Abstract

My presentation consists of the major policy challenges in the trade policy area that I see facing countries. The way I have structured my presentation is first to make some comments about the general economic environment in which trade policy is currently taking place; second, to think about major trends in the agenda, which are confronting trade policy; and then to turn more specifically to some issues in trade policy.

My presentation consists of the major policy challenges in the trade policy area that I see facing countries. The way I have structured my presentation is first to make some comments about the general economic environment in which trade policy is currently taking place; second, to think about major trends in the agenda, which are confronting trade policy; and then to turn more specifically to some issues in trade policy.

I shall begin by making some comments about the general economic environment within which the discussion about trade policy is taking place, because I think it is important to bear in mind that trade policy often gets the credit and takes the blame for changes in our economies, many of which may have nothing to do with trade. For instance, while economists agree that the high protection during the 1930s contributed to the Great Depression during that period, they also believe that there were many other factors that caused that depression, and yet people who look at the 1930s blame protectionism for the Great Depression. Protectionism did contribute to it but certainly was not the only source of the difficulties. Similarly, trade policy gets the credit for a lot of the dramatic growth that was recorded in the postwar period; people associate liberalization with strong economic growth. So whether we like it or not, trade policy is going to be blamed, or given the credit, for the broader economic performance in our economies, and that is in fact what we see taking place.

General Economic Environment

It is important for us then to pay some attention to what the broader economic performance is, and I would like to highlight basically three elements in that economic environment. The first is the emergence of a period of slow economic growth in the developed countries. Now, we have seen widespread economic recession over the last few years. But what else is very significant is that we look at the current projections for long-term potential growth across the developed world and see that those projections suggest that growth is going to be rather slow. For instance, in the case of the U.S. economy, traditionally, it was able to grow at about 3 percent a year. A reasonable projection of the potential growth rate of the United States, once the economy reaches full employment, is probably just over 2 percent a year—basically, slow, long-term growth. A major source of the slow growth is the slow growth of productivity in the United States. There is some evidence of a small recovery in productivity growth over the last few years, but it is still growing much more slowly than it had in the 1950s and the 1960s, and as a result, the U.S. labor force is growing just over 1 percent a year. If we add in just over 1 percent for productivity growth, we get a rather slow potential growth rate in the United States. If we look at Europe, similarly, we see very high unemployment rates, but again projections that suggest a potential growth rate somewhere between 2 percent and 3 percent, again slower than it used to be. And, certainly, if we look at Japan, we see revisions downward in the potential growth rate of the Japanese economy. If you had asked a few years ago what the potential growth rate of Japan was, you would have been told that it was between 4 percent and 4½ percent. Today, the numbers are much closer to 3 percent. So we have slow, long-term potential growth rates in these developed economies. And what that means is that improvements in living standards will inevitably be slower in these economies than they have been in the past.

Second, in addition to the slow average growth, what we see, particularly in countries like the United States and the United Kingdom, is an increase in inequality in these economies. If you look at earnings of American workers, split according to any criteria you like, educational levels, occupational levels, or experience, you see a growing disparity. Basically, highly educated Americans have seen an improvement in their relative earnings; poorly educated Americans have seen a decline. To give you one number: if you were a college graduate with no experience, in 1980 you would have earned about 30 percent more than a high-school graduate with no experience. By 1990, a college graduate was earning about 70 percent more than a high-school graduate. So there is a growing disparity in earnings associated with skill and levels of education. Smaller increases in inequality also occur in other developed countries. Some believe that what shows up as an increase in inequality in the United States with its more flexible labor market shows up as an increase in unemployment in Europe. The unskilled workers in Europe are a disproportionately high share of the unemployed workers in Europe.

So we have a shock, or maybe a set of shocks, that is hitting the developed economies, causing increasing inequality, and in particular, the unskilled and the less educated are doing relatively poorly within the context of an overall growth rate that is relatively slow. Now, there is considerable research as to what is causing this. Certainly one candidate explanation is international trade. Indeed, we have a theory of trade that does suggest that if we had liberalization in developing countries, if we got more developing countries to produce labor-intensive products, what we could expect to see is the price of those products falling and exerting downward pressure on the wages of workers who are relatively less skilled. So we do have an economic theory that suggests that growing inequality could result as a consequence of international trade. My own examination of the evidence—an area where I have done considerable research recently—suggests that there are much more powerful effects operating than international trade. Indeed, technological change in my view is skewing the demand toward more skilled workers and away from less-skilled workers. But, be that as it may, international trade is clearly a candidate here for taking the blame. And even if it is not, certainly it will become increasingly difficult, and it is already difficult, for policymakers to say they are liberalizing with respect to developing countries when there is growing inequality and, in particular, unskilled workers are doing relatively poorly for technological and other reasons. So, in addition to the environment of slow growth, I would add this issue of growing inequality.

