A New Trade Order

Peter F Cowhey & Jonathan D Aronson. Foreign Affairs. Volume 72, Issue 1, 1992.

A New Global Economic Order

In the emerging world economy the choice is no longer between free trade and protectionism. Governments are regulating in new ways, using measures that open markets to foreign competition and embrace national industrial policies simultaneously.

It is impossible today to sustain the traditional American arms-length relationship between business and government on which world trade rules rested after 1945. The redistribution of much economic power to Japan and Europe means that new styles of industrial organization—more intimate relations between governments and firms, as well as among firms—place increasing pressures on that longstanding American approach.

Corporations have long adapted to the new forms of government economic strategies by internationalizing their operations. The initial emergence of transnational corporations, and later of international corporate alliances, was often a political gesture to assuage local sensibilities about the national identity of businesses and to circumvent trade barriers. In many markets traditional free trade never really existed because of this corporate adaptation.

The cumulative impact of this kind of foreign investment is staggering. Foreign investment flows are only about 10 percent of the size of world trade flows each year, but intra-firm trade (for example, sales by Ford Europe to Ford U.S.A.) now accounts for up to an astonishing 40 percent of all U.S. trade. Investment now dictates much of the composition and direction of trade flows.

While the original political motivation for globalization remains, it has become secondary to broader economic imperatives. International corporate alliances represent grudging acknowledgment that few firms can independently bear the economic risks or command the spectrum of technological expertise necessary to win major world markets. Growing numbers of firms rely on diverse partnerships around the world for know-how, components and selected product offerings in order to compete at home and abroad. They are willing to invest heavily in new global infrastructures, such as the worldwide design networks of Ford and Boeing or the world trading networks of major stock exchanges, in order to support their businesses and alliances.

Rise of a “Market Access” Regime

The process of developing and implementing a new international economic order is underway; it can be called a “market access” regime. The post-1945 free trade regime removed barriers at borders and established limited rights of investment. The emerging regime is more flexible about border barriers, but more demanding about access for investment and the international review of domestic policies to assure fair market competition.

A market access regime acknowledges that active government assistance to firms in many forms is a fact of life. International agreements cannot end this assistance; international rules provide for timely review of the concerns of foreign competitors and, in some cases, lead to limited harmonization of national policies. The best guarantee of efficient competition is using trade or investment, including alliances, to introduce robust foreign competitors in all major economic centers. Such a strategy undercuts the benefits of protectionist policies by letting foreign competitors share in any special benefits conferred by trade barriers or special assistance to boost particular industries.

A market access regime will upset the structure of existing international economic agreements. Policymakers can no longer depend mainly on multilateral trade agreements, nor can they emphasize trade as the leading edge of global commerce or assume that domestic and international economic policies are largely separate and independent from each other. Governments have to create a new global framework and tools for managing world commerce.

The outlines of the task can be best illustrated by an examination of the automobile and semiconductor industries and of telecommunications services—a revealing cross-section of heavy manufacturing, high technology and complex services. These sectors long ago confounded the conventional economic policy debate. Arguments about free trade and protectionism have nothing to do with the major global issues facing these industries. Despite continuing active government support for national automobile and semiconductor champions, the world market is more thoroughly integrated and no less open today than two decades ago. By comparison telecommunications services, which always were dominated by government-owned or -controlled monopolies, have experienced significant liberalization and new international competition. The experience of these sectors suggests an approach to the restructuring of government rules for world commerce.

Auto Markets Integrate Despite Protection

The revolution in automobile manufacturing and design processes in Japan abruptly transformed the world market. For the first time, vehicle exports across regions became central to world competition as Japanese automobiles flooded the American market. The influx of Japanese imports stiffened demands for protection of America’s largest manufacturers and employers and led to voluntary export restraint agreements on the number of Japanese automobiles exported to the United States. (Such export restraints are a wink-and-nod arrangement that evade General Agreement on Tariffs and Trade rules by being “voluntary” actions of the exporting country.) As economists correctly predicted, the restraints resulted in higher prices for consumers, a shift by Japanese firms from cheap compacts to more lucrative sedans and massive Japanese investment in U.S. manufacturing capacity. An additional consequence was a rapid tightening on imports into most of Europe. Although the United Kingdom welcomed Japanese plants to replace failing British automakers, France and Italy feared that Japan would divert its firepower toward their large auto firms.

