THE GATT NEGOTIATIONS

AND U.S. TRADE POLICY

The Congress of the United States

Congressional Budget Office

For sale by the Superintendent of Documents, U.S. Government Printing Office

Washington, DC 20402

PREFACE

In September 1986, the member nations of the General Agreement on

Tariffs and Trade (GATT) inaugurated a new round of negotiations aimed at

further opening the world trading system. The Congress must provide U.S.

representatives at these negotiations with negotiating authority and policy

direction, and will be asked to ratify the final results when talks end,

several years from now. These negotiations come at a time when trade

imbalances have become a source of tension in the world economy and when

governments are playing a growing and important role in determining the

flow of commerce. This report, requested by the Subcommittee on

International Trade of the Senate Finance Committee, provides an overview

of this round of trade talks and examines how they might affect four sectors

of the U.S. economy--high-technology goods, agriculture, mature industries,

and services. In keeping with the mandate of the Congressional Budget

Office to provide objective analysis, no recommendations are made.

This report was prepared in CBO's Natural Resources and Commerce

Division, under the direction of Everett M. Ehrlich and Elliot Schwartz.

Stephen Parker made valuable contributions to the content and structure of

the report throughout its development. The overview and historical

material was written by Stephen Parker and Elliot Schwartz. Chapters on

specific sectors were written by Daniel P. Kaplan, Stephen Parker, Elliot

Schwartz, and Philip C. Webre. Roger Hitchner, David Trechter, and James

G. Vertrees contributed to the chapter on agriculture; Gwyn Adams and

Jerrold Abrahams to the chapter on services. Kristen Galles, Peter Glick,

Julie Goldman, and Pam Pritchard provided research assistance. Valuable

comments were received from Victoria Farrell, Neil Fisher, George Iden,

Andrew Horowitz, James Kiefer, and Eileen Manfredi of CBO, and from

Robert Baldwin, Thomas Dorsey, Harry Freeman, Robert Hudec, Gary

Saxonhouse, Nancy Schwartz, and Lee Tuthill. Helpful suggestions were also

made by the Office of the U.S. Special Trade Representative. The report

was edited by Francis Pierce, assisted by Nancy H. Brooks, and prepared for

publication by Kathryn Quattrone, assisted by Pat Joy.

