Trade Trouble Ahead

I've written a few times about Obama's ambivalent-at-best position on trade, warning that Obama's poor choice of US Trade Representative and "re-open NAFTA", "Buy USA" and "protect labor standards" rhetoric threatened to ignite a trade war.

Well, today's Obama's choice for USTR, former Dallas mayor Ron Kirk, won approval from the Senate. Meanwhile, Mexico announced that it would impose $2.4 billion of tariffs on US goods "ranging from strawberries to Christmas trees" in retaliation for a US ban on Mexican trucks on American highways. The new tariffs, ranging from 10% to 40%, are Mexico's response to the scrapping by the US Congress of a program allowing Mexican trucks to haul goods inside the US, an action that Mexico deems a violation of NAFTA. Mexico has graciously exempted staple goods, such as rice, corn, wheat, and meat, from the tariffs so as not to raise consumer prices for people being pummeled by the economic crisis.

These two events are unrelated, but are also more than mere coincidence. How Obama responds to the Mexican tariff imposition is going to be a vital test of his commitment to existing free trade regimes, let alone expanding free trade. The truck issue has been simmering since 2001; some key US lawmakers backed by American trucking unions claim, without any merit, that Mexican trucks do not meet US standards, a claim that looks suspiciously like an effort to protect US trucking from Mexican competition. Regardless of what Obama intends to do regarding reopening NAFTA or trying to re-do the signed but not yet ratified free trade deals with Colombia and South Korea, it is essential that he send a strong signal on this issue, not only to Mexico but to the rest of the world. The US is the leader and driving engine of the global market and of the free trade regime, but US support for free trade has always been very slim (recent survets by the Pew Global Attitudes Project have found year after year that the US has the lowest public support for free trade among all developed nations).

With the economic crisis cascading around the globe, pressures for protectionist measures have increased, and while we're not anywhere close to Smoot-Hawley land yet, the last thing the US and the global economy needs is more inefficiency, waste, and protection. Obama may have picked a trade lightweight for USTR but his willingness to adhere to an existing US trade agreement, to compromise with one of the US's most important trade partners, and to show a commitment to free trade can send an even more powerful signal.

The Danger to Free Trade

Last Friday, the Wall Street Journal ran one of the scarier articles I've read in quite some time. In short, according to the article, "Countries grappling with global recession have enacted a wave of barriers to world commerce since early last month, scrambling to safeguard their key industries -- often by damaging those of their neighbors."

The details:

Russia has introduced 28 measures to raise tariffs on other countries' imports and subsidize its own exports since November, and plans six more.

It's not alone. The European Union has warned the U.S. that proposed "Buy American" provisions in planned stimulus spending could break trade rules. Meanwhile, EU nations have reversed direction and tightened their own trade rules, for instance by resuming subsidies to dairy farmers' exports and effectively barring Chinese screws and bolts from their market, while accusing China of dumping them below cost.

The U.S. is planning retaliatory tariffs on Italian water and French cheese to punish the EU for restricting imports of U.S. chicken and beef. India is proposing to increase tariffs on foreign steel at the request of its steel industry.

The landscape is moving so fast that officials at the WTO, the world's top trade-law enforcer, say they're relying on news reports to keep up with the changes, as governments are often slow to report them. They are reconsidering their Jan. 23 report that concluded protectionist pressures were largely being kept at bay.

Among the changes just since that finding: Egypt has imposed duties on sugar, and the U.S. has levied new tariffs on Chinese goods it contends are being dumped on the market, including mattress springs and graphite electrodes, used to conduct electricity in factory furnaces.

The WTO's figures show that antidumping cases overall, in which nations contend others are disrupting markets by unloading goods below cost, are up 40% since a year ago. In October, as the extent of the global recession became more certain, WTO director Pascal Lamy ordered his staff to start tracking protective actions, say WTO officials.

This is very scary ground we're treading on here. Free trade is subject to massive collective action problems that make these kinds of protectionist responses to crises very attractive. And the implementation of trade barriers can take on a spiral dynamic as one aggrieved party acts to protect its own industries and punish another state for its actions. In the 1920s and 1930s, such "beggar-thy-neighbor" policies undoubtedly worsened the impact and length of the Great Depression and led to a 66% contraction in global trade that contributed to the collapse of the German economy and the rise of Nazi Germany.

Is such an outcome possible today? The Wall Street Journal article doesn't seem to think so:

Economists and trade analysts say the current rash of trade constraints could make it harder for global economic growth to recover from the current downturn. Global trade is expected to shrink by more than 2.1% this year after growing by 6.2% in 2008, according to the WTO.

To be sure, the current growth of protectionism is different and less sweeping than the trade wars of the 1930s. "It's a creeping form of protectionism," said Frederik Erixon, director of ECIPE, a trade-policy think tank based in Brussels. By comparison, the Smoot-Hawley act in 1930 raised U.S. tariffs on foreign imports by an average of 20% across the board. "That could never happen now," Mr. Erixon said. "Political leaders agree it's illegal and immoral."

It's true we're a long way from the 20% tariff increases of Smoot-Hawley. But I don't put much faith in the legal and moral impulses of our political leaders. Just look at the idiotic "Buy American" language contained in the US stimulus package.

