(Mis)managed Trade

by Claude E. Barfield
The author is coordinator of trade policy studies at the American Enterprise Institute.

During the 1996 primaries and general election campaigns, openly protectionist trade proposals advanced by Patrick Buchanan from the right, by Ross Perot, and by Rep. Richard Gephardt (D. Mo.) from the left did not fare well with voters. The issue of free trade versus protectionism, however, continues to divide Americans; and since the election, neither Buchanan nor Gephardt has given up the fight. Indeed, both have mounted spirited challenges to the expansion of free trade areas in South America and the inclusion of the People's Republic of China in the World Trade Organization.

Buchanan in particular represents a striking throwback to earlier, more nakedly protectionist policies. But his position, though misguided, is refreshingly honest -- almost wholly devoid of the deceptive cant forthcoming from many policymakers and opinion leaders who are often heard to say, "I am for free but fair trade," or "I am for free trade with a level playing field."

Despite the recent failures of explicitly protectionist rhetoric to garner voter support, proposals for government intervention to manage trade in the name of opening foreign markets represent the flip side of the government interventionist coin. Managed trade can involve the government of a country limiting the exports of its enterprises to the United States or even to third countries under pressure from U.S. officials. It can involve a country's government "guaranteeing" a percentage of its market to American exporters. Or managed trade can take the form of a government agreeing to change its regulatory regime in a way that harms its own enterprises, to give American firms a competitive advantage.

The Reagan and Bush administrations, although publicly espousing free trade, undertook "temporary" managed trade policies for automobiles, steel, and semiconductors. But the effort was left to the Clinton administration to transform supposedly temporary expedients into a formal policy of "results-oriented" trade.

Certainly it is advantageous for a country to remove its barriers to imports from the United States and other countries. Such restrictions simply punish a country's consumers and its industries that rely on imports.

Managed trade and old-style protection share many characteristics. In both situations, bureaucrats rather than private individuals and enterprises make decisions concerning what is bought and sold. In both situations, special interest groups profit by enlisting the government not to open markets but to manage trade flows. Furthermore, in both situations, government controls limit the freedom of individuals and enterprises to trade. And even further, in both situations, the policies are inconsistent with free markets and limited government. Managed trade is distinct from old-style protectionism, more in operation than in outcome or even intent. This chapter points out the similarities between the two styles and the flaws of managed trade.

That Old-Time Protectionism

The classical form of trade protectionism is found today in the views of Pat Buchanan, Ross Perot, and Rep. Richard Gephardt among others. They believe imports rob Americans of jobs and render the country less competitive. They maintain that trade deficits are problems needing some solution. Yet, the notion that restricting the freedom of individuals to trade with one another will somehow create wealth is valid neither in economic theory nor in fact. The advantages of free trade are acknowledged by libertarian, conservative, and liberal economists alike.

An interesting yet ironic aspect is that the baldly protectionist prescriptions of advocates such as Buchanan, who claim to favor limited government, would have consequences perhaps contrary to the ones they hope for. For example, Buchanan calls for "social tariffs" to compensate for differential wage rates in individual countries. Thus, low-wage Mexico would face higher American tariffs to "equalize" wages. But if adopted universally, such a policy would have unintended and surprising consequences for the United States.

A social tariff policy would be aimed principally at the less developed countries, even though 60 percent of U.S. trade remains with developed countries, not low-wage ones. With such a policy, given the higher total labor compensation among many of America's most important trade partners, this country could face social tariffs against its exports. Germany and France would have to place a 25 percent tariff on American goods to "equalize" wages. Japan would have to place the tariff at 15 percent, up from its current overall tariff rate of less than 3 percent.

Such an outcome is certainly not what Buchanan and other protectionists intend -- nor could support. Consequently, the more unapologetic kind of protectionism has not caught on.

Unfair Trade: Foundations
of a Flawed Policy

But even though classical protectionism has been slow to revive, an economic danger still exists. Over the past few decades, but particularly in the 1980s, the U.S. government greatly expanded its definition of what constitutes "unfair" trade as well as the remedies for overcoming alleged unfairness. Two major instruments were vital to such expansion: antidumping laws, and Section 301 of the Trade Act of 1974. Both have become the instruments of choice to coerce other countries into accepting the recent favored forms of protection: voluntary export restraints (VERs) and voluntary import expansion (VIE). A typical and ominous pattern has emerged, in which the U.S. government first threatens to invoke antidumping duties or Section 301 but then settles for "voluntary" solutions by the allegedly offending country. Each is examined as follows.

