provisions, and more.

All of these forms of protectionism are costly and unfair.

There has been a lot of attention focused on the trade distortions and other adverse consequences of America’s agricultural policies for developing countries. These programs are indeed egregious. Abolishing or significantly reducing U.S. ag tariffs and subsidies would help farmers in developing countries make ends meet. But they would also go a long way toward reducing wasteful government spending.

The U.S. antidumping law, which operates in a manner that clearly stacks the deck in favor of domestic petitioners, is also quite notorious for raising input prices for U.S. producers and final prices for consumers. Many of the products subject to excessive trade remedy duties are important inputs consumed by U.S. industries, like sugar, lumber, cement, structural steel, sheet steel, and paint. These duties make it more difficult for the using industries to compete at home and abroad.

Others antidumping measures drive up the prices of everyday consumables like honey, salmon, pasta, mushrooms, tomatoes, garlic, apple juice, orange juice, and more.

And the costs of this protectionism go well beyond the direct impact on prices. A study from the Federal Reserve Bank of Dallas in 2002 found that the average cost to save a single U.S. job from import competition amounted to $231,289 (and my paper contains citation and table from that study).

Leadership by Example

The U.S. does not need reciprocal agreements to remedy the costs of its protectionist policies. In fact, reciprocal agreements might ultimately prove c,ostly.

The fact is that there are now 149 members in the WTO at disparate levels of economic development with different negotiating priorities and asymmetric negotiating resources attempting (presumably) to reach consensus on a diversity of issues in an increasingly contentious environment.

Even if agreement were reached, it would likely tax U.S. credibility further, as naysayers would inevitably allude – rightly or wrongly – to U.S. arm‐​twisting and blackmail. The U.S. should not expose itself to such assertions because it just might get blamed for disruptive adjustments to, or ill effects from, greater import competition in developing countries.

If the U.S. were to take the lead and remove its remaining trade barriers without demands for reciprocity abroad, not only would it reap the economic benefits of greater openness at home, but others might be inclined to follow suit. It could trigger a reciprocal response, what Professor Bhagwati calls “sequential reciprocity.”

Others may be inspired to emulate U.S. policies because we have demonstrated them to be successful or simply because they recognize it is in their best interests to do so.

In this new world of just‐​in‐​time supply chains and relentless competition among developing countries for investment and markets, developing countries really have no alternative but to open up.

Most developing countries already understand this. According to a World Bank study, most comprehensive trade reforms in developing countries were undertaken unilaterally to increase productivity in the domestic economy. Between 1983 and 2003, developing countries reduced their weighted average tariffs by 21 percentage points. Unilateral reforms accounted for 66 percent of the cuts.

More trade liberalization around the world is needed. But the U.S. should allow other countries to reform at their own pace. By not insisting on anything in return for its own liberalization, the U.S. can lead by example, reap the benefits of greater openness, and start rebuilding trust.

Making the Case at Home / Correcting the Mercantilist Misconception

I know that, even though you are all convinced of the merits, selling unilateral liberalization to Congress is a long‐​term project. Vested interests and entrenched ways of thinking about trade will take time to overcome. But the effort can begin now by attempting to change the rhetoric:

We need to stop demonizing imports. Imports have more than tripled over the past 25 years, while the number of net new jobs has increased by 32 million. And as imports rose, so has GDP – nearly continuously, with the exception of two relatively small recessions.

The record increase in imports in 2005 occurred alongside the creation of 2 million net new jobs, a decline in the unemployment rate to 4.7%, and 3.5% increase in GDP.

Likewise, the USTR’s office needs to stop touting the export benefits of every trade agreement and downplaying or rationalizing the improved access to our own market.

We have a ways to go to get a critical mass on board, but the time to begin is now.