It is vital that in a time of economic fears and rising worries over trade that the US send a strong message to the international community of its own commitment to free trade. By backing away from the "Buy American" language, the US can help stop the justifications being used by other countries to protect their own industries and do what is best for the American economy. But American action needs to go beyond that. President Obama must push to stop these anti-dumping actions and to reestablish the norm of free trade. If he doesn't, we're in for some longer, harder times.

Obama's Bad Move on Trade

Reuters is reporting that President-elect Obama has settled on former Dallas Mayor Ron Kirk to be US Trade Representative. This does not bode well. Obama's first choice, California Representive Xavier Becerra reportedly turned down the job because Obama wasn't planning on making trade a priority of his administration:

"My concern is how much weight this position would have had, and I reached the conclusion that it would not be a top priority or even a second or third priority," Becerra told La Opinion, a Los Angeles Spanish-language newspaper, in an interview earlier this week.

With the Doha round of WTO talks stalled, hopefully to resume in 2009, it is imperative that trade be made a priority so the impasses over intellecutal property and agricultural subsidies can be broken. Nominating someone to USTR with zero trade experience and with lowered priority is not a good sign. Furthermore, Reuters reports that Obama's first trade priority will be "to make good on Obama's promise to add stronger labor and environmental provisions to the North American Free Trade Agreement, a pact often blamed by labor groups for moving U.S. jobs to Mexico."

All of this bodes very badly. Obama's anti-trade rhetoric during the campaign bordered on protectionist, and was often down-right scary. Re-opening NAFTA would be a disastrous move, making other states less likely to sign agreements with the US for fear that they would be re-opened in the future, undoing all the hard negotiating on the original agreement. Many people claimed that Obama's talk on trade was just that: talk. The hope was Obama was spouting protectionist rhetoric to win the election and that once president he would adopt a saner approach to free trade. Such hopes were bolstered by top economic adviser Austin Goolsbee's comment in Canada that Obama's anti-NAFTA positions "should be viewed as more about political positioning than a clear articulation of policy plans."

But the closer it gets to inauguration day, the more it looks like Obama was serious in his rhetoric.

Why Antigua Matters

Last August, the US lost an important decision before the WTO in which Antigua challenged American bans on on-line gambling. The WTO found that, in general, US bans on on-line gambling were illegal under WTO rules because the US allows significant amounts of domestic on-line gambling (e.g. on-line purchases of lottery tickets, Internet-based off-track betting). Antigua won the right to, if the US didn't comply with the WTO rule by either allowing on-line gambling or banning all on-line gambling, impose sanctions equivalent to $21 million (Antigua had asked for $3.4 billion) on the US through copyright violations. In response, the US withdrew from the part of the WTO dealing with on-line gambling, and is presently in negotiations with several countries over compensation for the US action. According to the previously referenced article:

Under WTO rules, a country may withdraw a service sector committed to WTO jurisdiction only with the authorization of other WTO signatory countries interested in the sector and only after compensating for future lost revenue a WTO signatory country might have earned were the commitment maintained. ... The U.S. is engaged in negotiations with the European Union, India, Costa Rica and Macao to determine how much it must pay them for withdrawing the gambling sector. These negotiations focus on what new service sectors the U.S. will submit to WTO jurisdiction in exchange for withdrawing gambling.

Yesterday, however, apparently dissatisfied with American offers of compensation, the European Union launched an investigation into American rules banning on-line gambling to determine whether those laws discriminated against EU-based companies. The investigation is seen as laying the groundwork for a potential suit in the WTO against the US.

US behavior in this case is absurd and barely explicable. The moral opprobrium argument holds no water, as gambling in the US is widespread and accepted. Is it really any different if someone buys lottery tickets, go to Vegas or Atlantic City, or gambles on-line? The only possible explanation is the US seeks to protect a small gambling industry, and is willing to undermine the global free trade regime to protect that industry. When it was Antigua challenging the US, the US was apparently willing to pay millions of dollars to avoid opening up (or banning altogether) gambling markets. But the entrance of the EU into this equation changes the parameters of the game quite drastically.

Since the dynamics of the US law haven't changed, it seems all but certain that the EU could win any suit filed in the WTO. It also seems certain that the EU would be granted far more than $21 million of damages. At which point the US would be faced with a real choice: Pay the EU billions of dollars in compensation (which would, in all likelihood be equated by some penalty against the EU for European protection) or lift the ban. The latter is, obviously, not preferred by the US domestic political arrangements. The former threatens to undermine the WTO. As I wrote when I initially blogged about this case:

It is very important that the US comply with the WTO's decision. The WTO is one of the cornerstones of the international order, and is vital for insuring the continued prosperity of this country, and nearly every other country in the world. Furthermore, the US has been trying to get smaller, developing countries to accept American intellectual property rights laws under the WTO. Why would they do so if the US refuses to play by the rules (of course, the American, European, Japanese, and Korean refusals to ease or cease agricultural subsidies are already driving this line of thought, but at least ag policy is not currently covered by the WTO)? Refusing to comply will fundamentally damage US credibility and interests to a degree that not even the invasion of Iraq was able to do. It is vital to the US that other countries commit themselves to the WTO and comply with its obligations; it is equally vital that the US do the same.

That was true when it was just Antigua. Now that the EU is involved, it's even more true.

A Test For China

For the first time, the World Trade Organization has issued a major ruling against China. According to the AP report:

The WTO found that China was breaking trade rules by taxing imports of auto parts at the same rate as foreign-made finished cars, according to a copy of the ruling's conclusions obtained by The Associated Press.

