U.S. Trade Policy: Free Trade and Globalization

PRINCIPLES

Free Trade and Globalization have been buzz words for the last two decades, but they were not the concepts that the Founding Fathers thought would build the United States. Free trade means the conduct of international commerce “free” of government direction and “globalization” means to engage in economic activity without regard to national boundaries or allegiances. Even before he became the first U.S. Treasury Secretary under President George Washington, Alexander Hamilton had written in his famous “Continentalist” essays, “There are some who maintain that trade will regulate itself [but] this is one of those speculative paradoxes…rejected by every man acquainted with commercial history.” Richard B. Morris in his biography of Hamilton observed that his “brand of conservatism meant holding to the tried and proven values of the past, but not standing still….He could scarcely be expected to allow government to stand inert while the economy stagnated or was stifled by foreign competition.”

Hamilton had a leading hand in writing the Constitution. Article 1, section 10 removes the power to regulate interstate commerce from the states, thus creating a large internal market free of local barriers, a single, large continental market to support American business and industry. In pursuit of economic growth, Article 1, section 8 gives Congress the power to regulate commerce with foreign nations including the enactment of tariffs on imports. Section 9, however, prohibits the levying of taxes on exports. The clear purpose of treating imports and exports differently is that the former are to be controlled, the latter encouraged. James Madison, speaking at the constitutional convention defended tariffs as necessary for “revenue, domestic industry and to procure equitable regulations from other countries.” Writing in 1832 of what the Framers had meant by “a power to regulate foreign commerce” Madison stated, “in all nations this regulating power embraced protection of domestic manufacturers by duties and restrictions on imports.” Hamilton recommended the use of these powers in his Report on Manufacturers in 1791, a work that has remained a classic of nationalist economic thinking.

As an agrarian leery of the Industrial Revolution, Thomas Jefferson, at first, opposed Hamilton’s trade policies. But after the War of 1812, he embraced them, writing to the French liberal economist J.B. Say, “The prohibiting duties we lay on all articles of foreign manufacture which prudence requires us to establish at home, with the patriotic determination to use no foreign articles which can be made within ourselves without regard to difference in price, secure us against a relapse into foreign dependency.” Hamilton’s policies guided the United States as it became the world’s leading economy in the years between the Civil War and the First World War.

That international conflict changed Jefferson’s mind is central to the debate over trade policy then and now. The classical liberals who popularized “free trade” in the early 19th century claimed trade promoted peace. The British radical Richard Cobden, for example, asserted that commerce was “the grand panacea” and that “the motive for large and mighty empires, for gigantic armies and great fleets would die away.” The last 150 years have made hash of this view, and the world remains a dangerous place as far into the future as one can see. It thus matters for national security as much as for job opportunities where shipyards, auto plant, aircraft factories, steel mills, computer chip foundries, nuclear reactors, research centers, and a myriad other productive assets are located.

Henry Clay, whose political career is described by Pulitzer Prize winning author Daniel Walker Howe as having “bridged the America of Alexander Hamilton and the America of Abraham Lincoln” made protective tariffs an important part of the “American System.” Lincoln succeeded in raising tariffs during the Civil War. Notwithstanding the prosperity of these eras of protective tariffs, the Smoot Hawley tariff of 1930, in particular, is often demonized and blamed for the onset of the Great Depression and the collapse of world trade. “Contrary to the enduring political myth, the Smoot-Hawley Tariff was not the cause of the Great Depression, which actually began nine months prior to its enactment,” writes American economist and author Pat Choate in his book Dangerous Business. “Neither did the law induce fierce foreign retaliation and trade wars or a spiraling decline in U.S. trade, which subsequent data have confirmed.”

GOAL

U.S. trade policy should aim at expanding the market for American-made products both at home and abroad, using every tool in the policy playbook, in a world economy based on competition for wealth and power. The objective should not be merely a level playing field, but a home field advantage for American producers.

