The Impact of the U.S. Presidential Election on United States Trade Policy

Date October 28, 2004 Peter COWHEY(Dean, Graduate School of International Relations and Pacific Studies, University of California, San Diego) TANABE Yasuo(Vice President, RIETI)

Summary

My topic today is U.S. trade policy after the presidential election. But let me start by saying that I have no idea who will be president. The big uncertainty is turnout, which is unpredictable and it could lead to a significant victory for one candidate at the last second. However, President Bush has more ways of winning the election because of the Electoral College. The second point that is that so far, there is no indication of any radical change in the control of Congress. So either one or both houses of Congress will remain under Republican control, and there is a certain element of stability to trade policy. My general conclusion is that either a Bush or Kerry administration will have room to continue to do new trade agreements and bring the Doha Round to a successful conclusion. But in general, both will find it easier to do bilateral and regional trade agreements than WTO agreements. Asia and especially China will be tough political problems. We also need to take a careful look over the long term at the new security issues and how they may affect trade.

The Uruguay Round left so many innovations in trade that just implementing the Uruguay Round and figuring out the implications of the agreements on intellectual property and investment-related measures on trade and services as new areas for the World Trade Organization (WTO) constitute a continual agenda for trade policy. Both President Bush and Senator Kerry will face the problem of building the same excitement about Doha that existed about the Uruguay Round. The Doha Round has made substantial progress, and the issue of trade facilitation is attractive to U.S. business interests, but politically it is not an exciting negotiation. Trade policy in this election has been low-profile because Senator Kerry does not want to get caught in a discussion of free trade versus protection because of his labor union support; and outsourcing of jobs is a troubling issue for the blue-collar support of President Bush. Both candidates avoid trade issues in the election, reflecting the general politics in the U.S. that trade is O.K. as a specialized issue, carefully watched over and interest-balanced, but it is not a popular issue.

During my three years in the Clinton administration as a U.S. negotiator of the WTO agreement on basic telecommunication services, I learned that trade agreements are political agreements. They are political commitments at the highest level to try to act in good faith in regards to these very legal sounding obligations. You can use WTO enforcement actions to retaliate, but these are crude tools for keeping a trading relationship going. So the real purpose of binding trade agreements is to keep a very high level of political attention and commitment to the trading relationship.

In order to have the president paying attention, you have to have new initiatives that justify committing the president's time. If trade is to maintain the type of political commitment in order to have a free trade policy, the trade representative must have a continuous series of new agreements, which is why we will see a high level of bilateral activity no matter which party wins the presidency.

As my colleague, Professor Richard Feinberg, has noted, there are five big arguments that make bilateral and regional free trade agreements easier for administrations to support than WTO agreements. First, they help open particular foreign markets for U.S. companies. Most analyses show that concessions made by the trading partners are proportionally larger than those made by the United States, which is good politics for any White House. Also, there is the argument of defensive bilateral liberalization - for the U.S. to keep pace with other major trading powers. A third argument is that the small agreements advance the bigger global agenda of the U.S. For example, in the early days of the Uruguay Round, U.S. Trade Representative Bill Brock engaged in bilateral trade agreements as a way to push the Uruguay Round agenda, which was a good negotiating technique for the United States.

Fourth is the argument that bilateral and regional trade agreements are strategic economically and in the broader political sense. They allow for more secure, long-term diplomatic partnerships with key countries. It is important to note that most bilateral free trade agreements are initiated by the other country and by countries that are considered to be close political allies of the U.S. Finally, the support of domestic market reforms around the world is an important rationale for these bilateral agreements. Together, these five explanations of bilateral free trade agreements make for a powerful package in Washington and they are the reason why such agreements are the easiest route for any U.S. president.

