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The implications of developing trends in trade policy.

At present the world trade system is characterized by uncertainty. As the U.S. budget deficit recedes as a issue, trade policies will rise in priority. Major issues will be the U.S.-Japanese bilateral trade deficit and targeting specific industries instead of broad industrial policies. Regional trading blocs are expected to develop, but their policies cannot be forecast at this time. Global corporations must function in this uncertain environment.

THE CENTRAL POINT of this paper is that the governing characteristic of the world trading system at present is mounting and pervasive uncertainty. This uncertainty is the product of the separate but interrelated decisions of the main actors who together shape the international economy -- the governments of the triad of the U.S., Japan and the European Community -- and the global corporations. None of these has a clear strategic view of what the system as a whole should be. Hence the pervasive uncertainty.

Let me first sketch out the major background factors and then raise some policy questions.


The world trading system of the 1980s has been affected as much by macroeconomic or financial forces and policies as by the micro factors that are its traditional domain. As is well known, a powerful force fueling protectionist pressures in the U.S. in the first half of the decade was the wide swing in exchange rates and the rapid deterioration in the U.S. trade balance stemming from incompatible macro policy positions among the key industrialized countries of the G-7. The improvement in current account positions and exchange rate realignment since 1985 has been attributed in large part to the initiation and evolution of policy coordination in the G-7 since the Plaza Accord of that year.

While the full fury of the protectionist pressures has abated, and the Omnibus Trade Act of 1988 is an improvement over most of its 300-plus ancestors of the earlier part of the decade, some of its provisions suggest that U.S. trade policy is set on a new course, a subject to which I'll return later. During the next few years, once again, a key element in how this is exemplified is likely to be the current account positions of the U.S. and its main trading partners.

The U.S. Budget Deficit

There are several reasons for this assessment. The first relates to the U.S. fiscal deficit. Throughout the policy debate of the 1980s, a near-universal agreement existed among policymakers in the G-7 that a necessary (even for some, sufficient) "solution" to the problem of the current account imbalances was a sustained and significant reduction in the U.S. fiscal deficit. That consensus view is fast eroding, both internationally and domestically in the U.S.

On the international front, while standard communique rhetoric still scolds the U.S. for lack of decisive action on the fiscal front, the heat has dissipated. The fiscal-solution-to-the-world's-problems tone has evaporated. The reason is made quite clear in the most recent OECD Outlook: "In the more open international financial environment of the past decade, current account imbalances have proved financable on a large scale, and for longer, than would have been expected earlier." The threat of a dollar crisis -- the best international argument to spur U.S. budget action -- has become embarrassingly less credible in the face of reasonable exchange rate stability and, indeed, recent dollar strengthening. The heat has gone out of the issue. But the problem of current account sustainability should be redefined. The urgent issue is not financial but political sustainability.

On the domestic front in the U.S., the fiscal-deficit-doesn't-matter school has attracted more and more adherents and is certainly gaining strength in public opinion. As Brookings head Charles Schulze recently observed, "The left of center finds common ground with the supply siders of the far right" in arriving "at a common set of conclusions deemphasizing the importance of the deficit."

In effect, both international and domestic opinion seem to be converging on a newly emerging theme: The U.S. budget deficit is largely a U.S. domestic problem. More importantly, in terms of political dynamics, the "crisis" rhetoric is proving very difficult to sustain. The fiscal deficit "problem" is not immediate but will emerge only gradually over the long term. Anorexia is unlikely to carry the same emotional charge as an imminent heart attack. As fiscal action recedes in political weight, a likely consequence will be to raise the priority of micro policies, including trade policies.

Trade Policies

This latter consequence seems logical for several reasons. First, all forecasts by international agencies, while differing in detail, agree that the improvement in the U.S. current account imbalance has probably plateaued. While U.S. fiscal action would certainly improve the outlook, that (as argued) seems increasingly unlikely. Moreover, recent studies of the U.S. "twin deficits" stress the importance of other factors in explaining the evolution of the current account, factors such as U.S. household savings behavior (for which a budget surplus is the only feasible but increasingly elusive solution) but also structural "competitivity problems" for which new micro policies, both domestic and international, are required. The pressure for such policies thus is likely to build both because they are considered essential in themselves and because, in the absence of fiscal action, the stalled current account adjustment process once again will create mounting popular demands to "do something."

Nowhere does this scenario appear more plausible than in the case of Japan, where the current account adjustment process, begun in 1986, is forecast to slow in the coming years.

