Issues in US-EC Trade Relations

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Issues in US-EC Trade Relations

The University of Chicago Press

An Introduction to the Issues and Analyses

Robert E. Baldwin

1. The Importance of US-EC Trade Relations

A minimum requirement for a viable trading system is the active support of both the United States and the member countries of the European Community (EC). This is not only because their trade makes up about one-half of total world trade but because the United States and members of the EC have been the main architects and supporters of the post-World War II international trading regime. Other major trading groups have generally been willing to accept the leadership of the United States and the EC in initiating multilateral negotiations aimed at reducing protection and modifying the rules of the General Agreement on Tariffs and Trade (GATT).

In recent years a series of United States-European Community (US-EC) disagreements have developed that threaten the degree of consensus between these two trading blocs that is necessary for the maintenance of a stable international trading order. They are on such diverse matters as the consistency with current GATT rules of particular actions taken by one of the parties, the need for new rules and for changes in existing rules to cover forms of trade not now subject to GATT discipline, the adequacy of present dispute settlement procedures, the proper agenda and procedures in new multilateral trade negotiations, and the relationship of trade policies to balance-of-trade deficits.

As the some 90 members of the GATT embark on a new multilateral trade negotiation, the Uruguay Round, the United States and the European Community face an historic challenge. They can either use the occasion to move toward the resolution of their disputes and thereby strengthen the trading system or they can adopt inflexible negotiating positions with the likely result that, as others follow suit, the negotiations become the occasion for a further weakening of the rules and arrangements of the world trading system. Fortunately, the Ministerial Declaration adopted in Punta del Este in September 1986 gives some promise that the first course will be followed. Besides agreeing upon a standstill and rollback of traderestrictive measures inconsistent with the GATT, the participants included in the agenda as subjects for negotiation most of the issues on which US-EC disagreements have arisen.

The purpose of this volume is to facilitate the resolution of the two blocs' present differences by analyzing some of the most important issues of disagreement and considering alternative policy options to reduce tensions and lessen the risks of a breakdown of the trading system. In carrying out this objective, emphasis is placed on utilizing appropriate combinations of historical, theoretical, and empirical analyses. Each general subject is analyzed, in most cases, from both an American and a European perspective.

Of course, many US-EC disputes cover matters on which there is widespread disagreement within the entire trading system. Thus, the theoretical analysis in most of the papers, though not the institutional detail, is also relevant for studying trade policy in general, nonregional terms.

1.2 US-EC Litigation in the GATT

Under the GATT, if one member considers that any benefits accruing under the Agreement are being nullified or impaired as a result of the actions of another member, that member can request consultations with the other party to resolve the problem. Should the dispute not be settled through this procedure, the complaining party can request that a panel of appointed experts make a report to the general membership with their judgment on whether the GATT rules have been violated. The general membership then decides whether or not to accept the judgment of the panel. An appropriate place to begin an analysis of US-EC disputes, therefore, is to examine the nature and frequency of cases between these two parties that have been brought before such panels.

In part 1 of this volume, "The Legal Framework," Robert Hudec (chapter 2) examines the 80 GATT "lawsuits" filed between 1960, when the European Community became a full participant in GATT legal affairs, and 1985. Hudec finds that almost one-third of all the GATT lawsuits (26 of 80) during this period were between the United States and the Community. Furthermore, 45 of the remaining 54 cases involved either the United States or the European Community as one of the parties. The volume of US-EC litigation has increased in recent years, but so too has the volume of GATT litigation in general.

Most of the GATT lawsuits (43 of 80) have involved trade in agricultural products, and in most of these (25 of the 43), the EC has been the target of the complaint. Complaints about subsidies, both export and domestic production subsidies, and about tariffs, including the Community's variable levy on agricultural imports, dominate the list.

Hudec concludes that the United States has litigated in the GATT mainly to satisfy certain domestic political imperatives, while the Community has litigated primarily for defensive purposes, without really believing in the process. Nevertheless, he believes the lawsuits between the two trading blocs have provided a peaceful alternative to real economic warfare. Although he thinks there is some reason to wonder whether GATT litigation can retain political credibility, he is generally optimistic that political leaders will continue to strengthen the dispute settlement procedures of the GATT.