Antidumping as Antitrust

Early in the 20th century when they were first introduced, dumping laws were tied directly to antitrust policy. The theory behind antitrust laws held that firms offering goods or services for prices that were "too low" (below the costs of production) were actually engaging in predatory pricing to drive competitors out of business and allow a firm to establish a monopoly.

As with antitrust laws, laws against dumping initially placed the burden of proof on the accuser who had to show that a foreign competitor had used "predatory" pricing to monopolize markets. Because the tough standard produced few triumphs for domestic producers, the definition gradually was broadened. "Unfair" was applied to differential pricing between the home country and importing country; alleged pricing below the costs of production plus reasonable profit was also deemed unfair.

"Not in Violation But . . ."

Section 301 gives American firms the right to petition the U.S. Trade Representative (USTR) for remedial action against any "act, policy or practice of a foreign country that is unreasonable or discriminatory and burdens or restricts U.S. commerce." Such acts usually include differential regulatory, tax, or performance standards treatment.

If the USTR grants that a complaint is valid, then it must negotiate a settlement within 18 months or devise some form of retaliation -- through raising tariffs or other means.

Early interpretations of Section 301 limited its applications to redress for violations of negotiated trade agreements. Subsequent revisions of U.S. trade law in 1979, 1984, and 1988, however, greatly expanded the scope of Section 301 to include any other "unreasonable" act, policy, or practice that is "not necessarily in violation of or inconsistent with the international legal rights of the United States, but is otherwise deemed to be unfair or inequitable." One act that the 1988 law specifically declared unreasonable was denial of the right of establishment, which means that a foreign company is not allowed to create a local corporate presence. Another was denial of workers' rights -- for example, the right of workers to organize and strike. Yet another was tolerance by a foreign government of anti-competitive activities by private firms; such activities might, for example, deny distributors selling a firm's products the right to sell competing products.

It should be noted that the recent Uruguay Round negotiations of the General Agreement on Tariffs and Trade (GATT) do not absolutely prohibit unilateral sanctions; but the agreement does stipulate that nations must first use the new World Trade Organization (WTO) dispute settlement procedures before resorting to such sanctions. The United States maintains that, ultimately, it still retains the authority to retaliate against allegedly unfair traders.

Although both antidumping suits and direct retaliation under Section 301 have become important tools in the arsenal of American protectionists, the United States has often settled trade disputes through the more informal, though equally protectionist, negotiation of VERs and VIEs. Especially in the cases of the politically powerful automobile and electronics industries, successive U.S. administrations have preferred those approaches to the more legalistic and time-consuming antidumping and Section 301 procedures.

VERs: The Case of Automobiles

The oil shocks of the 1970s dramatically shifted American consumer demands toward smaller, more fuel-efficient cars. As a result, between 1978 and 1981 the share of Japanese imports, mostly smaller cars, into the American market increased by almost 50 percent, from a share of 17 percent to 26 percent. Meanwhile, more than 200,000 American auto workers found themselves unemployed.

The first VER, which pertained to automobiles, was negotiated with a wink and a nod by the Reagan administration in 1981. Fearing that Congress might pass legislation directly aimed at curbing those imports, and with the threat of a wave of antidumping suits, the Reagan administration and the Japanese government agreed to a "voluntary" annual ceiling on Japanese auto imports. Although granting relief to a purportedly beleaguered U.S. automobile industry, the results were hugely expensive for the American economy, particularly for consumers. The genuine beneficiaries were Japanese and European auto makers, who reaped high profits on the automobiles they did sell in the United States -- an estimated $2 billion for Japanese and $1.5 billion for European auto makers in 1982 alone. With fewer autos available to American consumers, and with less competition, all manufacturers -- Japanese, European, and American -- were able to charge higher prices.

Robert Crandall of the Brookings Institution has calculated that the informal quota added about $2,000 to the price of a midsize American car. Other economic studies have revealed that the cost per American auto worker job supposedly "saved" was $180,000.