Earlier in the decade, while the dollar was still high, demands mounted for aggressive action to deal with what were considered the unfair trade practices of Japan, which led to an unduly low import propensity. Specifically it was argued by Senator Gephardt and others that the U.S. should shift from a multilateral rules-oriented approach to a bilateral results-oriented policy from the United States. At the time of that debate in the earlier part of the decade, the Japanese current account surplus was under $20 billion. While the full Gephardt proposal was quashed, the 1988 Omnibus trade act contains, in its new super - 301 clause that names whole countries as unfair traders, many of the essential features of the original proposal. Today the Japanese current account surplus is over $70 billion. This time around another difference also is evident in the nature of the concern over the bilateral balance. While Japan's low import propensity (a condition I have termed Acquired Import Deficiency Syndrome) is still being analyzed and argued, a much broader issue has emerged: Japan's increasing competitiveness in key sectors of industry where American dominance has been challenged and overtaken.

Against this background of rising deficits and mounting concern over the American position in the world trading system, the so-called Structural Impediments Initiative with Japan, launched to avoid full-scale super-301 action, is not likely to be the end of the story. By its very nature is cannot produce short-term results. By next summer when the first stage of the talks end, it seems highly probable that demands will be made for new and tougher measures to be carried out. It also seems likely that the Administration will attempt to avoid this action for fear of jeopardizing the Uruguay Round negotiations. Historically, a GATT Round has served to contain serious trade disputes. This time, however, putting all eggs in the GATT basket may prove very risky. A glaring disparity exists between the objectives of the bilateral policy and the agenda of the Round or, indeed, of the domain of multilateralism itself.

The new direction in American trade policy has been described as aggressive reciprocity, bilateral activism, unilateralism, etc. The confusion in terms reflects a lack of clarity in the policy. One will have to wait and see how it is implemented. Certainly super 301 includes a unique form of unilateralism in defining American's trade rights by defining other countries' unfair trade practices, in determining violation, and in implementing retaliation to secure compliance. A possible shift to a results-oriented policy is also there -- so far most clearly manifested, by the way, in the U.S.-Japan semiconductor agreement with its inclusion of market share targets. This thrust involves a unilateral definition of "reciprocity": market opening in one country to be achieved by the threat to suspend one's trading obligations if the demands are not met. This unilateralism is inherently at odds with the GATT rationale of multilaterally negotiated rules. There is bound to be continuing friction at the GATT for the U.S. as well as a possible imitation or retaliation cycle with the European Community, which, in its New Trade Policy Instrument of 1984, has a similar mechanism at hand.

If we turn from macro to micro background factors, further insight is provided on the possible shape of new trends in trade policy, not just in the U.S. but also in the European Community.


There are two strands to the heightened profile of competitiveness as a major political and policy issue in the United States. One, as has just been noted, is linked to the current account deficit and heavily centered on the U.S. - Japanese bilateral trade deficit. The other, also focused on Japan, is the idea of targeting strategic industries. At the level of popular opinion, but also partly supported by the so-called new international trade theorists, is the growing conviction that Japan has successfully pursued such targeting policies (with the Asian NIC's not far behind).

No consensus exists on the definition of targeting or of strategic industries, or, within the economics discipline, on policy prescriptions. Nonetheless, the likelihood is far higher that new micro policy developments in the U.S. in both trade and domestic policy will be directed to "competitiveness," rather than to traditional import blocking or other defensive industrial policies that are seen as outmoded and anticompetitive in their effects.

While the ongoing debate in the United States about the need for a new policy on competitiveness is very divisive and by no means settled, a number of significant technology initiatives have been undertaken. The most prominent has been the establishment of Sematech, a joint government-industry cooperative research initiative in semiconductor technology explicitly developed as a response to Japanese capture of the DRAM market.

But in this instance the U.S. is not alone in new policy. The European Community also enters the picture. Impelled by the Japanese example, and reinforced by the implementation of Europe 1992, the European Community has started to put in place elements of a policy strategy focused on competitiveness. Part of the strategy, perhaps unplanned, appears to be an increasingly active and innovative use of antidumping regulation. This is worth spelling out briefly.

The specter haunting Europe in the early 1980s was fear of declining competitivity vis-a-vis the Americans and especially the Japanese. Europessimism was heavily concentrated on the information technology industries. Here the preoccupation became focused on Japan with the Japanese announcement of their new Fifth Generation Program on computer technology in 1981. European multinationals first in electronics and later from a broader range of industries played a key role, in continuing and close consultation with the Commission, in establishing new MITI-like R & D programs and in catalyzing the momentum for Europe 1992 after the passage of the Single European Act of 1985.

At the same time the more frequent and novel use of antidumping duties by the Commission in information technology products from Japan, Korea and Hong Kong has already increased friction with those countries but is also spilling over to disputes with the United States, where exports from Japanese-owned plants are also being subject to antidumping duties, and sales from U.S. subsidiaries in Europe are falling.

Finally, friction also has developed about Jessi, the much bigger European Community version of the U.S. Sematech. While both consortia want to keep out the Japanese, they are not sure how to accomplish this without excluding each other's subsidiaries. So Motorola Europe is complaining as loudly as Siemens U.S.!