ON THE WEB

ISSUES LIBRARY

Recommended Reading


I. TRADE AGREEMENTS

Governments negotiate trade pacts that reduce tariffs for certain products for the countries that are parties to agreement. Tariffs and other restrictions are not necessarily eliminated, but they are lower than for countries that are not party to the agreement. The proper term for such pacts is “preferential trade agreement,” as a member nation is treated better than others. There are two general reasons for treating some countries better than others in trade. One is to gain an advantage over a rival in the trade partner’s market, for which a reciprocal benefit is granted. The other is to give the partner an advantage, to further a diplomatic or security objective. Often trade agreements of this sort are called “free trade agreements” (FTA) even though in principle they are an alternative to genuine free trade because they are based on an attempt to gain a special advantage in a defined market from which rivals will hopefully be excluded.

The North American Free Trade Agreement (NAFTA) is the best known U.S. trade agreement. It was signed with Canada in 1988 and Mexico in 1992. The agreement with Canada, a country with a comparable level of economic and political development, who is also a military ally with similar cultural roots, was not controversial. Incorporating Mexico, however, has been very contentious because it does not have Canada attributes. The public argument for Mexico was that it was a “big emerging market” for U.S. exports, but this has not proven to be true. U.S. trade with Mexico has moved from a small surplus to a large deficit since NAFTA was signed. Mexico uses it surplus with the U.S. to buy goods from Europe.

The real argument for “free trade” with Mexico was that cheap labor could be combined with American capital to better compete with Asian producers in world markets which had a vast pool of labor available. It was a plan for investing in Mexico and shifting jobs there from the U.S. But Mexico has failed as an export platform because it cannot compete with state-supported competition from Asia. Mexican output cannot even hold its own in the U.S. market. The rail and road network being built to carry NAFTA trade is increasingly being used by China to ship goods made in the Far East into the American heartland across the “open” Mexican border to so-called Inland Ports for distribution to American markets – Inland Ports that are tax-abated, to the detriment of American businesses, and sovereign set-aside foreign territory.

DR-CAFTA (Dominion Republic-Central American Free Trade Agreement) was based on NAFTA. It was narrowly passed by Congress in 2005. The final votes were gained by arguing that the agreement would give the democratic governments of the region a trade advantage against China in the U.S. market, making it a foreign policy rather than an economic issue.

The Free Trade Agreement of the Americas (FTAA) was considered a further extension of NAFTA to cover all of Latin America. This idea has been set aside because of the major political divisions that exist in the region. Argentina, Brazil, Paraguay, and Uruguay formed MERCOSUR in 1991 to create their own trade bloc to compete with the United States. Bolivia, Chile, Colombia, Ecuador, Peru, and Venezuela are associate members. The U.S. has FTAs with Chile, Colombia and Panama and a pending FTA with Peru, which can be seen as efforts to compete with MERCOSUR. The Columbia agreement is also about politics, part of the effort to support the Bogota government against narco-terrorism. The same can be said for the Andean Trade Preference Act. Meanwhile, Venezuela has been supporting the insurgents in Columbia and working to put together an anti-American network of left-wing regimes in the region.

Other FTAs with Singapore, Israel; Jordan and Morocco should be seen as part of foreign policy rather than trade policy. Commercial flows are small, but the diplomatic ties are of considerable importance.

Perhaps no other President of the United States has contributed more to trade globalization than Bill Clinton (1992-2000), who was responsible for the congressional passage of NAFTA, the WTO and PNTR for China during his last year in office.

