European Affairs

Spring 2003

 

Trade Relations
Global Free Trade in Manufactures Would Be an Historic Step Forward
By Ernest H. Preeg

 

On November 26, 2002, the United States launched a potentially historic initiative for the course of the world trading system. The Bush administration proposed the elimination of all remaining tariffs on industrial and consumer goods, or manufactures, as a central objective of the multilateral Doha Development Agenda trade negotiations currently under way within the World Trade Organization (WTO). It is a two-stage proposal, which would bring tariffs down to a maximum level of eight percent by 2010 and to zero by 2015. A parallel process would seek to eliminate non-tariff trade barriers in such areas as licensing, standards, and customs procedures.

The scope of the proposal is enormous. Seventy-five percent of merchandise trade is in manufactures, and most of the remainder is composed of items that are already duty free, including petroleum, industrial raw materials, and farm commodities such as coffee, tea, and bananas. A Doha global free trade agreement in the dominant manufacturing sector would be decisive in consolidating the recent proliferation of bilateral and regional free trade agreements within a multilateral framework.

There would be unprecedented gains from trade from such an agreement, because the manufacturing sector is the engine for growth for the U.S. and global economies. U.S. manufacturing accounts for two-thirds of research and development and over 90 percent of American patents, which lead to new productivity-enhancing products disseminated through-out the economy. A similar pattern of innovation and growth is taking place throughout the world, aided by the rapid expansion of trade in manufactures with embedded new technologies and related investment. Multilateral free trade would greatly accelerate overall global growth.

The U.S. initiative is especially timely because the WTO negotiations are bogged down in an impasse over other issues such as agriculture and anti-dumping, with increasingly dim prospects for the outcome. Multilateral trade diplomacy over the decades has been driven by bold initiatives to open trade on a reciprocal basis, thereby creating the necessary political momentum for success. Such initiatives had been sadly lacking in the Doha negotiations until the U.S. free trade proposal.

Finally, a Doha free trade agreement would reap foreign policy dividends as a positive economic foundation for strengthening and broadening the community of market-oriented democracies in their confrontation with international terrorism and the proliferation of weapons of mass destruction. Support for the U.S. proposal from the European Union would also provide a golden opportunity to begin rebuilding the Transatlantic political relationship after its battering by the Iraq crisis.

Despite all these attractions, initial reactions to the U.S. initiative have been mixed and for the most part skeptical, if not hostile. An EU official characterized the U.S. proposal as "unrealistic," while a Japanese trade diplomat similarly doubted that it is "practical or realistic." India's ambassador to the WTO called the proposal "clearly unfair" and a Malaysian representative said that Malaysia would "jealously defend its right to maintain customs duties in order to protect its infant industries."

Other initial critics include Brazil, South Korea, the Philippines, and Pakistan. WTO Director General Supachai Panitchpakdi says that many poorer nations "would face a disproportionate burden" under the U.S. proposal. For developing countries, he explains, tariffs often serve a dual purpose: "They protect domestic industries from foreign competition and they are a major source of tax revenue." On the other hand, the plan has been welcomed by Singapore, Hong Kong, Taiwan, Australia, New Zealand and Uruguay. Singapore and Hong Kong already have zero tariffs and Australia is engaged in bilateral free trade negotiations with the United States.

Initial reactions have also been mixed within the United States. The National Foreign Trade Council, a business organization representing 400 companies, had been out front in 2001 calling for such a WTO free trade initiative, and its president, William Reinsch, was quick to endorse the official proposal. "It will energize the Doha Development Agenda by setting a bold goal that will provide enormous economic benefits to developing and developed economies and raise the level of ambition in all other areas of the negotiations," Mr. Reinsch says.

The much larger National Association of Manufacturers, however, had been advocating a more modest and selective sector-by-sector approach to tariff reductions, and its director of trade policy says that his organization "is leery of relying only on across-the-board tariff reductions." Van May, chairman of the American Textile Manufacturers Institute, has been predictably displeased, referring to the U.S. proposal as an "outright gift to China" that "will simply ensure China's takeover of the worldwide textile and apparel trade."

The Chinese response, in fact, will probably be critical for the outcome of the U.S. initiative, and initial Chinese reactions have been unclear. Long Yong-Tu, the Chinese Vice Minister of Foreign Trade and Economic Cooperation, who negotiated China's entry into the WTO, at first said that he personally saw merit in the proposal, emphasizing that China had benefited from a previous WTO free trade agreement for the information technology sector. Later, however, China circulated a communication in Geneva proposing a harmonization approach for tariff reductions, with emphasis on special treatment for developing countries.