In the sweeping decision, the three-member WTO panel found against China on nearly every point of contention with the U.S., the 27-nation EU and Canada.

The three trade powers argued that the tariff was discouraging automakers from using imported car parts for the vehicles they assemble in China. As a result, car parts companies had an incentive to shift production to China, costing Americans, Canadians and Europeans their jobs, they said.

...

China, which will still be able to appeal, claims the tariffs are intended to stop whole cars being imported in large chunks, allowing companies to avoid the higher tariff rates for finished cars. It argues that all measures are fully consistent with WTO rules and do not discriminate against foreign auto parts.

But the U.S. and the EU say that China promised not to treat parts as whole cars when it joined the WTO in 2001.

China's accession to the WTO was a vital component of the US strategy of engagement, in which economic relations with China are pursued as part of a two-pronged strategy. The first goal of economic development is to transform China's domestic economy into a middle-class, capitalist-style market which, it is argued, will in turn create domestic pressure for political reform. The second strategy of engagement is to make China increasingly dependent on the international community so that adherence to the status quo is more valuable than challenging it.

The WTO is an excellent forum for the latter strategy, as it requires countries to alter their domestic laws and economic rules to comply with international free trade requirements. As protection of domestic status is, more or less, the raison d'etre of national governments, agreeing to alter those arrangements for the sake of international free trade is a powerful signal of adherence to the status quo. How China reacts to the first negative ruling will be a meaningful statement of how China understands its own preferences vis-a-vis the status quo and the international system. If it agrees to comply with the ruling, which will certainly harm a sector of China's domestic economy that it desires to protect, it will be a strong sign that engagement is working.

The Costs of Free Trade

Steven Landsburg, an economist at the University of Rochester and author of the excellent The Armchair Economist, has a very interesting op-ed in the New York Times today. Landsburg argues that calls for retraining and support from workers who lose their job due to competition and globalization should be ignored, especially by the Republican presidential candidates who, particular before the Michigan primary, openly pandered to such calls. According to Landsburg:

All economists know that when American jobs are outsourced, Americans as a group are net winners. What we lose through lower wages is more than offset by what we gain through lower prices. In other words, the winners can more than afford to compensate the losers. Does that mean they ought to? Does it create a moral mandate for the taxpayer-subsidized retraining programs proposed by Mr. McCain and Mr. Romney?

Um, no. Even if you’ve just lost your job, there’s something fundamentally churlish about blaming the very phenomenon that’s elevated you above the subsistence level since the day you were born. If the world owes you compensation for enduring the downside of trade, what do you owe the world for enjoying the upside?

I doubt there’s a human being on earth who hasn’t benefited from the opportunity to trade freely with his neighbors. Imagine what your life would be like if you had to grow your own food, make your own clothes and rely on your grandmother’s home remedies for health care. Access to a trained physician might reduce the demand for grandma’s home remedies, but — especially at her age — she’s still got plenty of reason to be thankful for having a doctor.

Some people suggest, however, that it makes sense to isolate the moral effects of a single new trading opportunity or free trade agreement. Surely we have fellow citizens who are hurt by those agreements, at least in the limited sense that they’d be better off in a world where trade flourishes, except in this one instance. What do we owe those fellow citizens?

One way to think about that is to ask what your moral instincts tell you in analogous situations. Suppose, after years of buying shampoo at your local pharmacy, you discover you can order the same shampoo for less money on the Web. Do you have an obligation to compensate your pharmacist? If you move to a cheaper apartment, should you compensate your landlord? When you eat at McDonald’s, should you compensate the owners of the diner next door? Public policy should not be designed to advance moral instincts that we all reject every day of our lives.

Landsburg is exactly right. In theory. But, in theory, communism works. Landsburg has the economics down, but misses the larger political context of free trade debates. It is true that, as Landburg argues "Americans as a group are net winners. What we lose through lower wages is more than offset by what we gain through lower prices." But that winning can't happen if Americans as a political entity reject free trade and globalization due to the costs.

Free trade by nature is particularly vulnerable to collective action problems (in short, the steel worker who loses his job to foreign competition has more incentive to lobby for redress than the millions of people who save $2 on each car they purchase have to lobby for expanded free trade). As we saw in the 2006 midterm elections, the political opposition against free trade is growing stronger, even as the economic benefits from globalization continue to increase. A recent Pew Research Center poll showed that Americans had the lowest favorable attitudes towards globalization and trade of all 47 nations surveyed.

In terms of pure economic efficiency, and maybe even morally, it might not make sense to compensate the losers from globalization. But from a political perspective, it is imperative that we do so, if only to be able to maintain public and political support for expanding free trade. If some of the gains of free trade have to be spent to maintain the regime, so be it.

Antigua 1, US Nil

Typically, international politics is an arena dominated by power. In conditions of anarchy, those who can do, and that rule is frequently followed by the US, which uses its hegemonic status to ignore rules that the US finds inimical to its interests.

International institutions are the primary ways in which anarchy is mitigated in international politics, as strong institutions can create norms and rules that states must follow or risk falling afoul of the enforcement mechanism of the institution. The WTO is one of the most significant of these institutions, as it possesses a relatively credible and powerful enforcement mechanism (described here) and has succeeded in forcing states to change their policies and domestic laws.

