The World Trade Organization judgment Friday that the U.S. use of “Foreign Sales Corporations” was an illegal export subsidy appears to have been correct on the merits, but raises the question of whether, now that the world economy is in downturn, we will see resurgent protectionism.
If we do, the outlook is bearish indeed; protectionism is both most appealing and most dangerous in times of economic difficulty.
The economic case for free trade is clear-cut, but in many cases marginal. The big gains for free trade come from the low hanging fruit. Eliminating an absolute prohibition on imports (as Japan did recently for rice) or dismantling quantitative restrictions (like U.S. and European textile quotas) or very high tariffs (as India is currently doing) are all far more important to economic efficiency than worrying about the details of tariff schedules that already are below 20 percent ad valorem (a rate percent of value). Needless to say, past rounds of trade talks have concentrated on the minutiae rather than the substance.
It is not clear that unilateral trade disarmament is sensible. The most extreme evidence that it isn’t is Britain, whose decline from world economic supremacy can be dated to her adoption of free trade as a dogma with the 1846 repeal of the Corn Laws.
British Prime Ministers had understood the benefits of free trade since Pitt’s private tutorials from Adam Smith in the 1780’s. Lord Liverpool, Prime Minister from 1812 to 1827, a man with a very sound grasp of economics, enacted the Corn Laws in 1815 to counteract an expected postwar depression and preserve the tax base needed to service Britain’s huge international debts. He then relaxed them in stages in the 1820’s, as the economy began to recover, but took care to maintain a trade policy only moderately less protectionist than that of the United States (which had passed protective tariffs under Hamilton in the 1790’s) and Britain’s major Continental competitors. The result was an astonishing efflorescence of the British economy, later christened the Industrial Revolution, that has never been matched in Britain before or since.
Robert Peel and William Gladstone, architects of the 1846 repeal of the Corn Laws and the 1860 Cobden treaty with France (the arcana of whose details produced a particularly revolting cheap wine sold in Britain known as Gladstone claret) were not pragmatists, they were ideologues, of the worst type, whose ideology consisted of conversion to some new nostrum, followed by deliberate and systematic betrayal of the ideas in which they had previously believed, and of the people, their followers, who had shared that previous belief. Peel did it over Catholic Emancipation, over Parliamentary Reform, and over the Corn Laws; Gladstone did it over the Corn Laws, over the Irish Church, and over Home Rule.
Free trade, to Peel and Gladstone, was not a policy, it was a doctrine. It was sold to the British people on the basis of providing cheaper food, it was accepted on that basis, and once established it was an immovable fulcrum of British international policy. Their trade policy was equivalent to unilateral military disarmament and, by putting temptation in the way of aggressive foreigners, it made trade war more likely not less.
France after 1870, the U.S. after the Civil War, and Germany under Bismarck all adopted high tariff policies, taking advantage of tariff protection to undercut British industries in the world markets, while there was no corresponding British response.
Salisbury, prime minister from 1885-1902 (with two short gaps) hated Britain’s free trade policy but regarded any attempt to change it as electoral suicide. Joseph Chamberlain, by attempting to change it in 1903, produced a Liberal landslide in 1906, thus proving Salisbury right.
Only Neville Chamberlain, with the Ottawa agreement of 1932 signed at the depth of the Depression, was able to abandon Britain’s extreme free trade position, and by that time it was too late to restore Britain’s economic preeminence and, as it proved, too late to keep the British Empire together — Roosevelt, viscerally hostile to the Empire, forced Churchill to abandon Ottawa as a condition of U.S. aid in World War II.
Only after 1979, with Lady Thatcher’s doughty battles against the European Commission, was a certain independence in British trade policy restored.
The history of U.S. trade policy is much simpler and more successful. Rejecting Jefferson’s call for free trade, the U.S. imposed tariffs to protect infant industry early on, and then, over the protests of the agrarian South, kept raising them. William McKinley devised probably the most intellectually coherent set of industry-protecting tariffs in 1890, and was then triumphantly elected president six years later on the platform of the “Full Dinner Pail.” Tariffs, not free trade, were the populist platform in the United States.
Of course, the U.S. then went too far, passing the Fordney-McCumber tariff in 1922 (which produced a U.S. boom at the cost of deep damage to European recovery after World War I) and the Smoot-Hawley tariff in 1930 (which plunged the world from a short sharp recession into the Great Depression.) After Roosevelt’s election, Cordell Hull, a Southern agrarian, favored lower tariffs but they only became national policy after World War II when the United States, by far the world’s dominant economic power, could afford to take the position occupied by Lord Liverpool in the 1820’s, and work for gradual worldwide tariff reduction, with the United States now being less protectionist than her competitors.