There is also some ambiguity as to how the initiative relates to broader U.S. trade strategy. A Mexican source has expressed doubt as to whether the Bush administration is ready to face resistance from politically powerful industrial lobbies such as the apparel industry. Washington trade analyst Gary Hufbauer says that "the strategy could be to get on the good side of the rhetorical fight."

In any event, the United States has been following a two-track trade strategy of pursuing both bilateral/regional and now multilateral free trade agreements, with momentum tending, if anything, toward the bilateral/regional track. Robert Zoellick, the U.S. Trade Representative, has reaffirmed this dual approach in responding to European skeptics: "If I can't do it (i.e., free trade) globally I'll do it piece by piece, and then they (the Europeans) can deal with the problem."

The U.S. proposal clearly faces formidable obstacles and a long uphill battle if it is to succeed. The first serious exchange will take place at the WTO ministerial meeting in Cancun, Mexico, in September 2003. Most other countries will probably rally to the EU position of a tariff harmonization formula, with the spotlight on very high U.S. textile and apparel tariffs, which would be reduced by a greater percentage than the lower tariffs in almost all other industry sectors. The United States, supported by a smaller coterie of free traders, will press for across-the-board free trade while making clear that disproportionately greater cuts for textiles and apparel is a political nonstarter.

The outcome of Cancun is thus likely to be a continued impasse in the non-agricultural market access negotiations. This should not, however, be a major concern. The important question is what happens next. In past negotiations, bold initiatives often took shape toward the end, in order to avoid failure. In the Uruguay Round, for example, the creation of the World Trade Organization, the fundamental restructuring of European farm policy away from unlimited price supports, and the limited sector-by-sector free trade approach for manufactures (as a way, incidentally, to extricate the negotiation from an impasse over a tariff harmonization formula) all came after the failure of the Brussels ministerial meeting in 1990 that was scheduled to conclude the negotiations.

The best outcome at Cancun would be to establish a working party to examine the U.S. proposal in detail, and to address specific questions about its content and implementation, including special treatment for poorer countries. Such an examination would start with an analysis of current patterns of trade and levels of protection for manufactures.

By far the largest part of manufactures trade – at least 90 percent – is accounted for by the three industrialized regions of North America, West Europe, and East Asia. If these three groupings were to agree to free trade, the 90 percent inclusion threshold, used for the 1996 WTO free trade agreement for the information technology sector, would be met. It is noteworthy that North America and East Asia, through APEC, are already committed in principle to Asia-Pacific free trade by 2020, while the European Union plans to extend industrial free trade to include a total of 1 billion people in an area stretching from Vladivostok to Casablanca.

A handful of "newly industrialized economies" in South America and elsewhere account for almost half of the remaining seven to 10 percent of manufactures trade. The more than one hundred other WTO members, almost all smaller and poorer countries, account for only three percent of world exports and six percent of world imports.

These many poorer countries could therefore be given highly differential treatment in their participation. Some could choose to postpone participation in free trade, while others would likely opt into the agreement. For example, five Central American countries, including very low-income Honduras and Nicaragua, are currently negotiating free trade with the United States, their predominant trading partner.

There is an unprecedentedly large imbalance in manufactures trade among the three main regions, and in particular between the United Sates and East Asia. The $304 billion U.S. deficit in 2001 was almost precisely offset by the $305 billion East Asian surplus, and these imbalances increased substantially in 2002. Such imbalances are not sustainable over the medium to longer term, and a gradual phasing in of free trade by 2015 would ease the adjustment and help to avoid trade conflict.Tariff rates are much higher in developing than in industrialized countries, 13.8 percent versus 4.2 percent for the overall averages. This presents a problem for the mercantilist approach to negotiations within the WTO, where tariff reductions on imports are considered "concessions." The East Asian and other newly industrialized economies would have to consider a break with this institutional tradition.

There is also a great divergence in tariff levels among developing countries. By region, the lowest levels are in Latin America, East Asia, and Transition Europe; higher levels prevail in the Middle East, North Africa and Sub-Saharan Africa, while the highest levels by far are in South Asia. The relatively lower levels in the newly industrialized economies of East Asia and Latin America reduce to some extent the North/South disparity, at least in tariff levels between industrialized and these key developing countries.