The Myth of Mighty MITI

The restrictions on Japanese auto imports had another unintended consequence. In the early 1980s, many American politicians and industrial interest groups were raising the specter of an all-powerful Japanese Ministry of International Trade and Industry (MITI), a body assumed to be busily manipulating world markets and trade flows. In fact, much of MITI's advice and many of its policies did not help the Japanese economy. For example, in the early 1960s, MITI advised Japanese auto manufacturers to produce only a few vehicle models rather than produce the diverse line of cars that they were later to sell successfully in the American market. But critics correctly maintained that MITI tended to act in ways that restricted imports into Japan's market.

Ironically, the restrictions on Japanese auto exports to the United States further empowered MITI bureaucrats: It was MITI that parceled out the quotas to individual Japanese auto companies and made the key decisions concerning who received the largest shares of the $2 billion in windfall profits from higher prices charged in the American market. In retrospect, students of Japanese government have noted that during the 1970s, as Japanese corporations became more global, MITI was gradually losing power but U.S. policy gave that body a temporary new lease on life.

Another example of the adverse effects of managed trade is the fact that, while the U.S. auto import quota system has lapsed, MITI retains a strong guiding hand in an even more tightly binding quota system for Japanese exports to the European Union. That supposedly voluntary system was also negotiated with Europe in the mid-1980s; its stated aim has been to allow European car producers time to adjust to Japanese competition. Although that system is slated to end in 1999, the president of Peugot, the French auto maker, recently called for an indefinite extension. With the European economies facing high unemployment numbers and slow (or no) economic growth, pressure for such an extension will be a true test for the European Commission. Rather than enjoying freedom to trade, European and Japanese citizens and enterprises have their transactions managed by bureaucrats.

VIEs: The Shift to Export
Protectionism

Although forced to impose import restrictions on automobiles, the Reagan administration was aware that VERs were a clumsy and costly political expedient. Driven by the high U.S. dollar and a rapidly expanding economy, a trade deficit burgeoned in the mid-1980s. Such deficits are not an economic problem per se. They simply demonstrate that citizens of one country purchase more products than citizens of another do. In the 1980s, the deficit was an indication of America's prosperity.

Still, the Reagan administration felt it had to deal with the deficit, by instituting more export-oriented trade policies. Beginning in 1985, the administration made selective use of Section 301 to open up foreign markets to American exports. Between 1985 and 1989, 33 Section 301 cases and 217 antidumping actions were initiated.

The Reagan and Bush administrations were also responsible for moving toward VIEs, at least on an ad hoc basis. In 1986, the Reagan administration negotiated a semiconductor agreement with Japan, an agreement that combined some of the worst and most costly features of earlier automobile quotas along with a new demand for special privileges in the Japanese semiconductor market. For example, the import restrictions set such a high floor price on basic semiconductor chips that later economic analyses calculated that they had resulted in a transfer of more than $5 billion of profits to Japanese semiconductor producers -- a sum promptly plowed back into semiconductor research and development.

Of equal significance, the United States forced the Japanese government to help ensure that foreign suppliers would gain 20 percent of the Japanese market. That market share target was set out in the supposedly secret sideletter accompanying the agreement in which the Japanese government acknowledged the American expectation that foreign semiconductor suppliers would achieve 20 percent of the Japanese market within five years. The Japanese government stated its belief that "this (percentage) can be realized and welcomes its realization."

During the Bush administration, the semiconductor VIE was extended, and that administration negotiated a second VIE for automobile parts. The latter was notable for two reasons. First, unlike with the semiconductor agreement, the Japanese government did not officially undertake the achievement; that effort was left to Japanese private companies. Second, the agreement favored American companies specifically, stating that "special consideration will be given to the U.S. parts industry, which is currently under a difficult situation."

Clinton's "Results-Oriented" Policy

Although both the Reagan and Bush administrations have much accountability for their abetting the drift toward managed trade, it was the Clinton administration that em-braced managed trade as the centerpiece of the U.S. trade agenda. From the outset, U.S. Trade Representative Mickey Kantor and the late Commerce Secretary Ron Brown stated that "measurable results" and "objective criteria" would form the basis for future U.S. trade agreements. As Kantor put it, "if you don't get real numbers in an agreement, you'll effectively have nothing." He likened the demands on the Japanese government to "affirmative action" programs in the United States.