A third key element in the environment is the revolution that is taking place in developing countries. Throughout the world, since the mid-1980s, we have seen an astounding movement toward trade liberalization in almost every country in the developing world. Emerging economies are coming out—formerly planned economies moving to market economies, and economies in Asia, Latin America, and Africa, are now all adopting more outwardly oriented policies. And, indeed, the striking feature of this environment, on the one hand, is that the developing countries are all counting on being able to sell to the developed economies, and on the other, the emergence of these trends is of concern to the developed economies. These are the elements of the environment that we should keep in our minds as we discuss the trade policy question as it relates to the developed economies.

Now, what is striking to me is that, despite this rather gloomy set of tensions that I have just described, if you look at what has been accomplished in the 1990s with respect to liberalization, I think from the standpoint of a free trader, the record is rather good. In fact, progress—considerable progress—has been made in liberalizing the developed economies. Indeed, if you look at the U.S. economy, for instance, a recent study by the Institute for International Economics shows that the impact of protection on the U.S. economy is virtually minimal. It is confined to the impact of textile protection. But other than that, in terms of formal border barriers, the U.S. economy is much more open today than it has been over the postwar period. Second, we see Europe making efforts: having almost completed its program for the creation of a single market, which is an immense liberalization effort in that internal market, it has extended that arrangement now to three other countries of the former European Free Trade Association (EFTA). The United States, Canada, and Mexico have concluded the North American Free Trade Agreement (NAFTA). In the countries of the Asia-Pacific Economic Cooperation Council (APEC), we see pledges for free trade liberalization, and we have seen a successful conclusion of the Uruguay Round. So it is quite remarkable that liberalization has taken hold, despite the economic environment that I described earlier. It certainly was not easy, but nonetheless, we should take heart from the accomplishments that we have seen in the past.

Trade Policy Today

But where is the future going to take us? I would argue that there are two key features of trade policy today that are different from what they have been traditionally in the postwar period. The first difference is that we have a new agenda. By and large, particularly when it comes to developed countries, the agenda has shifted from issues of what one might call “shallow integration” to what one might call “deeper integration.” And second, particularly when it comes to the United States, the approach to dealing with these issues has shifted from one that concentrated heavily on obtaining multilateral solutions to the agenda of what we now call a “multitrack approach,” in which there is multilateral discussion but unilateral measures, bilateral measures, and regional measures. These are the two issues that I will describe.

I will address first the shift from the agenda of shallow integration to that of deeper integration, because it runs through many of the policy discussions in which the developed countries are today involved, and increasingly, even developing countries. Let us step back and think about what was the major challenge for the postwar period. In the early postwar period, the need was to reverse what had taken place in the 1930s, which was the erection of large barriers at the borders of most countries. The world was separated, if you will, by high tariff and nontariff barriers and by restrictions on capital movements. And so when I talk about shallow integration, I am really emphasizing the idea of removing these border barriers. That was the major task of the early postwar period: lower those tariffs. And in fact, we have seen over the postwar period spectacular success in accomplishing that goal. By and large, the border barriers have been lowered. When it comes to the developed economies, tariff rates are on average very, very low. In some sectors, they have been completely eliminated. In some laggard sectors, the tariffs have not quite been lowered. But, by and large, through a process of multilateral negotiation and a series of trade rounds, success has been achieved. In fact, most of the analytical issues—most of the debates of how to go about doing this—have been resolved.

What is striking, and a second achievement of more recent vintage, is capital mobility. By and large, among developed countries, capital is free to flow; investors are, particularly in terms of portfolio investment, free to invest and to take their money and send it out of their own economies. So these are noteworthy achievements. In addition, in the 1980s, there was a major acceleration in direct foreign investment. In the 1950s and 1960s, American firms went out and invested heavily in Europe and in other parts of the world. The United States was the technological leader. The Americans had some know-how they could profitably exploit by investing abroad, and they did so. In the 1980s, there was an explosion in direct foreign investment coming from Japan and Europe into the United States and very strong flows of direct foreign investment throughout Asia and other parts of the world.

