A Tale of Two Trade Deals

Never mind Asia, time to pivot to Europe.

While Washington is consumed by political furor over how to get the federal budget deficit under control, strangely few people are talking about its troublesome twin sister. Unlike the budget deficit, the half-trillion-dollar U.S. trade deficit does nothing to stimulate the economy even in the short term. Rather, it is sucking jobs out of the country year in and year out while also raising doubts about America’s ability to maintain its global security commitments. Taking sensible measures to reduce our chronic imbalance of trade would require neither austerity nor tax increases, and is the key both to creating jobs and to restoring confidence in America.

So what, you might ask, is the administration’s policy on trade? Right now its primary focus is on a deal known as the Trans-Pacific Partnership, or TPP, which President Obama wants finished up by October. If concluded according to plan, the TPP will include the United States, Canada, Mexico, Peru, Chile, New Zealand, Australia, Brunei, Singapore, Malaysia, and Vietnam, with the possibility that Japan and Korea might also join. The treaty would also be open for other countries to join if they could meet the required standards.

Beyond this, as Obama announced in his State of the Union address, the White House is looking for a deal gazing in the opposite direction. Known as the Transatlantic Free Trade Agreement (TAFTA), it would tie the United States and the European Union into the world’s largest trading block.

As with most trade deals, both the TPP and TAFTA have geopolitical as well as economic significance. Indeed, one reason the administration is placing strong priority on the TPP is because it sees the deal as an important part of its larger foreign-policy “pivot to Asia.” With the rise of China and recent U.S. emphasis on Iraq, Afghanistan, and the Middle East, some Southeast Asian and East Asian countries have been looking for assurances that the U.S. will remain engaged in the region and provide a countervailing power. So along with stationing 2,500 Marines and increasing the U.S. naval presence in Australia, opening a drone base in the Cocos Islands, increasing naval visits to Singapore and other Asian ports, and raising the U.S. naval presence in the western Pacific to 60 percent of all U.S. ships, the administration is seeking special economic ties with the nations noted above—which, of course, do not include China.

A potential trade deal with Europe also has economic and geopolitical implications, but it has not yet generated the same level of expectation, commentary, and lobbying. This is partly because it is not as far advanced as the TPP, but it is also because few imagine that Europe will be a source of either major opportunities or major threats. Why place bets on an aging, stagnant Europe, goes the conventional thinking, when this is likely to be the century of Asia?

Yet the geopolitical case for the TPP is not nearly so strong as the administration argues, and the agreement is certainly not worth the cost the U.S. is likely to have to pay. Meanwhile, the economic case for forging closer trading ties with Europe is comparatively much stronger. It’s time to look deeper at how these two trade deals fit into America’s grand strategy.

In early 2011, Deputy National Security Advisor for International Economic Affairs Mike Froman invited me and a few other trade experts to the White House to request suggestions and support for the TPP.

Froman made two basic arguments. The first was geopolitical: the TPP, Froman explained, was the administration’s way of demonstrating to our Asian friends and allies that we are back and committed to them. The second was economic: the deal would further open some important markets to American business, he argued, and, most importantly, would serve as a template for negotiating much broader and purer global free trade deals in the future.

To understand the administration’s reasoning, it is necessary to have a little background. In 2001, the World Trade Organization (WTO), the 158-nation body that attempts to govern global trade, launched the so-called Doha Round (after Qatar’s capital city, which hosted the launch meeting). The purpose of these negotiations was to achieve a dramatic increase in global trade liberalization. By 2008, however, the talks had gone nowhere and American frustration was at the boiling level.

In response, the Bush administration developed a theory of competing free trade agreements, or FTAs. The idea was that by concluding a series of special bilateral and regional trade deals, the U.S. would eventually force reluctant countries to sign on to Doha for fear of being frozen out of preferred access to key markets. While such FTAs were permissible under WTO rules, they were anathema to free trade economists because they inevitably distort trade and welfare by granting preferential treatment to favored partners.

As a test of the theory, the Bush White House announced in the fall of 2008 that it was joining an existing, largely ignored regional trade agreement among Singapore, Brunei, New Zealand, and Chile. After this, however, not much happened until the Obama administration committed to its “pivot to Asia.” That put crafting a much larger “Trans-Pacific” deal on Washington’s front burner, as Forman explained.

This reasoning struck me at the time, and still strikes me, as dubious at best. Let’s start with the geopolitical calculation.

