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A New Focus: The Future of US Trade

As summer slowly unfolded in Washington in 2015, the global trade bill was tenuously moving forward after surviving more than one near-death experience. It is a syndrome as well as a legislative event: No global trade liberalization agreement has advanced beyond the aspirational stage since the Uruguay Round was completed more than 20 years ago, and the United States has managed to finish only one substantial regional agreement, the North American Free Trade Agreement (NAFTA), since 1994. There is a simple explanation for this indecisiveness and inaction: Trade liberalization is hard to sell to a skeptical public bombarded with populist fear of competition from a succession of low-wage countries, and political leaders have consistently failed to muster the political will to push agreements to completion.

But while we waver—despite tepid growth and the need of a boost from new and growing markets outside the US—other nations like Mexico and Korea, and regions including the European Union, are aggressively moving ahead to forge new trade partnerships. We are in danger of losing our global leadership position, originating in the Bretton Woods System, as China, Brazil, and others aggressively push for new economic growth models and muscle the United States out of growing areas of the world economy. Two major regional agreements, the Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP), have been mooted in recent years, but other events and priorities continually sap the political attention away from completing them. Now that the stars seem to be aligning—a second-term president looking for an economic legacy and a pro-trade Republican majority anxious to show its ability to govern—the time is right to reaffirm US global leadership by completing these agreements. 

 

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America emerged from the colossal destruction of World War II as the industrial superpower of the world. Standing above the devastation of Germany, Japan, and much of industrial Eurasia, the United States enjoyed an era of unprecedented growth, prosperity, and global economic dominance. By the 1970s, that dominance began to slowly erode as the European and East Asian economies rose from the ashes, enjoyed the advantages of the latecomer, and began to compete again in global markets, especially for industrial goods. By the early 1970s, President Nixon felt compelled to act to stem the tide of losing global (and domestic) market share to new industrial powers. He authorized the secretary of the Treasury, John Connally, to end the link of the dollar to gold and devalue the US currency. With a 10 percent import surcharge levied at the same time, the battle to combat foreign economic competition had begun. It has continued unabated since then, as new competitors, most recently the newly developed “BRIC” countries of Brazil, Russia, India, and China have joined the fray, along with Mexico and many others.

While the dominant position of the United States in the immediate postwar period was bound to wane as the world recovered from the consequences of global war, the further erosion of the competitive position of the United States in the last few decades was not a necessary result. Figure 1 shows the slow loss of global market share for manufactured-goods exports by the United States, whose share declined from 14 percent in 2000 to 9 percent in 2013. During this period, total US exports continued to grow—by 85 percent between 2005 and 2014—but they failed to keep pace with those of the new export superpowers in Asia and the developing world. Europe lost global market share, but not at the same pace as the United States.

A slightly different picture emerges from an examination of trade flows in terms of value added. The Apple iPhone, to take a famous example, is assembled in China, but the lion’s share of the value added originates in the design and engineering of the phone, and in processing chips made or engineered in the United States. Germany’s luxury cars, to take another example, are often assembled in the United States or China, while key parts are made in Germany or nearby Slovakia. Traditional trade statistics count the entire value of the resulting product according to its last place of substantial transformation, hence China for the iPhone, and so forth. The Organization for Economic Cooperation and Development (OECD) and the World Trade Organization (WTO) now provide estimates of trade flows on a “value added” basis, which tell a slightly better story for the United States. Figure 2 shows the trade balance for the United States using this method, and it reduces the trade deficit in merchandise for the United States, while reversing it for services trade. Another measure of the impact of global competition is what share of domestic US consumption for manufactured goods is captured by foreign producers. As Figure 3 illustrates, import shares of total domestic demand grew from 31 percent in 1998 to a high of 39 percent before the Great Recession, but appear to have leveled out since then at 38–39 percent. As noted earlier, exports from the United States (see Figure 3 for exports’ share of output) have grown faster, around 85 percent in gross terms, since 2005, than imports, which grew only at a 40–45 percent rate. Nonetheless, since the value of imports is so much larger, the trade deficit has been reduced only marginally.