Another point about the politics of bilateral trade agreements is that the other countries, usually ones with good political relations to the U.S., ask for them. This allows the White House to do something important politically: it turns to the trade advisory groups that advise the U.S. trade representative and asks if they would like this free trade agreement and what the priorities should be for U.S. negotiators. This allows the White House to get a political reading in advance, and reduce risk. The group then lays down the terms and conditions that would make it enthusiastic and then the trade representative can negotiate these terms. Politically, it is the safest route and this is the reason why bilaterals are so popular. In contrast, a WTO negotiation concerns a huge number of countries and takes years to figure out, which can be a risky situation.

The other important point is that on many of the issues that the American business or labor community cares about most, it is easier to make progress on the bilateral and regional negotiations. The agenda for Doha has essentially dropped major discussions on investment, competition policy, and transparency from the final negotiating agenda. In contrast, at the bilateral level, you can do a lot on these issues. Let me admit to the dirty secret that some of these bilateral agreements may not make for good global policy. But after we admit that, nonetheless, they allow for more innovation than at the global level on many issues that are central to U.S. commercial or labor interests.

I would like to turn to some of the economic factors of trade policy, especially the role of foreign investment, China, and the current account deficit as three economic factors that are going to shape the choices of either candidate. The U.S. stock of foreign investment is very high: over U.S.$1 trillion. This investment is central to explaining American trade policy and market patterns of trade. Over half of the trade involving the United States now goes through internal channels of multinational corporations, not between independent exporters and importers. To make an account of U.S. trade balances is to look at the flows of economic activities inside these corporations. So U.S. trade policy is limited by the percentage of U.S. trade that is just an internal production decision inside a multinational corporation. Also, years of large U.S. current account deficits have led to huge overseas holdings of U.S. dollars. So the U.S. freedom to manage its trade policy is limited by those holdings, which limit U.S. freedom to manipulate the exchange rate. The consequences of changing the dollar's exchange rate are very complex. A rapid decline in the dollar's value may lead to a sell-off of Treasury holdings in Asian financial markets, causing a problem for the Treasury's financing of the U.S. deficit. Any adjustment in the U.S. dollar capable of affecting the trade deficit will require a negotiated understanding among the major economic powers. Also, we have the fact that the euro is a substitute, increasingly, for international transactions. And there is the possibility of a virtual Asian currency. By a virtual currency, I mean financial markets may invent a currency from a bundle of key currencies. So the U.S. constraints will grow larger over time and that means the U.S. has limited options on free trade, which makes it hard for any president to contemplate a significant retreat from free trade policies. But the U.S. trade deficit is not politically neutral in its impact. The U.S. global account deficit in 2003 was about 5% of GDP - larger than the deficit run in the 19th century. This is difficult to sustain over the long term, and there needs to be adjustments in the size of the deficit. Looking at the composition of the deficit, the U.S. accounts with the EU are in deficit by U.S.$95 billion; with the North American Free Trade Agreement (NAFTA) partners by U.S. $95 billion; and in Asia, by U.S.$125 billion with China and U.S. \$67 billion with Japan. So the political impact in Washington of those deficits differs, depending how people see those countries politically in the United States. In terms of the EU, there will be some issue-specific fights over some prominent industries such as Boeing and Airbus, and steel; but Europe is not seen as a strategic economic threat.

The story with NAFTA is a little different. These deficits together are quite large, but Mexico and Canada are so much a part of the U.S. production base that it is impossible to dissolve those networks. The trade deficit is there because of U.S. or foreign corporations sourcing their U.S. supply bases out of Canada and Mexico. No U.S. company will support shutting down those open borders. The political issues that arise tend to be about very specific domestic political issues in the U.S. Mexico is particularly tied up with the labor unions because of the effect of Mexican trade and migration on wages in border areas. They are also tied to environmental issues like timber and fishing. These issues are classic domestic political issues in the United States that take on a trade dimension because Canada and Mexico are so close. The biggest structural issues are those involving Canadian subsidies, especially in raw materials and timber.

