THE LEAGUE OF WOMEN VOTERS OF THE DISTRICT OF COLUMBIA

February 2001

TRADE AND GLOBAL ECONOMIC INTEGRATION

Sharply accelerating international economic integration, i.e., Globalization, is said to define our era. A similar level of economic integration existed particularly among European states at the end of the 19th century. That earlier Globalization deteriorated at the beginning of the 20th century and collapsed entirely following US enactment of high trade barriers after World War I.

The collapse of world trade and the world economy at the onset of the Great Depression coincided with a rise in extremist movements all over the world. Given the disastrous subsequent history, we have come to view the maintenance of world trade and an integrated world economy as essential to maintenance of world peace. The League's advocacy of freer world trade is based on this understanding of 20th century history.

Some believe that there is now a conflict between the League's advocacy of freer trade and its more recent advocacy of environmental stewardship and human rights. The restudy of the League's trade position is intended to reconcile these positions.

The Virtues of Openness

Ever since Adam Smith published The Wealth of Nations in 1776, mainstream economists have agreed that people, companies and nations ought to trade with one another because it is a more efficient way to organize production. Trade increases the quantity and quality of total output, increases the variety of products available and lowers prices-thereby permitting us all to raise our standard of living.

Another British economist, David Ricardo, refined Adam Smith's central insight about the virtues of specialization with the concept of "comparative advantage." Ricardo demons that even if a country were better than any other country at producing absolutely everything, that nation would still be better off if it concentrated on producing those things that it did comparatively best and then traded for the others. This is true even though somewhat less efficient producers are ceded the opportunity to produce those other things.

Being best at producing particular things depends not just on natural resources but also on historical accidents of time and place. Silicon Valley, spawned by its proximity to Berkeley and Stanford Universities, then gained powerful advantages simply from being thereafter "close to the action" -- i.e., in the midst of an ever growing pool of talent, skilled labor and ideas.

Trade is not a "zero-sum" game in which one nation wins only at the expense of its competitors. Nations are mutually better off when their firms produce and trade those goods and services in which they enjoy a comparative advantage in exchange for goods and services that foreign firms can supply more cheaply. The purchasing power of workers' wages increases when they can buy imports at lower cost. Inflationary pressure is reduced. This restraining effect on inflation means that the Federal Reserve need not move so quickly to raise interest rates to cool the economy when growth accelerates in a tight labor market.

Competition from imports, or the mere threat of imports, keeps domestic producers from charging excessive prices and having to compete with imports spurs local producers to innovate, thereby producing better products and services at lower cost. Innovation is responsible for as much as half of US growth and the hot breath of foreign competition drives producers to innovate as quickly as possible.

A country exports goods and services in order to import the goods and services that it cannot (or opts not) to produce. Rich countries typically import oil and other commodities as well as labor-intensive low-tech manufactured goods, such as shoes and shirts . from poor countries. Poor countries use export earnings to buy high-tech capital goods, such as computers, software and aircraft from rich countries. Imported higher-tech capital goods are essential if poor countries are to develop their economies. An increasing proportion of global trade is in services rather than goods and the US enjoys a comparative advantage in the services sector.

Large multilateral trade deals, referred to as "rounds," have, since the end of World War 11, lowered consumer prices thereby encouraging consumers to consume more imports. World trade has consequently expanded much faster than total world output. (The share of global production traded worldwide grew from about 7% in 1950 to more than 20% by the 1990's.) Similarly, the volume of US trade has expanded much faster than total US output. (International trade accounts for nearly 25% of the US economy today; thirty years ago, trade accounted for little more than 10%.) US prices for goods and services traded internationally have risen slowly as compared with US prices for products and services that are not traded internationally.

The Costs of Openness

The downside of open trade is that there are losers-the industries that fail to compete with imports and their workers. Critics of freer trade claim that trade destroys jobs, especially good jobs in manufacturing, where wages and benefits have traditionally been generous for people with limited education — meaning a high school diploma or even less. (Hourly wages in manufacturing are about 9% higher than wages in other private sector jobs.)

