(What’s Left of) Our Economy: So Far, Trump’s New NAFTA Only Deserves an “Incomplete”

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automotive, China, currency manipulation, dispute resolution, domestic content, exports, globalization, imports, light trucks, NAFTA, non-market economy status, North American Free Trade Agreement, passenger cars, rules of origin, SUVs, Trade, Trump, U.S.-Mexico-Canada Agreement, USMCA, value-added taxes, VATs, {What's Left of) Our Economy

“What was all the fuss about?” is a question that supporters and especially critics of conventional, pre-Trump trade policies are entitled to ask after reading the text of the new “U.S.-Mexico-Canada Agreement” – the brand new revamp of the North American Free Trade Agreement (NAFTA) just agreed to by the three signatories.

Although President Trump has repeatedly called NAFTA “the worst trade deal ever,” the new pact seems to retain the previous deal’s fatal flaw. Interestingly, though, the very modesty of “USMCA’s” departures from NAFTA means that, because U.S. trade is so worldwide in scope, the best chance for Mr. Trump to keep his campaign promises to turn U.S. trade policy into an engine of domestic growth and employment rather than of offshoring depends on two additional steps. The first is following through with his threat to impose stiff tariffs on automotive imports from the rest of the world. The second is expanding his already substantial tariffs on imports from China.

As I’ve explained repeatedly, that fatal NAFTA flaw entailed the treaty’s failure to provide significant incentives to producers outside the free trade zone to supply U.S., Canadian, and Mexican customers with goods – mainly in the automotive sector – produced in the United States, Canada, and Mexico, not in Europe, Asia, or elsewhere.

USMCA does create stricter “rules of origin” governing trade in vehicles and parts – by phasing in increases in the share of inputs provided from inside North America that vehicles and parts will need to contain in order to qualify for tariff-free treatment when traded among the three countries. The new treaty also mandates that a certain percentage of these products be made in factories paying workers wages much higher than prevail in Mexico currently. But the penalties non-North American producers face for ignoring these requirements, at least for duty-free treatment in the U.S. market, by far North America’s largest, are exactly the same sorely inadequate tariffs imposed by NAFTA – 2.5 percent for passenger cars and nearly all parts, and 25 percent for sport-utility vehicles (SUVs) and light trucks.

In other words, non-North American companies and entities (such as are found in China) will find it just about as easy to absorb or evade the costs of exporting to rather than investing in North America – through increased subsidies, currency devaluation, or accepting slightly lower profits – as they have for NAFTA’s entire 24-year history.

Automotive-wise, as previously reported in the news media, USMCA does differ from NAFTA in one seemingly important respect:  The Trump administration won the right to increase greatly tariffs on passenger cars, SUVs, and light trucks from Mexico if these shipments to the United States exceed certain levels (1.6 million vehicles) and on auto parts if these shipments exceed $108 billion per year. Interestingly, no such limits are imposed on automotive imports from Canada.

The catch is that these thresholds significantly exceed current American import levels, so they’ll provide no noteworthy relief for U.S. autoworkers and domestic production facilities for the time being.

The good news for these beleaguered American workers and companies is that major incentives to move non-North American production to the continent can still emerge.  But their fate will turn on whether President Trump imposes stiff tariffs on automotive products from outside North America under Section 232 of U.S. trade law, and whether he keeps curbing American trade with China.

Canada and Mexico have won major exemptions in the USMCA from these threatened levies (see here and here for the relevant side letters), but such new barriers to imports from Germany, Japan, South Korea, China, and others should create plenty of new work and sales opportunities for facilities in all three USMCA countries.

Section 232 auto tariffs alone wouldn’t achieve my own favored goal of turning all of North America and its economy into a genuine trade bloc, which would require non-continental industries across the board to supply North America from North America. In one fell swoop, this approach would solve nearly all of America’s longstanding trade problems with all of the aforementioned non-North American countries along with a host of others. But given the prominence of automotive products in the North American trade and broader economic landscape, it would be an important first step. And more China-specific levies would help as well, given the huge and rapidly growing shares of U.S. manufacturing markets grabbed by the People’s Republic in the last 25 years.

To be sure, other features of USMCA look worrisome to me. Principally, the deal does nothing to eliminate the problems caused by the Canadian and Mexican use of value-added taxes (VATs) and America’s lack thereof. These levies serve as hidden barriers to the Canadian and Mexican markets, and hidden subsidies for exports from Canada and Mexico to the United States.