However, the WTO now faces a difficult situation by virtue of its very strength. The WTO has found that US laws barring American citizens from gambling on-line with off-shore casinos are a violation of free trade and of the US's obligations under the WTO. The ruling, initially made in 2004 and upheld in two appeals, supported Antigua's claim that the US law has unfairly impacted Antigua's trade in Internet gambling (Antigua's second-largest business behind tourism), and the case is now in damage assessment, with Antigua claiming $3.4 billion in damages and asking for the right for reciprocal violations of US intellectual property. If the US wishes to avoid allowing Antigua to violate US IP protections (to the amount determined by the damage assessment hearing), the US will either have to allow Americans to gamble with off-shore casinos on the Internet or ban all forms of domestic on-line gambling, such as the on-line purchase of state lottery tickets, off-track betting on horse-racing, and even fantasy sports leagues in which prize money is awarded.

The problem is, as the New York Times notes, that:

For the W.T.O. itself, the decision is equally fraught with peril. It cannot back down because that would undermine its credibility with the rest of the world. But if it actually carries out the penalties, it risks a political backlash in the United States, the most powerful force for free-flowing global trade and the W.T.O.’s biggest backer.

“Think of this from the W.T.O.’s point of view,” said Charles R. Nesson, a professor at Harvard Law School. “They’re this fledgling organization dominated by a huge monster in the United States. People there must be scared out of their wits at the prospects of enforcing a ruling that would instantly galvanize public opinion in the United States against the W.T.O.”

Over at his blog, Dani Rodrik sees this as a serious problem for the WTO, writing that "this is another example of how existing WTO practices are leading to the narrowing of policy space to the detriment of legitimacy (and economic logic). When the system serves to enforce new restrictions on domestic policy autonomy that would be wildly unpopular at home, it is time to rethink the system."

But I don't see why this example is any different than any other trade dispute for which the WTO has jurisdiction. The point of the WTO is to allow states to tie their own hands. That is, states know that free trade is an overall good, but that they have powerful short-term domestic reasons to opt for protection. Committing to the WTO allows states to avoid the collective actions problems that are so endemic in trade and stick to a free trade policy. There are exceptions, under which states are allowed to impose protectionism, such as protection of domestic morals, national security, public safety, and so on. But states often try to disguise protectionist policies with legitimate rationales, like France's attempt to ban GMOs.

Indeed, the US invoked such language, claiming that the US has the right to ban Americans from on-line gambling "on moral grounds, just as any Muslim country would be within its rights under international trade agreements to ban the import of alcoholic beverages." However, given that the US allows many types of gambling, including on-line wagering, the claim rang hollow, and was rejected by the WTO.

Despite Rodrik's claim, this is exactly the kind of issue that the WTO should be dealing with. The US has no legitimate reasons to ban on-line gambling, given that gambling is obviously legal and quite prevalent in this country. There are entire cities devoted to gambling, states run massive gambling operations, and every local paper prints sports odds on a daily basis. Gambling has long been subject to massive protectionism in this country for no good reason, but the advent of on-line gambling has changed the venue and scope of the country's ability to maintain that protection. As other countries, like Antigua, developed gambling industries, the US's double standards looked more and more like unfair and illegal protectionism.

It is very important that the US comply with the WTO's decision. The WTO is one of the cornerstones of the international order, and is vital for insuring the continued prosperity of this country, and nearly every other country in the world. Furthermore, the US has been trying to get smaller, developing countries to accept American intellectual property rights laws under the WTO. Why would they do so if the US refuses to play by the rules (of course, the American, European, Japanese, and Korean refusals to ease or cease agricultural subsidies are already driving this line of thought, but at least ag policy is not currently covered by the WTO)? Refusing to comply will fundamentally damage US credibility and interests to a degree that not even the invasion of Iraq was able to do. It is vital to the US that other countries commit themselves to the WTO and comply with its obligations; it is equally vital that the US do the same.

The Abomination That Is The Farm Bill

There are few things in the world I hate more than domestic politics, and fewer things still that illustrate why I hate domestic politics so than the US farm bill. In testimony before Congress on July 24, the General Accounting Office revealed that the US Department of Agriculture:

paid $1.1 billion in farm payments in the names of 172,801 deceased individuals. ... 40 percent went to those who had been dead for three or more years, and 19 percent to those dead for seven or more years.

Over $200 million went to farmers who had been dead for more than 7 years. Meanwhile, farmers in Africa are unable to find decent prices for their goods as global prices are suppressed by artificially inflated supply from the US. This year alone, the US farm bill will cost the average American family about $320 in subsidies.

But wait you say...the farm bill preserves the tradition of small farming, a la Willie Nelson's Farm Aid.

Hardly.

As Nicholas Kristof notes in his recent mea culpa revealing that he, a New York Times journalist who writes most often about human rights, is paid $588 a year not to farm the land he owns in Oregon, "the majority of payments go to commercial farmers who earn more than $200,000 annually, while 95% of farmers get little or no benefit from the farm bill." Meanwhile, the Democratic Congress defeated a proposed $200,000 cap on payments, preferring to set the maximum that any single farmer can receive at $1 million (per farmer, so a farming couple can get $2 million).

And as John Stossel notes, the farm bill undercuts American legitimacy on free trade. Why should developing countries join the WTO and comply with US intellectual property laws if the US won't play by the rules on agriculture (it goes without saying that Europe is even worse, but that's no excuse for the US).