Laura Tyson, then chairwoman of the Council of Economic Advisors, also defended VIEs, but with a nuance. Pointing specifically to so-called strategic industries, she argued that a results-oriented approach "may be essential if barriers to critical foreign markets are causing serious harm to domestic producers in important high-technology industries."

Organizations representing U.S. domestic producers quickly rallied behind the Clinton administration's new dirigiste tilt. Both the Advisory Committee on Trade Policy and Negotiations (ACTPN), a business advisory group to the USTR, and the Council on Competitiveness, another trade-related business group, issued a report strongly backing numerical trade targets, particularly regarding the Japanese market. Also, the ACTPN report stated that "failure to achieve the indicator (target) within a pre-agreed time frame would call for internal review in the United States, and/or bilateral discussions to determine what additional measures are necessary to achieve the result, possibly leading to retaliation."

From the outset, as a part of new "framework negotiations," the Clinton administration demanded that the Japanese government agree to guaranteeing quantitative benchmarks in four sectors: (1) automobiles and automobile parts, (2) medical equipment, (3) telecommunications equipment, and (4) insurance.

In the 1996 negotiations to renew the pact, the United States demanded continued government-to-government oversight of the semiconductor industry in Japan and its trade with America. To their credit, the Japanese adamantly refused to continue oversight. Unfortunately, industry associations in both countries, at the urging of their governments, will create the World Semiconductor Council to collect data and make suggestions to the governments. More ominously, the United States and Japan will create the Global Government Forum to receive reports and recommendations from the council. Those actions seem to set the stage for a more formal version of the ad hoc managed trade in semiconductors that began a decade ago.

Automobiles, Unilateralism, and the WTO

The major battle over targeted import quotas, concerning American auto and auto parts exports, was fought in the first half of 1995. Despite claiming victory, the Clinton administration backed away from retaliation when the Japanese government firmly refused to guarantee a share of the auto and auto parts market to American companies.

Events leading to that confrontation had a bizarre, even random, quality. Although the Clinton administration had given priority to the automobile sector during the initial talks in 1993, regarding the U.S.-Japan framework, it reacted calmly in July 1994 when Ryutaro Hashimoto, then trade minister in Japan, resisted U.S. demands for quantifiable import targets. During the fall of 1994, Commerce Undersecretary Jeffrey Garten and others indicated that the administration was seeking "other methods" for dealing with the Japan problem. Understandably, then, the Japanese government was quite surprised when suddenly, at the end of March 1995, Clinton spokesmen reversed course -- and rhetoric -- and moved toward a confrontation.

Undermining GATT

One other important event occurred during that period: The new multilateral trade rules adopted by the Uruguay Round of the GATT came into force on January 1, 1995. The newly created WTO had a much stronger dispute settlement process than that under the old GATT. Establishing that process had been a top U.S. priority. Although the new rules did not preclude a country from taking unilateral action, they did demand that grievances first be taken to the WTO. Furthermore, the rules forbade a country from unilaterally changing bound tariffs unless a WTO panel found the alleged offending nation guilty.

U.S. demands on Japan essentially involved three issues: (1) increased purchases of U.S. automobile parts by Japanese manufacturers, both in the United States and in Japan; (2) a fixed number of new dealerships in Japan offering American-made autos by the end of 1996 and the year 2000; and (3) easing of some of Japan's restrictive inspection rules for critical auto parts. One problem Japanese negotiators experienced (as did the media reporting on the negotiations) was the clearly duplicitous public and private stance of U.S. negotiators. As the deadline for a settlement, June 30, 1995, neared, American negotiators reiterated that they were "not after numerical targets," in the words of Jeffrey Garten. Yet it was clear that the United States, at the negotiating table, did push for both specific numbers and for some kind of endorsement by the Japanese government for validity of the numbers.

Section 301 Bullying

In early May 1995, with Hashimoto and his cohorts refusing to accept targets, Kantor invoked Section 301 and threatened to impose 100 percent tariffs, at a total cost of $5.9 billion, on 13 luxury Japanese car models exported to the United States, unless Japan changed its position by June 28, 1995. At the same time, the United States announced its intention to take the case before the WTO. Japan responded to the U.S. threat by steadfastly refusing to agree, by fixed dates, to numerical targets. Japan also announced its own intention to appeal to the WTO if the United States indeed invoked sanctions unilaterally.