Jobs are lost as production shifts away from goods and services that the US is comparatively poor at producing — autos, steel, textiles, apparel, and footwear. However, new jobs are created in export industries where we have a comparative advantage — computers, software, communications equipment, aircraft and financial services. Workers in those new industries are more productive because of high-tech machinery, or special knowledge and skills. Their greater productivity results in better pay and benefits. This is confirmed by data showing that jobs in exporting industries pay wages that are 5-15% higher than the national average. In the end, better jobs are created but such industries hire fewer workers. This is quite logical. Higher productivity means that fewer people are needed to produce more.

Employment in the services sector has increased as manufacturing payrolls have declined. Unfortunately, productivity is lower in service sector industries and not so easily boosted with technology. Therefore, such jobs pay considerably less. The problem is further compounded by our increasing wealth. As incomes rise, we choose to spend a larger percentage of income on services, including health, education, travel and meals away from home. Consequently, less is spent on manufactured goods. The decline in manufacturing payrolls is also due to much faster productivity growth in manufacturing. Steelworkers were 125% more productive in 1995 than in 1973 — meaning that fewer workers were needed to produce the same volume. The productivity of hotel workers improved by just 11% during the same period.

The culprit here is technology, with its boost to productivity, and the shift in demand to services as our society grows richer. The loss of "good" manufacturing jobs is for the most part not due to trade. This conclusion is supported by data showing that most US imports come from high-wage developed countries-not from low-wage developing countries. Most US trade is with Europe, Canada and Japan, where wages are. as much as twice the US wage rate. Furthermore, most US direct investment abroad in factories and facilities has gone to these same rich trading partners. The failure of our public education system to provide the highly educated workers employers need in this new economy would be a more appropriate target for protestors!

There is also a widely reported growing inequality in wages paid to US workers — especially, between the top 10% and the bottom 10% of wage earners. The gap in family or household income is also growing. But the reason for the gap is clearly a surplus of low-skilled workers, including recent immigrants, at a time when demand for low-skilled workers is steadily declining. Again, education is the solution.
A further downside to all of this global economic interconnectedness is that it makes it increasingly difficult to disregard each other's domestic policies. What country A does may impact or seem to impact country B's economy, or its moral or cultural sensibilities. Thus, trade policies of competitor countries are often described in pejorative terms. For business, the problem is "price dumping," — i.e., selling in foreign markets at a price below cost or below the price charged at home or in third-country markets. For labor, the problem is "social dumping." — i.e., foreign producers being able to sell their products at lower prices than US producers because their countries do not have or do not enforce costly labor regulations and social safety nets. For environmentalists, the problem is "ecodumping," — i.e., foreign producers being able to sell at lower prices because they do not face costly environmental regulations at home. All aggrieved parties are seeking relief from what they term "unfair" competition.

However, many of those who complain are really seeking a pretext for increased trade protection. Others are sincerely committed to freer trade, but are equally concerned about unfair competition and lax labor and environmental standards. For them, a globalized world requires global standards.

An unusual coalition has attacked the World Trade Organization for usurping US sovereignty. The Left charges that the WTO can nullify environmental, labor and other US regulations when a WTO panel finds that they impede trade. Similar charges have been made against NAFTA tri-national panels that oversee administration of certain trams, labor and environmental standards-so-called "site agreements." The Right objects because it believes that such international bodies claim powers that belong to US government at all levels. The Right believes that this shifts power to unresponsive tribunals on distant shores.

Critics who accept the legitimacy of the WTO want the organization to enforce tough environmental, labor and human rights standards as part of trade agreements. Basically, they want to hitch their progressive causes to the WTO "engine" because the WTO has standing authority to seek compliance with trade treaties through economic sanctions. Environmental, International Labor Organization (ILO) and other kinds of treaties lack strong enforcement mechanisms.

All international treaties limit countries' freedom of action in some fashion. Countries sign such agreements because the benefits of doing so outweigh the constraints placed upon them by those agreements. Moderate observers generally agree that we do not give away our national sovereignty when we choose to participate in an international institution or agreement.

In the worst of all possible circumstances, the US could withdraw from the WTO after giving 6-months notice. Critics scoff that in this interdependent world that is inconceivable and unworkable. Nevertheless, our membership in the WTO is like all other treaty commitments. It has an escape hatch.