In Asia, trade tensions have existed between the U.S. and Japan for years. Today, the political relationship is much stronger than in the 1980s and early 1990s and the trade issue is less politically sensitive. After a decade of slow economic growth in Japan, there is not the same political intensity in the U.S. about the trade deficit with Japan, and the fear that Japan will surpass the U.S. in the world economy is no longer a central issue. While there are tensions on particular issues like the automobile trade, Japan's relationship is much better than in the past. But there are memories, and some in Washington will try to play off those memories in the future.

But Japan is, in a sense, hidden behind China now, as China accounts for the larger trade deficit and it is the latest fear for those worried about the long-term economic leadership of the U.S. The trade deficit with China, partly created by China's imperfect trade policies, will be the center of political attention in Washington, and trade relations with China will be a hot button for either candidate. To some extent, it has been buried thus far because the Clinton administration agreed to China's joining the WTO. And security arrangements with China have been stressed more than trade by the Bush administration. But in the long term, our current trade pattern with China is not politically viable and either candidate will have to have more aggressive trade policies towards China in the future while maintaining a basic free trade policy.

Both Bush and Kerry fundamentally support free trade, but are capable of compromising on that if it gets politically tough. But at core, they support a free trade policy. President Bush has already shown and Senator Kerry will show that he will support reform structurally through the WTO on issues like export subsidies and credits, though it is unlikely that either one will give up the ability of the U.S. to subsidize exports entirely. For the reasons I have suggested, they will tend to emphasize bilateral and regional negotiations, but both would support a conclusion to the Doha Round. In truth, a Kerry administration will not be that different from a second Bush administration in regards to issues of labor, the environment and outsourcing.

There are some possibilities for significant differences on issues like structural adjustment, currency realignment and other basic economic issues that affect trade; and areas like energy policy and high technology. First of all, we know who the leaders of Kerry's macroeconomic team will be but we do not know who the U.S. trade representative will be. So there is no trade policy team waiting in the wings in the same sense that there is a macroeconomic policy team waiting in the wings. Kerry will try to politically set a profile that emphasizes some distinctions about targeted trade adjustment agreements. In highly unionized areas like the automobile industry, a Kerry administration will try for a firmer trade negotiating stance. But the problems of American industry on trade are not going to be fixed by any minor adjustment, so there is a limit to what a Kerry administration could do. A Kerry administration will try to be a champion in U.S. high-technology disputes and bring more enforcement actions to the WTO than the Bush administration has. Also, a Kerry administration will experiment with "buy America" programs for government procurement. But they will not let themselves get into a major WTO fight about this.

More structural policies by a Kerry administration will be in areas such as exchange rate policy. Both President Bush and Senator Kerry's economic teams are going to face the need for a major change in the value of the U.S. currency against other currencies. But changing your currency's value is as much a part of domestic macroeconomic policy as it is a foreign exchange rate policy. Therefore, how they go about trying to deal with currency depreciation will be different because their macroeconomic policies will be different. This is a big unknown.

While the U.S. labor market is flexible, there has been significant political pain in the last four years due to the adjustments in the labor market caused by international competition. A Kerry administration may try a dramatic new initiative on worker assistance. For example, instead of giving workers job training and temporary wages, he could do something like buying out their jobs. A buyout is cheaper than protecting the job and it provides an independent economic base for the worker in the future. Senator Kerry is going to need a big idea for helping labor - one that is not protectionist. Senator Kerry will also try to justify a major health care initiative as a type of economic trade relief for unionized American companies. Nationalized health care programs will be a way of helping companies with their high costs of health care. That linkage between health care and international competition will be more explicit in a Kerry administration.

A Kerry administration may have a more dramatic policy for reducing oil imports through conservation and other methods. Politically, it would be good as a contrast to the Bush administration and would be a way to tackle the trade issue, as oil imports are roughly 20% of the U.S. trade deficit. Regarding outsourcing, you heard a lot in the early days of the campaign but not so much now. As we know from economics, it is the slow economic growth and rapid rise in productivity in the U.S. that are the main sources of job losses, not outsourcing. The Kerry proposals to lower the U.S. corporate tax rate and end tax deferment of overseas profits are pretty modest ways of addressing outsourcing.