The extremely high tariff levels in South Asia will probably require special consideration. Of the 105 countries listed in World Bank trade statistics, Pakistan and India have the highest average tariffs in the world, followed by Rwanda, Tunisia, and Burkina Faso. This means that India and Pakistan, likely to be among the strongest critics of the U.S. free trade proposal, are out of step with other newly industrialized economies that are far more open to trade. It also means that, in view of the exceptionally high levels of pro-tection in South Asia, a longer phase-in period to free trade could be appropriate.

The outcome for the U.S. free trade proposal will not depend on the negotiators in Geneva or even the trade ministers who are in close and frequent contact about the Doha negotiations. This bold and potentially historic agreement will only succeed with strong support at the highest levels of government, taking account of the broader interests involved. The essential leadership, however, is limited to only three participants: the United States, the European Union and China.

The United States should garner support from its partners in the North American Free Trade Agreement and many or most other countries in the Western Hemisphere, which are already negotiating a Free Trade Area of the Americas. The European Union is expanding to 25 members, and has free trade agreements with 20 or more other countries in Europe and the Mediterranean basin that are likely to follow its lead.

The China connection is more complicated but, in the end, equally determinant. China is currently negotiating a free trade agreement with the ten-member Association of South East Asian Nations, while Japan and South Korea are seriously considering joining an "ASEAN Plus Three" agreement. If China were to opt for the WTO multilateral approach, together with the United States and the European Union, the other East Asians would find it very difficult not to follow suit.

Whether the European Union and China will join with the United States as the Doha negotiations proceed cannot be predicted. For Europe, much will depend on how the Transatlantic political relationship emerges from the war in Iraq. Certainly a WTO free trade agreement in manufacturing, which nicely finesses agriculture to something less than free trade in a separate negotiating group, could have appeal to those seeking reconciliation as a truly multilateral undertaking of mutual interest.

The ultimate Chinese response is unknown, probably even to China, with a new generation of leadership just installed. Looking ahead to 2015, multilateral free trade would appear to be in the commercial interest of an increasingly competitive Chinese manufacturing sector. China, however, preoccupied with internal developments, rarely plays an active role in multilateral diplomacy. Joining together in a strong leadership role with the United States and the European Union for this WTO initiative would thus be without precedent. The resulting positive impact on the U.S.-China bilateral relationship would undoubtedly be a critical factor, and personal exchanges between President Bush and new Chinese President Hu Jintao, could therefore prove decisive.

A Chinese proverb warns that: "Many a false step is made by standing still," and a decision about the U.S. free trade proposal needs to be taken in the context of what would happen if it fails. The assessment here is offered as a benchmark for such policy deliberation.

In the absence of a major trade liberalizing objective like the U.S. free trade proposal, the Doha negotiations are likely to drag on beyond the 2005 scheduled conclusion and produce disappointing results. These would probably amount to significant liberalization in services trade, where mutual interests prevail, somewhat less in agriculture, and modest tariff reductions in the dominant manufactures sector. Negotiators would achieve enough to declare victory with a reasonably straight face, while privately expressing relief at not having to face another such ordeal for at least another ten years.

In parallel, the bilateral/regional free trade track, already moving faster forward, would gather additional momentum. Almost half of world trade is currently within such free trade agreements, and by 2010 the large majority of trade would be included.

Each of the three industrialized regions is already in the process of negotiating free trade agreements, within the region and beyond, and this trend would accelerate. The big question is whether there would be free trade mergers among the three regional groupings, across the Pacific, the Atlantic, or among all three.

Such a three-way agreement would include more than 90 percent of manufactures trade and would thus constitute a de facto transition to multilateral free trade, albeit outside the WTO. Such a scenario, however, is fraught with uncertainties and pitfalls, including potential geopolitical rivalries and trade conflict among the three industrialized regions. Some doubters and critics of the U.S. Doha free trade initiative could thus reluctantly come to the conclusion that it is preferable to the likely alternative.

Ernest H. Preeg is Senior Fellow in trade and productivity at the Manufacturers Alliance/MAPI. He was the William M. Scholl Chair in International Business at the Center for Strategic and International Studies from 1988-1998. Previously, he spent 25 years as a Foreign Service Officer, including as a member of U.S. delegations to the Kennedy and Uruguay Round GATT negotiations. His book, From Here to Free Trade in Manufactures, is scheduled to be published by MAPI in July.