From the Great Depression to the WTO

The infamous Smoot-Hawley Tariff increases in 1930 led to a near-total collapse of world trade. FDR sought to revive trade by negotiating reciprocal tariff reductions of up to 50%. Congress cooperated by giving him advance authority to negotiate such bilateral trade deals. Reciprocity was to become the objective in US trade negotiations thereafter.

Clearly, unilateral reductions, though economically sound, would be a hard sell politically and reciprocity is better not only for us but also for our trading partners. Our insistence upon reciprocity forces them to do what is good for their economies — although it might seem like drinking castor oil. Reciprocity is an optimum win-win outcome for all parties.

Still, bilateral trade deals are less than ideal. A deal between country A and country B necessarily affects trade with other countries and often leads to unintended and economically inefficient diversions of production to countries that are not "good" at producing a particular kind of widget. Production moves to such places merely because the relative height of trade barriers ends up producing a higher profit for the firms involved. In other words, taxation determines the location of production, not comparative advantage in endowments, knowledge or those lucky historical accidents of time and place called "economies of agglomeration."

Recognizing this, the US at the end of WW II persuaded other countries to adopt a whole new trade regime, based upon "multilateral reciprocity" and something called Most Favored Nation (MFN) treatment. MFN, which is now called Normal Trading Relations (NTR), simply means that everyone has t6 treat everyone else equally. You cannot discriminate for or against any other signatory country. The important thing to understand about a multilateral reciprocity trade deal (e.g., a trade round such as the Kennedy Round) is that it is a bunch of bilateral deals worked out during the same time frame. Different countries give up different things, for example, different percentages of tariff on different goods and services. Each party to the overall deal has to carefully calculate what each concession is costing its domestic economy and what political hurdles its government faces back home. In the end, each hopefully tallies it all accurately and finds that it will in the aggregate be better off with the new deal and able to handle the protectionist protestors back home. To reach such a happy conclusion, the guys who come out winners back home have to offset the guys who lose.

Last winter, the terms that the US had worked out with China concerning its accession to the WTO were kept secret while the EU continued to negotiate its final deal with the Chinese. This was because the two parties were entitled to slug it out at the bargaining table without the Europeans knowing for certain what we had already gotten from the Chinese and visa versa. When everyone finished bargaining, the WTO Secretariat took all of the deals and compiled a document called a protocol embodying the best deals that the various parties had wrested from the Chinese. The protocol is the final deal that all parties will get from the Chinese. In other words, each party ended up with the best deal that anyone had gotten.

This post WW II trade regime is called GATT (General Agreement on Tariffs and Trade). It was intended that it be housed in a new international agency, the International Trade Organization. However, the US Congress refused to approve the new agency. GATT to everyone's surprise performed its duties beautifully without an ITO to house it. In 50 years, there have been 8 major trade "rounds" that reduced trade barriers. Average tariffs in industrialized countries have plummeted from 40% to 6%.

The last round, the Uruguay Round, was completed in 1994 after nearly 8 years of negotiations. It is the most comprehensive trade treaty in history with 26,000 pages of text. The 125 signatory countries committed to reduce remaining tariffs by an average of nearly 40% and to phase out long-standing worldwide quotas on textiles and clothing over 10 years. It, for the first time, includes protections for trade-related intellectual property rights, patents on things such as drugs, software and music recordings. Although little was accomplished in lowering agricultural trade barriers in the immediate future, a pledge was made to reconvene to deal with this most egregious violation of the general free-trade principles of GATT. Most agricultural quotas were converted to tariffs, a lesser evil, but those tariffs remain extraordinarily high — as much as 300% on dairy products imported into Japan and more than 100% on sugar and and dairy products imported into Europe. Voluntary export restraints, an ad hoc invention used by the US in its auto wars with Japan, were prohibited. Some restraints were placed on domestic subsidies for export industries and the use of antidumping duties against imports, but much remains to be done in both areas. Very importantly, trade in services was added to GATT's agenda for the future.