So a spectacular growth in trade occurred, and spectacular growth in investment and in the development of international capital markets. But what has been striking is that as we have removed those border barriers—as we have taken down the fences that have separated our economies—we have become increasingly aware of the differences in domestic policies that remain. The essence of the General Agreement on Tariffs and Trade (GATT)—and why I talk about it as a shallow integration approach, particularly in its earlier years—was that the GATT was not trying to harmonize domestic economic policies. It was trying to lower border barriers, and it strove to achieve national treatment, particularly when it came to goods trade, that is, treat foreign goods in the same way as you treat domestic goods. But the philosophy of the GATT is actually “let one thousand flowers bloom”: countries can be different, the key is that they should not discriminate against foreign goods; having different policies is not a problem.

Indeed, what is striking about the GATT is that even when it came to tariff reductions, it was not striving for a level playing field in the sense that tariff levels had to be the same across countries. It was striving for equal concessions—what Jagdish Bhagwati calls first difference reciprocity: as long as you give up in some negotiated sense as much as I give up if I come from another country, that is reciprocity, even if our levels are not going to be the same. So that was the norm; that has succeeded very well, but increasingly there are pressures to move toward deeper forms of integration. And we have seen these pressures emerging in a number of areas, for different reasons.

One major reason really comes from the growing role that multinational corporations are playing in international trade, and these are essentially functional demands. If a multinational company is going to set itself up in a number of countries, what it would like is, first and foremost, secure intellectual property rights. A company has know-how. That is the key to its competitive success. It wants to be sure if it goes and produces abroad its know-how will be secure, it will have property rights over it. Second, it would like compatible standards. If you are going to source in one country and then add value in a second, it would be very helpful to you if they have similar standards and norms. Otherwise it is going to be difficult and costly for you to do so. In addition, if you want to be secure in the ability to sell, to enter other markets, you want to be sure that your goods are going to be free to enter. It is not just the question of tariff or nontariff barriers, you do not want to be harassed by antidumping rules and other kinds of administered forms of protection. So what we see is a growing demand, which is functionally driven, by multinational companies for deeper forms of integration, and we saw this emerge very, very strongly in Europe in the call by major European companies for a single European market. Companies like Philips and Siemens in the early 1980s said they could not compete in world markets if they were going to be based in a fragmented European market. Even though we have removed the border barriers within Europe, there are still these major differences in standards and regulatory frameworks that do not allow us to fully integrate our operations to enjoy genuine economies of scale at the European levels. And so they said, we call for a single market form of deeper integration. That, I think, was strongly driven by the functional needs of those multinational corporations.

Second, in addition to those pressures, we also see political forces starting to respond and calling for deeper forms of integration. When competition gets tough, as countries open up to one another, many start to be struck by the fact that the foreign firm is operating in a very different economic environment from the domestic firm; calls to somehow “level the playing field of international competition” arise. So, some see unfair advantage given to foreign firms as a result of the differential treatments. We have three noteworthy words in the trade debate: dumping, ecodumping, and social dumping. These are words that people use when they do not like what is taking place because of differences, whether they are corporate differences (dumping), whether they are social rules and norms (social dumping), or whether they are environmental rules (ecodumping). Nonetheless, we see groups who care about these issues, whether they are multinational companies who want that level playing field, or environmental groups, or labor; they are all saying, “In order for us to trade and expose ourselves to one another to the degree that we are now doing, we want to have more harmonized regulatory arrangements.”

And so, whereas in the early postwar period we had a clear division and countries were sovereign with respect to their domestic issues, now it seems as though many more aspects of what countries once considered to be their sovereign policies are coming under fire in the international arena. The major tension in our world today, faced by developed and developing countries, is how to reconcile these demands. On the one hand we have a global economy, on the other, we have a world organized into nation states, and when that division was clear as to what the nation states were responsible for, we knew how to handle that. Now we are trying to rethink these issues, and we ask, how would you try to resolve some of these questions? We obviously do not have all the answers, but the key issue is how we deal with this transition from shallow to deep integration. If we look at the trade policy discussions and issues in the 1980s as they emerged, and now in the 1990s, they are certainly dealing with issues of deeper integration.

