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Reviving Free Trade Offers Best Chance for ‘Happy’ Global Outcome

Anne Krueger, Johns Hopkins University

You usually start by saying, “It is a pleasure to be here and thank you for inviting me.” That’s at least half true. It’s half true because the dinner talk is supposed to be a happy talk. It’s supposed to be a pep rally. I should try to tell you that everything is all right. You wouldn’t believe me, anyway, because it isn’t. So, I will not say I’m entirely happy to be here. I tried hard to think about how to make this a happy talk, and I did not succeed.

There is an anecdotal story, or there was at one time, when Mrs. Thatcher (former British Prime Minister Margaret Thatcher) visited Russia at the time of the May Day Parade. She was notably impressed with the tanks, and then shining missiles and smartly uniformed men went marching by. And then came a straggly series of columns, men, almost all scruffy, mostly with patches on the sleeves, trousers that were too long. As the story of that time went, she asked Khrushchev who those men were, and he answered, "They are the economists. You will be surprised how much damage they can do.”

I decided that tonight, that’s the appropriate story, except it’s not the economists who are doing the damage—it’s the politicians and the policymakers. That said, I’m going to try and spend a few minutes and see if I can put things a little bit in context. I want to start with the prospects for global trade mostly. I cannot even begin to think through how the USMCA (United States–Mexico–Canada Agreement) should go until it is put in context of the entire global trading system.

I want to start by saying that the WTO (World Trade Organization) is very much under threat. It is incredibly important, and I did not hear a word about it today. I think that’s a mistake on all of our parts.

Two countries with high tariffs that get together to trade aren’t going to gain as much as two countries with low tariffs, all else equal. This was true for Canada and pretty true, or is becoming true, for Mexico. That’s enabled them to get the benefits of the preferential trade agreement without the trade diversion that might otherwise have happened. And let’s recall the principles of the international system because they are important.

We have to have a rule of law, commercial law, if you like—the commercial code covering international trade and other international economic transactions. If you enter into a contract with your fellow countrymen and something goes wrong, one of you could take it to court and get it sorted out. To do business internationally, we need something of the same sort, and that’s what the WTO provides the basis for.

The WTO is our rule of law for international trade issues, and it is crucially important. You cannot function bilaterally with over 200 countries. There are now 164 members of the WTO. Those other 30 will soon be there or they are in the waiting line. Basically, we need a multilateral system. WTO principles say we are going to have only tariffs, and the reason we’re going to have only tariffs is because they are transparent, and your trading partner can know what you’ve been doing and businessmen can know what to expect. Everybody can set their own tariffs, but they have to be transparent and they have to be public.

Secondly, there must be nondiscrimination between trading partners except when there’s a preferential trading arrangement. If you have a preferential trading arrangement, all tariffs must go to zero within a specified time. Nondiscrimination is terribly important as a principle of international trade, and it makes sense for the most part. If you’re going to buy a home, certainly you’d like to buy from the cheapest source at least 95 percent of the time. The preferential trading arrangement brings you basically into an area in which the partners join a nondiscrimination area, and discrimination in the form of tariffs applies to the rest of the world.

Third is national treatment—and this is crucial—yet we forget it all the time. The WTO gives us all assurance if we run afoul while dealing with another country or a business in another country. National treatment means that I have the same right to go to court in Mexico as a Mexican has, and a Mexican has the same right in U.S. courts as a U.S. resident has.

The final important WTO principle is that there must be a safety belt. Unfortunately, that has come to be used too much for the U.S. That’s the (Section) 301 (provisions allowing the U.S. to impose trade sanctions on countries determined to violate trade agreements) that you hear so much about, and they are misused by the United States. It certainly would be desirable to have those rules stricken, or at least amended to make them correspond to cases where there might be an economic rationale for the measures. But at least there are some rules in the WTO that prevent things from getting even worse.

Additionally, the WTO has sponsored multilateral trade negotiations. There have been some big disputes that didn’t make headlines because they got settled. You may recall there were at least two chicken wars between the U.S. and Europe. We’ve had disputes over and over again—the GMO arguments (over genetically modified agricultural programs) with the Europeans; Canadians and lumber. There are many of these. There has to be a mechanism internationally to sort them out. Although the president of the United States (Donald Trump) seems to think that he should be judge, jury and executioner, most of us would agree that you need a third party to adjudicate cases and serve as an impartial judge.