Despite Detroit’s restructuring over the past two decades, Japan has captured almost 30 percent of the U.S. auto market. U.S. producers are counterattacking with improved products, reduced costs, demands that U.S.-based Japanese plants use more North American parts and labor, and pressure for increased U.S. automobile and component sales in Japan. The likely effect will be a stagnant Japanese market share in the United States, greater incorporation of U.S. component producers into the supply networks of Japanese manufacturers and modest success for U.S. vehicles in the Japanese market (even if Japanese plants in the United States are the source of many of the Japanese imports). At the same time, the Big Three are discovering the advantages of collaboration on research and development for key component technologies, sometimes with government support.

Meanwhile the European Community 1992 program is slowly unifying the European automobile market, despite difficult political battles. The EC could only find common ground between French restrictions on Japanese cars and Japanese automobile plants in Britain by negotiating a voluntary restraint agreement with Japan that capped Japanese imports and local production in Europe at 16 percent of the market by 2000. Extending such an arrangement to cover local production was a new idea. It nonetheless allowed a 50 percent increase in the Japanese share of the European market. The EC also won promises to assist its entry into the Japanese market, where European luxury automobiles already lead their American counterparts in the five percent of the market claimed by imports. But the two sides disagree on the precise interpretation of the agreements. Such disagreements are a growing problem because bilateral pacts often use ambiguity to skirt multilateral trade rules.

On balance, trade diplomacy has abetted truly trilateral competition in the world market for the first time. The world automobile market is fundamentally more integrated today despite massive government intervention to protect local producers. This will also make alliances among automobile companies more important. In addition to political considerations, firms will share plants, swap product designs and diversify the national origins of their suppliers because of the huge costs of fielding global product lines and responding to quickening technical innovation.

Alliances Transform Semiconductor Industry

American producers dominated the semiconductor market until the early 1980s when their efforts to create a new generation of memory chip products faltered. The Japanese government had sponsored years of sustained collaboration on manufacturing process and product design among Japanese firms. Tokyo’s efforts prepared Japanese firms to seize this opportunity to dominate the memory chip market, and they soon did, putting U.S. firms on the defensive throughout the rest of the decade.

U.S. firms concluded that they needed a new line of competitive attack. On the one hand they created new domestic consortia, such as Sematech, in the mid-1980s to replicate the Japanese experiment in industrial collaboration. These consortia received special U.S. funding and required a novel antitrust waiver. On the other hand the U.S. industry worried that despite its best efforts it had never won more than seven percent of the Japanese market. Japan’s sheltered market permitted its firms to build economies of scale and increase profit margins before competing in foreign markets. Their costs were low, and they could afford to dump chips (sell them below cost) to win markets overseas. To counteract these advantages the consortia lobbied the U.S. government for stronger protection against Japanese dumping and better access to the Japanese market.

The outcome, a radical innovation in trade policy, was the 1986 U.S.-Japanese semiconductor agreement that introduced measures to control dumping and promised a 20 percent share of the Japanese market for foreign (not just U.S.) suppliers. Despite teething problems the two countries renewed a modified agreement in 1991 after the U.S. computer industry came to support it. The new pact cleaned up the antidumping provisions and reaffirmed the market access goal. As a result foreign suppliers now have about 15 percent of the Japanese market. More remarkably, an elaborate consultative system between the industry associations of the two countries has expedited responses to many access problems.

Given the shrouded start to the 1986 pact, European officials worried that its provisions would only put Europe into an even more distant third place in semiconductor production. They quickly won GATT review and revision of some parts of the U.S.-Japanese pact, and then negotiated their own antidumping pact with Japan. In addition the European Commission continued massive joint research and development programs, such as Esprit and RACE, which poured huge sums of money into collaborative work by European firms. The 1992 program was also intended to reinvigorate European electronics firms by expanding their home market and reviving local competition.