The above historical survey is I hope useful in pointing to an appropriate policy. The United States, as the world’s leading economic power, but without the dominance it enjoyed in 1950, should be pragmatically in favor of free trade, not ideological like Peel or Gladstone, nor using it as a weapon against allies, like Roosevelt, but also not protectionist, like McKinley or Chamberlain.
Lord Liverpool’s policy of the 1820’s in other words, making the United States somewhat but not excessively more free trading than its competitors, and seeking to promote new industries rather than to preserve old ones.
In practice, this means keeping an eye on the world economy, to avoid at all costs a Smoot-Hawley slide into depression. In steel, the United States should recognize once and for all that an industry that has been in deep trouble since at least 1959 does not represent the future of the U.S. economy. Yes, there is a modest military/strategic case for the United States having a steel industry, but if in 2001 the United States can allow computer chips to be manufactured in Taiwan, under the guns of China, then it can afford to allow steel to be made in Mexico or Brazil, two low wage countries within the U.S. strategic orbit. In any case, mini-mill technology and efficient operation allow smaller U.S. steel producers to flourish while Big Steel moans for government aid.
In textiles, also, there is no excuse for U.S. protectionism. Basic textiles and garments are highly labor-intensive, and it is absurd to insist on manufacturing them in North Carolina rather than India.
Even the strategic argument doesn’t work here, as evidenced by the U.S. Army ordering its berets from China.
Agriculture is protected by all advanced countries, which are cost-inefficient, while most Third World countries, which are cost-efficient in agriculture, damage it for the sake of industry. The world’s agriculture protections and subsidies are hugely economically damaging, with their major costs, like those of textile quotas, falling on the Third World. The argument used for them, the protection of family farming, is nonsense, since most of the subsidies, based on output volume, go to agribusiness conglomerates.
Steel, textile, and agricultural protectionism are all areas that the United States can usefully abandon unilaterally without great economic damage to the U.S. and with enormous benefit primarily to the poorer countries. Europe and Japan both protect agriculture and Europe both protects steel and textiles; their policies will become only more morally and financially bankrupted by unilateral U.S. action.
In other areas, action needs to be multi-lateral, to avoid the danger of trade “unilateral disarmament.” The Foreign Sales Corporation tax policy is contrary to current WTO rules, but its abandonment should be negotiated directly with the infinitely protectionist EU, many of whose tax laws have an equivalent effect and are equally trade-damaging. Aircraft sales are likely to be a huge area for competitive subsidization once Airbus and Boeing feel the pain of the next recession; the U.S. and the EU should negotiate now an agreement to avoid such subsidies. Export credits are a subsidy of the least creditworthy foreign buyers, and usually end by a Paris Club agreement that writes off debt and penalizes taxpayers; their abolition, however, again needs to be negotiated with the U.S.’s trading partners.
In other areas, new protectionist methods are arising, which have the effect of damaging trade, but are not themselves tariffs. The EU decision on GE/Honeywell, blocking a merger that had been accepted by the regulator of the country in which both corporations were domiciled, is one such example; bank capital regulations, that under the proposed new Basel accord, subsidize existing oligopolists at the expense of new bank entrants, are another. Again, apart from avoiding such measures itself, the U.S. needs to negotiate with trading partners the elimination of such trade barriers as they arise. The WTO is an admirable instrument for this, which is another good reason for the U.S. to abolish FSC’s, thus giving the WTO a substantial victory, strengthening it for future work.
Finally, there are the trade areas in which the U.S. needs the Third World to give something, primarily those of trademark, patent and copyright protection, where OECD countries, but not the ThirdWorld, are generally in conformance with U.S. needs. Currently, U.S. policy is to push for a new round of trade talks, with these items top on the agenda.
However, intellectual property protection means higher costs for AIDS drugs, to take a high-profile example, and is thus unattractive to the Third World, particularly while egregious U.S. non-tariff barriers in steel, textiles and agriculture remain in place.
Accordingly, unilateral removal of such barriers by the U.S. can be an important lever to move a new trade round forward. Re-imposition of restrictions against particular countries can always be used as a threat if the trade round stalls, but the improvement in world trade and Third World living standards produced by liberalization is likely to prove both an incentive to further progress in trade talks, and a spur to domestic reform in countries where that is needed.
As for the AIDS and other drugs problem, it can be solved by direct subsidy through bulk drugs purchase (at costs which include intellectual property recovery) and distribution thereof to the Third World at below cost by charitable agencies.
In summary, therefore, the world economy is sliding into recession, which can be made much less painful by well timed trade liberalization, or can be made excruciating and lengthy by tit-for-tat protectionism. The United States, by abandoning its indefensible protectionism in steel, textiles and agriculture, can benefit its own consumers, push forward trade progress, and ensure that the oncoming world recession ends happily.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
This article originally appeared on United Press International.