The WTO dispute-settlement mechanism is far from perfect. The WTO dispute-settlement mechanism basically goes through an appeals process and negotiation. The court of appeals has seven judges and, for any given case, it has to be decided by a majority of at least three (they normally have five (judges) per case). Right now, the appeals court has only three judges left. No. 1, that means that if anyone is sick, there can be no decision. It also means as one of them leaves—his term ends in December (2019)—there will be no more dispute-settlement mechanism process within the WTO, which is disastrous.

This is serious. The reason we don’t have any more (judges) is because there have been some nominees, and the U.S. administration has refused to approve any of them. I do not hear as much pressure as I would like from other countries, including Mexico, on that score, and yet it is at least as important for Mexico’s future and for NAFTA’s (the North American Free Trade Agreement’s) future.

There are proposals out there for new judges. A number of countries got together and put forward proposed changes in an attempt to satisfy the U.S. However, the Trump administration has turned down the proposals so far for any amendment or any way to change things in such a way that they (U.S. officials) say they would be satisfied. So, we have a World Trade Organization that is under threat, and a serious threat, and what happens to it is going to matter for NAFTA—which I will keep on calling it even though, of course, I should say USMCA.

During the first 25 years after World War II, we had the fastest rate of economic growth for the world economy that we know of in recorded history. Developing countries think they didn’t do so well, but they actually grew just about as fast as the developed (countries)—partly because there was a healthy growth of international trade because of the WTO, which enabled prosperity in all kinds of ways, and because commodity prices held up pretty well. Tariffs for manufactured goods among the advanced countries were about 47 percent on average in 1947—and in 2003 or 2004, they were 3 percent. There have been a few peaks; it’s not all good, but it’s much, much better than it was. The remaining problems that need to be resolved involve cultural trade, services trade, intellectual property, digital commerce and other new issues. It’s not perfect; there’s more to be done. But on the other hand, we have had some tremendous successes.

One thing that happened—I’m getting closer to NAFTA, as you’ll see in a minute—was, of course, that the European Union, or the European common market, started after the Second World War. Europeans had very high tariffs. The U.S. Marshall Plan came in, but as a condition, the Europeans had to stop their bilateral trade and clearing arrangements, go to multilateral clearing and begin lowering their tariffs.

The Europeans had an average tariff rate of about 70 percent to 75 percent. The international economy was getting rid of its restrictions, and so for Europeans, their internal tariffs went to zero. For the rest of us, it (tariffs) went to 3 percent. And yet people saw the European Union and thought the preferential trading arrangement was a success. Now, I would assert that the European Union was a success, no doubt about it, but it was a success, in part, because of the external tariff lowering at the same time as it was lowering tariffs to zero among themselves in general. European integration on top of that enabled them to do even more.

Most countries stayed with the multilateral system—except for the European Union—until the 1980s. There were few preferential trading arrangements. There was one in Latin America, where all of the import substitution finance ministers or trade ministers got together and (in essence proposed), “Would you please take my high-priced washing machines while I take your high-priced refrigerators?” There was one in East Africa, same kind of thing. India has one now. As far as I know, there may be 10,000 items that they don’t allow in duty-free out of some 12,000, or something like that. It’s not really a preferential trading arrangement in any sense of the word.

Until the 1980s, nothing big changed. In the 1980s, Canada approached the U.S. and said, “We want a free-trade agreement.” That seemed fairly easy. They were a neighboring country. The U.S. had tried twice before to get Canada to do it, and they said, “No.” Finally, in the late 1980s, Canada negotiated with the U.S., and the CUSFTA (Canada–United States Free Trade Agreement) was formed. And then, of course, Mexico wanted to join, so in 1994 it became NAFTA.

When the Berlin Wall fell (in November 1989), all of the newly independent countries—if that’s the word I should use—had to establish some kind of trade agreement. You don’t get into the WTO fast, so in the meantime, many of them wanted preferential trading arrangements, usually free-trade areas with the European Union. All of a sudden, within a year, you went from a world in which there were maybe five (preferential trade agreements)—I don’t know the number—but it was very small, to 90. We now have something like 250. Free-trade areas are all over the place. Some of them are more meaningful than others.