There is no doubt that the growth of China’s power does unnerve other Asian nations. A Singaporean minister for foreign affairs expressed the concern succinctly to me over dinner one night. “As an ethnic Chinese myself,” the minister said, “I know that China views the world hierarchically—with a particular position, either up or down but not equal, for each country. Furthermore, I know the place the Chinese are likely to have for Singapore, and I don’t want to be in it in a Chinese-dominated world. So we need America to prevent Chinese domination.”

Yet if the rise of China makes Singapore and other Asian nations feel insecure, it’s hard to see how the TPP should make them feel better. It won’t halt the rise of China nor the relative decline of the U.S. And in any case, the United States has hardly abandoned Asia. The Pentagon maintains 100,000 troops in East Asia and the Pacific and keeps the Seventh Fleet patrolling the western Pacific as it has for nearly seventy years. We have security treaties with Japan, Korea, the Philippines, and Australia and quasi-security arrangements with Singapore.

We have done this despite no longer having to worry about the Soviet Union or the spread of world communism. We have done it despite China’s lacking any motive to interrupt its trade with us, and any desire to attack us. Meanwhile, most of the Asian countries benefiting from our security umbrella pursue industry targeting and strategic trade policies that have contributed to the chronic U.S. trade deficit and the offshoring of millions of U.S. jobs even as our Navy dutifully patrols the trade lanes. Geopolitically, the question should not be what we can do for prospering Asian countries made anxious by the growth of China. Rather, it should be what they can do to help relieve us of the economic burden of our continuing military commitment.

Then what about the economic case for the TPP? The Peterson Institute for International Economics has done an analysis showing that the TPP might result in a 0.0038 percent increase in GDP for the U.S. by 2025. In actuality the economic benefits, if any, are likely to be still less.

The agreement would virtually abolish tariffs. It also has provisions for liberalizing textile trade, and for reducing agricultural subsidies and barriers. It would ensure that state-owned enterprises compete fairly with private industry, and provide for stronger protection of intellectual property and investment rights. And it would reduce barriers to entry in a variety of service industries, including telecommunications and environmental goods and services.

No doubt, many multinational companies headquartered in the U.S. would benefit from these provisions. Companies such as Apple and General Electric, for example, would find it easier and safer to offshore R&D and production and to avoid U.S. taxes by keeping profits in Asia.

But whether it will be good for the U.S. economy as a whole is doubtful. That’s because the TPP ignores the most important drivers of global trade and investment. For example, it has no provisions for dealing with currency manipulation, even though several of the countries in the negotiation, and others that are likely to join later, routinely drive down the cost of their exports and drive up the cost of their imports by keeping their currencies artificially low.

The effects of this easily negate any benefits that might result from lowering trade barriers. For example, new Japanese Prime Minister Shinzo Abe’s first policy action to restart the Japanese economy was to devalue the yen by about 20 percent versus the dollar. That is a multiple of Japan’s average tariff level.

Nor does the TPP address the many structural issues that lock foreign producers out of Asian markets. Consider the Japanese car market, for example. Because of the strong yen and high wages, Japan has become a high-cost location for automobile production. At the same time, the United States has become a low-cost production center, thanks to the recent restructuring of its industry and the stagnation of American wages. One would expect that in view of its high costs, Japan’s imports of foreign cars would be soaring and Japan’s producers would be closing factories as U.S. and European producers have done under similar circumstances.

But none of that is happening, despite the fact that Japan imposes no tariffs on imported cars. So what else is at work? Complex Japanese rules and taxes that favor its domestic industries, plus a dealer network designed to exclude foreign-built cars. Joining with Japan in the TPP would not fix any of that. Indeed, by reducing the 2.5 percent U.S. tariff on cars built in Japan, it would help Japanese automakers to avoid having to reduce their costs.

Nor does the TPP deal with the problem of investment incentives. These are the packages of tax holidays, free land, state-financed worker training, regulatory exemptions, and capital grants that countries use to attract investment in production, R&D labs, and other facilities by global companies.

For example, Intel recently opened a new plant in China to make Pentium chips, the microprocessors that drive most of the world’s computers. Why China? Chip fabrication is highly automated, making labor costs insignificant. In the absence of distorting subsidies, the low-cost places to produce Pentiums would be Intel’s facilities in New Mexico and Arizona. But Intel CEO Paul Otellini has pointed out that the financial incentives offered by China are not available in America, and that they are worth about $100 million in annual Intel profits. These kinds of incentives are far, far more important as drivers of trade, production, and jobs than anything the TPP is talking about.