The farm bill is shameful. But unfortunately, it is not surprising. As Thomas Paine wrote in Common Sense, "government even in its best state is but a necessary evil, in its worst state an intolerable one."

Amen.

The Return Of The Club For Growth

The passage of the Smoot-Hawley Tariff Act in 1930 is now widely seen as one of the most disastrous laws ever passed by Congress. The high tarrifs lengthened and intensified, if not caused, the Great Depression and contributed to the coming of World War II by exacerbating poor economic conditions in Europe and undermining any sense of international trust. At the time, it was opposed by 1,028 of this county's leading economists, who called themselves the Club For Growth. Unfortunately, Congress thought it knew better than the economists and ignored their advice.

History seems to be repeating itself today as a newly protectionism-minded Congress prepares to pass legislation that will impose punitive tariffs on China if China does not raise the value of its currency, the yuan. While the yuan has risen by about 9% in value relative to the dollar, it may still be undervalued by 40%.

Fortunately, the Club For Growth has returned, as 1,028 of our leading economists have once again signed a petition urging Congress to abandon punitive tariffs as a policy tool. Unfortunately, it's likely that the current incarnation of the Club will be ignored just as was the first.

There are so many reasons why these tariffs would be a bad idea. First, they are little more than protectionism disguised as congressmen seek to protect their inefficient and struggling manufacturing industries from foreign competition. Succeeding will cost this country, and the global economy, billions of dollars, and will punish the poorest Americans who can least afford to waste their money on tariffs.

Second, this policy threatens to undermine the long-standing US policy of engagement towards China. While China is not a model global citizen, there can be no question that the China of today is infinitely better -- economically, socially, politically -- than the China of 20 years ago, and little doubt that the China of tomorrow will be better than the China of today. And there is little question that economic interdependence, globalization, and engagement are large reasons why.

Undermining such a critical long-term policy for short-term political benefit is so short-sighted as to be moronic. But why would we expect anything less from our elected officials?

A Trade Trade?

The Washington Post reports that congressional Democrats are seeking to expand the role, scope and power of the Trade Adjustment Assistance program. The TAA was implemented to help workers adjust to the impact of globalization, by providing funds for re-training, relocation, and job searching to those "whose hours of work or wages are reduced as a result of increased imports." Currently, TAA assistance is limited to those in the manufacturing sectors, whom had been the hardest hit by globalization; the Democrats are trying to expand TAA to jobs in the service industries, such as computer programmers and call-center staffers. According to the Post:

Last year, the Labor Department approved 1,400 petitions covering about 400,000 workers, according to a recent study by the Government Accountability Office, though fewer than 100,000 workers sought and received benefits. The agency denied 800 petitions, mainly because the workers did not produce "an article" and hence fulfill the basic definition of a manufacturing worker. Most of the denials involved two industries, the GAO said: business services such as computer programming and airport-related services such as aircraft maintenance.

The TAA is a grand political compromise that helps make globalization possible. While globalization produces massive net benefits, those benefits tend to be spread across the entire population, while the costs of globalization are typically localized in inefficient industries that suffer as jobs move abroad. Those that lose their jobs have a larger incentive to lobby their congressmen than the vast majority that benefit from lower prices and increased quality; thus, globalization contains the seeds of its own defeat. The TAA helps reduce the cost of economic dislocation, making it easier for the public and politicians alike to "do the right thing" by advancing the cause of globalization. The TAA has typically enjoyed broad bipartisan support, and the current bill is co-sponsored by Sen. Olympia Snowe (R-ME) and Sen. Max Baucus (D-MT).

Why is this effort from the Democrats problematic then? In the past, TAA has been part of a grand trade deal: Republicans would support TAA and in return Democrats would support free trade deals. But the current Congress doesn't seem as willing to give that quid pro quo. The extension of Trade Promotion Authority (formerly known as Fast Track, TPA means that Congress can only vote up-or-down on trade bills, rather than amending, adding, and subtracting to the deal. Without TPA, it is exceedingly difficult to conclude trade agreements, as other states are loathe to make concessions knowing that Congress may very well undo whatever US concessions are given in return.) is in danger, and Congress has delayed consideration, let alone approval, of the previously signed trade deals with Peru, Panama, Colombia, and South Korea, despite a deal in May to bring the agreements to a vote. Protectionism was a major theme of many of the Democrats who won office in last year's election, and passing TAA in the absence of a commensurate expansion of global trade will only further retard the global and domestic economy.

Hopefully, Senate Republicans will insist that the Democrats acquiesce on trade in exchange for expanding protection for those who suffer from globalization. If they don't, and the growing anti-trend continues, economic promise will grow dim.

China's Poker Face

The US recently announced that it would soon file suit against China in the World Trade Organization (WTO) over Chinese trade barriers as well as violations of intellectual property through piracy of DVDs, video games, CDs, books, and other good. The decision is a change in the long-standing approach of the US, defined as "engagement," in which the US has overlooked Chinese violations of various laws and norms -- such as in human rights as well as economic -- in order to not derail the process of tying China more tightly to the international political and economic community. For example, after the Tiananmen Square massacre in 1989, the economic sanctions imposed by the US only lasted about 6 months (although a joint arms embargo imposed by the US and the EU is still in place today). When newly-elected President Clinton tried to condition renewal of Chinese Most-Favored Nation status on improvements in Chinese human rights policies as a response to the perceived soft American reaction to Tiananmen Square, Clinton was forced to abandon his threat and back away from confrontation.