Unfortunately, recent events have reversed the trend toward greater integration both multilaterally and through free-trade agreements. We had, of course, the renegotiation of trade agreements. Korea finally decided that they’d rather take a quantitative restriction on steel exports to the U.S. They agreed that they would cut back to 70 percent of the average level of steel exports in the past three years. Only later, the U.S. informed them that was true for each kind of steel that they exported to the United States. They found out that the U.S. delineated 59 types of steel. Not only that, any time you want to import it, you had to specify all kinds of things. I think there are seven different dimensions that have to come in on each application. I’ve forgotten them all, but they include tensile strength, chemical composition, whatever the finish is, shape, thickness and a couple more.

In any event, all of this has led to a large bureaucracy in the U.S. It is busy trying to administer the Korean quotas, waivers and everything going with that. The Trump administration thought there would be about 20,000 applications for waivers in cases where it (manufacturing) couldn’t be done in the U.S. I know of one company alone that filed 10,000 applications for waivers—one small company. Every waiver is good only for a year for one specific product for one purpose, and those things must come in quarterly. If you wanted, for example, to have steel to build snowplows for next winter, you kept bringing it in during the summer because you can’t get it all in during the winter.

They have now, I think, up to 60 people in the Department of Commerce who are looking through those applications. The last I heard, they are six months behind in deciding what to do with them. The United States has gotten itself in one glorious mess already on that issue.

And of course, the Koreans were big exporters to China, so that creates complications there. Then there’s the Japanese situation and, of course, they don’t like things the way they are. Meanwhile, the Koreans are now mad at the Japanese, so we’ve triggered some really bad stuff there. The Japanese are trying to renegotiate with the U.S. As of yesterday, the Japanese would not sign the deal. They would not sign the deal because they said, “OK, we’ll give you a lot of the stuff you want. But if you put auto tariffs on us, we’ll take it back.” “No,” the Trump administration said. That was not satisfactory.

We have the China trade war; we have all kinds of things going on that aren’t making a lot of sense. Vietnam’s exports to the United States have gone up something like 50 percent in the past year. Nobody thinks they’re all from Vietnam, including the Trump administration. The Trump administration is now mad at Vietnam, of course, because they’re allowing the (Chinese) goods to come in that way.

Trade in the world is in a mess. So, what do poor people in Canada and Mexico do and people like me who think the international trading system is worth saving? I think the first thing is, we have to think in terms of what can happen to the world economy, and this is where I started. I think there are really three outcomes.

The first is the optimistic one, and that is basically simple. The damage is being done and there’s a lot that becomes sufficiently evident, sufficiently fast. Either a new administration in Washington reverses it quickly, or the Trump administration does what it has once or twice before: declare victory and walk away and let things go back to normal. I can hope for that; I don’t think we should bet on it.

The second one: Things continue to deteriorate and countries form trading blocs or smaller groups. That’s very negative for world economic growth, and it is a very poor outcome for the trading nations.

I think, however, there is a third possibility, which I want to address. There are enough countries in the rest of the world that want to keep open and don’t like this. So, they could form some kind of mini WTO, almost like the TPP (the Trans-Pacific Partnership) did, and then implement basic WTO-type rules and anybody who wants to join can, according to those rules.

That one I think is an optimistic scenario, not because I want it to happen. Because if it does happen, the countries who’d do that will get ahead, relative to the countries that try and put up protective barriers. And, over time, people (will) begin to see that the free-trading countries in this new group are actually thriving and prospering more than the United States, which is now the Argentina of the 21st century. It could turn things around, and I think it would eventually. How long would it take? I don’t know.

I happen to have spent a lot of time in Australia over the years, and the Australians and New Zealanders were very cocky earlier on because, of course, they would go to Europe and say that they were much richer than Europe. But then the Europeans kept growing, and they (Australia and New Zealand) didn’t grow as rapidly. Finally, Australia and New Zealand changed trade policies because they saw that, indeed, they were losing out.

I think the same has happened to some other countries. They see that, indeed, the ones that are open to trade are doing better.

I don’t know what will happen. I don’t know which of these scenarios will happen. Maybe there’s some fourth alternative I haven’t thought of. But what I do know is that right now we have to worry about NAFTA or USMCA, whichever you want to call it.

We also have to worry about the world trading system. No matter how good the outcome is right now for NAFTA—even with the effect of this NAFTA 1.0, the old one, which we agree is better than the new one, which in turn certainly is better than none—it will not be as good as it once was unless we get the WTO sorted out as well.

Anne Krueger presented at the conference "Forging a New Path in North American Trade and Immigration" held Sept. 26–27, 2019, at the Dallas Fed.