The Free Trade System Facing the Threat of Collapse

The Free Trade System Facing the Threat of Collapse*
Shujiro Urata**

Abstract
Triggered by the United States imposing tariffs on Chinese imports and subsequently
China`s retaliatory action, the exchange of tariffs has escalated into a full-blown trade war
between the two countries in 2018. The United States is aiming to reduce or eradicate
its trade imbalance by using protectionist measures. There are two main reasons behindprotectionism in the United States. One is an attempt to secure jobs in certain sectors ofUS industry. Another reason is the alarm it feels in the face of Chinaʼs rapid development
in information technology (IT) and other areas of advanced technology. The latter concern
is shared by many members of the US Congress and business leaders, and this makes it
possible that measures against China may continue long beyond the Trump presidency.
I propose three options that the rest of the world can take in these circumstances topersuade the United States to return to a rule-based free trade system: (1) a possible U-turnin US policy would be brought about by the increasing severity of the negative impact ofprotectionist measures on the US economy itself; (2) the worldʼs major economies̶Japan,
the EU, China, and so on̶to work toward comprehensive and liberal regional integration
without the United States on trade and investment, and thus push the United States intoa disadvantageous position; and (3) countries that share interests in common, like Japanand the EU, to involve the United States in efforts to reform the World Trade Organization(WTO).

Protectionism and the Outbreak of a US-China Trade WarIn March 2018, US President Donald Trump imposed additional tariffs on imports of steel(25%) and aluminum (10%), based on Section 232 of the 1962 Trade Expansion Act (nationalsecurity). He is currently considering imposing additional tariffs on motor vehicle imports.
Meanwhile, in July 2018, citing infringements of intellectual property, he used Section
301 of the 1974 Trade Act (unfair trading practices on the part of a foreign government) to slap
tariffs (25%) on Chinese imports worth ＄34 billion. China retaliated by imposing tariffs (25%)
of its own on imports from the United States to the same amount. Riled by Chinaʼs retaliatory
action, the United States imposed further tariffs on Chinese imports worth $16 billion in August,prompting China to retaliate by slapping additional tariffs on US imports worth the same amount.
In September, the United States and China both implemented a third round of tariffs. The UnitedStates slapped tariffs on $200 billion worth of imports from China, while China imposed tariffs on
US imports worth $60 billion. Following these three rounds of tariffs, the total value of affected
US imports from China is around $250 billion; around $110 billion of Chinese imports from theUnited States are affected by Chinese tariffs. This is equivalent to roughly half of all US imports*This essay was originally published on Kokusai Mondai [International Affairs], No.677, Dec. 2018.

** Shujiro Urata is Professor of Economics at Graduate School Asia-Pacific Studies, Waseda University.

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Shujiro Urata

from China, and approximately 85% of the goods that China imports from the United States on avalue basis. The exchange of tariffs has escalated into a full-blown trade war between the UnitedStates and China.
In addition to the trade war it started with China, the United States is aiming to reduceor eliminate its trade imbalance by using protectionist measures through bilateral talks withcountries with which the United States has a trade deficit. These policies are based on the ideathat a trade imbalance indicates an excess of imports over exports, and that this leads to aloss of American jobs. The United States has renegotiated the US-Korea (KORUS) Free Trade
Agreement and the North American Free Trade Agreement (NAFTA) with Mexico and Canada,
in both cases to the advantage of the United States. In the revised version of the US-Korea Free
Trade Agreement, for example, the United States successfully extended the tariff on Koreanmade pickup trucks (25%), due to be scrapped on January 1, 2021, until January 1, 2041. Basedon the assumption that they meet Korean safety standards so long as they meet US federal safety
standards, the revisions also doubled the number of vehicles each auto company can export toKorea, , from 25,000 to 50,000 a year. As a condition for removing tariffs on vehicles, the revisions
to NAFTA require cars imported from another NAFTA country to contain 75 percent made-inNAFTA components, up from the current 62.5 percent within three years. The revisions also
allow tariffs to be imposed on any vehicles imported from Mexico or Canada after an exemption
for the first 2.6 million vehicles a year. Negotiations with the European Union and Japan are still
to take place, but it is clear that the United States will seek to revise agreements in its favor bythreatening to use protectionist measures, including raised tariffs on automobiles and othermeans.
This frequent resort to protectionist measures by the United States has brought about acrisis in the free trade system that was constructed under American leadership and drove therapid growth of the global economy; this system now faces the threat of collapse. However, it isimportant to remember that protectionism is not limited to the United States; there is a growing
tendency toward such measures in other countries as well, though it is not as great as in the US.