The result of the U.S.-Japan clash serves as an object lesson in Washington public relations spin. President Clinton hailed the achievement of "real concrete results" that were "specific" and "measurable." Kantor, straddling the boundary between obfuscation and outright misstatement, later claimed that the "increased commitment by Japan can be enforced by U.S. trade laws." Both the President and Kantor wanted the public to believe that, once again, the Japanese government had itself signed off on a government-to-government guarantee for additional market share for U.S. (and foreign) automobile companies.

Such an interpretation was flatly belied by the documents actually signed by the two governments -- and by statements from Japanese officials at the signing and later. An alleged $6.75 billion increase in sales of American automobile parts to Japanese manufacturers, hailed by the Clinton administration, was merely a compilation of business plans announced independently by a group of Japanese automobile companies. The official communiqué from the two governments, which was widely publicized by the Japanese government, explicitly acknowledged that the plans "are not commitments . . . . Rather, they are business forecasts and intentions of the companies based on their study of market conditions . . . . Both ministers recognize and understand that changes in market conditions may affect the fulfillment of those plans." More surprising, the United States agreed to the explicit concession that the plans "are not subject to the trade remedy laws of either country," seeming to foreclose -- despite Kantor's disclaimer later -- the use of Section 301 for automobile parts.

Regarding increased foreign dealerships, the Japanese government merely agreed to send letters affirming the freedom of companies to establish multiple-brand dealerships. Furthermore, Japanese companies agreed to appoint a contact person to facilitate joint dealerships.

Finally, the Japanese government agreed to ease regulations for independent auto repair shops that compete with dealer shops and to expand the list of parts that did not require strict certification.

WTO Rules

In the Uruguay Round, the United States had insisted on the new dispute settlement procedures. As mentioned earlier, the rules did not prevent a nation from retaliating unilaterally against an alleged unfair trade practice but they did circumscribe unilateral action in two ways. First, they required WTO nations to use the procedures of the multilateral dispute system before retaliating. Second, they forbade retaliation by increasing WTO-bound tariffs with the offending nation, action which would have violated the multilateral unconditional most-favored-nation rule.

One of the most damaging actions the United States took during the confrontation on Japanese automobiles was announcing that it was prepared to flout the new rules by imposing punitive tariffs against Japanese automobiles before undergoing the WTO dispute settlement process. Although the matter was settled before the threat could be carried out, the United States had, in effect, announced to the world its willingness to destroy the new system that it had itself demanded as an accompaniment to the new substantive rules of the Uruguay Round. There could be no worse example for other nations that might enter trade disputes in the future.

Arguments for VIEs: The Flaws

Over the past three years, administration officials have advanced a variety of arguments defending the use of VIEs. Five of those claims are (1) that VIEs are a means of reducing America's trade deficit with Japan, (2) that the disparity of import penetration in targeted sectors proves that the Japanese market is closed to foreign companies, (3) that in key sectors the tightly organized Japanese keiretsu system of exclusive supplier agreements and business ties precludes foreign competition, (4) that U.S. demands for import targets benefit all nations in the international system, and (5) that temporary VIEs for U.S. companies will not undermine the multilateral trading system. But all of those arguments are questionable.

1) Trade Deficits. Clinton administration trade officials have repeatedly argued that targeted import quotas constitute an indispensable tool in reducing the U.S. trade deficit. As the late Commerce Secretary Ron Brown put it, "The only logical way . . . to address the trade deficit is to have some measurable results, some targets."

As is often the case, however, one part of an administration does not know what another part is arguing; thus the party line gets muddied. Indeed, President Clinton's chief economic adviser, Joseph Stieglitz, in the 1996 Economic Report of the President, flatly -- and correctly -- rejected the economic fallacy that targeted import quotas will change the overall size of the U.S. trade deficit. As the report stated, the trade balance "represents the bottom line on the income statement of the United States. If it is positive, the United States is spending less than its total income and accumulating assets. . . . If it is negative, as it has been in most recent years, our expenditures exceed our income, and we are borrowing from the rest of the world." The report concluded: "The continuing external deficit remains a cause for concern, but it must be kept in mind that the deficit is caused by macroeconomic factors, not trade policy. It should not be used as a test of whether our trade policy is beneficial."