The Trump administration also has granted Canada’s demand to preserve the old NAFTA’s dispute-resolution process, which greatly helps Canada and also Mexico to frustrate U.S. efforts to curb dumped and illegally subsidized imports from those countries.

On the plus side, the agreement contains enforceable prohibitions against currency manipulation – a first for an American trade deal.  And the administration won for the United States the right to withdraw from the trilateral USMCA and substitute a bilateral deal if one of the parties signs a separate trade agreement with a “non-market economy.”  Since that clearly means, “China,” it’s one more barrier to non-North American economies enjoying some of the benefits of the free trade agreement without incurring any of the obligations.   

But the origin rules have always been central to the promise of integrating the three North American economies for truly mutual benefit. And since the auto tariff decision has now become the development that can make or break the effectiveness of these rules, the only grade merited so far by President Trump’s NAFTA rewrite is “incomplete.”

(What’s Left of) Our Economy: Trump’s NAFTA Rewrite Blueprint is an Encouraging Start

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bubbles, Buy American, Canada, dispute resolution, environmental standards, GATT, General Agreement on Tariffs and Trade, government procurement, labor standards, manufacturing, Mexico, NAFTA, national treatment, non-discrimination, North American Free Trade Agreement, reciprocity, rules of origin, tariffs, TPP, Trade, trade deficit, trade enforcement, trade laws, Trans-Pacific Partnership, Trump, value-added taxes, VATs, World Trade Organization, WTO, {What's Left of) Our Economy

The Trump administration is out with its detailed statement of renegotiation objectives for the North American Free Trade Agreement (NAFTA), and if you’ve favored turning U.S. trade policy from an engine of debt-creation and offshoring into one of production-fueled growth and domestic job creation, you should be pretty pleased.

As critics have noted, yesterday’s statement does lack numerous important details about how the administration intends to achieve its goals, and some of these omissions (as will be explained) raise legitimate questions about the depth of the president’s commitment to these changes. But the statute requiring the release of such statements doesn’t mandate disclosure of every – or any – specific strategy for reaching these goals. Moreover, the talks haven’t even started, and these tactics naturally tend to change with circumstances. So those accusing the administration of excessive vagueness should start holding their fire.

As indicated in yesterday’s post, the most important change needed in NAFTA is the addition of teeth to the agreement’s existing rules of origin – the requirements that goods sold within the NAFTA free trade zone comprised of the United States, Mexico, and Canada be made overwhelmingly of parts, components, and materials made inside the zone.

After all, manufacturing dominates trade not only inside NAFTA, but between the NAFTA countries and the rest of the world. Without imposing teeth, non-NAFTA countries will have no meaningful incentive to invest in new NAFTA-area facilities to produce the intermediate goods that comprise the content of final products, like automobiles. And the economies, businesses, and workers in the three countries will be denied immense opportunities to boost production and employment. Indeed, this is precisely this opportunity that’s been missed under the current NAFTA.

It’s difficult to imagine these teeth taking a form other than steep tariffs on goods imports from outside NAFTA, and the Trump blueprint never mentions that “t” word. But it does contain a call to “Update and strengthen the rules of origin, as necessary, to ensure that the benefits of NAFTA go to products genuinely made in the United States and North America.” And it specifies that these improved origin rules must “incentivize the sourcing of goods and materials from the United States and North America.” How could anyone supporting more U.S. manufacturing production and employment not be heartened?

Also impressive – as widely reported, the administration has prioritized preserving America’s ability to “enforce rigorously its trade laws, including the antidumping, countervailing duty, and safeguard laws” chiefly by eliminating the NAFTA provisions that established international tribunals as the last word in resolving trade complaints among the signatories, rather than the U.S. trade law system. The Trump administration is also seeking to reestablish America’s unfettered authority to impose “safeguard” tariffs on imports from Mexico and Canada when they begin to surge into the United States. So if you’re worried that NAFTA and other recent U.S. trade agreements have needlessly undermined American sovereignty, this blueprint is for you.

Similarly, critics have long complained about NAFTA’s overriding of the Buy America provisions of U.S. public procurement regulations aimed at maximizing the American taxpayer dollars used to purchase goods and services for government agencies. The Trump strategy laid out in the blueprint seeks to preserve these and other key domestic preference programs.