1.3 Current Issues: Agriculture, Embargoes, and Declining Industries

As Hudec's analysis demonstrates, the leading area of dispute between the United States and the European Community is agricultural policy. Much of the success of the Uruguay Round is likely to be judged on the extent to which these two parties resolve their differences on agricultural trade relations. In part 2, "Agriculture: Trade and Protection," Dermot Hayes and Andrew Schmitz (chapter 3) and Alexander Sarris (chapter 4) tackle this difficult issue and propose policies for dealing with the trade problems that have arisen.

Both Hayes/Schmitz and Sarris agree that the Community's Common Agricultural Policy (CAP) entails heavy economic costs both to the United States and the Community and substantially distorts world agricultural markets. Hayes and Schmitz also show, however, that recently adopted U.S. farm legislation has long-run implications that are surprisingly similar to those of the CAP.

Having described the Community's CAP and the U.S. agricultural policy, especially the Food Security Act of 1985, and shown how these policies have led to an international price war, Hayes and Schmitz propose specific policy changes they consider both politically feasible and welfare-enhancing. Under their proposal, all production would be sold at whatever price the market would yield, but through the use of a per-unit production subsidy, the government would ensure a certain reference income to those farmers whose operations are at the size that it most wants to support. Smaller, less efficient farmers would receive an income that is less than the reference income but more than from their market sales, while larger, more efficient units would receive at least the reference income, either from their market sales or the government. Hayes and Schmitz believe that this alternative to present agricultural policies would help alleviate the world oversupply situation in agriculture by shifting producers' emphasis from output-increasing technology to cost reduction and output-price enhancement.

Sarris reviews US-EC agricultural policies from a European perspective. He outlines a simple model with random demand and supply shocks that is designed to capture the key economic features of the trade in grains between the two blocs and uses the model to estimate empirically the effects of actual and alternative US-EC grain policies.

Sarris focuses in particular on three policy options available to the United States to offset some of its economic losses resulting from present EC policies. One is to take advantage of U.S. monopoly power by imposing an optimal export tax on grains; the second is to institute an optimal buffer stock scheme; and the third is to inflict a budget loss on the EC by introducing an export subsidy on U.S. grains. He concludes from his empirical analysis that an optimal export tax would more than compensate the United States for its CAP-induced losses but suggests that such a response is probably not politically feasible, since the U.S. Treasury rather than the U.S. farmer would be the big gainer. He also finds that an export subsidy is likely to prove too costly for the United States, since to inflict a $100 million annual budgetary loss on the Community would cost the U.S. Treasury $530 million. The best alternative, in his view, is the use of a government stockpiling policy. By buying for storage when world prices are low and selling when they are high, the U.S. Treasury is not hurt, producers benefit when they need it most, and consumers get more stable prices.

While agricultural issues dominate the list of US-EC trade disputes, there are several areas of trade in manufactured goods and services where disagreements between the two trading blocs have arisen. Part 3, "Embargoes and Strategic Trade Issues," examines their differences over the use of embargoes as a means of inducing foreign countries to change a particular political action. A recent example is the U.S. embargo, introduced after the imposition of martial law in Poland in 1981, on sales by U.S.-based firms and their affiliates in foreign countries of equipment for use in building the Soviet gas pipeline from Siberia to Western Europe. Henryk Kierzkowski (chapter 5) and Alasdair Smith (chapter 6) point out that the difference in views between Western Europe and the United States on the wisdom of imposing embargoes has been evident on many other occasions.

An imperfectly competitive framework is especially suitable for analyzing the embargo issue, and both Kierzkowski and Smith utilize this approach. In doing so, both conclude that embargoes generally are not very effective in carrying out their intended purpose.

Kierzkowski focuses on the following question: Can protection of a domestic industry considered to be strategic be justified when there is the possibility of an export embargo by a foreign producer? Since strategic industries often have a relatively small number of firms, to analyze this question he utilizes a model in which imperfect competition prevails. He demonstrates that, in the extreme case where open competition results in the product being produced in only one country, it could be advantageous for the importing country to produce the product for itself under import protection rather than risk the loss of the product because of a foreign embargo during the time needed to establish domestic production. Yet, when this extreme case is set aside and there are at least a domestic and a foreign firm supplying the domestic market, he finds that a foreign embargo cannot deal a devastating blow to the domestic economy. Strategic interdependence, as he terms the latter case, is, therefore, a far better state of affairs for a country than strategic dependence, as he terms the former situation. He argues, however, that strategic interdependence may be achieved without sacrificing efficiency by liberalizing foreign investment and providing for the freedom of establishment. As was demonstrated in the pipeline embargo case, a foreign monopoly operating within the frontiers of a country is less likely to deny goods and services to the host country even if ordered to do so by its home government.