Edward M. Gramlich

Acting Director

June 1987

" 77" 'llilllllllllllHII
I I ID Ilil
CONTENTS

SUMMARY AND CONCLUSIONS x

I INTRODUCTION 1

What Is At Stake? 2

The Negotiating Environment 5

The Uruguay Round and the Congress 12

II GATT NEGOTIATIONS IN PERSPECTIVE 15

The General Agreement on Tariffs

and Trade 15

Previous Rounds: Stage-By-Stage

Liberalization 25

Looking Ahead: The Uruguay Round

Agenda 37

III HIGH-TECHNOLOGY TRADE 47

Current Problems in High-Technology

Trade 48

Targeting 52

Access to Markets 58

Intellectual Property Rights 61

Bargaining Positions in the Uruguay

Round 63

Implications of Liberalized Trade 69

IV AGRICULTURE 71

Recent Trends in Agricultural Trade 72

National Farm Policies and International

Trade 78

Bargaining Positions in the Uruguay Round 89

Implications of Trade Liberalization

For U.S. Agriculture: Two Scenarios 95

III1111
imiiiKHii

vi GATT June 1987

V MATURE INDUSTRIES: AUTOMOBILES, STEEL,

TEXTILES AND APPAREL 99

Current Problems in Mature-Industry

Trade 101

Bargaining Positions in the Uruguay Round 112

Implications of Liberalized Trade 114

VI TRADE IN SERVICES 119

Defining Services 120

Recent Trends in Services Trade 121

Current Problems in International

Services Trade 123

Bargaining Positions in the Uruguay Round 130

Implications of Liberalized Trade

in Services 132
CONTENTS vii

TABLES

1. U.S. Tariff Rates, 1789 Through 1984 26

2. Duty Reductions Since 1934 Under

the U.S. Trade Agreements Program 28

3. Tokyo-Round Tariff Cuts by Stage of

Processing for the United States, the

European Community, Japan, and Canada 31

4. Tokyo-Round Tariff Cuts by Industry

for the United States, the European

Community, and Japan 32

5. High-Technology Balance of Trade

for Selected Years 50

6. World Market Shares for Wheat and

Coarse Grains in Trade Year 1985/1986 75

7. U.S. Exports and Imports of

Agricultural Commodities, 1971-1986 76

8. U.S. Agricultural Exports by Region,

Fiscal Years 1981 and 1986 77

9. U.S. and EC Outlays for Price

and Income Supports 80

10. Ranking of Producer Subsidy Equivalents

by Commodity and Country, 1982-1984 90

11. Weighted Averages of Producer Subsidy

Equivalents by Country, with Major Sources

of Assistance, 1982-1984 91

12. Trade Balances by Products and Countries 100

13. Net Balance of Trade in Services 122

14. U.S. Exports and Imports, Selected Years 124

hi 1111
viii GATT June 1987

FIGURES

1. World Agricultural Exports 73

2. Apparel Industry: Trade Balance of the

United States and the European Community

with Developing Countries 108

3. European Community: Steel Production,

Consumption, and Capacity 110

BOXES

1. Reciprocity in GATT Negotiations 7

2. The U.S. Trade and Budget Deficits 10

3. The General Agreement in Brief 18
SUMMARY AND CONCLUSIONS

The General Agreement on Tariffs and Trade (GATT) is both a multilateral

agreement and an organization that administers the agreement among the

93 signatories. Seven rounds of GATT-sponsored multilateral trade negotiations have progressively lowered postwar tariff barrriers, and an eighth

round-the "Uruguay Round"--is now taking place.

The Uruguay Round is occurring at a critical juncture in international

trade relations. The GATT rules and procedures that have successfully

guided four decades of trade liberalization show signs of breaking down.

Unless confidence in GATT is renewed, present difficulties could lead to a

costly global trade war.

IMPORTANCE OF THE URUGUAY ROUND

Governments are increasingly resorting to policies that are not regulated by

GATT, and that conflict with its principles of open and nondiscriminating

trade. Such government actions are often felt to be essential to maintaining

the competitiveness of national industries. As tensions rise, this tendency

may escalate into retaliatory measures and countermeasures. The

importance of the Uruguay Round lies not so much in how any one of the

items on its agenda is resolved as in the recognition by governments of the

need to modernize the GATT framework so as to reflect the increasing

importance of international markets, and to accept the resulting changes in

their own policies.

Many hope that new GATT agreements will work to reduce the huge

U.S. trade deficit. Such a hope is probably misplaced. Most of the aggregate trade deficit can be attributed to divergent macroeconomic policies

among the major industrialized countries. In particular, high U.S. government budget deficits have been a major cause of the recent surge in the

U.S. trade deficit.

The Uruguay Round requires attention from the Congress for several

reasons. Most immediately, the Congress must provide new authority for

these negotiations, along with policy direction. In addition, it must consider

hi Jill
x GATT June 1987

the possible effects of the Uruguay Round on federal programs that are

sensitive to international trade--most obviously in agriculture. Through

their effects on such programs, new trade agreements could ultimately have

an impact on the federal budget.

Trade negotiations take time. This round of talks--preliminary negotiations have already begun--is not scheduled to end until 1991, although

some interim agreements may be reached before then. After Congressional

approval, more time will be required to phase in the new policies. Whatever

the outcome of the trade talks, then, most of the direct effects on U.S. policy and economic activity will not occur until well into the 1990s.

The Uruguay Round could nevertheless have an immediate impact on

the way governments deal with their trade problems. If the talks were to

deadlock, governments might resort to actions outside the realm of GATT to

serve their national interests. On the other hand, indications that the talks

were moving toward a successful resolution of key problems would lessen

pressure for immediate and possibly harmful government actions. In this

sense, the talks will succeed in the short run if they foster an atmosphere of

cooperation that reduces current tensions among countries.

The main focus of these negotiations, however, will be on the long

term. The benefits of open trade are well known: trade expands the range

of goods available for consumption and increases productivity by allowing

producers to specialize according to their resources and technology. But

opening up trade creates problems, such as how to address the unequal distribution of benefits and losses among different groups in a country, and how

to react when another country attempts to promote some of its own industries at the expense of its trading partners.

One way of analyzing the Uruguay Round is to examine its possible

consequences for particular sectors of the U.S. economy. This report looks

at four broad sectors--high-technology goods, agriculture, mature industrial

products, and services--to see how they might be affected by trade liberalization.