In summary, another important source of uncertainty is the future evolution of what the OECD calls innovation policy. If all three blocs target the same strategic industries, what are the international implications of such a development? Answer: no one knows -- and no one seems to be thinking about it either.


The final background factor of note in the current climate is the growing interest in regional trading blocs. The two developments that have triggered the current discussion are the recently concluded U.S. - Canada Free Trade Agreement (FTA), and the European Community move to dismantle impediments to the free flow of goods, services, capital and labor among member states by the end of 1992 (Europe 1992).

The FTA and Europe 1992 are very different in both genesis and nature. Indeed, their coincidence in timing is accidental, not planned. Yet both are highly significant developments in the world trading system that will foster increasing integration in the two largest and richest markets of the world. So it is probably not surprising that, in spite of their marked differences, these two regional developments have provoked questions about a possible new trend in the world trading system.

The origins of the FTA were quite dissimilar in the U.S. and Canada. In the U.S., the bilateral initiative was spawned by a need to quell the rising tide of protectionist pressure and the growing frustration of the Administration with the difficulties of launching a new round of multilateral negotiations they had been pursuing without success since the early 1980s. The bilateral approach developed as an early example of U.S. "strategic threat" policy to unblock the launch and to underline the significance of the "new issues": services, investment and intellectual property. It is intended to warn the foot-draggers (especially the European Community, fearful of the inclusion of agriculture as a central item on the multilateral agenda) and the opponents (some developing countries, led by Brazil and India, opposed the new issues), that there were feasible and attractive alternatives to the GATT.

For Canada, the overwhelming proximate reason for the bilateral initiative was fear of mounting U.S. protectionism, although equally important over the longer run was the objective of improved competitiveness to be gained from secure access to a market ten times its size.

While numerous factors, both political and economic, were at play in launching the move to full integration of the internal in Europe, the external trading environment does not appear to have been a major consideration, in sharp contrast to the genesis of the FTA. Moreover, little information was provided on the external implications of the internal measures until recently, and a number of questions remained unanswered.

It was largely this lack of information that created uncertainty and suspicion in some quarters and evoked the talk of Fortress Europe. However unjustified such a term may prove to be, the combination of euphoria and vagueness that marked the European public discussion was bound to create disquiet abroad. (This seems to have largely abated; concern has now centered on specific issues such as standards, antidumping and rules of origin, the precise meaning of reciprocity in new areas, etc.)

These coincident but unrelated policy actions in Europe and North America have in turn coincided with another regional development. In the Pacific area, not only have exports and imports surged in recent years, but major structural changes catalyzed by the appreciation of the yen and the expansion of real domestic demand in Japan, are spurring regional integration via enhanced trade and investment linkages. Both for economic reasons but largely as a defensive response to the FTA and Europe 1992, a number of proposals for bilateral (with the U.S.) or regional arrangements in the Pacific area are now being proposed and analyzed. Clearly the political difficulties of institutional integration in the Pacific are immeasurably greater than in Europe, so much so that many observers discount its possibility. But the continuing interest in and exploration of bilateral and regional options in the Pacific region, combined with the European and North American developments, are together generating a view in many quarters that regional blocs are an inevitability and only the question of timing remains unsettled.


Finally, let me get to the other big actor on the world scene -- the global corporation. Decisionmaking in a situation of rising uncertainty is difficult, and prudence dictates caution. Concern about European Community antidumping and rules of origin have already induced an investment response by Japanese and Korean enterprises. More generally, uncertainty about certain aspects of the external impact of European Community internal regulations or about the emergence of regional blocs are stimulating corporate planning for a presence in each. Of course other reasons exist for these investment decisions, such as rising R & D costs that increasingly require transnational linkages. We seem to be at the onset of a new wave of internationalization in which flows of investment and technology will dwarf trade flows. Yet there are no policy rules nor, indeed, international institutions that can deal with the frictions that inevitably will emerge as this new phase of global interdependence gathers speed.


The basic public good aspect of the postwar international trade regime, as embodied however imperfectly in the GATT, was the use of rules to reduce uncertainty. But increasingly the distinction between domestic and international issues and policies has blurred and the sources of international friction are too complex and diverse to be captured by rules governing trade flows. This GATT Round, to be sure, will tackle some of these issues in negotiations on services, trade-related intellectual property and trade-related investment measures. It also will seek to strengthen GATT as a contract and as an institution. But it seems that more innovative policy approaches, in the GATT or elsewhere, will be required if we are to come to grips with the new developments I've described. The alternative will be managed trade, and it is not most unlikely, in the final analysis, to do other than increase uncertainty for all decisionmakers, government and corporate.

Sylvia Ostry is Special Advisor to the Secretary of State for External Affairs, Government of Canada.
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Author:Ostry, Sylvia
Publication:Business Economics
Date:Jan 1, 1990
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