An additional problem is how the TPP would destroy the Caribbean Basin Free Trade Agreement (CAFTA) and poke big holes in the North American Free Trade Agreement (NAFTA). For example, under both agreements, textile producers in the Caribbean and Mexico who use U.S. yarn receive duty-free access to the U.S. market for textiles and apparel. The U.S. struck these deals partly in response to the discriminatory trade and industrial policies of some Asian countries that were distorting markets and causing the loss of U.S. jobs. A second objective was to help create jobs in Mexico and the Caribbean and thereby reduce the number of undocumented immigrants from these countries while also providing an alternative to employment in the drug-trafficking trade.

By removing tariffs on textile imports from Vietnam, the TPP would displace an estimated 1.2 million textile workers in the Caribbean Basin and Mexico along with about 170,000 in the United States, according to Mary O’Rourke, an industry analyst. Some see that as simply the price of achieving true free trade and optimizing the planet’s division of labor. But Vietnam is dominated by state-owned enterprises and is far from being a market economy. Furthermore, under a situation of true free trade, it would be China, not Vietnam, that would take most of the textile business, because China has gigantic excess capacity in textiles, as it does in just about everything else.

Meanwhile, it isn’t even clear that the TPP will change trading patterns within Asia to the advantage of the U.S. economy. Beijing is now pushing its own Regional Comprehensive Economic Pact, and so far all ten member countries of the Association of Southeast Asian Nations, plus Japan, Korea, Australia, New Zealand, and India, have signed up. This China club has more members—and more important members—than the American TPP club. Indeed, all the TPP members except those from the Americas are also in the China club.

None of this is to suggest that the United States couldn’t prosper from a deeper trading relationship with Asia if it were done on the right terms. Indeed, imagine if the U.S. went for the whole enchilada and proposed something like a trans-Pacific European Union? Take the advanced democratic economies of the Pacific—Canada, the U.S., Mexico, New Zealand, Australia, Japan, and Korea—and make them one integrated economy with a common antitrust regime, a common set of employment and environmental standards, one banking system, and eventually one currency—call it the Yollar or the Yelarso or the Denso. Make the union open to new entrants if and when they reform their economies enough to qualify for membership.

That entity would be the world’s biggest, richest economy. It would eliminate the structural impediments to U.S. exports in much of Asia, and bring most of the world economy under a true free trade standard. With this kind of a union there would be much less currency manipulation and much less (if any) need for “pivots” and more U.S. military in Asia. But, alas, Washington isn’t even thinking about anything like this, even though it would be a game-changing economic and geopolitical move.

So if the TPP looks like a lose-lose situation for the United States, what about a deal with Europe?

This notion was first voiced at a high level in 1995 when then Secretary of State Warren Christopher proposed a joint effort to better bridge the Atlantic. In November of that year, I was with 100 European and American CEOs when they met in Seville, Spain, and proposed a far-reaching agenda to increase trade and investment in the European and American markets. The following December, Washington and Brussels agreed to conduct a joint study on how to reduce tariff and non-tariff barriers. In a book at the time, I cited analysis by my own Economic Strategy Institute estimating that a TAFTA would boost U.S. GDP by 1.6 to 2.8 percent while raising EU GDP by 1 to 1.9 percent.

Nevertheless, objections were raised. Because it would be so large, some feared that a U.S.-EU deal might destroy the newly created WTO. Because the markets were already highly integrated, the likely gains from the deal might be small. A formal negotiation might actually worsen U.S.-EU relations by bringing contentious issues, like subsidies to our respective aircraft manufacturers, brutally to the fore. Some also said it would really be the rich, white guys ganging up against the rest of the world. So nothing happened. Eventually the WTO launched the aforementioned Doha Round, in which important parts of the rest of the world thumbed their noses at the European and American visions of free trade.

This experience is one reason why TAFTA deserves a second look, but there are also others. First is the need for growth in an age of high debt and austerity. Neither the U.S. nor Europe is politically prepared to stimulate its economy through any significant increase in deficit spending. That means growth must come from some other source, and the efficiencies that would come from further integration of European and American economies are a plausible answer.