It’s true, as is being contended, that in areas ranging from promoting high labor rights and environmental standards, to dealing more effectively with the trade distortions created by state-owned enterprises (SOEs), the Trump NAFTA blueprint looks a lot like the Trans-Pacific Partnership (TPP) trade deal that the president condemned as a candidate and withdrew from on his first day in office.

It’s just as true, however, that formidable obstacles were bound to prevent effective enforcement of those proposed TPP rules. These loom as large as ever – notably, the huge numbers of U.S. government officials that would be needed to monitor the even huge-er Mexican manufacturing sector on anything close to an ongoing basis. But the final TPP text demonstrated beyond reasonable doubt that the Obama administration failed to address these concerns adequately. Maybe the Trump administration will come up with viable answers.

Finally, the Trump NAFTA blueprint contains two conceptual objectives that have never been prioritized since the current world trading system was created shortly after World War II, and that trade policy critics should be applauding vigorously. The first is the endorsement of reciprocity as a lodestar of American trade strategy. The second is an emphasis on reducing America’s mammoth trade deficits.

Although reciprocity (i.e., America opens its markets to certain trade partners only to the extent that their markets are open to U.S.-origin goods and services) seems like an uncontroversial trade goal for Washington to seek, and is often presumed to be the goal, nothing until now could be further from the truth. In particular, the foundational principles of the world trade system under the General Agreement on Tariffs and Trade (GATT), and the World Trade Organization (WTO) are national treatment and non-discrimination.

National treatment simply insists that countries deal with foreign enterprises the same way they deal with their own domestic enterprises. Non-discrimination simply mandates that countries treat imports from all trade partners’ identically. The big problems? They enable closed economies to maintain way too many trade barriers. For instance, countries that favor certain companies over others for either political reasons (as with China’s state-owned sector) or reasons of national economic strategy (as with Japan’s efforts to limit entrants into certain industries to prevent excessive domestic competition) can continue discriminating in similar ways against foreign competitors. And countries can maintain high trade barriers as long as they apply equally to all imports.

As for trade deficit reduction, it’s a great way to promote healthy, production-led American growth, rather than the kind of debt-led, bubble-ized growth that’s been engineered arguably going back to the 1990s. But here’s where the Trump blueprint can be faulted. Especially if the new NAFTA contains better rules of origin, it’s likeliest to reduce the U.S. trade deficit with non-NAFTA countries, not with the treaty signatories that the blueprint targets. And nothing would be wrong with that result at all.

Two other aspects of the NAFTA objectives deserve comment – and merit genuine concern. First, although it’s good that the administration has included on the list currency manipulation, critics are right to note that specifics are urgently needed. Their development, moreover, is important not mainly because Canada and Mexico have been important culprits (they haven’t been) but because this is a challenge that President Trump needs to meet in connection with countries that clearly have manipulated in the past and could well do so again.

Second, the Trump blueprint makes no mention of value-added taxes (VATS). Mexico’s is 16 percent, Canada’s is five percent at the federal level and eight percent at the provincial level. As with all other VATs, these levies act as barriers to imports and subsidies for exports. Candidate Trump rightly called for American countermeasures in order to level the trade playing field inside NAFTA. President Trump should take heed.   

(What’s Left of) Our Economy: More Evidence of Germany’s Stealth Protectionism

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Angela Merkel, consumers, consumption, developing countries, Financial Times, Germany, Global Imbalances, globalization, imports, Matthew C. Klein, protectionism, savings, taxes, Trade, Trump, value-added taxes, VATs, wage suppression, wages, {What's Left of) Our Economy

President Trump’s charges that the United States has signed terrible trade deals in recent decades, and that foreign economies have been the main beneficiaries, inevitably have triggered a potentially useful debate over which major countries are most open to trade and which are tightly closed. Unfortunately, such arguments won’t actually be useful until “open” and “closed” are properly defined, and a new Financial Times column on Germany’s economic policies nicely illustrates how remote that goal remains.

I’ve previously made the case that accurately measuring protectionism – and thus accurately gauging which countries are contributing adequately to global prosperity and which are free-riding – entails much more than adding up individual trade barriers. Such simple counts also mislead on the equally important question of which countries the United States can reasonably hope to trade with for mutual benefit, and which countries can’t possibly qualify.