U.S. officials worried that the EC 1992 program might exclude U.S. firms by creating a “Fortress Europe.” In practice, Americans received quiet reassurances that European markets would remain open so long as U.S. markets did the same. Reciprocal access was the clear implication when Siemens, the strongest European firm, formed vital research and production alliances with IBM, despite Siemens’ major role in pan-European research programs sponsored by the EC. (Japanese firms, it was acknowledged, might have more trouble exporting to Europe in the future, but Toshiba, for example, later joined the IBM-Siemens project.)

The IBM-Siemens alliance symbolized a fundamental transformation of the semiconductor industry. A torrent of collaborative alliances among European, Japanese and U.S. producers of semiconductors and critical components for computer technology tried to limit political, financial and technological risks. Moreover semiconductor producers increasingly entered into collaborative arrangements with key customers because customers often possess vital knowledge for the design of successful chips. One profound consequence of the 1986 semiconductor agreement was to induce alliance strategies that are blunting the nationalist edge of the semiconductor and related computer industry. Toshiba, Apple and IBM have announced a dizzying set of deals to codevelop and cross-source software, components and products for the next generation of portable computers. Still Europe and Japan will continue to pursue activist government policies in the semiconductor arena. The question is whether Washington, lulled by new international corporate alliances between U.S. and Japanese firms, will continue to match the efforts of other governments.

Market share in itself is not sacred; the ability to reach customers and needed know-how globally is. International corporate alliances are one novel solution to market and technology access problems. Trade talks plus a refurbished technological base allowed American firms to bargain for more advantageous alliances. A decline in the U.S. base would weaken the alliances. In short, new tools of activist microeconomic policy have to complement trade policy if alliances are to serve American interests and the demands on trade policy are not to get out of control.

Guided Competition in Telecommunications

Even as economists warned of growing protectionism, the world services industry was charging in the opposite direction. Telecommunications services reflect the transformation.

Today the United States, Britain and Japan—the three main financial and communications hubs of the world economy—all permit competition in the provision of basic telephone and advanced data services. Canada, Australia, New Zealand, Sweden and South Korea are rapidly moving in the same direction. The rest of Europe has liberalized competition in advanced information services, and many countries are licensing new providers of mobile telephone services to compete with the former monopoly providers. In many cases foreign companies are becoming minority owners and key managers of local phone companies.

Entirely new forms of global communications firms are also emerging. New competitors, for example, own many of the new generation of international communications satellites. Global data networks are burgeoning; international cellular telephone companies may one day emerge, and most certainly their ownership will be a hybrid of international partnerships.

Despite this remarkable liberalization, governments everywhere continue to steer their domestic telecommunications markets. Governments view network innovation as a technological spur that acts to stimulate the whole economy. Competition has strengthened American telecommunications. Washington is nonetheless conducting a massive review of its competitive policies because it worries that a rival like Japan is better at combining government regulation and market competition to expedite universal fiber-optic networks. There are similar worries about regulation and trade competition in the electronics equipment market. For example, Washington protested the way in which Japan partitioned cellular phone licenses among Japanese firms because U.S. equipment suppliers sold only to some of the licenses. The original allocation of licenses favored firms relying on Japanese manufacturers. Not only were old licenses revised but foreign firms are now minority owners of new ones.

Trade negotiators have also learned that it is vital to extend “transparency”—regular and observable government administrative procedures—to national rule-setting and regulatory oversight. Otherwise it is difficult to bargain successfully in a complicated environment. Clyde Prestowitz puts it well. “The Japanese cannot ‘open’ in the American sense,” he writes. “They think of openness as removal of restrictions case by case, as the bureaucratic giving of permission, and have not the generic Western concept of an absence of the need for permission.”(2) In Europe, too, governments retain the final discretion over which companies may enter their markets even after liberalization.

Negotiations on transparency can make progress. The United States has slowly influenced Japanese regulatory thought and practice. Washington, for example, has successfully urged that American firms sit on the advisory committees setting telecommunications standards in order to gain timely oversight on potential nontariff barriers. Foreign ownership of Japanese networks also helps.