Labor unions in the EU are strong and wages are high, so there will be no race to the bottom. And the EU and the U.S. largely share a commitment to free markets, free trade, and democracy. Much of what has gone wrong with the WTO derives from systemic conflicts between the U.S. and the EU on the one side and the more interventionist and authoritarian political economies of the rest of the world on the other.

The biggest economic gain from TAFTA would be from harmonizing regulation. Inconsistencies in regulation raise the costs of transatlantic trade in automobiles, for example, by 27 percent, and by 6.5 percent in the electronics sector alone. The United States and Europe both have safe headlights, for instance, but EU cars exported to America must have different headlights than those sold in Europe and vice versa. That non-tariff barrier inhibits exports while raising costs by forcing producers to keep extra stocks of different headlights. The same holds true for electronics and most other products. Mutual recognition of essentially equivalent standards and removal of similar non-tariff barriers would boost U.S. GDP by 1 to 3 percent ($150 billion to $450 billion), according to a 2005 study by the Organisation for Economic Co-operation and Development.

Beyond this, there are also significant economic gains to be had by eliminating non-tariff barriers to trade in services. More than 70 percent of the GDP in both markets derives from provision of services. Yet service trade is highly restricted by non-tariff barriers, such as differing rules and conflicting standards that bar the integration of cell phone service in the U.S. and Europe.

Meanwhile, although tariffs between the two economies are already low, there would also be significant immediate economic gains from tariff elimination. These potential gains range from 1 to 1.3 percent of GDP ($135 billion to $181 billion) for the United States. The European Commission has estimated that a comprehensive deal would result in a 50 percent increase in overall transatlantic trade. Putting all this together suggests that TAFTA would add 2 to 4 percent to U.S. GDP.

There is also a strong geopolitical case for TAFTA. For one, it would help contain the centrifugal forces in the EU that are gaining strength. British Prime Minister David Cameron wants to renegotiate the UK’s membership and submit the results to a referendum. This creates a real threat of a UK exit from the EU that might take others along. TAFTA would provide glue to hold Europe together, something that is a major long-term U.S. geopolitical and economic objective for the very good reason that the EU is not only a zone of peace and democracy but also America’s major partner in dealing with Russia, the Middle East, and Africa. It is also, of course, America’s biggest economic partner by far.

To those who view Europe as a demographic and economic backwater compared to Asia, it may be surprising to know the facts. Yes, Europe faces an aging population. But birth rates have plunged far deeper and faster in East Asia than in Europe, and as a result East Asia’s population is aging far more quickly. Fully 30 percent of Japan’s population will be over sixty-five by 2030, and its working-age population has been shrinking since the mid-1990s. China’s workforce is shrinking now too, thanks to its one-child-one-family norm. Demographers expect China to soon experience hyper-aging unlike anything in the cards for Europe. South Korea, Singapore, and Taiwan are already experiencing the same fate. The United Nations projects that by 2030, France and South Korea will each have the same proportion of elders in their population.

Europe also remains, despite its slow recovery from the Great Recession, the world’s largest economy and a powerhouse that is vital to the United States. Americans sell three times more merchandise exports to Europe than to China, while the EU sells the United States nearly twice the goods it sells China. Transatlantic trade generates $5 trillion in sales annually and employs fifteen million workers. It accounts for three-quarters of global financial markets and more than half of world trade. No other commercial artery is as integrated. Roughly $1.7 billion in goods and services cross the Atlantic daily, equaling one-third of total global trade in goods and more than 40 percent in services.

Finally, far from destroying the prospects for a global economy based on true free trade, TAFTA may be the only thing that can get China and other mercantilist nations on board. Given that the U.S.-EU economies constitute more than half of the global economy, TAFTA would tend to set global standards, and along lines affirming the fundamental precepts of free trade.

The conclusion is clear. The TPP is lose-lose for the U.S., both geopolitically and economically. The White House should drop and the Congress oppose it while we focus on the vast promise of a stronger transatlantic partnership that will benefit the whole world.

Clyde Prestowitz

Clyde Prestowitz is the founder and president of the Economic Strategy Institute. He formerly served as counselor to the secretary of commerce in the Reagan administration, as vice chairman of President Bill Clinton’s Commission on Trade and Investment in the Asia-Pacific Region, and on the advisory board of the ExIm Bank. His most recent book is The Betrayal of American Prosperity.