A second change in addition to this change from shallow to deep is from multilateral to multitrack. In essence, here we should focus on the United States, because the great change has been in the American approach to international trading relations. In the 1950s and 1960s, the United States almost solely, not totally but almost solely, conducted its trade relations using the GATT and in a multilateral arena; it was very wary of regional arrangements. One reason was the fact that the United States had had a very bitter experience in the 1930s. Indeed, a major motive of the United States was to avoid a repetition of the fragmented world in which American products had been shut out of other markets during the 1930s. And so the United States was intent on achieving a multilateral system rather than allowing regional arrangements, although the United States obviously tolerated, and indeed encouraged, the integration of Europe. Second, integration accorded very well with America’s geopolitical interests. The United States saw itself engaged in a struggle with the Soviet Union. Its desire was to contain the expansion of communism. In that context it was very important to the United States that there be prosperity in the capitalist nations. Therefore, there had to be a systemic prosperity. The United States saw prosperity in Japan, in Europe, and in the developing countries as in its own geopolitical interests, because that would weaken the attraction of the United States’ big geopolitical rival, the Soviet Union. So the geopolitical considerations of the United States led it to stress very strongly a multilateral approach, seeking to obtain liberalization not only for itself and its own goods, but to spread multilateral liberalization so that its allies would also enjoy access to one another’s markets.

Let me also say that it is important to appreciate that trade policy in the United States is not driven solely by the President of the United States. Indeed, the Constitution gives the U.S. Congress the final say in trade agreements. Congress keeps the President on a short leash. It says to him, “You can have a couple of years to go and negotiate, but we will not give up our final authority to provide a verdict on trade policy.” So what you have to understand then is that U.S. trade policy is not the result of the conscious action of a single actor. It is much more the outcome of a political process. People analyze U.S. trade policy as if there is someone who makes it, but there is no single individual who makes U.S. trade policy. It is the result of a political process. One telling illustration of the importance of politics in U.S. trade policy is to look at who the U.S. special trade representatives are. If you go back and look at who has been chosen as the special trade representative, you will find two qualifications stand out: little prior experience in trade policy and a strong sense of the American political system. Understanding politics in the United States is desirable. If you go back, you will find that the U.S. special trade representative, Robert Strauss, had been the head of the Democratic Party, so he really Understood politics. Bill Brock, a later U.S. special trade representative, became the head of the Republican Party. Ron Brown, who had been considered very seriously for special trade representative, was formerly head of the Democratic Party. So when the President of the United States thinks about his special trade representative, he is much more worried about how that person will represent him to the Congress than he is about representation to the rest of the world, because, quite frankly, that is really very, very important in getting trade measures through Congress.

What I would suggest is that in the 1950s and 1960s, by and large, trade was not a highly salient political issue in the United States, and so the President had considerable leeway in exercising his leadership role. And, indeed, when it came to most protection, which was administered when it came to antidumping and other kinds of rules, you could leave it up to the experts to take care of it. But what has happened over the postwar period is that the U.S. economy, like other economies, has become increasingly globalized, and so trade has become an increasingly salient political issue. And as trade has become an important political issue, Congress has wanted to play a more and more active role, and pressure increases on each administration to come back to Congress and bring results. In this context, the United States has been forced to change its strategy from relying purely on the multilateral approach, which proceeded rather gradually, toward shifting to a multitrack approach, toward trying to come up with achievements in a multiplicity of forums. Now a major question is, Are these tracks all leading down to the same goal? Will they converge or will they diverge? There is a major management problem when you are pursuing a policy strategy on a number of tracks. But, nonetheless, what we see today is U.S. trade policy being pursued unilaterally, bilaterally, regionally, and multilaterally.

Trade Policy Approaches

I would now like to turn to the different tracks on which trade policy is being pursued. What is striking is that in each of these areas the issues are primarily those of deeper integration. There remain some issues about border barriers that are being dealt with, but increasingly, in each of those tracks, the questions relate to behind the border, to what was formerly thought of as domestic, policy practices.

Unilateralism

First is the unilateral approach. The United States has had measures in its trade rules, on the books since the 1970s. They take the form of so-called 301 Legislation, but they have only been implemented vigorously since the mid-1980s. Implementing these measures has meant that the United States has challenged foreign countries, in some cases, for not fulfilling international obligations, so-called unreasonable actions by foreign countries where there was an international agreement and now the United States argues that it has not been given what it had been promised, and so it goes to the country and says, “Give us what you promised us or else we will take some form of action or retaliatory action.” Other kinds of actions, so-called unreasonable acts, are when the United States simply differs with the foreign practices. In these cases, the United States has sought to change practices that discriminate against American firms or products, but in which there has not been a GATT or international agreement. In addition, we have seen Super-301 legislation in which the United States has chosen some priority countries, and priority practices, and argued that countries ought to change their practices toward U.S. products, otherwise they would be subject to retaliation.