THE URUGUAY ROUND IN PERSPECTIVE

The Uruguay Round will be judged largely on how well it addresses issues

related to nontariff barriers. Examples of nontariff barriers (NTBs) range

from direct quantitative controls on imports to the less visible effects of

national economic policies on trade flows. GATT has been unable to regu-
SUMMARY AND CONCLUSIONS xi

late the use of NTBs for a number of reasons: they are inherently less

"transparent" in their effects than tariffs, which makes them difficult to

evaluate; and they are often linked directly to national policies that are

based on domestic rather than international priorities.

The General Agreement on Tariffs and Trade

The GATT was created following the Second World War as one of three

international organizations intended to oversee postwar economic relations,

the other two being the International Monetary Fund and the World Bank.

GATT's members today account for over 80 percent of world trade.

Four key principles underlie the General Agreement:

o Member countries should work for the steady reduction of trade

barriers and the elimination of quotas.

o Trade policies among member countries should be applied on a

nondiscriminatory (most-favored-nation) basis.

o A tariff concession, once made, cannot be rescinded without compensation to affected countries, and other forms of protection

cannot be substituted to circumvent the concession.

o Trade conflicts should be settled by consultation.

These principles are not inviolate; exceptions to them have always

been tolerated. In fact, many of GATT's current problems stem from both

old and new evasions of these principles. Examples of current exceptions

include:

o The Multifiber Agreement governing trade in textiles and apparel;

o Voluntary export restraints, such as the recent U.S. limits on

automobile imports from Japan;

o Escape-clause actions, such as the recent protection given the

motorcycle industry;

o Agricultural import quotas and agricultural subsidies;

o Barriers to trade in services, and the failure to protect intellectual property rights;
Hill flH I

xii GATT June 1987

o Free trade areas, such as the European Community;

o Preferential treatment for developing countries;

o Nontariff barriers to trade; and

o Retaliatory trade actions.

This list of exceptions to GATT's general principles will comprise much of

the agenda for the Uruguay round of multilateral trade negotiations. In essence, the agenda aims to strengthen GATT discipline and expand it to cover

all trade in goods and services. If successful, most nontariff policies would

come within its purview, which would extend to all major trading countries

of the world. The primary concern, however, is not so much strengthening

the role of GATT as resolving fundamental disagreements among countries

over the role of government in economic activities.

IMPLICATIONS OF THE URUGUAY ROUND

FOR U.S. GOVERNMENT PROGRAMS

A distinguishing feature of the Uruguay Round is its emphasis on liberalizing

trade barriers-especially NTBs--that are integrally linked to national economic policies. Foreign trade can no longer be dealt with apart from other

domestic economic policy concerns. Governments often employ trade policies less for commercial ends than to achieve other goals--economic, political, and social. Significant trade liberalization thus means changing these

national programs, and for this reason domestic policies will increasingly be

the focus of trade negotiations.

The following is an illustrative, but not comprehensive, list of U.S.

government policies that are effectively on the Uruguay Round bargaining

table:

o Farm programs (including export subsidies, import quotas, and domestic price and income support programs);

o Federal support for research and development;

o Tax policies that favor domestic producers;

o National security regulations;
SUMMARY AND CONCLUSIONS xiii

o Trade Adjustment Assistance and the Job Training Partnership

Act;

o Various trade policy procedures (notably, escape-clause actions);

o Antitrust regulations;

o Import quotas (or voluntary export restraints) for various manufacturing goods;

o All import tariffs;

o Government procurement practices that favor domestic goods;

o Federal and state regulations governing banks and other financial

institutions;

o Immigration laws;

o Transportation regulations (including airlines and shipping);

o Patent and copyright law, and other intellectual property rights

laws;

o Technical standards and health and safety rules;

o Bilateral economic agreements;

o Rights of establishment for foreign firms;

o U.S. economic policies toward developing countries; and

o U.S. acquiescence to GATT enforcement powers.

The length of this list illustrates the deep ramifications of foreign trade in

the U.S. economy. Similarly lengthy lists could be made for most other

countries. Although the Uruguay Round is not likely to require substantial

changes in all of these programs, those included in the list will increasingly

become the focus of future trade policy negotiations. The United States and

other countries have already started reforming several of these policies on a

unilateral basis in response to internal economic and political pressures.
xiv GATT June 1987

The following discussion shows the bearing of the trade negotiations on

domestic policies in four sectors. I/

High-Technology Products

Trade in high-technology products is already covered by the GATT, but

numerous disputes have arisen because many governments subsidize production of these goods in an attempt to gain a competitive advantage. An

underlying issue is the extent to which governments can, and should, enhance the competitiveness of domestic producers; and how the spillover effects of such policies can be controlled.