But most important of all, the Uruguay Round Treaty created the World Trade Organization to improve the process for settling trade disputes. Under GATT, there had been such a system but it was dysfunctional — meaning that nothing could be done when a country failed to honor its trade treaty obligations.

It is important that we understand how the WTO enforces its findings of non-compliance. It cannot compel any country to comply with its judgments. If a country refuses to comply, the most that the WTO can do is require that the guilty compensate the injured country. A dollar value is determined for the loss incurred and may be paid either by the injured party raising barriers against the guilty worth that amount or the opposite, the guilty opening or lowering .barriers to the injured worth an equivalent amount. In the famous banana case, the US raised barriers against EU products. In the beef-hormone case, the EU will lower barriers to hormone-free US beef. This lowering of barriers is vastly superior from the economist's point of view because it opens markets.

The World Bank expects consumers to gain between $100 billion and $200 billion every year in additional purchasing power as a result of the Uruguay agreement. Two-thirds of that gain will go to consumers in the rich countries, including the US. Later agreements in 1997 to remove tariffs on high-tech products and to liberalize telecommunications markets around the world will further enhance those consumer gains. The most recent agreement, one on financial services, will further increase consumer gains and be very beneficial to US financial services firms-an industry in which the US leads internationally.

The Road Forward

Unfortunately, big multilateral deals have fallen from favor since the Uruguay Round ended. All of the easy stuff, such as reducing tariffs on most manufactured goods, has already been accomplished and all parties are suffering from fatigue — given the length of the Uruguay Round. Developing countries think that they were taken to the cleaners during the last round; they took on responsibilities for which they were not prepared and the financial and technical help promised by the Developed Countries has not been delivered — certainly not in a timely fashion. The WTO is playing catch-up right now. It is unlikely that a major new round will get off the ground anytime soon. The failed Seattle meeting of the WTO, which was intended to reopen talks on agriculture, only worsened all of this. There is a risk that an agricultural trade war will break out with Europe. The US and the EU had agreed to refrain from taking their agricultural complaints to the WTO for resolution for a period of five years. This so-called "peace clause" expires in 2003.

At the same time, regional trade agreements such as NAFTA, which are quite legal under Article 24 of GATT, are now in vogue. As pointed out in the earlier discussion of the drawbacks of bilateral deals, regional agreements risk creating new irrationalities in trade because the special deals given to regional partners may displace the advantages other nations won in earlier multilateral deals. Seattle was to have opened discussions about ways to guarantee that the regional deals not set back the larger multilateral deals.

Fast-track negotiating authority for the President was needed to shore up the regional arrangements — particularly in the Western Hemisphere — in order to avoid such irrational outcomes. With fast-track the President could have struck bilateral and/or regional deals to prevent backsliding. However, Congress denied President Clinton such authority twice. Fast track is simply permission from Congress for the President to make trade deals that Congress could not later amend during the ratification process. Congress agrees in advance to vote such deals up or down with no amendments. Negotiators need that guarantee to have credibility when making trade commitments. Otherwise, the other party will not believe our negotiators' promises and will not cut a deal.

The US has not been an innocent lamb in trade matters. We have a long history of threatening to close our enormous lucrative market in order to force changes in the trade and investment practices of other countries. Section 301 of the Trade Act of 1974 authorizes the President to "enforce US rights under international trade agreements" and to "respond to actions that burden US commerce." The offending practices were not spelled out in the legislation. Discretion was left to the President. The Section 301 legislation has been used, for example, to negotiate voluntary import expansion agreements with Japan. When negotiations fail, the US may retaliate by restricting access to our market. Section 301 and follow-up amendments known as "super" and "special" 301 have been used successfully to protect US industries from foreign practices we consider "unfair." However, other countries view Section 301 as a unilateral weapon that can target countries unfairly, such as when the law is used to deal with foreign practices that are not subject to international agreement. When the US brings action under Section 301, it acts not only as complainant, but also as judge and executioner! In a sense; Section 301 authorizes the US to act as a sort of international trade vigilante.