Some have looked at these American actions and have pointed to them as indicating growing American protectionism. I think that is simply false. It does indicate growing American aggression, aggressive behavior, but it is important to appreciate that these are policy measures fundamentally designed to change the way foreigners are pursuing policies rather than to protect the American market, so it is a desire to open a foreign market. And, typically, although the priorities have been American, the idea has been that the market would be open to all. Nonetheless many see this, justifiably in my view, as a challenge to the multilateral system. It is partly because of this American action that the World Trade Organization (WTO) has been formed, with a much more credible dispute settlement mechanism than has been used elsewhere in the past. The idea would be to channel these disputes into that forum rather than to have them enacted unilaterally. All I would emphasize is that frequently the issues are those of deeper integration. The concerns are over such issues as intellectual property, like an insurance sector, which has been regulated in a protectionist way rather than over tariff barriers.

Bilateralism

A second area where we see this is in bilateral relationships; a big area is U.S.-Japan relations. Clearly, we have a controversy that does not concern border barriers. The United States has pursued a bilateral set of negotiations with the Japanese, which has taken many forms. One major concern has been the allegation by the United States that the Japanese market is unusually closed, that there is an asymmetry of access. American firms and American products find it very difficult to penetrate the Japanese market. Indeed, it is a perception shared not only by the Americans, but also the Europeans and other countries. The United States, however, has chosen to emphasize the bilateral route in dealing with its frictions with Japan, even though, again, once agreements have been achieved, they have been extended on a most-favored-nation basis to other countries. The major thrust is the concern about the allegedly closed Japanese market. There are several approaches to deal with this. First, the argument is, it is not border barriers in the case of Japan, rather it is more invisible barriers. One form of these has to do with government policies where there is a large amount of bureaucratic discretion, where regulations are allegedly applied in a discriminatory fashion. Second, these may also have to do with private practices, where firms tend to have very close relationships with one another, refuse to deal with outsiders, and in particular are grouped in close corporate groupings. There is also the interaction between public policies and private practices in the sense that antitrust or competition policies are barely enforced, and implicitly, or explicitly, this allows domestic firms to collude to keep foreigners out of the marketplace. These are the allegations that the United States makes about its problems in selling in the Japanese marketplace.

There have been negotiations over many, many years. The emphasis by the Bush administration took the form of trying to achieve an increase in the application of competition policies and antitrust policies in the so-called structural-impediments-initiative discussions between Japan and the United States, although there have been many sectoral discussions in which efforts were made to try to change the rules governing foreign participation and, indeed, general participation in the Japanese market. The argument in the United States is really a debate about whether the emphasis should be on changing the rules or trying to ensure results. One group says that the Japanese system is simply too different to have agreements on changing the rules, that these changes would occur too slowly, and what we need to do is to try to ensure results by actually negotiating something more objective than changing a rule. We have to deal with outcomes rather than simply changing the rules.

That is a very knotty problem. The first experience in this area, or what I would consider to be the seminal experience, has to do with semiconductors. In the mid-1980s, there was a semiconductor agreement, in which there was a secret side letter that was not so secret. In the American interpretation, the Japanese committed themselves to giving foreign semiconductors a 20 percent share of the Japanese semiconductor market; the Japanese disputed that interpretation. Nonetheless, there was an agreement that actually had a quota and was a form of managed trade. It involved setting a numerical target. Whether it was going to be mandatory or voluntary is debated, but there was a numerical target set, and what happened over a five-year period, to cut a long story short, was that eventually foreign semiconductors actually increased their share of the Japanese market, moving up from roughly 10 or 11 percent where they had been for many, many years, to around 20 percent. For both sides this was a seminal experience, and the Americans looked at that experience and what they learned was “Aha, results-oriented policies work!” and what the Japanese learned was “Aha, never again!” and that, basically, set the context for the subsequent discussions that occurred between the Clinton administration and various Japanese administrations. The Clinton administration came in, arguing in fact that the semiconductor agreement had been a success, and what we needed was more of them. The Japanese felt very embittered by this experience. They felt that it was wrong to hold the government responsible for the purchasing practices of private Japanese firms, that in fact this policy was inducing an unwarranted intervention by the government into market practices, and so the Japanese government was intent on avoiding similar commitments in the future.