GOALS

  1. Trade agreements can further U.S. interests if they are carefully crafted to open foreign markets to American exports or gain favored access to overseas resources. Agreements should seek to give American producers an advantage over foreign rivals in the trade partner’s market. Agreements must be reciprocal and not increase the U.S. trade deficit. They should be structured in a complementary manner so as not to subject American-based industries to foreign competition. Simply trusting to “free trade” to yield good results by an indiscriminate opening of the domestic economy is to be avoided.
  2. NAFTA has become less about free trade than about ‘development’ and ‘wealth transfer’ from the American taxpayer to the Mexican government through the creation of self-perpetuating and extra-governmental agencies like the North American Development Bank (NADB), which the American people know little or nothing about. Further, the proposed creation of a North American Investment Fund to close the income gap between the U.S. and Mexico will neither improve NAFTA nor the U.S. trade deficit, since under its present configuration, Mexico does not serve as an American export platform but rather as an import platform from Asia. NAFTA has failed to achieve its objectives, while imposing large costs on the United States. NAFTA’s abject failure calls for America’s complete withdrawal and a new way of thinking on free trade – international commerce ‘free’ of government direction.
  3. Permanent Normal Trade Relations (PNTR) with Russia should be rejected by the United States for numerous reasons: Russia is not a free market economy; the government has reasserted a dominant role over key industries; it has increased its value-added taxes charged to imports from the US; and, it subsidizes its state-run companies. Initially accommodating the West to shore up his strength, Vladimir Putin recognized the necessity of obtaining Western technology and investment to modernize Russia. Post-Soviet Russia continues to view the West and NATO in adversarial terms, with the United States as the “main target.” Putin continues his disregard for the rule of law, human rights and democracy. The Obama administration’s ‘Reset’ policy was a failure. Russian resurgence continues to view the former Soviet Empire as its sphere of dominance, typified by its Customs Union (Russia, Belarus and Kazakhstan) and t he formation of a Eurasian Economic Union. Following its 2008 invasion, Russia continues to occupy the sovereign and independent republic of Georgia.

ON THE WEB

ISSUES LIBRARY

Recommended Reading


II. WORLD TRADE ORGANIZATION (WTO)

The WTO evolved from the General Agreement on Tariffs and Trade (GATT) which was established in 1948, based on the classical liberal notion that free trade would promote peace in the aftermath of Second World War. The advent of the Cold War limited its scope as the Western strategy of containment sought to isolate the Soviet bloc from world commerce. The WTO was created in 1994 at the end of the Uruguay Round of negotiations, which had started in 1986. The end of the Cold War gave new life to the classical liberal idea, but the Doha Round of talks which started in 2001 has stalled as national rivalries have again heated up, although, the Russian Federation became a member of the WTO on August 28, 2012.

According to the WTO, “The system’s overriding purpose is to help trade flow as freely as possible — so long as there are no undesirable side-effects.” What constitutes an undesirable effect should be determined by national governments as a matter of sovereignty. The WTO, however, has a dispute settlement process which can rule national laws “illegal” and authorize plaintiff governments to apply sanctions to force defendants to change their laws. The WTO does not have any power to directly apply sanctions itself.

There are two basic problems with the WTO. The first is that it if the United States feels it is being treated unfairly by the policies of another country it is supposed to file a case with the WTO and seek the approval of foreign judges before taking any action to redress the injury. This is a long and uncertain process during which time American firms and workers continue to suffer. In the end, even if the U.S. wins the case, it will have to enforce the verdict by taking the same actions if could have taken from the start to protect its interests. The U.S. should not have to ask permission of others before acting to safeguard its citizens from foreign threats, economic or otherwise. And in practice, the U.S. has more often continued to use its own trade remedy laws to counteract unfair trade policies.

Unfortunately, it has also too often accepted adverse WTO rulings and changed its own laws rather than fight back against sanctions authorized by the WTO, even though its immense economic power to retaliate gives it the edge in any confrontation. International law treats large and small nations are equals, which makes it a system that runs against the interests of large nations like the United States.

The second problem is that the GATT-WTO system has sought to lower all trade barriers on a global basis, making the advantages that the United States can confer on friends and allies through preferential trade agreements less useful. If general barriers are already low, there is not much room to give an extra advantage in exchange for a diplomatic gain. Adversaries and rivals are treated like everyone else under WTO rules which take no account of political or security issues. It is based on the ideals of classical liberalism and is thus ill suited to the real world of power politics.

The creation of the WTO, like NAFTA, was by way of another legislative-executive agreement. Once again, under President Clinton, the agreement, this time, was approved in a lame duck session of Congress by majority vote in November 1994, rather than with the Advice and Consent of the Senate and the required two-thirds vote that a treaty should have to be considered constitutional. It was described by Newt Gingrich, the future Speaker of the House and a supporter of the WTO, as a “transformational moment” that would transfer from the United States a significant amount of authority to a new global organization.