The background to protectionism: saving jobs, standing up to China
There are two main factors behind protectionism in the United States. One is an attempt to securejobs in certain sectors of US industry. Since the election campaign, President Trump has argued
that growing imports and direct foreign investment by US firms lead to fewer job opportunities
for American workers, and that protectionist measures are necessary to protect jobs by limiting
imports and foreign direct investment. Specifically, he has argued that it is necessary to limit
imports to be able to protect jobs in heavy industries like steel and automobiles, concentrated
in the “rust belt” of the Midwest. He has also espoused protectionism and anti-globalization asa means of criticizing the establishment, made up of the Washington politicians and New Yorkbusiness elites who have pushed the trend toward globalization through the expansion of tradeand investment. Workers and other voters who responded to arguments like this from Trump as
a candidate played a large role in winning him the presidency; by activating Section 232 of theTrade Expansion Act after taking office, Trump has moved to fulfill his campaign pledges and put
them into action.
Another reason for US protectionism is the alarm it feels in the face of China ʼ s rapid
development in information technology (IT) and other areas of advanced technology. To achievethe “Chinese dream of the great rejuvenation of the Chinese nation,” China has set a target tobecome a global economic, military, and cultural superpower alongside the United States by thetime of the centenary of the founding of the Peopleʼs Republic in 2049. On economic front, it haslaunched the Made in China 2025 industrial policy with the aim of becoming a manufacturing
superpower, and is promoting a strategy built around development of cutting-edge technology. It
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The Free Trade System Facing the Threat of Collapse

is also working on construction of a China-centered economic sphere by implementing the Beltand Road Initiative. The United States sees Chinaʼs system of state-run capitalism as a challenge
to the American-led free trade system, and is seeking to shift the direction of Chinaʼs policy
through protectionist measures, in order to prevent China from achieving policies and strategies
that challenge the United States. Specifically, it is demanding an end to intellectual property
infringements by Chinese companies, forced technology transfers from foreign companies
investing in China, and other unfair practices.

The impact of protectionism: economic downturn
The impact of the trade war between the United States and China is already being felt in a
reduction in trade volume, increasing import prices and domestic prices within the importing
country on which tariffs were imposed, and falling export prices in the exporting country. We
can expect a drop-off in production and consumption in response to these changes in price.
At present, the US economy is doing well, as President Trumpʼs policies of tax cuts, increased
government spending, and deregulation have their effects, and this is having a positive effect inother economies. However, the impact of these stimulus policies is expected to wane from thebeginning of 2019. If the negative economic aspects of protectionism come to the surface in suchcircumstances, this would likely have serious repercussions not only on the two countries directly
involved but on the entire global economy. Today, when countries around the world are closely
linked by trade and investment and the global value chain, the negative economic effects ofprotectionism would be felt throughout the world. Analysis by the International Monetary Fundsuggests that a trade war between the United States and China could depress economic growth
rates for 2019 by up to 0.9 percent for the United States and China and by up to 0.7 percent for theglobal economy as a whole.
Will the United States attain its desired objectives through its protectionist measures,canceling out bilateral trade imbalances, reviving the protected industries and saving jobs, andputting an end to Chinaʼs unfair practices? It seems unlikely. Although tariffs might help toimprove bilateral trade figures, it is likely to lead to a trade deficit with other countries, and will
therefore not help to increase employment in the United States. On the relationship between
trade and employment, the consensus view in economics is what is important is not simply thebilateral trade balance with particular trading partners but the balance of trade with the world asa whole. Protectionist policies are not an effective way of improving the trade balance with theworld, and macroeconomic measures relating to exchange rates, fiscal and monetary policies
are necessar y. Experience teaches that revitalizing industr y and saving jobs by protectionist
measures is extremely difficult.
The US steel industr y was the source of trade frictions with Japan and other countries
from the 1970s to the 1990s, owing to an increase in imports. The United States responded bydemanding voluntary export restraints and introducing the trigger price mechanism (introducedin 1978 to guarantee a minimum price for imported steel goods with the aim of preventing asharp increase in steel imports), and has used these measures to protect its steel and relatedindustries with the aim revitalizing these industries. These hopes have not been met and now theadministration has resorted to tariffs. But to revitalize an industry that has lost competitiveness,
what is needed is not protectionism but a free market environment unbound by red tape that will
facilitate improvement of workersʼ skills and the introduction of new technology.
Protectionist measures that impose additional tariffs on materials like steel and aluminum canbe particularly harmful. It is necessary to recognize that tariffs raise prices, which has a knock-on
effect on the price of automobiles and other products made from these raw materials. Consumers
are not the only ones to suffer as a result. The impact on companies can be severe, as exports
become less competitive and sales and production volumes fall. Tariffs end up causing industrial
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Shujiro Uratastagnation and decline̶precisely the opposite effects from those they were intended to have. In
order to address Chinaʼs unfair practices, it would be more effective for the United States to act inpartnership with the EU and Japan, which face similar problems.