What actually happened was a long and protracted drawn-out battle on sectoral issues. There were many such negotiations. Both sides were forced to compromise and to give a little in terms of the final agreements that were reached. They discovered that it is very complex to carry out such negotiations. One of the lessons that we keep learning is that even the powerful United States is no longer able to carry out its policies independently in this world, that the international capital markets are increasingly looming out there and exercising powerful influences. As the talks between Japan and the United States seemed to be stymied, we saw currency markets reacting, we saw the yen strengthening very strongly. Some saw interest rates rising in the U.S. economy; the interpretation being that the Japanese would be more reluctant to invest in the United States. This was the invisible, if you will, counterweight that the Japanese had, and it did operate to put pressure on the American administration. I think what we had was an agreement originally in principle that objective indicators would be used to measure progress. The American interpretation was that this did not involve quotas or managed trade. The Japanese interpretation was that it could, and they wanted to avoid such use. What we have in these agreements is a commitment to measure progress by some kind of objective indicators. In that sense, some Americans were presumably successful, but it is not clear what the consequences would be if these objective measures did not turn out to be satisfactory. So we have got a rather vague agreement, in my judgment.

Another whole aspect of the U.S.-Japan difference has involved the macroeconomic question. In my view, this has been a greatly mistaken debate, a great error, particularly on the part of the United States, to confuse the discussion about the current account surplus of Japan in the context of a framework agreement that is also talking about a closed Japanese market. There is in economic theory no relationship necessarily between the size of a country’s trade balance and whether or not it is open or closed. And yet, it is irresistible from the American side to use the size of Japan’s trade surplus in making the argument that its market is relatively closed. I mean, we can think of countries—take Mexico in the early 1980s, take many developing countries, many from which you come—when you had highly protective policies you also had large trade deficits. So there is no reason why you cannot have those two things take place and have causal connection between them. And then we can think about countries like Germany, which is a very open economy and has a high international participation both through investment and through trade, and we can see in the mid-1980s the Germans had a very, very large trade surplus, and nobody pointed to their surplus and said, “Aha! You have a closed economy.” This is a macroeconomic phenomenon that reflects saving and investment behavior.

When the United States was trying a few years ago to get Japan to accelerate its economic growth, it should have taken place in the normal setting of the Group of Seven1 discussions on macroeconomic policy rather than making it a bilateral issue. It was a long-run structural question, rather than a trade question. And, indeed, today, given an American economy virtually at full employment, there is no reason to seek stimulus through increased Japanese economic growth. In fact, that growth and a smaller Japanese trade surplus could mean higher interest rates both for the United States and for the rest of the world.

So it was an error—this is just purely my own subjective comment—to integrate these two and, indeed, it is a tragedy in a way that economic policy has involved these two countries like strangers passing in the night over the last few years—on the one hand, the Americans, or some Americans, trying to push for more managed outcomes, and on the other hand, for many Japanese to be arguing that what they need to do is to deregulate their economy. It would seem to me that there has to be more room for concurrence between the two and, indeed, between the developed countries more generally that the real emphasis of the policies has to be on strategies to achieve deregulation, which is a rules-oriented process, but which would open markets and make them more contestable. The Japanese have said they are interested in deregulation and are moving to a five-year program. Thus far, that program looks disappointing, certainly from an external viewpoint, but it does seem that that area is where we need to see more collaboration and discussion and, indeed, it is where we are going to see more collaboration and discussion. One of the striking changes in the United States has been the shift in the composition of the U.S. Congress. The Democrats have been basically beaten in both houses and Republicans are much more interested in pursuing an agenda of deregulation and much less interested in pursuing the alternative approaches.

Regionalism

I will touch very briefly on regionalism, from my vantage point. It is clear that we have seen a proliferation in regional arrangements around the world, and the debate, as I like to frame it is, Are these arrangements stumbling blocks or are they building blocks? Are we seeing the fragmentation of the world economy à la the 1930s, or are we seeing integration in a way that finally combines the regional arrangement in a more liberal, open world economy? Those who see a reaction to the 1930s I think are absolutely wrong. Similarly, there are others who, particularly when it comes to developing countries, point to the experience in trying to have regional integration programs in the 1950s, which was not very successful, and they say these new arrangements that are emerging throughout the world are similarly going to fail. I think that ignores the basic motivations behind these new regional arrangements.