GOALS

  1. As long as the U.S. remains a member, it must maintain and use its own trade laws to protect American producers from the unfair or predatory tactics used by foreign rivals, rather than rely on a WTO process that is not designed to defend American interests as are national institutions.
  2. The U.S. must be prepared to defy adverse WTO rulings that strike at important elements of the American economy and its sovereign control; and to retaliate against those who would impose economic sanctions against the United States so as to deter WTO cases from being filed.
  3. Global trade agreements are to be avoided as they limit the ability of the United States to use its economic leverage in negotiating advantageous trade agreements on a bilateral or regional basis; or from offering preferential trading terms to further larger diplomatic purposes.
  4. Public support should be developed for the immediate withdrawal of the U.S. from the WTO.

ON THE WEB

ISSUES LIBRARY

Recommended Reading


III. DEFENSE TRADE: CONTROLS AND OFFSETS

During the Cold War the Western allies maintained Coordinating Committee for Multilateral Export Controls (CoCom, established 1949) to restrict the technology and goods that could be sold to the Soviet bloc so as to retard their industrial and military capabilities. Since the Cold War ended, it has been harder to form multilateral coalitions to restrict sales as export competition has heated up. For example, the U.S. and the European Union banned the same of lethal military equipment to the People’s Republic of China after the Tiananmen Square massacre in 1988, but in recent years many European governments have been working to have this ban lifted and the U.S. has had to expend considerable diplomatic effort to keep the EU in line, though many states have allowed their firms to sell “non-lethal” military and dual-use equipment to Beijing. Chinese officials have also lobbied hard in Washington to get export controls lifted because they know American military superiority is based on advanced technology.

Broader sanctions on economic development have been harder to orchestrate. Multilateral sanctions under the United Nations are ineffective because of opposition on the Security Council by China and Russia. Washington must rely on “coalitions of the willing” to apply sanctions against rogue states and rising peer competitors, and not be afraid to apply unilateral restrictions since American technology, especially with military applications, leads the world due to extensive battlefield experience and massive investment in research.

Economic sanctions are often oversold as being tools that can force a rival power to change its strategic behavior, such as halting aggressive behavior, allowing domestic dissent or halting weapons programs. Commerce is likely to be considered a lower tier concern to hostile regimes. The real role of sanctions is to deny hostile regimes the means to carry out their agenda or build up their capabilities, so if a direct confrontation takes place, they will be weaker and less able to resist.

The U.S. is the world’s largest exporter of military equipment to friends and allies. Thanks to leading the world in research and development spending and battle experience, American firms have a comparative advantage in the arms trade. Unfortunately, the U.S. is not allowed to fully benefit from this advantage because of the use of offsets by foreign governments. Foreign governments usually require industrial compensation to “offset” the cost of buying U.S. weapons systems. These include mandatory co-production or licensed production of some of the system, technology transfers, counter trade (meaning the American purchase of foreign exports), and/or U.S. investment in the purchasing country. Governments require offsets for a variety of reasons: to ease the burden of large defense purchases on their budgets, to increase or preserve domestic employment, to obtain desired technology, and to promote targeted industrial sectors. According to the Department of Commerce Bureau of Industry and Security 2010 reports on offsets, during 1993-2008, U.S. firms reported entering into 677 offset agreements with 45 countries valued at $68.9 billion. The value of these agreements equaled 71 percent of the $97.1 billion in foreign sales of defense items reported during the period.

GOALS

  1. The first goal of strategic trade policy must be the protection and sustainment of a comprehensive and deep defense industrial base that can be expanded in a crisis to meet the nation’s needs in all fields critical to the operation of the American economy.
  2. Trade should generally be guided toward allied and friendly powers where the gains from trade can be shared in ways that will strengthen ties and be more secure over time than trade with countries whose governments do not share American GOALS: and values.
  3. Because American security depends on staying well ahead of the capabilities that any potential adversary can mobilize, the transfer of technology, capital or other resources to rival powers through trade, investment or espionage must be prevented.

ON THE WEB


IV. THE VALUE-ADDED TARIFF

The value added tax (VAT) has become a substitute for protective tariffs in many countries, particularly in Europe. The VAT is a sales tax levied on production. It is a major source of revenue for many of the 167 countries that use it, but it is not used by the United States.

