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Last month, when World Trade Organization (WTO) talks in Cancún collapsed in acrimony, the United States responded with a brave face. Though the meeting was seen as the best chance to push forward the Doha round of trade negotiations, which aims to slash trade barriers and boost the global economy, America’s negotiators insisted the United States would continue to fight for freer trade. "For over two years, the U.S. has pushed to open markets globally, in our hemisphere, and with sub-regions or individual countries," said Robert Zoellick, the U.S. trade representative. "As WTO members ponder the future, the U.S. will not wait: We will move toward free trade with can-do countries." Zoellick’s message is clear: If pesky "won’t-do" countries block the multilateral, WTO route to liberalization, they will be left by the wayside. The United States will instead spearhead a push for free trade through bilateral and regional agreements.

Yet Zoellick’s statement blends fantasy, hubris, and hypocrisy. Rather than emerging from the Cancún wreckage to lead the charge toward liberalization, the United States looks set to undermine global free trade. The bilateral and regional agreements Zoellick promises will actually tie world trade up in knots. Worse, U.S. election-year politics combined with rising unemployment could trigger a protectionist backlash in the United States, with China the first target and Europe not far behind. The potential consequences? A global trade war and possibly even a world recession.

Though American trade negotiators claim otherwise, bilateral and regional deals offer only a facade of free trade. They are, by definition, discriminatory: By granting preferences to some countries, they impose handicaps on others. Worse, negotiating regional and bilateral deals with many countries leads to a tangled web of rules–differing tariff rates, rules-of-origin requirements, and other regulations–that constrain commerce.

Such deals are also, by definition, partial. They encompass only a small fraction of America’s total trade. Under Zoellick’s watch, the United States has signed bilateral trade deals with two countries: Singapore and Chile. Singapore, the eleventh-biggest destination for U.S. exports, accounts for 1.67 percent of America’s trade; Chile, the thirty-fourth largest, for a further 0.34 percent. In total, then, Zoellick has signed deals with countries that account for a mere 2 percent of U.S. trade, hardly an earth-shattering achievement.

But, wait, Zoellick might protest, you ain’t seen nothing yet. The United States is also negotiating potential deals with Australia, Morocco, five Central American countries, and five southern African ones. It is also looking to open talks with Bahrain and the Dominican Republic. Yet add up U.S. trade with these 14 countries, and it accounts for a mere 3 percent more of the total.

Of course, Zoellick–and President Bush–have grander trading ambitions. They dream of creating a free-trade area that stretches across the Western Hemisphere (excluding Cuba) by 2005. Yet, even including this proposed agreement, known as the Free Trade Area of the Americas (FTAA), the administration’s bilateral and regional ambitions amount to liberalizing trade with countries that account for just over one-tenth of U.S. trade.

What’s more, negotiating the mooted FTAA is proving just as tricky as making progress in the Doha round. A meaningful FTAA must tackle controversial issues–such as Latin American demands that the United States reduce its farm subsidies and America’s insistence that Latin American countries accept rules on services and investment–on which agreement has so far proved elusive at the WTO. Yet neither side is willing to undermine its bargaining position in the Doha round by making concessions in the FTAA negotiations. The United States, for instance, has stated that it will only cut its farm subsidies if Europe and others do too, as part of a global WTO agreement. So hopes of concluding a meaningful FTAA deal while Doha remains stalled are slim.

American officials suggest that concluding bilateral and regional deals puts pressure on the European Union, China, and other leading WTO members to negotiate in earnest, a strategy Zoellick dubs "competitive liberalization." "If some countries hide behind the false security of protectionism, the U.S. will work with those that believe true economic strength is achieved through openness," he has said. "The strategy is simple: The U.S. is spurring a competition in liberalization." Perhaps–if other countries were scared that the United States was going to corner their main export markets through sweetheart trade deals. But Zoellick’s grab bag of small prospective pacts poses little threat to big players like Europe, especially since the EU has already signed its own bilateral and regional agreements with many countries.

Zoellick is guilty of far worse than hype. The bigger danger is that the collapse of the Doha round will help trigger a lurch toward protectionism–with the United States leading the way. While governments are negotiating to free up trade, they are wary of giving in to the demands of protectionist interest groups that antagonize their negotiating partners and thus jeopardize chances of securing better export opportunities. But now that there is little hope of a WTO deal any time soon, governments will find it harder to resist pressures to limit imports. And history shows that, once one country acts to keep out foreign products, others are often tempted to retaliate, as happened during the 1930s.

For all its free-trade rhetoric, the United States looks set to act first. Even in the halcyon late ’90s, when the economy was growing strongly and unemployment had virtually disappeared, support for free trade was weak among many Americans, as shown by a 2000 study by the Program on International Policy Attitudes, a Washington think tank.