Discussions of intellectual property rights will bear directly on hightechnology goods. If an agreement can be reached that tightens the penalties against unauthorized use of patents, copyrights, and trademarks, U.S.

firms holding those rights--most generally in high-technology industries- -should gain.

Trade liberalization should in general benefit most U.S. producers of

high-technology products--in aerospace, computers, electronics, pharmaceuticals, and scientific instruments.

Agriculture

Most barriers to trade in agricultural products have been erected to accommodate domestic farm policy programs. In this country, for example, such

restraints often serve to protect domestic farm price supports. Many other

developed countries use import barriers and export subsidies in much the

same way: to stabilize and nurture the domestic farm sector, not to achieve

export or import goals. Such trade barriers cannot be significantly reformed

without changing the domestic farm policies they serve. The negotiations

will focus on the agricultural policies of developed countries, most importantly those in the United States, the European Community, Japan,

Canada, and Australia. Although major policy reforms are likely to benefit

the economies of all countries, some farmers may be made worse off by

reductions in farm support programs, especially over a transition period.

Efforts to compensate farmers for losses may be necessary. For each

1. No attempt is made here to summarize fully the sectoral analyses

contained in Chapters III-VI. A short precis appears at the beginning

of each of those sectoral chapters.
SUMMARY AND CONCLUSIONS xv

country, however, the adjustment costs may be lessened if all countries

concurrently open their agricultural markets, which should expand world

trade and bolster prices, and if agreements are phased in over a long period

of time.

Mature Industries

These industries, such as steel, textiles, apparel, and--increasingly--automobiles, have declined in the advanced industrial countries, even as they

have grown in some developing countries. They are technically covered by

the GATT, but many countries have sought to develop special protective

arrangements for them through formal and informal agreements. Abolishing

such practices would force governments to confront the consequences of

economic change, such as unemployment, and to revise policies that often

impede, rather than promote, adjustment. GATT negotiations over subsidies, escape-clause procedures, and the GATT dispute settlement process

will be of particular importance for mature industries. Negotiations in

these sectors often take on a North-South polarization, since developing

countries are rapidly becoming major suppliers of such goods to developed

countries.

Agreements that liberalize trade and reduce trade barriers will have a

direct impact on those mature industries that are now accorded special protection. The negative effects would be lessened if the liberalization was

truly multilateral. The U.S. automobile industry, for example, might benefit

from a reduction of European barriers to Japanese autos, since those barriers have diverted Japanese auto exports from Europe to the United States.

Services

An agreement on services trade would bring a new set of national policies

under international scrutiny. All countries regulate service activities to

some degree—with the added complication that much of this occurs at the

state or provincial level. Many of the regulations embody long-standing

social values, such as consumer and producer rights, that are generally considered well within the bounds of national sovereignty. But the spillover

effects can be stifling to international trade. The United States, in particular, has untapped export growth potential in many kinds of services, particularly those employing large amounts of high-skilled labor (such as construction, telecommunications, financial services, and skilled professional

business services). On the other hand, the United States stands to lose from

greater imports of lower-skilled, labor-intensive services (in construction,

shipping, and personal services).
xvi GATT June 1987

KEY ISSUES UNDERLYING THE NEGOTIATIONS

The Uruguay Round agenda covers most of the current issues in international trade. But underlying these issues are a number of more subtle questions. How can trade policy be made more transparent? When does a

national economic policy become an internationally unacceptable nontariff

barrier to foreign trade? To what extent are governments willing to relinquish their sovereignty and shift their national priorities to accommodate

international agreements? Should discriminating trade practices of any kind

be allowed? If nontariff barriers are to be liberalized, how can this best be

done? Would bilateral or multilateral agreements be preferable? When does

a developing country graduate to become a full-fledged member of the international trading community?

Need for Policy Transparency

It is difficult to measure the relative benefits and costs of trade reform

unless the effects of national policies can be compared for different

countries and industrial sectors. This can be done easily for ad valorem

tariffs, which apply a tariff rate in percentage terms to the value of a

traded good. For nontariff barriers, however, there is no such "transparent"

measure of protection. To negotiate the liberalization of nontariff barriers,

ad valorem equivalents of their protective impact must be measured in a

way that can be consistently compared between countries, types of policies,

and economic sectors. Producer subsidy equivalents, which are being employed for this purpose in the agricultural sector, are one such measure.