When an American company exports to Germany, it will pay the 19 percent German VAT in addition to all the U.S. taxes to which it is subject at home. When a German company sends its products to America, it is not subject to any U.S. taxes and has its home VAT refunded. Without these tax burdens, German firms can sell their products in America for much less, gaining a competitive advantage. The VAT works both as a tariff on imports and as an export subsidy, but is explicitly recognized as legal by the WTO.

The Europeans have been substituting the VAT for tariffs, seemingly liberalizing trade but in reality protecting the continental economy. In 1968, the average EU member tariff was 10.4 percent with an average VAT rate of 13.4 percent making a trade barrier against U.S. goods of 23.8 percent. By 2008, the average tariff rate had declined to 3.9 percent, but the average VAT rate had climbed to 19.4 percent, keeping the trade barrier against U.S. products at 23.3 percent! In response to Europe’s fiscal deficits, In 2008, it is estimated that the combined export/import effects of VAT worldwide put U.S.-based firms at a $518 billion disadvantage. VAT rates are rising which will further affect trade. Attempts to offset the VAT effect by U.S. law have been declared illegal by the WTO, and the EU has refused to negotiate any changes in a system that so clearly benefits them.

GOAL

The United States should impose a border adjustment tax (tariff) to offset the adverse affect on American-based firms that arises from the use of the VAT by foreign governments, and stand firm in its application even if the WTO rules against such a measure. Such a stance would strengthen the U.S. negotiating position in future talks to create a level playing field in international tax policy, while safeguarding American interests until a beneficial agreement can be reached.

ON THE WEB

ISSUES LIBRARY

Recommended Reading


V. ECONOMIC INTEGRATION

That economic integration can add to political unity has long been recognized. The interstate commerce clause and the vesting in Congress of the power to levy tariffs in the Constitution were considered by the Founders as ways to bind the States together as trading partners differentiated from the outside world. The famous Zollverein customs union presaged the unification of Germany under Prussian leadership in the 19th century, though it still took a series of wars to accomplish nation-building. The areas integrated, however, also had compatible cultural, linguistic and historical ties that made political unity feasible and desirable, towards which economic policy played its part. Attempts to expand beyond these natural limits with economics alone have not proven as successful. The financial meltdown in parts of Europe have called into question the wisdom of adopting a single currency in the European Union, where strong national identities and divergent policies frustrate the creation of an effective central administration.

Attempts to build a North American Union or otherwise pull the United States, Canada and Mexico together based on an expanded meaning of NAFTA are simply not seen as feasible, although significant progress in that very direction has been made by each and every president beginning with George H.W. Bush in 1988. From the start of NAFTA negotiations to the passage of the Intermodal Surface Transportation Act (ISTEA) to the Trans-Texas Corridor (the hub for the NAFTA superhighway trade corridor and toll road system) to the Security and Prosperity Partnership agreement in 2005 to ‘open borders’ and the creation of Inland Ports, economic integration is moving forward, albeit at a less than discernible snail’s pace.

Though the U.S. and Canada have similar cultural, political and legal values and a history as military allies, substantial economic integration has not overcome Canadian desires to remain independent. The gap between the U.S. and Mexico on a host of values and developmental issues remain immense and are far more controlling of the relationship than trade flows. And in matters of foreign policy, Washington and Mexico City are often at odds. Indeed, the prudent and popular course of action is to strengthen border security between the U.S. and Mexico to contain the rising problems south of the border, not bring those problems northward via further integration. Neighbors can act together when they have common interests, but that is a far cry from unification or the forging of a new, joint identity that can command popular support.

GOAL

The United States should seek to protect itself from the spread of violence and corruption in Mexico by strengthening border security. It should also pull back from further economic integration with Mexico because of instability south of the border and the need to rebuild America’s own industrial and financial capabilities. The national unity and independence of the United States is threatened by transnational business interests who seek to substitute foreign commercial ties for domestic partnerships, so policy must favor internal development as the Founders envisioned. As Alexander Hamilton put it in his famous 1791 Report on Manufactures:

“Mutual wants constitute one of the strongest links of political connection….It is a truth as important, as it is agreeable, and one to which it is not easy to imagine exceptions, that every thing tending to establish substantial and permanent order, in the affairs of a country, to increase the total mass of industry and opulence, is ultimately beneficial to every part of it.”

ON THE WEB

ISSUES LIBRARY

Recommended Reading