Smith presents a model of multilateral investment to focus on the embargo issue from a somewhat different viewpoint. How does the fact that the home-country government may impose an export embargo and thus reduce the profits of the multinational affect the company's decision to invest abroad? He assumes that it is also possible for a host-country firm to produce the good for its own market.

Among the possible outcomes in this duopoly situation, two cases are of particular interest for the embargo issue. In one case, the multinational will choose not to invest abroad but instead to export its product to the foreign country if there is no threat of an export embargo by its government, but if this threat is strong enough, it will undertake foreign investment and thereby make the embargo ineffective. In the second case, the embargo threat is not strong enough to induce foreign investment by the multinational, but when the embargo is introduced, it becomes profitable for the host-country firm to undertake production and thereby make the embargo ineffective. As a practical policy issue, Smith concludes from his historical and theoretical analysis that, in most instances, embargoes are quite unlikely to succeed.

In both the United States and the European Community there are a number of industries facing severe competition from third-country sources. The attempts to adjust to these new circumstances have led to US-EC disputes with these third countries and with each other. Part 4, "Industry: New Protectionism and New Competitors," examines certain aspects of protectionism and responses to this policy in two industries, steel and textiles.

David Tarr (chapter 7) analyzes what he describes as the crisis that has arisen in the steel industries of the United States and the European Community as declining demand and the emergence of new lower-cost producers have reduced production and employment in both regions by more than one-third since 1974. The EC and the United States, he notes, have responded by adopting similar external policies, namely, greater import protection, but quite different domestic policies. At first, the Community attempted to maintain minimum prices for certain steel products with a system of voluntary production quotas; when this did not work, EC officials imposed mandatory production quotas. Shortly thereafter, a code on the subsidies provided by national governments to steel producers, aimed at reducing and finally eliminating such subsidies, was adopted. In contrast, the U.S. government has not intervened directly in the domestic market and has allowed losses suffered by domestic firms to be the guide in plant closings.

These differences in domestic policy led to a major trade dispute in 1982 when U.S. producers filed charges of dumping and subsidization of steel exports against the EC. The U.S. Department of Commerce agreed that EC producers were being subsidized, some by substantial margins, and the International Trade Commission found that U.S. firms had suffered material injury. After the dispute reached the highest political level in both regions, however, and before countervailing duties were imposed, the Community agreed to a Voluntary Restraint Agreement (VRA) on steel.

Tarr argues that a more viable, efficient EC steel industry would emerge if the Community eliminated its domestic controls on prices, output, and investment. These controls, he contends, create more distortions over time and make the adjustment problem worse. He also believes that the United States and the European Community should eliminate the nontariff barriers they have erected. His empirical investigations indicate that the costs of these trade barriers far exceed the adjustment costs they are designed to save.

Carl Hamilton (chapter 8) considers two aspects of the protection of textiles that has been introduced by the United States and Europe by means of quantitative import restrictions: the levels of protection that these controls provide and the levels of rents earned by exporters of textiles because of these restrictions. The importance of these questions is reflected in the fact that trade in textiles and clothing makes up 9 percent of world trade in manufactures and 25 percent of the manufactured exports of the developing countries.

Using data on the prices of quota rights in Hong Kong and (for a short interval) in Taiwan, and an indirect method to calculate the degree of restrictiveness of quotas imposed on South Korean and Taiwanese textiles, Hamilton estimates the tariff equivalents of quotas plus tariffs on imports of textiles into the United States and the European Community from Hong Kong, Taiwan, and South Korea. He finds that the combined rate of protection from quotas and tariffs in the United States on textiles from these three suppliers ranges from about 45 percent to 65 percent. In contrast, the degree of restrictiveness on textile imports into the EC ranges from only about 25 percent to 35 percent. Rents derived by Hong Kong, Taiwan, and South Korea because of the quotas imposed by the United States and the EC are estimated by Hamilton at more than $500 million in 1983 alone. Some 80 percent of this amount is due to U.S. quantitative restrictions.

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Excerpted from Issues in US-EC Trade Relations by Robert E. Baldwin, Carl B. Hamilton, André Sapir. Copyright © 1988 The National Bureau of Economic Research. Excerpted by permission of The University of Chicago Press.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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