The trade establishment is looking for comfort as supply chain shocks upend confidence in the rules of the global trading system. They’re turning to the same playbook they used in the 1990s, arguing that tariffs, regulations, and export bans are the problem.
The supply chain shocks aren’t due to tariffs or regulations or export bans.
The supply chain shocks are due to a global shortage of personal protective and medical equipment.
The rules of the global trading system incentivized that shortage.
Shortages Lead to Export Bans. The GATT Says So.
Because of the shortage, many countries have concluded that they have no better short-term alternative than to ban exports of essential goods so that they can respond, democratically, to the needs of their people. In fact, the GATT anticipates just such an outcome. This is one of the exceptions to GATT’s export ban:
Export prohibitions or restrictions temporarily applied to prevent or relieve critical shortages of foodstuffs or other products essential to the exporting contracting party.
Do WTO Members consider ventilators and PPE “essential products”? Of course! It’s a pandemic! Does it mean this is an ideal response? Of course not. In an era of enormous aggregate wealth, we shouldn’t have shortages in the first place.
Let’s Keep Doing The Thing That Caused the Shortage
But the trade community struggles to update its thinking to reflect the new reality. As a result, the solutions floating around are the same-old same-old. There is a proposal to create a medical equipment version of the allegedly “successful” Information Technology Agreement. But we have already explored whether agreements like the ITA in fact caused supply chain concentration in China – and the dominance of Huawei. If our duty on a product is zero, then the PRC can use its usual bag of tricks to lure supply chains to its shores, and then export back to the United States duty free, even as it puts everyone else out of business by lowballing prices.
This approach, then, operates against diversification of supply chains. And once a country’s tariffs are zero on a plurilateral or multilateral basis, that country no longer has the leverage to use smaller trading blocs to incentivize the kind of regional integration TPP advocates have argued is necessary to address the China problem.
Rules of origin don’t matter if the MFN rate is zero. As a result, a sectoral “medical equipment” agreement would actually undermine Japan’s effort to expand TPP. Companies use regional agreements to get a leg up on tariffs. If the tariff is already zero, then the regional agreement doesn’t serve as an incentive to source within the region. (As it is, the Japanese effort will, as we discussed last week, fall short unless the TPP rules themselves are reworked to shift away from, rather than reinforce, Chinese supply chains.)
But if you want a Huawei of medical equipment, then an ITA-type deal is a good way to go. Otherwise, yes, waive tariffs in the short-run, but think carefully about the incentive structure you’re creating before you decide to waive them permanently.
And if you think you’re going to dodge that bullet by creating a sectoral agreement that excludes China, well, let me introduce to you to TiSA. The United States kept China out of TiSA – while our allies clamored for us to let China in.
Comparative Advantage is a Euphemism
The theory of comparative advantage has been used to justify this approach for years. But it operates against what we have come to realize we need: diversification. Comparative advantage is just a fancy way of describing cross-border rationalization of resources — or, offshoring entire industries in the name of “efficiency.”
Today, we are learning that there is some benefit to having England and Portugal both make cloth and wine (or, for a more contemporaneous take, medicines and medical equipment). It’s not either/or. No, not every country is in a position to make equipment, and cooperation will be necessary to make sure there’s enough to go around, especially in developing countries. But that won’t magically happen by getting rid of tariffs.
The WTO Thinks Regulations are the Problem
For its part, the WTO is not solely focused on tariffs. It is advocating some sort of regulatory cooperation as part of the solution. But again, these stale solutions miss the mark. The problem is not regulations! The problem is a production shortage. Making it about deregulation is a “Let them eat cake” moment for an institution that seems unable to relate to reality or modernize its thinking.
Trade experts shouldn’t just serve up the same answers they’ve had since Seinfeld was must-see-TV. They should be figuring out how trade rules can be reconceived to mitigate the risk of having these kinds of shortages in the first place.
Fossilized Thinking Will Sideline the WTO
Unless the trade establishment updates its playbook, the “rules-based system” will, at best, be seen as irrelevant to the lives of most of the 7 billion people on this planet. At worst, it will continue to be seen as a system that promotes returns to capital while leaving workers behind. (Do most people on Earth care more about the Appellate Body, or whether their workplaces crush them to death? Guess which of the two issues the WTO is focused on?)
We must confront the fact that the existing rules of globalization have put friendly nations in a beggar-thy-neighbor situation with respect to life-saving equipment. When there’s a shortage, removing barriers to trade relocates the shortage from one country to another – it doesn’t solve the shortage itself. Democratically elected governments feel their first responsibility is to protect their own citizens. No trade rule will alter that dynamic.
Fix the Shortage! Permanently.
The only answer is to fix the shortage. Even firing up the Defense Production Act (which should have been done in January) won’t solve the shortage in the long run. As long as the global marketplace does not operate on market-based principles, any producer required to make a profit to stay in business will eventually fail when a non-market actor decides to occupy the space. Steel and aluminum are prime examples; everything on the Made in China 2025 list is next.
The old playbook doesn’t account for this dynamic, because the old playbook is premised on a rules-based system that only allows market-oriented players in the game. But in today’s system, we’ve got clean players up against doped players.
If we are serious about preventing the kind of shortages we see now, then, unless we change the rules of the system, we are going to have to expect newly-created DPA capacity to operate at a loss. And we are going to have to subsidize those losses, if we want to keep the capacity. In this way, the PRC exports state capitalism – directly, or indirectly.
In an ideal world, export bans wouldn’t be necessary. But the ideal world doesn’t actually exist. In the real world, market distortions have left us all vulnerable to supply shortages that are killing people.
There’s an ancien regime feel to the discussions going on in elite circles, a profound obliviousness to the cause of the current trade crisis, or the effects. As a result, there’s seemingly no capacity to find a real remedy.
Indeed, the old playbook contributed to the upheaval we see in the system today. Reverting to that playbook is going to aggravate the problem, not solve it.
April 7, 2020