The clear message from the case of telecommunications services is that sustained intervention by governments need not block a fundamental liberalization and integration of a politically sensitive world market. As in the other industries, corporations are emphasizing expedited global expansion along with elaborate commercial partnerships across national boundaries. It is becoming clear that major firms need to operate on four premises. First, firms need to think and act globally to survive. Second, the only way to guarantee access to other countries’ markets is to provide their companies with significant access to the home market. Third, carefully delineated alliances among leading competitors from different countries may be in the interest of all. Fourth, trade and investment policies alone cannot suffice; complementary government policies also are needed to nurture industries.

Designing Trade Rules from the Bottom Up

Policymakers have to acknowledge that all governments have obligations to support the world economy. When countries demand special treatment, all obligations are called into question. Countries should retain the flexibility to design and pursue policies that mix intervention with increased global market competition, but they also have an obligation to be sensitive to the costs their own policies of adjustment impose on other countries. Even Japan is cautiously considering acceptance of this position. The United States has obligations of its own; it cannot continue to rely on trade policy to fix its economic woes. U.S. political leaders can reconcile international obligations and national measures only if they are more honest with voters. The United States has to address its budget deficit, the low rate of national savings and problems in the structure of its capital markets.

The United States must keep its markets reasonably open on the basis of multilateral global principles. American bargaining power is greater because European and Asian business interests want to be here and will push their governments to compromise to retain their access. The strategic problem for the United States is that, although its interests are global, many of the most pressing negotiations need to be bilateral or regional. The United States needs multilateralism to ensure that the playing field is level and to safeguard against becoming entangled in its own web of contradictory bilateral deals. At issue, then, is how to reconcile global arrangements with specialized agreements.

When issues get more complicated, problems of negotiation increase. Getting more than a hundred GATT members to agree on a comprehensive package covering a wide range of complicated trade issues simply overloaded the Uruguay Round negotiations. Governments have to lay down basic multilateral principles to provide a consistent framework for trade agreements, but the global process will yield only incremental progress toward liberalization. Governments should concentrate more on bilateral and minilateral efforts to manage the practical details, and then multilateralize them from the bottom up. Even if the Uruguay Round achieves an acceptable outcome, Europe and Japan are fooling themselves if they think that a refurbished GATT will curb bilaterals, minilaterals and regional pacts.

Bilateralism and minilateralism allow countries to make special side deals and to set up specialized enforcement and monitoring institutions in support of international commercial agreements. The trick is to make sure that agreements reached under bilateral and minilateral bargaining encompass the basic principles of the multilateral regime and are subject to scrutiny by third parties that fear injury.

Some contend that bilaterals and minilaterals are less efficient than one-stop bargaining though the GATT. In fact specialized negotiations may be superior ways to solve problems. For example, although nobody seriously advocates extending the EC system to cover global trade, expanded regional arrangements can complement global problem-solving. Regional arrangements offer two advantages. First, creating large enough regions with common rules and commerce permits improved access through foreign investment. Second, regional pacts permit side payments that are sufficiently complex to tackle the worst problems associated with nontariff barriers. In short, regionalism is a legitimate approach and probably provides a superior solution to many issues so long as there exists a mechanism for minilateral consultation to reconcile the differences among regions. GATT already has provisions for such a review, but they need to be reformulated. The test should be whether the flow of trade between bloc members and nonmembers declines following a pact. Given the powerful role of investment as a form of access, any “passing grade” on trade flows alone is a doubly powerful statement about continued integration of the world economy.

Uneasiness about the implications of regional blocs nonetheless persists. If global talks cannot fully resolve key issues, then perhaps a hybrid between regional and global multilateral talks would. The time may now be ripe to negotiate significant cross-regional agreements.

Fundamental Reform for GATT

Fundamentally reforming GATT would be another step toward creating a new international architecture. Institutional innovations are necessary to cope with blurred bureaucratic authority and the collision of domestic and international economies and regulations. World economic management requires a new role for GATT, a new emphasis on transparency and a new approach to oversight.