The policy of engagement is based on two assumptions. One is that the process of domestic economic growth will create a climate more conducive to the development of a middle class, which in turn will demand political reforms, such as property rights and increased access to information, to protect their new-found wealth and status and to ensure future competitiveness. Such political reform will inevitably move the country closer to democracy, and following the logic of the democratic peace theory, democracies are less bellicose. Thus, China's peaceful rise can be assured by turning the country into a nation of rich, middle-class consumers.

The second thread of engagement is an argument that as China's economy grows, China will become increasingly tied to international economic and political institutions, such as the WTO. As that interdependence grows, China will come to identify its national interest with cooperation, not confrontation, as confrontation would risk upsetting the apple cart, threatening to undermine all of China's economic ties.

This larger policy of engagement, however, does create a moral hazard problem, in which China is encouraged to "cheat" in the short-term, knowing that the US is taking a long-term approach, and won't punish defection too seriously for fear for ruining the larger relationship. This explains, among other things, the "China-Google" controversy from last year.

So why is the US willing to challenge China now? For one, the process of Chinese integration into the global economy and political superstructure has proceeded nicely. Chinese entry into the WTO marked a critical junction; if China was willing to join the WTO and alter its laws to meet membership requirements, it is possible that the appropriate level of economic and political integration has occurred, and that China now identifies its interest with the status quo.

In my dissertation, as well as an article I published in the journal Security Studies entitled "Institutional Signaling and the Origins of the Cold War," I argued that institutions are vitally important to international politics not only for their intended benefits, but because they force states to reveal private information about their type and preferences. Complying with an institutional obligation forces a state to revel that it values adherence more than defection. That enables other states to then judge the first state's intentions and preferences.

China will be faced with a separating equilibrium -- a costly decision that will force actors of one type to choose one action, while actors of another type will not be willing to pay the cost and thus will choose a different action; this then reveals the preferences of the actors -- in the WTO: Risk losing in the WTO process and be forced to change its laws and behaviors (something China obviously would prefer not to do, otherwise the laws and behaviors in question wouldn't exist), or refuse to comply. Refusal will, however, force the EU and the US to question Chinese commitment to the multilateral economic and political institutions that make up the international system. Why would China be allowed to benefit from those institutions if it won't meet its obligations and responsibilities? Failure to comply would put at risk the economic growth that has buoyed the Chinese state. But, if China would prefer to pursue its own path, if it sees the extant rules as incommensurate with its national interest, it will not be willing to pay the price of WTO compliance.

The suit filed by the US against China signals that the US is ready to test Chinese intentions. All eyes will be on China to see if it complies with the institutional processes and any adverse ruling. If it does, the policy of engagement will be justified. If not, however, expect to see increased confrontation and suspicion of Chinese intentions. My guess is that China will comply. There's simply too much at stake for China to prefer being a revisionist state that seeks to undermine the status quo.

A Test For Trade

As the 109th Congress prepares to close this afternoon, both the House and Senate are racing to finish up some critical business, including a bill that will serve as an excellent bellwether of the new Democratic Congress' commitment to free trade (true, the newly-elected members aren't voting on this bill, but the Democrats already in Congress may feel empowered to vote the bill down, as has already happened with free-trade agreements with Peru and Colombia).

The bill, in addition to including numerous domestic tax breaks [full disclosure: As a resident of Washington state, which has no state income tax, I stand to benefit from this bill which will allow residents of states without income taxes to deduct state and local sales taxes from their federal income], contains several vitally important trade elements, including the granting of permanent normal trade relations (what used to be known as Most-Favored Nation status) to Vietnam, an essential criteria for Vietnam's entry into the World Trade Organization. The bill will also extend existing agreements with Haiti and sub-Saharan African states to allow those countries to export textiles and apparel to the US at lowered tariff rates, and extends a program to provide low tariffs for the products of more the 140 developing countries.

It cannot be stressed enough how important free trade is to the economic health of not only this country but of the entire international community. I have blogged in an earlier post about how restricting free trade and increasing either protectionist tariff rates or subsidies produces massive harms for the poor in this country and in the developing world. But free trade is also a critical component of the democratic peace. By trading and interacting with other countries, mutual expectations of gain are formed, patterns of behavior are established, and economic interdependence is created to connect the future well-being of states to one another.

The US has spent much of the latter half of the 20th century building a liberal economic trade regime that has resulted in massive improvements in the living conditions and well-being of peoples all over the world. The creation and maintenance of this order is one of the most important components of US global leadership. This regime must not only be sustained, it must be broadened by dropping the remaining impediments to free trade so that all states might benefit.

If this bill is defeated, I fear for the future, as should you.

More On The New Congress And Free Trade

Yesterday, the House of Representatives failed to approve Vietnam's permanent normal trade relations, which is a pre-condition for Vietnam's entry into the World Trade Organization, by a vote of 228-161. Because the vote was held on the "suspension calendar," it required a 2/3 majority to pass, and the bill will likely pass when re-voted on during normal proceedings later this week.