Now that the economy has stumbled, the temptation to lash out at foreigners is much stronger. More than two million jobs have been lost since George W. Bush became president. America’s goods-trade deficit rose to a whopping $538 billion in the year to August. With his reelection chances next year dependent in part on taking states like Pennsylvania and Michigan, which have been especially hard-hit by the downturn, Bush will be tempted to slap duties on imports deemed to threaten U.S. jobs. In fact, the White House has already employed protectionist measures for political gain. The administration approved an enormous farm-aid package worth $190 billion in subsidies over ten years. And, in March 2002, when Bush was riding high in the polls, he succumbed to pressure from America’s steel industry and slapped emergency duties on foreign steel.

If at the height of his popularity Bush could not find the backbone to face down 160,000 steelworkers, he is hardly likely to resist the protectionist temptation now. China is already in the firing line. One in six jobs in America’s manufacturing sector have been lost in the past three years– 2.7 million in all. The powerful National Association of Manufacturers (NAM) argues that China is largely to blame. In a series of congressional testimonies and public events, the NAM has accused Beijing of gaining an unfair competitive advantage by keeping its currency, the yuan, pegged to the U.S. dollar at the same rate since 1994, making its exports artificially cheap and pricing U.S. imports out of its market. Pointing to China’s $100-billion-per-year trade surplus with the United States, the NAM argues that Beijing should have let its currency rise against the dollar over the past nine years by as much as 40 percent. If the NAM can convince Zoellick’s office that China’s policy is unfairly harming U.S. exports, the United States could hit back with punitive tariffs on Chinese imports.

Congress is also in a China-bashing mood. Congress has held committee hearings to consider whether or not China manipulates its currency for commercial advantage. Senator Richard Durbin of Illinois and five other senators are co-sponsoring legislation that would levy a 27.5 percent tariff on imports from China unless it adjusts its exchange rate; similar measures have been proposed in the House. Democratic presidential candidates echo the protectionist noises. "We must reexamine our trade policies," says Howard Dean. "We can’t allow some countries to subsidize exports, manipulate their currencies, or erect barriers to imports from the United States."

The administration is already swinging into action. President Bush has called for China to adopt a "monetary policy that is fair." On Bush’s trip to Asia this week, White House officials announced that Chinese and American experts would study how Beijing could move toward a floating exchange rate. Treasury Secretary John Snow visited Beijing last month to demand that China abandon its dollar peg, let its currency float upward against the dollar, and lift its capital controls. The United States also secured limited support at September’s meeting of finance ministers from the G7, the group of leading industrialized nations, for its position of pushing China to revalue. The G7 statement called for "more flexible exchange rates" to reduce global financial imbalances.

Such pressure on China could have disastrous consequences. One possibility is that, if China refuses to give in to America’s demands, a trade war could erupt. Under the terms of China’s entry into the WTO last year, the United States has broad discretion to slap emergency duties on Chinese imports deemed to be causing "market disruption," a clause the administration could invoke if China continues to refuse revaluation. Such protectionism would do the United States more harm than good. Higher duties on Chinese products would be a tax on American consumers and companies that rely on imports. The United States imported $103 billion from China over the past year; 27.5 percent duties would therefore be equivalent to a $28 billion tax hike on these imports. And, since many of these imports are made by the Chinese subsidiaries of U.S. firms, such protectionism would be particularly self-destructive.

Moreover, Beijing is unlikely to take any U.S. action lying down. Chinese leaders have reacted angrily to Snow’s suggestions. And Beijing could do serious economic damage to the United States. If China, the second-largest buyer of U.S. Treasury bonds, sold off some of its vast holdings, it could force U.S. interest rates up, undermining the U.S. economic recovery. Beijing might also retaliate with sanctions against U.S. exports or by taking away U.S. companies’ licenses to operate in the Chinese market, major blows for multinationals that view China as the world’s biggest emerging market and export base. As Ronald Reagan’s attacks in the 1980s on Japan showed, such commercial conflicts can quickly spiral out of control, seriously impeding trade. Indeed, according to a study by the Cato Institute, by the end of the Reagan years, one-quarter of U.S. imports were affected by trade restrictions.

A second scenario is that China caves in to U.S. pressure for a revaluation of its currency peg. This could be even more damaging–for the United States as well as China. A revaluation could harm China’s economy, which has been one of the engines of global growth. Contrary to U.S. claims, the yuan is not obviously undervalued. Although China’s trade surplus with the United States is huge, its surplus with the world as a whole fell to only $9 billion in the first eight months of the year–and is likely to shrink further as it opens its markets to foreign competition. Also, a revaluation could reduce the rate at which China’s central bank accumulates currency reserves, much of which it has been investing in U.S. Treasury bonds. If China buys fewer Treasuries, U.S. interest rates could spike up, denting U.S. economic growth.

What’s more, if China is bludgeoned into allowing the yuan to float, it would simultaneously have to open its weak financial markets. This could cause a financial crisis that might engulf the United States as well, since China’s ramshackle financial system and near-bankrupt banks are still too weak to handle the instability of global capital markets. The White House appears to have forgotten the lessons of the late ’90s Asian financial crisis, which almost plunged the world economy into recession. East Asian countries like Thailand that–under U.S. pressure–had opened up their underdeveloped capital markets prematurely suffered a devastating financial crisis, ruining many American investors who had bet on Asia and spreading turmoil to U.S. markets. At that time, China–thanks to its currency peg and capital controls–proved an oasis of stability. It is folly on a grand scale to risk a rerun of the late ’90s by prizing open China’s capital markets when its financial system is still so weak.