A reformed GATT should concentrate on four key tasks. First, it could play a central role in assuring that bilateral, minilateral and regional agreements are multilateralized. This is not unprecedented. In 1985, for example, the United States, Japan and Canada converted a trilateral understanding on computer parts into a multilateral one.

Second, GATT should build on its role as a “depository” of trade agreements. This seemingly innocuous function is important because it discourages secret pacts and side letters to agreements that undercut multilateralism. Discretion is admirable, but there needs to be international agreement that all trade understandings will be registered and made available—with safeguards, if necessary—to interested GATT parties.

Third, to deal with precedents and principles embodied in the proliferating number of bilateral and minilateral pacts, GATT members should agree that signatories of every new trade and investment pact must file a brief “multilateral impact statement.” This statement would analyze the impact of the agreement on third parties and concisely state the general rules and principles of behavior endorsed by the pact. Requiring these measures in order for a treaty to be legal under GATT would discourage ad hoc ventures that impose high costs on third parties.

Fourth, GATT should encourage other procedural innovations to expedite the reinterpretation and evolution of common GATT rules. Rather than relying on the reactive GATT process for dispute resolution, a country could actively build a consensus on difficult issues by lobbying countries to sign on to similar statements of national intent. Such statements of intent about the interpretation of trade and investment obligations could be especially important for advancing common standards on issues that would otherwise be slow to admit to international agreement. GATT and the Organization for Economic Cooperation and Development Trade Policy Committee, which may soon have South Korea as a participant, could work together on this task.

GATT authorities could also acknowledge the need for more extensive use on nontariff issues of conditional reciprocity—meaning, a country would enjoy additional privileges if it also assumed additional obligations. U.S. negotiators proposed this approach, which has precedents in prior GATT agreements, as a way out of some impasses over the talks on liberalizing services in the Uruguay Round. They met with opposition, but they were right to try.

A Sector-By-Sector Approach

Building a new international architecture could also be enhanced by governments focusing more on sectoral codes and less on universal ones. Just as multilateral negotiations are too cumbersome, universal codes of conduct are also less effective.

Industry-specific agreements, once considered exceptions and economic disasters, are growing in number for reasons of efficiency, not just veiled protectionism. Industry codes could tackle many of the hard problems on subsidies, dumping, enforcement and rules of origin. The real question is how governments can formulate these codes so that they do not massively restrict market competition.

Part of the answer is to make each code recapitulate and adapt to general principles, such as transparency and the right to commercial establishment. Another step is to assure third parties the right to join codes and accept their benefits and obligations. Further, the pacts require conditional reciprocity—special rights mean special duties.

Critics of conditional reciprocity see it as impractical and unfair. They worry that trade deals will descend to absurd discussions about precise equivalencies of concessions. But this need not be. Conditionally could consist of ascending tiers of rights and obligations. A country would not have to offer every item in the tier, but a country would have to offer a reasonable balance within the tier’s range to participate in its special rights.

Finally, industry-specific agreements that require voluntary export restraints (as in autos) are an inefficient form of industrial assistance. By indirectly raising prices they hide the cost of adjustment to consumers. We favor converting most export quotas to temporary tariffs with an automatic phase-out schedule.

Combining Activism and Integration

A more activist government policy does not necessarily imply an end to an open integrated world economy. The ascent of Europe and Japan, however, does imply a change in the assumptions about the roles of governments and firms. The old architecture and tools for managing world commerce must be revised. GATT can remain at the center of the world trade order only if it redefines its mission and functions. Bottom-up multilateralism will be the order of the day.

None of these developments should be surprising or unduly worrisome. Weak decentralized political systems normally require more complex mechanisms for negotiation and enforcement of rules. But such systems can thrive—as anyone who has observed the constitutional order and economic success of Switzerland will attest. The narrow focus on liberalizing border trade barriers to manufactured goods—combined with strong U.S. influence—fostered the world’s postwar recovery and prosperity. Now a broader scope of liberalization with more complicated international obligations has to become the new world commercial order.