This clear loss of global market share, most notably in merchandise trade, almost certainly has a negative impact on domestic capital investment and, indeed, on overall productivity growth. In turn, this puts a limit on macroeconomic growth. While the total measure of investment lost as a result of erosion of market share is nearly impossible to calculate, I (along with some colleagues) have shown elsewhere that the most likely source of future growth in domestic output of goods is recapturing some of the lost global market share, including domestic market share (see The Manufacturing Resurgence: What It Could Mean for the US Economy). Together with these colleagues, I have also given some estimates of the effect on investment in the oil and gas sector and affiliated industries from lifting the ban on oil exports and, hence, capturing broader global market share in this sector (see Lifting the Crude Oil Ban: The Impact on US Manufacturing). The data cited earlier show some stabilization or slight improvement in US export performance and regaining of some domestic market share, but thus far the progress is almost certainly too modest to spur a measurable uptick in domestic investment.

 

Many opponents of further trade opening have vigorously asserted that US firms, particularly manufacturing firms, are moving their investments abroad at an alarming rate and, hence, both hollowing out domestic production capacity and shifting accompanying research and development out of the country. But such a view ignores the impact of inward foreign direct investment (FDI), that is, investment by foreign firms and individuals in domestic US assets. Data clearly show that the United States is the leading destination in the world for FDI. (In 1999, for instance, the US got 39 percent of global FDI.) For manufacturing, the net investment total by foreign firms in the United States is considerably larger than that of US direct investment abroad, as Figure 4 illustrates. Nonetheless, as Cato analyst Dan Ikenson points out, inward-bound FDI has been declining on a real and relative basis since the bursting of the dot-com bubble. The US share of global FDI is now around 17 percent, and it has been 13 years since FDI peaked at $314 billion. FDI in the United States fell from $227 billion in 2011 to $147 billion in 2012. While both domestic and foreign investment in the United States has slowed since around 2000, there is still more inward- than outward-bound FDI, and the slowdown in domestic investment extends to foreign investors as well. Even investments in the motor vehicle sector show a balance in recent years in favor of inward-bound flows. So the decline in domestic investment is not the result of moving investment abroad.


Related to FDI is the question of R&D investment by multinational companies, both domestic and foreign, in the United States and abroad. Again the story is that, partly due to the importance of foreign multinational production in the United States, there is no evidence of a net exodus of R&D by US firms to foreign destinations. US companies are expanding their foreign R&D spending more quickly (2.3 percent in recent years) than in the United States, but the same is true for foreign firms based in the States. All told, in 2010 foreign multinationals conducted more than $41 billion of R&D in the United States. It is worth noting that 70 percent of domestic R&D is accounted for by manufacturing firms, and foreign firms devote more for this purpose in the United States than do domestic firms. (Foreign multinationals operating in the United States also pay much higher average wages than other firms and export more.) Analysts have shown that foreign investment by US firms increases their hiring and research at home.

Moreover, despite the assertions of critics, in recent years the trade balance with countries with which the United States has some form of free trade agreement (FTA) has generally been more favorable than with the rest of the world. For example, the United States in 2014 had a trade surplus in manufactured goods of $55 billion with FTA partners, but a deficit of $579 billion with non-FTA countries. Experience and economic theory generally suggest that further trade opening agreements would be helpful for recapturing global market share and spurring domestic capital investment. The United States, however, has fallen behind other, more aggressive trade-oriented nations in implementing new trade opening agreements. More than 400 new regional FTAs have come into effect since 1995, and the United States is party to only two of them (as well as 10 bilateral agreements). In contrast, Mexico has three major regional agreements, adding all of Europe and Latin America to its list. The EU has 38 separate FTAs and is negotiating 12 more.