A consensus among economists holds that if all trade barriers between the United States and its trading partners were to be removed, the U.S. trade balance would change by no more than 10 to 15 percent. That consensus is the chief reason the President's own Economic Report pointed out that "the most effective policy option for reducing the trade deficit is the reduction or elimination of the Federal budget deficit." One lesson, then, certainly must be "Mickey Kantor, call home!"

2) Disparity in Import Penetration. Another often cited argument for mandated import targets is that Japan or other countries might be importing less than the average amount of market share that American goods hold in other countries or regions. For instance, to support renewal of the semiconductor pact, the USTR argued that because American firms had 50 percent of the European market and 40 percent of the Asian market, excluding Japan, their control of only 20 to 25 percent of the Japanese market was proof of trade barriers.

That claim truly is economic and statistical nonsense. It completely ignores the fact that Japanese companies are the only worldwide competitors with U.S. semiconductor producers and naturally, as with U.S. companies in the U.S. market, they will have a strong position in their own home market. Indeed, the Japanese could well turn the tables on the U.S. government, using the same flawed logic. Japan's worldwide semiconductor market share is about 40 percent; yet it has attained only about 20 percent of the European market and 23 percent of the U.S. market. Why should it not then file an unfair trade practices suit against the United States and Europe if the U.S. position is to hold for all that wish to stand by it?

Concerning automobiles, the U.S. assertion that low market share is only the result of unfair Japanese trade practices will not endure any analysis of the history of American automobile companies' involvement in the Japanese market. Those companies, by their own admission, have rarely exerted much effort to penetrate the Japanese market. As Chrysler chairman Robert Eaton stated in 1994, "We expect to be only a niche player. . . . We don't have any volume or penetration goal [for foreign markets]."

Until 1993, no American automobile company produced a right-hand-drive vehicle for the Japanese market. Even today, none of the Big Three firms, General Motors, Ford, and Chrysler, market models in the small two-liter-and-under class, which is the dominant class in the Japanese automobile market. In contrast, the Europeans, whose market penetration is growing rapidly, offer more than 100 right-hand-drive models and 124 models in the two-liter-and-under category. In 1993, European automobiles, mostly German, captured over one-third of the Japanese luxury auto market.

Such reality recently led one trade policy analyst to conclude that, like other American industries, the automobile industry "has been trying to gain a competitive advantage that would not be attainable in the absence of U.S. government pressure or threats."

3) Keiretsu. Even relatively moderate critics of Japan, such as Tyson, and trade economists C. Fred Bergsten and Marcus Noland, both of the Institute for International Economics, have identified the keiretsu as an important barrier to competition in the Japanese market. There are several types of keiretsu. Most critics have focused on the so-called vertical keiretsu, which are characterized by long-standing contractual or interfirm relationships and exclusive contracts between upstream and downstream suppliers and manufacturers. In some instances, according to Bergsten and Noland, the existence of "discriminatory networks of affiliated firms" justifies the institution of VIEs.

On closer examination, however, the arguments against the keiretsu are fraught with difficulties and contradictions. One should recall that the keiretsu are merely a form of industrial practice and organization. It is true that in the United States, at least until recently, a form of vertical integration much tighter than the keiretsu was the norm in most sectors. Thus, in the automobile industry, rather than outsourcing the production of many of their parts and components, the Big Three kept production within their own corporate confines. The situation changed in the 1980s when Chrysler and Ford began to outsource a good deal of parts manufacturing and developed a keiretsu-like relationship with many of their new suppliers. Today, Chrysler makes only about 30 percent of its parts in-house, and Ford only about 50 percent. General Motors has lagged far behind in that regard, but as a recent strike demonstrated, the company now is determined to increase its efficiency by outsourcing a larger percentage of production in the future.

In contrast, in the semiconductor industry -- the subject of much trade conflict between the United States and Japan -- IBM is not only a major computer manufacturer but also a semiconductor manufacturer. Indeed, it produces in-house most of the semiconductors that it supplies to its computers.

Can one imagine the reaction of the Big Three, IBM, or the USTR if Japanese companies demanded that those companies be broken up because Japanese companies could not compete against in-house parts manufacturing?