Another way to achieve transparency is to convert nontariff barriers to

equivalent ad valorem tariffs. Not only are ad valorem tariffs more transparent than nontariff barriers such as import quotas, but they also have a

less distorting effect on economic decision making.

Introducing transparency requirements should favor U.S. interests by

providing U.S. negotiators and firms with a much clearer picture of how

foreign governments influence trade flows. Trade policy procedures in the

United States are relatively open compared with those in other countries.

The United States does employ several nontariff barriers to trade, and converting these to tariff equivalents would show the extent to which import

quotas often represent high levels of protection. It would lessen the negative impacts of protection on the economy, and if the tariff-equivalent

amounts could be collected by the government (either directly or by auctioning quota rights to the highest bidders), the Treasury would gain the

quota rents that otherwise accrue to foreign exporters.
SUMMARY AND CONCLUSIONS xvii

Rules, Enforcement, and Trade Liberalization: the Role of GATT

Considerable effort will be exerted during the Uruguay Round to devise

rules to control better the use of various nontariff barriers to trade. New

rules, however, require general acceptance of underlying principles. Disagreement among GATT members as to what those fundamental principles

should be is a major stumbling block to improving GATT rules.

GATT's previous success in reducing tariffs was accomplished by developing a set of rules that discouraged increases in tariff rates, and then

gradually reducing existing tariffs--on a most-favored-nation basis--

through reciprocal bargaining during multilateral negotiations. The rules

reinforced, but did not lead, the liberalization process.

A first step in liberalizing nontariff barriers will be to develop rules

that clearly identify NTBs and demarcate those NTBs that are improper.

Then the rules must be implemented. The Tokyo Round codes of conduct-a

set of rules applying to several NTBs-relied primarily upon the good-faith

compliance of signatories of the code. GATT enforcement procedures for

the codes were cumbersome and ineffective. Although these codes may

have restrained some governmental actions, there is little evidence that

they have led to significant changes. The experience with tariffs suggests

that reciprocal bargaining, involving coordinated concessions among trading

partners at either the policy or the industry level, may be a more effective

medium for liberalizing NTBs.

GATT dispute procedures play an important role in the trade liberalization process by encouraging countries to resolve their conflicts in an

orderly manner without confrontations. Streamlining and enhancing the

GATT dispute settlement process will be a major priority for the Uruguay

Round. Establishing a nonpartisan standing panel of experts and applying

stringent procedural deadlines can prove beneficial. But efforts to strengthen GATT's power to enforce its rules will encounter the reluctance of most

governments to yield sovereignty over control of their national policies. It

is unlikely that GATT will ever be the primary enforcer of its rules. Rather,

in liberalizing NTBs, it will most likely rely on the adherence to mutually

accepted standards of behavior by governments; its role will be to facilitate

dispute settlements and other negotiations.

The Uruguay Round and Developing Countries

More vigorous participation by developing countries in the trade talks will

require concessions by the United States and other developed countries in
xviii GATT ' June 1987

several ways. For example, developing countries want long-term guarantees

of access to developed-country markets for their exports. Better access

would involve loosening such barriers as the Multi-Fiber Agreement, along

with promises by developed countries to refrain from erecting similar barriers in the future. This would force the developed countries to cede some

of their existing markets to developing countries, and to adjust their domestic economies accordingly--involving difficult economic and political decisions.

Developing countries now have almost one-quarter of total world exports, and about one-eighth of world manufactured goods exports. Economic

growth in developed countries is increasingly linked with the economic

future of the developing countries. Yet most trade policy actions by

developing countries are not regulated by GATT. Just as developing

countries argue that it is not fair for developed countries to erect trade

barriers that penalize them for their industrial success, so the developed

countries complain of the self-serving trade policies employed by many of

the most successful developing countries. Clearly, the advanced developing

countries must be more fully integrated into the GATT system. The question is not so much whether this will happen as when and how it will be

accomplished. Underlying the negotiations on many of the key issues in the

Uruguay Round will be compromises over this graduation process.

Product and Country Trade Policy Discrimination

Countries increasingly resort to bilateral agreements, involving quotas and

other nontariff arrangements, to solve trade disputes. Such agreements

introduce two forms of trade policy discrimination: the application of

policies unevenly across countries, and their application unevenly across industries. Although most forms of trade policy discrimination are discouraged by GATT, exceptions have always existed, and some observers question

whether the principle of nondiscrimination will remain the basis for future

trade agreements.

