Geopolitical strife? Let’s do a trade agreement!
The latest version of this strategy involves Taiwan. China is a geopolitical concern; Taiwan is an ally; ergo, the United States should do a trade agreement with Taiwan, because it will reinforce economic relations between the two.
Which two, though, is the question. Taiwan and the United States? Nope. China and the United States.
The model for this type of agreement came of age during the euphoric aftermath of the collapse of the Soviet Empire. As I testified before the Senate, policymakers bought into the Francis Fukuyama “end of history” line of thinking, where economic liberalization would lead to political liberalization. Fukuyama specifically referenced China and discounted the risk of backsliding. To his credit, Fukuyama now recognizes his mistake.
It’s critical to understand the underlying purpose of that particular trade paradigm — and the nature of the regional and bilateral trade agreement model that flows from it. The purpose of that model isn’t to create regional trading blocs. It’s to liberalize trade flows.
They aren’t the same thing! In fact, they are in direct opposition to each other.
If you want to create a regional trading bloc, your goal is to maximize sourcing within the region. You design rules to do that, by making duty-free treatment contingent on sourcing within the region.
But if you want to liberalize trade, then your goal is to maximize the volume of trade that circulates duty-free. And that means you design the rules to maximize capital’s flexibility to source from anywhere – including outside the region.
That’s why TPP talks about boxing out China — while, for example, allowing 70% of the content of medical equipment to come from China. TPP was negotiated using a liberalization model, not a regional trading bloc model.
During the “competitive liberalization” strategy that Ambassador Zoellick embraced in the 2000s, the United States negotiated agreements with a dozen countries using the liberalization model. And it just so happens that I was the USTR supply chain lawyer for most of that period.
USTR’s philosophy in negotiating these rules: if we don’t make it here, we don’t care where it’s made. This philosophy is reflected in the 2015 Trade Promotion Authority statute’s repeated deployment of the phrase “global value chains.” That’s code for getting stuff as cheaply as possible from anywhere in the world – and is contrary to the geopolitical goal of building regional trading blocs.
The more we offshored manufacturing, the less we made here, the more we loosened up these rules in every subsequent agreement, which then became the template for the agreement after that. The rules of origin in the new NAFTA aren’t stronger than those in TPP because the Trump Administration strengthened them. They’re stronger because they were originally negotiated in the 1990s, when we hadn’t yet offshored quite so much of our manufacturing base. But even the NAFTA industrial rules allow a significant amount of content to come from China. (The agricultural rules are a different story. They’ve always been strong.)
It is my guess that for some of the industrial goods trading under American trade agreements, as much as 90% – maybe more – of the content of those goods comes from China. Under competitive liberalization, the industrial rules were designed to facilitate just that result. And that will continue to be the case if we dust off our usual model and apply it to Taiwan. China is Taiwan’s main trading partner! An American FTA with Taiwan will just be a pass-through for Chinese content unless we radically overhaul the way we do these deals.
As a result of COVID, we finally respect the importance of having a core manufacturing base, and we understand the importance of diversifying away from concentrated industrial Chinese supply chains. But we assume that regional trade agreements are the solution to the China problem, whether it’s Taiwan, or TPP. The lack of understanding of what these rules actually incentivize is leading policymakers to push for agreements that do precisely the opposite of what they think these agreements do. This model embeds our dependence on China instead of diversifying away from it.
Even as both parties talk about the importance of onshoring, we’ll be pursuing agreements that lock in the offshored status quo. Think of the logic: the economic rise of China is a new geopolitical threat. We must confront it. Let’s use the liberalization model that allowed all these products to be sourced from China in the first place. It makes no sense.
And let’s not forget that this “liberalization” approach is currently being applied to data. So we’re prohibiting data localization and facilitating cross-border data flows – without protecting against having all the data end up in China. Gulp.
Is there a way for us to meet the challenge of China by cooperating with allies, including Taiwan? Absolutely. Some ideas:
- Stop assuming these “comprehensive” deals are the only way to move forward. No, the new NAFTA is not the new template. The sizable margins of support in both Houses of Congress are attributable to the fact that Members had the opportunity to upgrade an existing agreement with a country that has struggled to respect worker rights. The Brown/Wyden mechanism for labor enforcement was a critical component of Member support. None of those dynamics will apply to new agreements. Moreover, there are a lot of noxious provisions buried in these agreements that Congress hasn’t even begun to unearth. Speaker Pelosi’s concern over CDA Section 230 – shared by other Members – is just the beginning of a recognition that these agreements are rife with provisions that are designed to frustrate Congress’ own ability to change the law.
- Focus on specific supply chains. Taiwan can indeed be an important source of supply chain diversification. We should be identifying critical supply chains and evaluating how we can work with Taiwan to diversify them away from China.
- Face up to currency manipulation. Economist Brad Setser as usual is vigilantly observing who may be engaging in currency manipulation as countries struggle to address the economic consequences of COVID. He’s paying attention to Taiwan. If we do any kind of deal with Taiwan, we must have real currency manipulation rules in place. It remains a source of fascination that we continue to think the big lesson from the 1930s is Smoot-Hawley, when free trade economists like Doug Irwin point out that the more problematic beggar-thy-neighbor policies involved competitive currency devaluations. Can we finally learn the right lessons from history?
Trade agreements are too often offered up as superficial feel-good gestures, but they have profound feel-bad consequences because they are based on anachronistic model. We can – and must – do better.
September 29, 2020