And because Germany’s government has both taken trade fire from Mr. Trump and vigorously replied, I’ve used it to illustrate the above points. In a short op-ed for USA Today and a much more detailed RealityChek post, I’ve noted that, as with many other leading foreign economies, the main problem with Germany as a promising trade partner stems at least as much from its overall national economic strategy as from its specific trade practices. That is, countries like Germany, which heavily emphasize growing by saving, producing, and exporting, can’t possibly be good trade matches for countries like the United States, whose priorities have been the diametric opposites.

Of course, those national economic strategies manifest themselves in specific practices and policies. (How else could their focus be established?) But the links to trade flows aren’t always clear. For example, there’s widespread reluctance to acknowledge the trade impact of value-added taxes (VATs), which promote exports and penalize imports. The role played by other German policies, like suppressing wages or skimping on infrastructure spending, has been even less apparent.

What the new Financial Times post adds to the mix is a generally neglected form of wage suppression: Germany’s taxes on low-wage workers – which author Matthew C. Klein describes as “among the highest in the world” since at least the turn of the century.

These taxes inflict an outsized blow on Germany’s imports – and on the the world economy as a whole – in at least two important respects. First, economists tend to agree that the lower an individual’s or household’s income, the higher the share of that income will be spent (as opposed to saved). If they’re right, then these taxes ave been hitting Germany’s overall consumption and import levels especially hard. Therefore, these levies look like notable contributors to the bloated German trade and current account surpluses that are not only detrimental to America, but that could threaten the entire world’s financial stability.

Second, as supporters of pre-Trump U.S. trade policies constantly point out, much of what low-income consumers buy is produced and exported by low-income countries (e.g., apparel or school supplies or furniture). So since high taxes on low-wage workers in Germany prevent them from importing as much from the developing world as they could, third world countries need to focus more on customers in more promising markets – like America’s.

Germany and its leader Angela Merkel lately have been basking in the glow of praise from the political classes in the United States and abroad, which have anointed them as among the new, post-Trump champions of free trade and all its purported benefits. (China’s another alleged globalization champion, but that’s another story.) Its lofty taxes on low-wage workers add to the evidence that these titles are wildly premature.

Following Up: Obama’s Tech Trade Deal is a Success America Will Regret

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2016 election, China, currency manipulation, Donald Trump, Following Up, free trade agreements, Hillary Clinton, Information Technology Agreement, non-tariff barriers, Obama, subsidies, technology, Trade, Trade Deficits, value-added taxes, VATs

Since earlier this week I chided the Obama administration for prematurely declaring victory in reaching a global trade deal to phase out tariffs on information technology products, I’m honor-bound to report today that the final obstacles have been cleared and the agreement has been reached. Now for the bad news: This new World Trade Organization deal looks even worse for the United States as other recent agreements like President Obama’s Trans-Pacific Partnership (TPP).

Now that China has finally submitted its time-frame for eliminating duties on the 201 products covered in the Information Technology Agreement (ITA), the agreement is on track to enter into force next July. The staged tariff-cutting process could be problematic, vulnerable as it is to changing national and global economic conditions and thus to political will. But from the American standpoint, the biggest problem with the ITA mirrors some of the biggest problems with Washington’s previous trade deals: It promises to get rid of whatever trade barriers the United States still maintains, but leaves in place many of the biggest trade barriers erected by foreign governments.

As noted in a post last year, the ITA ignores non-tariff barriers (NTBs) and other forms of trade predation.  These longstanding policies and practices block a wide range of American exports and artificially boost the competitiveness of foreign products, and are much less prevalent in the United States. Recently, such measures have of course grown much more important in tech giant China in particular, as Beijing has stepped up its harassment of foreign-owned companies in order benefit the domestic champions it’s trying to build and to secure advanced knowhow.

Because foreign government bureaucracies, especially in East Asia, work so secretively, non-tariff barriers are often notoriously difficult for American companies and officials to identify with any precision, much less tackle. Therefore, even trade deal provisions that ban or curb them are never especially promising. But at least the TPP mentions them in the text and takes a stab at creating disciplines. The ITA negotiators’ apparent position? “Never heard of ’em.”

Moreover, like the TPP, the ITA leaves in place the foreign value-added taxes (VATs) that serve as hidden barriers to U.S. exports and hidden subsidies for foreign goods headed for the United States. VATs are used by nearly all significant trading countries, with the conspicuous exception of America. And like the TPP, the ITA ignores currency manipulation – a huge mistake given China’s apparent determination to weaken the yuan once again, and the fondness for exchange-rate protectionism displayed historically by many other major and emerging information technology producers ranging from Japan to Vietnam.