What's disturbing is that the bill, which Democratic leaders had referred to as a "slam dunk," was so widely opposed by Democrats. While Republicans voted 2-1 for giving Vietnam PNTR, Democrats split almost evenly on the issue. As I blogged about yesterday, the prospects of anti-trade Democrats scuttling international free trade is bad for many MANY reasons. It's bad for the domestic economy, it's bad for developing countries, it's bad for the poor here and abroad. But it's also bad on larger issues as well. Free trade and the international economy is a critical element of the logic of the democratic peace, and manifests itself in, for example, the current policy of engagement with China. Free trade is critical for institutionalizing international relationships, which helps states escape the anarchic pressures of the international system that creates security dilemmas, arms races, and raises tensions. Free trade is a vital asset of soft power. Free trade is so important to so many aspects of national and international security that undermining it could be said to be, without exaggeration, disastrous.

Things are likely going to get worse when the newly-elected nationalistic illiberal Democrats take their seats. Will President Bush expend his precious (and limited) political capital to advance free trade? Not likely, given the other issues on his plate. However, none of those issues, Iraq included, are likely as important to the economic health of this country, the international system, and international peace and stability as free trade. A Democratic Congress must not be allowed to block the spread of trade.

What Do Patrick Buchanan And The New Democratic Congress Have In Common?

Answer: An antipathy towards free trade.

As Buchanan makes clear here, he remains a staunch opponent for free trade, disguising his economic philosophy with a flag of patriotic nationalism. He asks:

But if the free-trade era is over, what will succeed it?

A new era of economic nationalism. The new Congress will demand restoration of its traditional power to help in shaping trade policy. When the U.S. trade deficit for 2006 comes in this February, it will hit $800 billion, pouring more fuel on the fire.

A rising spirit of nationalism is evident everywhere in this election, not simply in the economic realm. Americans are weary of sacrificing their soldier-sons for Iraqi democracy. They are weary of shelling out foreign aid to regimes that endlessly hector America at the United Nations. They are tired of sacrificing the interests of American workers on the altar of an abstraction called the Global Economy. They are fed up with allies long on advice and short on assistance.

Other leaders in other lands look out for what they think is best for their nations and people. Abstractions such as globalism and free trade take a back seat when national interests are involved.

We are entered upon a new era, a nationalist era, and it will not be long before the voices of that era begin to be heard.

Free trade was, in a sense, the "stealth" issue of the recent elections, as it received little public attention and yet is perhaps the foreign policy issue on which Congress can have the most effect. And while few candidates made trade their main issue, there is a lot of evidence that many of the new Congresspeople share Buchanan's opposition to free trade. For example, Jacob Weisberg writes in Slate:

Many of the Democrats who recaptured seats held by Republicans have been described as moderates or social conservatives, who will be out of synch with Speaker-to-be Nancy Pelosi. The better term, with props to Fareed Zakaria, is probably illiberal Democrats. Most of those who reclaimed Republican seats ran hard against free trade, globalization, and any sort of moderate immigration policy. That these Democrats won makes it likely that others will take up their reactionary call. Some of the newcomers may even be foolish enough to try to govern on the basis of their misguided theory.

...An even harder-edged nationalism defined many of the critical House races, where Democrats called for a moratorium on trade agreements, for canceling existing ones, or, in some cases, for slapping protective trade tariffs on China. These candidates also lumped illegal immigrants together with terrorists and demanded fencing and militarization of the Mexican border. In Pennsylvania, Democratic challengers Chris Carney and Patrick Murphy defeated Republican incumbents by accusing them of destroying good jobs by voting for the Central American Free Trade Agreement and being soft on illegal immigration. "Fair trade" candidates also won back formerly Republican seats in Ohio, Indiana, Iowa, North Carolina, and Wisconsin. Jerry McNerney, who defeated 14-year Republican incumbent Richard Pombo in California, says on his Web site: "I am deeply worried about the way this nation is plunging head-long into the global economy without a plan or a national consensus."

Sebastian Mallaby of the Washington Post echoes Weisberg's fears on trade, writing:

During their long years in the wilderness, Democrats lashed out against trade and globalization, even though denying the economic case for trade is like pretending that tax cuts pay for themselves. Now that they have won Congress, the Democrats must prove that they are more than the mirror image of their opponents. This means reviving the pro-market centrism of the Clinton era -- a spirit that lives on in the form of the Hamilton Project.

...During the recent congressional campaign, Democratic candidates mostly had the right diagnosis and the wrong prescriptions. They saw that middle-class and poor Americans have not experienced wage gains during the past five years of growth, and they saw that families are one health crisis away from financial hardship. But the Democrats' remedies -- bashing Wal-Mart, railing against globalization -- offered little more than symbolism for the poor and middle class while promising damage to the economy.

Why is trade is a critical issue? Because protectionism, even when garbed with the much nicer "fair trade" moniker, can create devasting economic inefficiencies. For example, Walter Williams points out:

The Washington-based Institute for International Economics has assembled data that might help with the answer. Tariffs and quotas on imported sugar saved 2,261 jobs during the 1990s. As a result of those restrictions, the average household pays $21 more per year for sugar. The total cost, nationally, sums to $826,000 for each job saved. Trade restrictions on luggage saved 226 jobs and cost consumers $1.2 million in higher prices for each job saved. Restrictions on apparel and textiles saved 168,786 jobs at a cost of nearly $200,000 for each job saved....