As economist Paul Sheard of the University of Melbourne recently wrote after an exhaustive analysis of the keiretsu practices, "popular discussion associating keiretsu with anticompetitive behavior lacks a solid foundation in economic analysis." Similarly, economist Gary Saxonhouse of the University of Michigan queried, "Why is formal vertical integration in the United States better or fairer than informal integration in Japan?"

4) Open for All. Although successive U.S. trade representatives have avowed that the goal of VIEs and other unilateral demands is to open markets for all nations, the results belie those virtuous claims. Thus, South Korea initially opened up its insurance markets only to U.S. insurance companies. The powerful European Union later also forced its way into the Korean market, but for small countries Korea said, "Forget it." Canada, when threatened with a Section 301 suit against egg and dairy producers, merely doubled the U.S. quota without changing total imports. In other instances, such as for automobile parts and beef, the EU and Australia have complained bitterly that even though no official discrimination exists, Japanese companies have routinely favored U.S. companies, to relieve pressure from the U.S. government. Finally, there has been the spectacle of cash-rich Taiwan and South Korea organizing shopping tours by their companies. One such trip by Korean companies netted over $2 billion of largely trade-diverting purchases in 1987.

Thus, managed trade is contrary to the freedom to trade goals that American policymakers have appropriately sought in the nearly 50-year history of the GATT. The goal of trade policy under the GATT has been to remove governments and bureaucrats from economic transactions between individuals and firms in different countries. Because elimination of all government involvement has, unfortunately, not been possible, governments have pledged themselves at least to abide by basic rules. Most notable is the most-favored-nation principle, by which countries agree to have nondiscriminating tariffs and other barriers to other countries. The record of managed trade is a record of greater government involvement in trade and explicit discrimination for or against certain countries.

5) Temporary Arrangements. Finally, supporters of VIEs have argued that they are containable and will be used only in special situations. If the history of the U.S.-Japanese automobile and semiconductor negotiations is any indication, however, the demand for VIEs is likely to spread and extend far into the future, vitiating multilateral rules in the process.

As many critics of the original U.S.-Japan semiconductor agreement predicted, the United States was not satisfied when foreign semiconductor imports into the Japanese market reached 20 percent. It had demanded, without disclosing what it considered a reasonable percentage of the Japanese market, that the agreement be extended indefinitely. Further complicating matters, the EU, which has severely criticized the current agreement as discriminatory against European companies, has recently demanded that it be included in any new agreement signed by the United States and Japan. Should that occur, it would be difficult to exclude the Koreans, for they now, with the Europeans, account for about 10 percent of the world's semiconductor market. Such an arrangement, should it come about, would have all the makings of a four-nation cartel.

A similar scenario could unfold in automobile and automobile parts, a sector in which again the Europeans and Koreans have an even stronger presence in world markets. Any future Japanese cave-in, however unlikely at the moment, would certainly be followed by an EU demand to be included. Likewise, Korea, with a small but growing share of the world automobile market, would have a strong case as a fourth participant.

Conclusion

In charting its future course with regard to voluntary export and import restrictions, American policymakers would benefit if they were to heed the counsel and advice of President Clinton's own Council of Economic Advisers. In the 1996 Economic Report of the President, the council stated,

Every protectionist action invites retaliatory reaction. The costs of a tit-for-tat escalation are so high that in the long run all countries are likely to lose from the adoption of restrictive policies. . . . Even when trade restrictions are used to curtail unfair foreign competition, they can still impose costs to consumers.

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References

Bhagwati, Jagdish and Patrick, Hugh, eds. Aggressive Unilateralism. Ann Arbor: University of Michigan Press, 1990.

Hindley, Brian and Messerlin, Patrick. Antidumping Industrial Policy: Legalized Protection in the WTO and What to Do About It. Washington, D.C.: American Enterprise Institute, 1996.

Irwin, Douglas. Managed Trade: The Case Against Import Targets. Washington, D.C.: American Enterprise Institute, 1994.

Latham, Scott. Market Opening or Corporate Welfare? Results Oriented Trade Policy Toward Japan. Washington, D.C.: Cato Institute, 1996.

Nivolo, Pietro S. Regulating Unfair Trade. Washington, D.C.: Brookings Institution, 1993.

Freedom to Trade: Refuting the New Protectionism is Copyright © 1997 by the Cato Institute. All rights reserved.

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