For labor rights in general, the Kerry team announced it will support the American Federation of Labor-Congress of Industrial Organizations (AFL-CIO) petition on unfair labor practices by China. The theory of the labor petition is that the lack of labor rights in China reduces wages and lowers Chinese costs, and therefore hurts U.S. jobs. The economics of this are not so clear and if it were brought to the WTO, it is hard to see that it would be a successful case. But you may see a Kerry administration try to show that they are honoring their commitment.

In general, the Bush and Kerry policies on labor are very similar in some ways. Both support national enforcement of international labor agreements and both will go toward more side agreements on the environment. A Kerry administration may be more aggressive on particular issues. Both would support the Doha agreement and, in the end, will be able to sign onto a reasonable WTO proposal. With respect to this, the U.S. offer made in July may be strengthened at the last minute of the negotiations, but either president will have restraints on what they can offer. Therefore, there will not be room for dramatic changes.

Lastly, regardless of who is president, we will face the implications of security policy for trade policy. The growth of information security infrastructures (ISI) could create a major new indirect trade barrier. This will be one of the real long-term security and trade issues that we will face. In closing, let me flag one other industry-specific issue. Biotechnology is going to be one of the driving forces of the world economy for the next 50 years, but the spread of biotechnology know-how is going to raise security risks in the industry. Today, the ability to do dangerous biotechnology experiments is limited to a small number of laboratories, but we are going to face the question of ground rules for the biotechnology industry 20 years from now. These issues are not partisan; they are the sorts of cutting-edge issues faced in the world trade agenda.

Q: What is your understanding as to whether Japan has become a more open country, regardless of American perceptions?

A: In the late 1980s and early 1990s, Japanese statistics, compared to those of other major industrial countries, did not look good on openness. Today, the stock of foreign investment in Japan is still relatively low and because of this, consumption of foreign goods and imports in Japan is low because foreign investment drives trade patterns to such a large extent. Also, slow growth in Japan has meant that import growth markets are constrained by the general slowness in macroeconomic growth. So the Japanese economy requires further internationalization for it to be more typical of an industrial country. That said, I am struck by how much the discussion by American and European companies about the Japanese markets has changed. Somewhere in the 1990s, there came to be a belief that it was possible to have a winning strategy in Japan. In 1994 it was not clear to me that people really believed that. So this is a big transformation.

Q: How do you evaluate the possibility of a Japan-U.S. FTA as well as U.S.-China FTA?

A: I think a U.S.-Japan FTA, unless Japan was willing to really make major concessions, is probably not a political ground you want to explore. If Japan really had a set of strategic economic objectives for additional access to the U.S. that they did not feel they had, and Japan was really willing to pay for, it might be politically viable. But it would take a very aggressive Japanese offer and I am not sure that is viable for you. I do not see a U.S.-China FTA in the near term. China is such a large political factor that I could imagine a U.S. trade representative sitting down with his or her team of advisors and spending a lot of time talking about it. Probably, at the end, they would say it is just too risky to attempt the agreement. But I could imagine a trade representative at least having that conversation and giving it serious thought.

Q: Whoever is chosen in the election will face pressure for currency realignment. Could you elaborate on that?

A: Economists have said that the U.S. current account deficit may not be easily sustainable. You can try to get additional markets for U.S. exporters or other adjustments in trade policy, but they are not significant. The major policy tool that you have is the currency exchange rate mechanism. The considerations you need to have are the degree of downward movement of the dollar and the implications of the adjustment on the willingness of others to hold U.S. bonds and securities, which affects macroeconomic policy. So the difference between Kerry and Bush in handling exchange rates is tied to macroeconomic policy and different approaches to handling government budget deficits. Whether Kerry will be able to reduce the U.S. government deficit will depend on whether he has control of Congress.