Partly to persuade the US to rely on multilateral approaches to settle disputes (i.e.. to rein in the use of Section 301), the WTO adopted a tough dispute settlement mechanism. The US had long been dissatisfied with GATT's inability to act when trade treaties were not honored. GATT prior to the creation decades ago, US balance of payments problems of the WTO required a unanimous decision by the panels selected to hear cases. GATT's unanimity principle allowed one or two dissenting representatives to prevent resolutions favorable to the US. Under WTO rules, panels decide on cases by majority vote. In fact, under the new system, it takes unanimity to prevent the WTO from hearing cases or adopting decisions. So far, the US has been the most active complainant at the WTO and the US has usually won its cases. But Section 301 remains on the books and could still be used if or when the US ceases to be satisfied with the new WTO dispute settlement mechanism.

U.S. antidumping laws also irritate our trading partners. Such laws provide protection for US industries competing against imports sold at "less than fair value" or subsidized by foreign governments. Many mainstream economists argue that these laws contain elements that are grossly unfair to foreign competitors. Dumping is defined as "price discrimination" (i.e., selling export products at prices below those charged at home or, if sales at home are insufficient to render a judgment, below prices charged in third countries). A producer may also be charged with dumping when he sells at less than "fair" value (i.e., average cost plus an allowance for profit). If material injury occurs — in practice, such injury may be very small indeed — an offsetting duty in the amount of the "dumping margin" is applied. The problem with all of this is that fluctuating exchange rates may produce such effects without any malintent by the foreign producer. Furthermore, US domestic firms are not held to the same standard — i.e., they do not have to avoid selling at a loss. Other countries are retaliating by enacting their own anti-dumping laws-thereby raising new trade barriers.

Logically, it is the consumers in a foreign producer's home country who ought to be outraged by being charged higher prices than those charged here in the US. It is, of course, US producers who are being protected by US anti-dumping provisions, not the US consumer!

During the last League restudy of trade, three dominated the discussion. The US trade deficit continues but we need to understand that trade balances are not controlled by trade policy — rather they are reflections of macroeconomic activity.

The trade balance is the major component of the current account. So, we are really talking about the current account balance, which includes dividends, royalties and some transfers of funds from, for example, people working abroad. The flip side of the current account is the capital account, consisting of portfolio investments in equities, bonds and government securities and sales of physical. assets, such as factories or land. By definition, the current account and the capital account must balance. A simplistic explanation of the dynamic at work here is that to obtain foreign currency with which to make capital investments abroad, an investor nation must sell more abroad than it imports. Conversely, to cover a current account deficit, a country must take in capital from foreigners. The capital and current accounts move in tandem.

If a country produces more than it consumes at home, it must by definition run a trade surplus, as Japan does. Conversely, if a nation consumes more than it produces, it must be running a trade deficit, as the US does. To finance a trade deficit, a country must cover the deficit with other current account income from abroad such as interest and dividends, or it must borrow capital from abroad (e.g., through public bond issues or private debt instruments) or it must sell assets such as Rockefeller Center to foreigners. Borrowed capital and assets sold to foreigners show up in the capital account thereby balancing the current or trade account deficit. The capital account and the current account must by definition balance even though there are some measurement problems.

The US would not need to borrow abroad if neither of its two major sectors — the government and the private sector — had to borrow, or if net saving by one more than offset borrowing by the other.

There is such a thing as a "good" current account deficit — the sort that we have been running lately. Foreigners simply want to invest their savings here because of the dynamic growth of US industry (especially high tech) and the relative safety of US dollar assets, especially US Treasury debt, in an unstable world. When such capital comes into the US, we must by definition run a current account (i.e., trade) deficit. Foreigners have to sell us something in excess of what we sell them in order to get the dollars to invest on Wall Street. Since the Federal Government is now running a surplus and is retiring the Federal debt, the present current account deficit is actually a pretty healthy state of affairs.

