The State of the Union and International Trade

"I’m asking both parties to give me trade promotion authority to protect American workers with strong new trade deals from Asia to Europe." -- President Barack Obama, January 20, 2015, State of the Union Address.

I copied Mr. Obama's remarks above from an online source (in this case the Washington Post) for accuracy, but watched the speech on television for nuance and congressional response. Throughout the 70-or-so minutes of the address, as the President touted the advances in the economy, education, and healthcare under his administration, and proposed new programs to further his agenda, the Democrats gathered in the House of Representatives, rose and applauded, while the Republicans remained seated. That is until the President spoke about international trade. Democrats were decidedly cool, prompting the President to add:

"I’m the first one to admit that past trade deals haven’t always lived up to the hype... But 95 percent of the world’s customers live outside our borders. We can’t close ourselves off from those opportunities."

Republicans, for the most part, greeted with applause the President's call for free trade agreements ("FTAs") with nations in Asia and Western Europe. The attitude of many Republicans can be summed up in the admission, by New York Times columnist Thomas Friedman, that he "wrote a column supporting the CAFTA, the Caribbean Free Trade initiative. I didn’t even know what was in it. I just knew two words: free trade." (Meet the Press, July 23, 2006). Now, I'm for free trade. By free trade I mean that if it is legal to buy a product made in the U.S. it should be equally legal to buy the same product when imported from another country. That, however is not what our free trade agreements are about. "Free trade," as I define it already exists. What Mr. Obama's FTAs will do is give foreign producers an advantage over domestic producers and maximize imports.

Take the proposed FTA with the European Union. Currently if you produce in the US you pay taxes in the US and then if you export to the EU you pay a very small import duty and a value-added tax ("VAT"), which varies from member state to member state, but is typically around 17%. If you produce in the EU you pay the VAT and when you ship to America you pay import duty, which is usually low, typically in the single digit as a percentage, and your European VAT is refunded. Under this current arrangement, the American producer pays the full American tax, plus the full European VAT, plus a very small import duty. The European producer pays no European VAT, no American taxes, and just a small import duty. In other words the American company is taxed twice, while the European company is not taxed. Now look what happens when the import duties are done away with. We know, historically, what has happened. Since the end of World War II there have been several international trade agreements that resulted in the EU lowering import duties. Which each lowering of the import duties the EU states have raised the VAT so that the actual cost of getting American goods into the European market has stayed constant. There is no reason to think that the result of a US-EU FTA will be any different. European companies will have better access to the US market because they wont have to pay taxes which American companies will still pay full US and EU taxes.

FTAs can favor foreign producers over Americans in another way. In the US, through our democratic process, we enact laws and regulations that distort trade by forcing employers to abide by certain standards regarding labor conditions, environmental protection, and consumer safety. These are constraints that a profit-maximizing firm, absent government interference, might not enact. Whatever one thinks of any particular regulation -- too lax or too rigid -- collectively they express what Americans believe is the minimum acceptable level of conduct and forbid trade in domestic goods or services violating those standards. However, under international conventions, the US is severely circumscribed as to imposing any limitations on imports from other countries that have lower standards. It is true that some of our FTAs contain labor, environmental, and sanitary provisions, but even they are slight in many cases compared to US rules. And such international standards as there are are denounced by "free traders" as trade distorting policies, rather than being recognized for what they are, attempts to create at least somewhat similar rules for the different players, again, a basic assumption of, not a derogation from, "comparative advantage" theory. In theory one could calculate the advantage lax rules confer on a trader and impose a countervailing "social" tariff. To the extent that we believe that our laws implement minimum humane standards, a good case could be made that we should so do.

Finally, I must address Mr. Obama's misleading statement that "95 percent of the world’s customers live outside our borders." It is misleading because it implies a vast -- 95% -- market outside of the US. The fact is that most of those 95% don't have any money to buy US goods. Yes, there are foreign markets that are attractive to American manufacturers (and would be more attractive with a FTA that truly levels the playing field). But that potential market is nowhere near the 95% that the President implied. According to Dave Tilford of the Sierra Club, "With less than 5 percent of world population, the U.S. uses one-third of the world's paper, a quarter of the world's oil, 23 percent of the coal, 27 percent of the aluminum, and 19 percent of the copper." (Scientific American, September 14, 2012.)

America is the largest consumer market in the world. If our companies cannot thrive by selling here, there is no way we can export our way to prosperity.