Whatever happens with China, the Bush administration is playing with fire by aggressively seeking a weaker dollar. Already, global financial markets have reacted to the G7 statement on flexible exchange rates by driving the dollar down, causing U.S. interest rates to rise. Worse, the dollar’s decline could turn into a rout if investors pull out of the United States and lose confidence in the dollar. If the U.S. currency crashed, investors, who have allowed the United States to maintain an enormous current account deficit by purchasing U.S. assets and equities, would require much higher returns to continue buying U.S. assets. U.S. interest rates would shoot up, and stock prices could plummet. Higher interest rates could bankrupt U.S. companies dependent on borrowing and cause others to cut investment. Unemployment would rise. Consumers, who have powered the U.S. economy for the past three years, would have to save more to pay off their debts and thus might spend less, further depressing the economy. U.S. demand for foreign products could collapse, since the weaker dollar would make them prohibitively expensive. Thus a U.S. recession could soon spread around the world.

Europe has so far borne the brunt of the dollar’s fall. The euro has risen by 40 percent against the U.S. currency since July 2001. At first, European policymakers welcomed the euro’s rebound as a vote of confidence in the fledgling currency. But, now, they fret that its rise is stunting EU exports and economic growth. German business groups have warned that, if the euro moves "significantly above" $1.20 per euro, it would harm German exports. Indeed, if the euro rises too far too fast and Paris and Berlin think the United States is gaining an unfair competitive advantage, the European Union could be tempted to hit back at the United States.

The European Commission, which handles trade policy for the EU’s 15 member states, has powerful weapons. The European Union has already won WTO authorization to impose retaliatory sanctions on U.S. imports in several important cases. By far the biggest case is that of America’s foreign sales corporations (FSCs), tax breaks for U.S.-based exporters that the WTO deems an illegal export subsidy. So far, the European Union has not imposed these retaliatory sanctions, in part because Brussels did not want to antagonize Washington while the new WTO round was being negotiated. Now that the Doha round is on ice, the European Union may feel more inclined to impose sanctions, especially if it feels provoked by U.S. actions on the dollar.

This could spark an enormous trade war. In the case of FSCs alone, the European Union is entitled to slap 100 percent duties on $4 billion of U.S. imports, and Europe has already drawn up a hit list of 1,800 U.S. products. President Bush’s tariffs on foreign steel also infuriate Europe. The WTO has ruled the tariffs illegal, but the United States has appealed. If the WTO’s appeals court confirms the initial verdict against the United States, America could be faced with more retaliatory sanctions from Europe.

Such a tit-for-tat battle could easily escalate. The United States also has a big WTO grievance with Europe: the EU’s failure to approve any new genetically modified crops since 1998, which the Bush administration views as covert protectionism. Washington initiated WTO proceedings against the European Union on genetically modified crops in May. If the WTO finds in America’s favor, the United States would be entitled to hit back against European exports. Even more worryingly, France and other EU countries may use the Cancún debacle as a pretext for reversing the EU farm-subsidy reforms announced in June. This would enrage Washington and could provoke a battery of new disputes once the "peace clause," under which countries agree not to challenge each other’s farm-support schemes at the WTO, expires at the end of the year.

Such disputes could not only damage political and economic relations between Washington and Brussels; they could also fatally undermine the WTO, which relies on cooperation between the United States and Europe. The failure in Cancún raises serious questions about whether the WTO can still function effectively, and, if the United States and the European Union remain at each other’s throats, the organization might never recover. If it cannot, prospects for free trade are grim, since it is under the WTO aegis that the most recent major multilateral trade gains, which helped usher in global growth in the ’90s, have been made. Worse, if American policymakers begin to feel that the WTO is primarily a rod with which the European Union and others can beat it, the United States might even consider withdrawing from the organization, as voices in Congress periodically propose.

Fortunately, the WTO is not dead yet. Even so, the next year or two will still pose a serious challenge. The big issue is how to deal with America’s vast trade gap, which is an indicator of larger problem–the world economy is dangerously unbalanced. Americans are living beyond their means, while the Europeans and Japanese are not spending enough. The U.S. current account deficit is swelling to record highs. To sustain its economic growth, the United States needs to borrow some $2 billion extra from foreigners every working day. This is clearly unsustainable. At some point, either Americans will reduce their borrowing or foreigners will get scared and stop lending. Were this shift to happen suddenly, jacking up U.S. interest rates, America’s economy would plunge into recession, dragging the rest of the world down with it.

What is needed, then, is faster growth in the rest of the world. This would boost U.S. exports, reducing the country’s borrowing needs. And it would allow Americans to start to pay off some of their huge debts without their belt-tightening pushing the economy into recession. One way to achieve this is to lower interest rates and run higher budget deficits in other major economies. Another is to free up world trade. Not much chance of that now.

Posted 03 Nov 2003 in Published articles

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