But there is concern about the US debt to the rest of the world. Economists worry that foreigners might suddenly decide to flee the US market. Foreign holdings of US Treasuries are massive and US households have been saving virtually nothing recently. Since there is no domestic source of alternative funds to cover this debt, the Fed would be in a bind. It would have to keep interest rates high to entice foreign money to remain here at a time when the dollar would be under attack and the economy would be contracting — the very kind of situation where a reduction in interest rates would be needed to revive our ailing economy. The decline in the dollar would also burden us with higher import prices, for oil especially. Of course, US exports would be cheaper in other currencies as the dollar declined and, over time, a boost in our exports ought to help revive the economy. But the size of the debt we owe abroad and the possibility of a sudden shift of foreign capital out of the US are reasons for concern. Trade is, of course, only part of this dynamic. International flows of investment capital are equally if not more important. The true culprit, however, is our failure to save.

The League's restudy of trade must include a fresh look at worker-adjustment assistance programs, which are not working very well. Under NAFTA, only workers in larger unionized firms have steed in tapping into the adjustment assistance programs. It seems somewhat ridiculous to tie help to the specific source of job dislocation. Why not treat all dislocated workers the same, no matter whether the source of their job loss was trade or automation or some other factor, such as tax-law changes?

NGO demands for labor and environmental standards to be written into trade treaties sound humane and sensible on the surface. Unfortunately, these strategies risk total gridlock and real damage to poor people in the Third World. Developing countries are adamantly opposed to both and now have the political clout at the WTO to block all action. We must keep in mind that a poor country's principal comparative advantage is cheap labor including that of children. Denying children employment in factories may cause families to starve or daughters to be sold into prostitution. There is concern among trade experts that multinational corporations would drag poor countries before the WTO for failure to meet new labor standards and that the multinationals would win their cases — thereby hurting poor people by injuring their export potential. Uniform global labor standards are therefore not possible in the near future although the long-term goals are very clear. It is somewhat reassuring that historical data shows that, as soon as they can afford it, parents send their children to school, not to work.

Historical data also indicates that as soon as incomes rise to about $5,000 per capita, countries clean up their environment. However, in the earlier stages of development, environmental quality deteriorates. Aid from the rich world could speed this process along. Environmental standards in trade treaties might backfire in a fashion similar to child-labor standards.

NGO programs, such as "eco-friendly" or "free-of-child-labor" certifications for products, together with media stories on inhumane and irresponsible factory and business operations abroad are having surprising results. Substantial improvements have occurred in the garment, soccer ball, and shoe industries in developing countries. Once they know about uncivilized factory conditions and damaging environmental practices, consumers in the rich world have voted with their pocketbooks in large numbers — avoiding purchases from producers not certified to operate responsibly. Multinationals are smart businessmen and have begun cracking down on their subcontractors in poor countries. How far such "sunshine" efforts can advance these worthy objectives remains to be seen, but it is encouraging and possibly worthy of our endorsement.

The global trading system of today is vastly better than it would have been without GATT/WTO. It is, however, still a flawed concoction with some glaring deficiencies. Much remains to be done and immediate prospects for further trade-barrier reductions are cloudy.

The NGO community is not going to settle for "side agreements" to trade treaties to further their labor and environmental causes because "side agreements" are not enforceable at the WTO. Article 20 of GATT clearly allows member countries to enact domestic environmental standards higher than those of their trading partners provided that such standards are enforced in an even-handed manner — meaning that there must be no favoritism for domestic firms over foreign providers. The environmental community, however, wants to "push the envelope." Their goal is to extend the impact of our domestic environmental laws beyond our borders. That is not allowable under GATT/WTO; efforts to extend our environmental laws beyond our borders to save species, for example, typically threaten trade sanctions against others because of the "method" by which they fish or produce a food product. GATT prohibits discrimination based on "method" or means of production because it would open a Pandora's box allowing all sorts of protectionists to obstruct trade. Many observers argue that the solution lies in giving environmental treaties their own "teeth" (i.e., strong enforcement mechanisms) not in grafting their cause onto trade treaties. The WTO could then be specifically authorized to recognize the binding nature of environmental treaty obligations.

Janet F. Burmester
LWVDC International Relations Committee

Report based largely on Globaphobia: Confronting Fears about Open Trade, Gary Burtless, et al., Brookings Institution Press, 1998. Having dispensed with footnotes, the writer wishes to give full credit to authors Burtless, Lawrence, Litan and Shapiro.