As a result, the only clear American winners from the ITA will be offshoring-happy U.S. technology companies whose business models have long emphasized supplying the high-income United States from countries whose production costs are super low, whose governments are enthusiastic subsidizers, or both. These firms’ profits may improve, but the U.S. economy will see even bigger trade deficits, and therefore even slower growth, even less hiring, and even weaker wage hikes.

During this campaign season, many establishment politicians have suggested that bombastic Republican presidential front-runner Donald Trump, a strong trade policy critic, is actually working for his Democratic counterpart Hillary Clinton. Trade deals this incompetent or special interest-driven make one wonder whether President Obama is actually working for Trump.

Making News: New Marketwatch Column on the Big TPP Loophole Even Critics are Ignoring

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China, currency manipulation, Making News, Obama, protectionism, subsidies, TPP, Trade, Trans-Pacific Partnership, value-added taxes, VATs

I’m pleased to announce that Marketwatch.com has just published a new article of mine on President Obama’s proposed Trans-Pacific Partnership trade deal.  It argues that the Pacific Rim agreement will be worse than useless for the United States unless it closes a loophole created by value-added tax (VAT) systems that are at least as protectionist as currency manipulation.  Click on this link to read.

(What’s Left of) Our Economy: Will China Repeat its VAT/Currency Shell Game?

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Asian financial crisis, China, currency, currency manipulation, devaluation, exchange rates, steel, subsidy, tariff, VAT rebates, VATs, WTO, yuan, {What's Left of) Our Economy

Speculation keeps abounding about whether China will weaken its currency has been on the rise, lately, for entirely understandable reasons. China’s own growth is slowing. It still depends heavily on exports for growth. Its leaders need good growth to maintain the job creation that’s crucial to the nation’s political stability (and their stranglehold on power). The world economy to which China needs to sell is slowing, too (except so far the United States). And last year, the yuan experienced its first year of decline versus the U.S. dollar since its 2005 revaluation.

Since the yuan’s exchange rate affects the price of everything sold by China, and the price competitiveness of whatever its trade partners want to sell to China, depreciating the currency is an obvious way for Beijing to keep its economy humming adequately. At the same time, it’s crucial to remember that it’s not the only way. Hats off, as a result, to India’s Business Times for just calling attention to another: manipulating the rebates China provides to many exporters with its value-added tax (VAT).

VATs affect trade flows significantly because they’re imposed on goods and services consumed in the taxing country (including imports), and rebated to domestic producers for products sold abroad. So they act just like a tariff on imports and a subsidy for exports. And if the rate is high enough, the subsidy effect can be even greater than that created by currency undervaluation.

But VATs aren’t subject to any international trade disciplines because they’re considered to be domestic taxes that sovereign governments have every right to impose. Significantly, the United States is the only major trading power that doesn’t use VATS, which creates huge disadvantages for all American producers facing foreign competition anywhere in the world.  That’s why Business Times deserves such credit.

The paper reports an announcement that China has removed entirely the rebate on boron steel. That would be good news for steel companies and steel producers everywhere, and for the global economy in general, since the rebate helped push China’s steel exports to record highs as Beijing sought to maintain production (and job) levels threatened by slower demand at home by dumping product abroad. In fact, the Chinese steel industry trade association reportedly is predicting that the rebate’s removal could depress overall steel exports by between 20 and 30 percent.

But there’s a catch. Business Times also reports that the same trade association is asking Beijing to increase VAT rebates on other kinds of steel. And as if the VAT-related distortions to trade flow aren’t already complicated enough, it’s apparently also possible to get the rebate by substituting chromium for boron in the steel.

If China agrees to its steel producers’ request, the effect of the boron steel rebate’s elimination could be completely offset. And if this practice is replicated throughout the Chinese manufacturing sector, Beijing could reap many or all of the gains generated by the much higher profile and more controversial practice of currency devaluation, without catching any of the flak or risking retaliation.

Think this is far-fetched? It’s exactly what Beijing did during the late-1990s Asian financial crisis – when it won applause from President Bill Clinton among many others on the currency front for acting like a responsible international citizen. I have no doubt that China’s leaders remember this episode well. And that America’s leaders don’t.