The old regionalism, particularly when it came to developing countries, was heavily driven by a desire to follow import-substitution policies at a regional level. In other words, they were fundamentally protectionist in orientation. The idea was that a group of developing countries could get some economies of scale so therefore they could engage in import-substitution policies more effectively. That, of course, meant that these countries were going to allocate their production on a political basis rather than on a market-driven basis, and they had great difficulty in implementing that approach.

What is striking about the new liberalization measures is that they are taking place in the context of countries who are trying to reinforce their outwardly oriented policies. Mexico is just one example. The Mexicans liberalized multilaterally first and then they joined the NAFTA, partly as a way to lock in those changes and partly to reinforce their domestic liberalization program. In that environment, countries are not trying to get economies of scale and shut the foreigners out of their marketplaces. They are opening their economies, and they see regionalism as a complementary approach. So that is broadly an accurate description of what is taking place and that means in a sense these are moves toward more liberal policies.

A second striking feature of these emerging regional arrangements is the strong role that multinational companies are playing, together with concerns about the role corporations and foreign investment are playing in all of these arrangements. The economic literature has not absorbed this sufficiently; there is still a tendency to look at these arrangements through the traditional prism of removal of all the barriers and to ignore the strong role that direct foreign investment flows are playing.

Certainly, as I mentioned earlier, the regional arrangement in Europe was very strongly supported by major European companies, by Philips, Siemens, and the European business roundtable. If we look at the NAFTA, what we find is strong support by Canadian business, by American business, and interestingly, by Mexican firms, all wanting to see an increased integration. It is a functional desire that the companies have to improve their operations on a regional basis. If we look at Asia, there is no doubt that the regional integration is being led by direct foreign investment, originally by Japanese firms in the mid-1980s moving out of Japan and investing in other parts of Asia, and later by Korean and Taiwanese firms going to invest throughout Asia. Indeed, in Asia, although arrangements are much less formal, regional integration is nonetheless taking place, led by multinational companies. This is a much more deeply embedded phenomenon. These companies are not simply concerned about the removal of the tariff barriers. In the case of Mexico and Canada, a major motive, so far not successful, was to get rid of the antidumping and the countervailing duties, where American trade rules harassed Canadian and Mexican products. So what actually happened in the NAFTA was not an agreement to remove those rules—and so an unsatisfactory resolution—but firms clearly driving and lobbying to try to integrate their economies.

That is actually the good side of the regional initiatives, but the fact that firms are playing a major role also has a dark side. It also means that when those rules are constructed, firms who have political influence try to tinker with them a little bit, so that those inside the arrangements get an advantage over those outside the arrangements. Most noteworthy has been the question of rules of origin. Basically, when you have a free trade agreement you have to come up with some rules of origin to define which products are going to be eligible for duty-free conveyance across internal borders. What has happened in the case of the NAFTA is that these rules have been carefully crafted, particularly in the area of textiles, in a very protectionist way and, indeed, even though the tariff barriers have not been changed, there is a much greater incentive today to use yarn and fiber that is North American. So we do not have an external tariff being raised against the outside world, but we could have serious trade diversion resulting as a consequence of those rules of origin. And so these regional arrangements have to be watched very closely, particularly when it comes to those rules of origin. In the European case, the abuses come to a much greater degree in the administration of the antidumping rules, where again pressures can be brought to get cases resolved in a way that hurts outsiders. Indeed, if we think about reform, it is not in changing the GATT rules that actually apply to regional arrangements, it is really in monitoring the practices on rules of origin and on antidumping.

So nonetheless we are seeing an extension of regional arrangements. The United States is now pledging in the Western Hemisphere to open up the NAFTA, and indeed, the United States, Canada, and Mexico are scheduled to start their negotiations this year with Chile, the next likely entrant into this arrangement. Subsequently, there is an agenda to incorporate other nations from the Western Hemisphere. We also see an APEC arrangement, and I will conclude with a few thoughts on that.

From my own perspective, we have a dramatic agreement at Bogor among the Asia-Pacific countries to achieve liberalization in trade and investment. Getting this vague agreement was politically quite easy, but we are a long way away from solid accomplishments that are going to make that agreement credible.