Relatively open access to as much of the world as possible is becoming a more important element of the calculus that informs global investment decisions. One prominent example is the decision of Audi to build its newest North American plant in Mexico, after it considered Tennessee and went so far as to buy land for a plant there. According to the Wall Street Journal, Audi’s chief executive cited Mexico’s web of FTAs for its change of heart, noting that these agreements “give exporters from Mexico duty-free access to markets that contain 60 percent of the world’s economic output.” BMW, Nissan, and the US big three (GM, Ford, and Chrysler) all produce cars in Mexico. 

Critics of trade agreements often ignore a key ingredient of the economic importance of trade opening. As Adam Smith, David Ricardo, and the young Paul Krugman have argued, open trade promotes the type of specialization that promotes efficient production, competition leads to greater productivity, and the result is increased standards of living for workers and lower prices for all consumers. In a graphic illustration of this phenomenon, Figure 5 shows that inflation for all products sold in the United States over the past 35 years is 40 percent lower for manufactured goods, which are the most traded category, than for the overall economy. One only needs to reflect on the stable-to-lower costs of an automobile or, even more, a computer or cell phone, versus the rising costs of non-competed sectors like health care and education to understand why.


 

There is little hope for a global trade agreement on the Uruguay and Kennedy Round model due to widely diverging agendas of the 161 nations who are members of the WTO. If there is to be progress, it will be in regional agreements like NAFTA or the EU’s single-market approach. Other nations, especially the EU, South Korea, and Mexico, are moving ahead rapidly, and China is eager to become part of this movement. If the United States is to share the future economic gains associated with globalization and remain the leader of the international economic order symbolized by Bretton Woods, it needs to complete TPP and TTIP. Domestic politics are aligned to achieve this, and partners in the Pacific and Europe are keen to complete these agreements, but concerted political will is required to cross the finish line with approval from Congress.

TPP and TTIP also are crucial to advancing global rules to cover new areas not fully part of previous agreements. Services trade is growing, as is trade in intellectual property products of all sorts (and the United States has a major competitive advantage in these sectors). The digital economy is a new frontier, and without agreement between Europe, the Pacific Rim, and the United States, the Wild West authoritarian practices of China, Russia, and sometimes India may fill the vacuum in international law. Agriculture is a traditional area for protection, which undermines the huge advantages of highly efficient US farmers. At some point, agricultural rules will have to be more firmly established for genetically modified products, lest the science-denying populists reinforce the traditional protectionist practices in this sector. Both the United States and its European and Pacific Rim partners would benefit by removing the ban on crude oil exports, which dampen new investment and production in the United States. Closer energy links between the United States and its partners would go far to strengthen the transatlantic and Pacific alliances and reduce dependence on Russian and Middle Eastern energy sources. 

Another fertile area for new rules is product standards. Huge efficiencies can be gleaned if producers can make products with identical or similar standards for global markets. Otherwise, protectionist elements can hide behind safety or environmental standards to protect domestic producers. A wrinkle in nontariff barriers to trade is in the use of antitrust standards for the high-tech and digital sectors. Pacific nations, proficient in producing but not innovating in sectors such as semiconductors and cell phones, often use antitrust type investigations to counter the innovations of American entrepreneurs in these industries, and the EU also is applying such tactics against US digital economy and software firms. Finally, some better understanding of what constitutes currency manipulation must also be found to head off further cycles of competitive currency devaluations.

This is not a zero-sum game. Far from it: In an era of sluggish economic growth, the United States, Europe, and the Pacific Rim countries can all benefit from TPP and TTIP, and establish appropriate rules of exchange and investment for the contemporary economy. Europe is motivated at least in part by a desire to reinvigorate the transatlantic partnership in the wake of new Russian assertiveness, and could be helped immeasurably by getting better access to newly abundant US energy supplies. Pacific Rim countries would benefit as well by a strengthened engagement with the US as China becomes more and more brazen in promoting regional domination. Will President Obama be flexible enough and use some of his remaining political capital to push these agreements over the top? America’s already diminished global economic leadership will be materially worsened if he doesn’t answer the call. 

Thomas J. Duesterberg is the executive director of the Manufacturing and Society in the 21st Century program at the Aspen Institute, in Washington. 

 

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