Q: You mentioned reducing the import of oil to reduce the size of the U.S. current account deficit, but when I think about the lifestyle in the United States, I wonder how Americans can conserve energy? In spite of the fact that the oil price is going up, they cannot reduce gasoline consumption because they have to use automobiles to get to work or in their daily lives. So a very important point for energy policy is whether the U.S. government will change its position regarding the import of nuclear power stations. That is the most important point to reduce the import of oil in the long term. How do you feel the policy will develop if Kerry becomes president?

A: It will not be easy for Kerry to greatly expand the nuclear power option. It is very politically sensitive. But there are options for the Kerry administration in regards to energy efficiency and conservation. Japan did this after the oil shock of 1973 by driving up the price of energy and through aggressive pro-conservation regulations and policies. Politically it is attractive for Democrats to move in that direction because they are seen as "greener" than Republicans and there are a number of technologies now available to do that. For a Democrat that is an attractive package and so I think that structural change in the U.S. economy is possible if it is politically attractive. It would not solve the total problem but as a matter of economic, military and political prudence, in order to do something about the trade deficit that is not protectionist, this would be a good move.

Q: I hope there are no attempts to make very radical, artificial adjustments in the dollar as a method of redressing the imbalance in the current account.

A: I would add two points. One, the Bush administration is working on the exchange rate with China through the G-7 mechanism - seeking an orderly change, which is an indication of how any administration would try to do it. Second, former Secretary of the Treasury Rubin, a powerful advisor to Kerry, believes in a strong U.S. dollar as it is an important signal to the financial markets and a type of self-discipline for the U.S. more than anything else. So the influence of someone like Rubin may be a factor.

Q: You talked about trading partners. Would you elaborate how you link the view on Japan and the view on Japan behind China?

A: Last year I testified to the U.S.-China Commission of the U.S. Congress that I did not believe China was a fundamental threat economically to the United States and that a good deal of the U.S. deficit with China was due to the restructuring of production chains in the Pacific, where China becomes the intermediate stage of production before goods are shipped to the U.S. So although the trade deficit with China is huge, we in the U.S. need to appreciate that China has assumed a different role in the global production system and that the system benefits the U.S. overall and is essential to American companies' economic strategies. The U.S. reasserted its competitiveness in the 1990s in part by the successful creation of very effective global production chains. But it is a politically more explosive relationship than the relationship with Japan. The Bush administration in the last two years has been careful in its trade policy with China because of the larger security questions. Given the realities of trade politics over time, however, both Bush and Kerry are going to have to be a little firmer and have a few more disputes with China in order to show they are upholding U.S. interests.

Q: That means if you come down on China too harshly, there will be some repercussions on security issues?

A: The U.S. and Japan went through all their economic disputes, but kept their security ties. In the long-term China faces a choice: If they are to truly be one of the world's great trading and economic powers, the other major economic and security powers have to be convinced that China is a reasonable place for their companies to do business fairly. That is ultimately why an economic relationship like trade is a political relationship. China's great challenge is to increase the world's confidence in it as a fair trading partner. That is something the U.S. will have to be aggressive in dealing with, but within the bounds of having a successful security relationship.

Q: Could you comment on the actual benefit of bilateral trade agreements to consumers and on labor and environmental standards and their potential to undermine successful Doha Round negotiations?

A: I take your point about the limited economic significance of many of the bilaterals. It is one of the reasons why they are politically safe, but I want to stress that they are important for other reasons, including the fact that they give the president a reason to be committed and active on preaching free trade policy - and that is vital.

Labor and environment could be a problem for Kerry. But there are no signs that the Kerry team has any policy that will be a show-stopper for the Doha Round. What they want to come out of the Doha Round with is room to maneuver on a bilateral basis and to be no worse off on a multilateral basis. The question is whether a Kerry administration could convince labor and others in the Democratic coalition that they are really making progress on facilitating worker protection and environmental protection in other countries. A Kerry administration would spend more money on foreign aid to enhance environmental and labor policy programs in other countries that are trading partners. That is the most viable approach.

*This summary was compiled by RIETI Editorial staff.