How to maintain the free trade system: mega-FTAs and reforms of the WTO
By unilaterally imposing protectionist measures against China, which is the second largest
economy in the world, the United States, the largest economy, has brought about a trade war
between the two countries. This threatens the survival of the global free trade system and ishaving a serious impact on the entire global economy. Since the use of protectionist measures
to protect jobs reflects the personal views of President Trump, it is possible that these policies
will be abandoned when his time in office comes to an end. But Trump is not the only influential
figure in the United States who is concerned at Chinaʼs rise. This sense of alarm is sharedby many members of the US Congress and business leaders, and this makes it possible thatmeasures against China may continue long beyond the Trump presidency. What steps can therest of the world take in these circumstances to persuade the United States to return to a rulebased free trade system? I believe that at least three options are possible, as outlined below.
The first does not require any new policies to be taken but rather involves a possible U-turnin US policy brought about by the increasing severity of the negative impact of protectionist
measures on the US economy. If protectionist trade policies are applied in the long term, this will
seriously affect the US economy through increasing prices of imported goods and decreasing
exports and production. If the outlook becomes bleak, the effect of the economic downturn willbe amplified through a fall in stock prices. If the negative impact of protectionist measures makes
itself felt in this way, then President Trump may decide to withdraw some of the measures. But
the economic circumstances would have to be quite serious to persuade President Trump to shift
his policy, and in this case the global economy would also suffer serious damage. This makes thisscenario the worst-case scenario of the three possibilities.
The second approach, which has some aspects in common with the first, would be for theworldʼs major economies̶Japan, the EU, China, and so on̶to work toward comprehensive
and liberal regional integration without the United States on trade and investment, and thus
push the United States into a disadvantageous position. If the US business elite truly felt thatthey were suffering a discriminatory and unfavorable position by being excluded, it is likely thatthey would demand President Trump to negotiate a place at the table for the United States. Thismight be attained by ensuring that the Comprehensive and Progressive Agreement for TransPacific Partnership (CPTPP), signed by the remaining 11 countries after the United States quit
the original TPP agreement, becomes fully implemented quickly and attracts new members.
Similarly, efforts should be made to broaden the membership of the recently enacted economic
partnership agreement between Japan and the EU, and to reach agreement and ratification of theRegional Comprehensive Economic Partnership (RCEP), including India and China, as quickly aspossible.
The third would be for countries that share interests in common, like Japan and the EU, toinvolve the United States in efforts to reform the World Trade Organization (WTO), which isresponsible for maintaining the present world trade order and is beset by problems. In fact, thismovement is already underway, and agreement has been reached at meetings between headsof government and trade ministers from Japan, the US, and the EU on the need for effective
enforcement of trade rules and commitments, improvements to the WTOʼs monitoring anddispute resolution functions, and the establishment of rules for the increasingly important new
field of digital technology. If these efforts progress, it may become possible to curb Chinaʼsunfair practices, easing US distrust of China, and possibly leading to a reduction in protectionist
measures.
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