A lot is at stake for those in the sugar industry, workers and bosses. They dedicate huge resources to pressure Congress into enacting trade restrictions. But how many of us consumers will devote the same resources to unseat a congressman who voted for sugar restrictions that forced us to pay $21 more for the sugar our family uses? It's the problem of visible beneficiaries of trade restrictions, sugar workers and sugar bosses, gaining at the expense of invisible victims -- sugar consumers. We might think of it as congressional price-gouging.

It gets worse. Not only is protectionism an unabashed economic loser, it also most hurts the very people the Democratics typically claim as their constituents. From Edward Gresser's Toughest on the Poor in the Nov/Dec issue of Foreign Affairs:

Tariff policy, without any deliberate intent, has evolved into something astonishingly tough on the poor. Young single mothers buying cheap clothes and shoes now pay tariff rates five to ten times higher than middle-class or rich families pay in elite stores. Very poor countries such as Cambodia or Bangladesh face tariffs 15 times those applied to wealthy nations and oil exporters.

Last year, the U.S. Customs Service collected $18.6 billion in tariff revenue on $1.1 trillion in goods imports -- meaning the effective U.S. tariff rate is 1.6 percent. But the low overall average masks something more troubling. Tariffs on industrial imports are not just low but extremely
low. For expensive consumer goods such as cars, appliances, and televisions, rates are also generally low and are further reduced in practice by trade agreements with Mexico and Canada. But for light consumer goods, the story is different. Tariffs on these products (with a few
exceptions, such as toys and furniture) remain at levels other industries last saw in the 1960s and 1970s: for instance, 8.7 percent for cutlery and tableware, 13.8 percent for suitcases and handbags, 10 percent for bicycles, and 11.4 percent for shoes and clothes, the largest category of consumer imports for the United States. In effect, the United States now has two tariff systems.
One, for low- tech consumer goods, has an average rate of 10.5 percent. The other, for everything else, has an average rate of 0.8 percent.

Cheap sneakers valued at $3 or less per pair carry tariffs of 48 percent (a rate, incidentally, far above that of any product on the administration’s steel list). Virtually none of these shoes is made in the United States. Last year, the United States imported 16 million pairs of these sneakers, at a total cost of $35 million. Thus the average price at the border was $2.20 per pair. The Treasury Department then collected $17 million in tariffs, adding another $1.06 per pair to the buyers’ cost. The extra dollar and change is then magnified by retail markups of around 40 percent and state sales taxes of about 5 percent to raise the final consumer price of the sneakers from about $3.25 (without tariffs) to $4.80 per pair (with tariffs).

Such tariff-based overpricing exists, though at less dramatic levels, in store aisles stocking baby clothes, T-shirts, silverware, and other typical family products. Because it is most pronounced on the cheapest shoes and clothes, its effect falls most heavily on single-parent families.
Incomes for these families are very low: at an average of about $25,100 per year, they are about 40 percent of a typical two-parent family’s income. But single-parent families face shoe and clothing bills nearly as high as those of wealthier families. In total, the average singleparent
family spends nearly $2,000 a year on clothes and shoes. Depending on the mix of purchases, as much as $400 of this total may simply be price inflation due to tariffs. Budgets for other tariffed goods, though smaller, are still a larger expense relative to income for poor families than for rich families. And so single-parent families lose much more of their income to tariffs than do other
families.

Average tariffs on European exports to the United States -- primarily cars, power equipment, computers, and chemicals -- now barely exceed one percent. Developing countries such as Malaysia, which specialize in information-technology products, get rates just as low. So do natural- resource exporters such as Saudi Arabia and Nigeria. Middle-income exporters that ship a broader variety of goods, such as China, Thailand, and Brazil, face rates typically between two percent and four percent -- above average but still not exorbitant. The least-developed
Asian countries, however, take it on the chin. For Bangladesh, Cambodia, Nepal, Mongolia, and a few others, clothes make up 90 percent of all exports to the United States. So they face average tariff rates of 14.6 percent -- nearly 10 times the world average, and 15 times the rate for wealthy Western countries. Translated into real dollars, the disparities can be remarkable.
As Table 3 notes, the U.S. now collects more tariff revenue from Bangladeshi goods than from French goods, even though Bangladesh exports $2 billion in goods a year to the United States and France $30 billion. Cambodia’s exports to the United States total $900 million and
Singapore’s usually reach $15-$20 billion -- but the U.S. government collects nearly twice as much revenue from Cambodian goods as from Singaporean goods.

What explains the willingness to impose such massive economic costs on the poorest American citizens, the poorest developing countries, and the US and global economy as whole? Trade presents an exceedingly difficult collective action problem that makes those opposed to it much more political powerful than those in favor of free trade. Returning to the sugar example, each US citizen may be $21 more each year due to sugar trade, but that loss is disguised in hundreds or thousands of transactions containing sugar. However, the 2,261 people whose jobs were saved, and would be at risk from free trade have much more to lose. Their potential costs are concentrated and huge. Sugar workers will lobby much louder for protection that will the free traders.

It's still too early to predict that a Democratically-controlled Congress will scuttle free trade. Indeed, just recently leading Democrats declared that there would be no problem admitting Vietnam in to the WTO. But, free trade is far to important to this country, the international political and economic environments (let's not forget the Smoot-Hawley Tariff), and the country's and the world's poor to let it be undermined by economic and political nationalists. For those Democratic voters who did such a great job making your voices heard, don't drop the ball on this one.