I can well see why an America that wants to show its desire to be part of the Asian scene would like such an agreement. I can well see why a Japan that is trying to make sure that NAFTA does not exclude it, and other Asian countries who do not want to be excluded, would like to commit themselves to an APEC agreement. We can well see why smaller Asian countries who would like both Japan and the United States to be involved in an agreement would commit themselves to such an agreement. There are strong political reasons why you could believe that the leaders could have come up with this pledge. But the difficult question is, How are they going to make it concrete? What will it all mean? And, quite frankly, there are major obstacles. Let me just say, if they can achieve a free trade and, in particular, if it is an open regionalism where other countries are invited to join on the same conditions—if an African country says, “Look, we will liberalize to the Asians if we are invited to join,” that would be a wonderful achievement.

So as an economist, I am happy that they have come up with such an arrangement, but the political economist in me, looking down the road, is a little more skeptical about the ability to achieve this agreement. The way I understand the strategy that is being laid out is that rather than negotiate to incrementally liberalize as we have done in the series of Uruguay Rounds, the approach in the APEC is to sit down and negotiate an agenda that will take us fully to free trade by a certain date. In other words, we are going to have all the political battles today. If Japan is going to have to commit to free trade in agriculture by the year 2020, the current administration in Japan is going to have to tell the farmers what it is going to do. And we can ask ourselves, “Why didn’t the GATT do that”? Why did we not turn around when we negotiated the GATT and say, “Look, we want to get to free trade; let us all pledge to go to free trade, and we can implement that agreement gradually”? My argument is, it is a terribly difficult thing to do politically. You must pick your time when you choose to liberalize individual sectors, and this is a political judgment that countries have to make. And so in a sequential approach you wait until the group is weak, or maybe even strong and can withstand liberalization, and then you liberalize. But what you do in the context of a universal approach is politically much more difficult, because you will have huge battles: you are going to have all your battles sooner rather than later.

Now, you may well ask then, “Why do we get regional arrangements?” Well, the answer, in my view, is, there is usually a sweetener. Usually, when you say “The United States and Mexico have a free trade agreement,” what is meant is that American firms have been told “You are going to have to liberalize, and you are going to full liberalization with respect to the Mexicans, but there is going to be a little trade diversion that is going to sweeten things for you.” So the American textile industry says, “Yes, we will be happy because we will get free trade in Mexico, we will be able to sell in Mexico, and the Koreans may find it more difficult, or certainly, we will get an advantage over countries who are outside the agreement.” So the trade diversion acts as a political sweetener to offset some of those political obstacles.

Now, think about the whole of APEC. How sweet is it for any individual group of firms, say, in the United States, to be told “Well, you are going to be able to go to free trade in the whole of the Asian region and, by the way, so are the Chinese, and so are the Japanese.” That is not a very protective market for you, and so I believe that you do not have sufficient trade diversion to actually sweeten the deal for groups of firms when you move in such a huge way to APEC liberalization. Now, do not misunderstand me. I would love to see it take place, and I am only an economist who does not understand political forces. And I have been surprised in the past. But I am just saying that that is just one reason why I am skeptical.

I also believe there is a very strong debate between the United States and Japan as to what form this liberalization should take in APEC. As I understand it, the Americans are strongly emphasizing the removal of tariffs, and the Japanese have a different approach that emphasizes collaborative schemes and cooperative arrangements in functional areas in terms of trade facilitation and others, and would rely more on countries to liberalize unilaterally their border barriers. I actually think while border liberalization is useful and important, a lot of the issues, even in Asia, are really about deeper integration. My own preference would be to see a much heavier emphasis on deregulation within the Asian area. We do see a drive for deregulation in Korea and in Japan and in other Asian countries. I would like to see deregulation play a much greater role in the APEC negotiations than it does currently, and I would put less emphasis on the border barrier approach. Anyway, I have not even touched on multilateralism, but it is clearly a complicated subject with which we have been dealing.

Conclusion

Briefly, what I have tried to do today is to argue about the environment in which trade policy is taking place and there I have sounded some alarms. There are worrying signs. Second, to emphasize that the issues are much tougher than they used to be, because we are moving behind the border barriers. And, third, that we are moving in this multitrack approach with initiatives taking place at numerous dimensions, and there, the open question is, Building blocks or stumbling blocks? Are the tracks going to converge or are we seeing fragmentation?

1

The Group of Seven industrial countries comprise Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.