Most-Favored-Nation Treatment. Unconditional most-favored-nation (MFN)

treatment~the application of a trade policy equally across all countries—is

a cornerstone of GATT. Trade policies that discriminate by country not only

complicate international trade relations and negotiations, but also may divert trade from low-cost producers to higher-cost producers. Such policies

invariably induce countries not covered by an agreement to alter their behavior, often offsetting the original intent of the agreements and leading to

further discord.
SUMMARY AND CONCLUSIONS xix

Violation of the MFN principle usually occurs for three reasons: a

small group of countries may be able to work out an agreement more easily

than a broader group (as in free trade agreements); a country aims specifically to penalize another country for what are perceived to be unfair trade

practices (by retaliating against dumping, or applying countervailing duties

in response to export subsidies); and a country places restrictions on imports

causing injury to specific domestic interests. In certain of these situations,

discriminatory practices may prove beneficial: free trade areas can create

trade among the members; retaliation can force trading partners to halt

unfair trading practices; and the selective application of trade remedies for

the relief of threatened industries can limit the negative effects of suppressing competition. The danger, though, is that discriminatory practices may

become the norm rather than the exception.

Specific Product Agreements. GATT does not explicitly require that protection be applied evenly across industries within an economy. But its

general thrust is to limit the use of quantitative trade barriers-which are

commonly used to provide higher levels of protection to some industries

than to others~and to encourage reductions in trade barriers across all industries. Uneven protection that favors some industries relative to others

can limit economic growth if low-productivity sectors are favored over

higher-productivity sectors.

The case for special treatment of specific products is made on several

grounds, namely: that temporary restraints provide an effective way of

handling temporary market disruptions (as in autos); that specific exemptions are necessary to save the general rule of free trade, since without the

ability to make exceptions the whole structure would fall; that different

products have different characteristics, requiring somewhat different trading rules (as in textiles and various services); and, in the extreme, that some

products (as in the steel, agriculture, and high-technology industries) are so

vital to national interests that administrative solutions are preferable to

market results.

Alternatively, it can be argued that most restraints to trade are detrimental to world economic growth, and often to the countries enforcing the

restraints. It can also be argued that the proliferation of sectoral protection and managed-market agreements breeds more protection, as it becomes

difficult to justify protection for some sectors and not for all.

The Uruguay Round will specifically address the most serious case of

sectoral discrimination--that in the agricultural sector. It will also take up

other specific sectoral actions, including barriers to trade in services, the

iMililllll
xx GATT June 1987

Multiflber Agreement and other voluntary export restraints in various industries, and the "safeguard" procedures that are used to implement many of

these policies. The United States has been an active user of discriminatory

trade policies, and the results of these trade talks may limit the flexibility

of U.S. trade policy in the future.

IS GATT WORTH SAVING?

The strongest defense of GATT is based more on what it has prevented

rather than on its explicit accomplishments. Since the creation of GATT,

world economic growth has not been fettered by nationalistic policies. Instead, it has been stimulated by expanding international trade.

GATT was created primarily to reduce the possibility of another debilitating trade war similar to that which followed the Smoot-Hawley

Tariffs at the beginning of the depression. It was also intended to undo

much of the damage caused by those actions. By this test, GATT can be

judged quite successful. Although trade relations have suffered numerous

crises over the last 40 years, these have not set back world economic

growth. And GATT-sponsored multilateral negotiations have helped to reduce the Smoot-Hawley-era tariffs by over 90 percent: the average tariff

rate for most developed countries is now less than 5 percent.

The value of GATT lies not only in its rules, but in the fact that it also

provides a forum where countries can resolve disputes over national policies.

GATT is one of the few policy forums where long-run goals guide the resolution of short-term crises. No comparable framework exists for settling

other key international problems--such as how to coordinate macroeconomic policies or to lighten the burden of debt.

GATT needs to be modernized, however, and this means rethinking the

principles that should guide trade policy for the rest of the century. GATT

has little independent power; it merely reflects the will of its members. To

revitalize it, the members will need to reexamine many long-standing

domestic policies and reassess their national priorities, given increasingly

important economic linkages among countries. The problem is not the inadequacy of GATT, but rather how governments are going to mesh their

policies with the requirements of the world economy. Opening up the

potential of international trade represents one of the great challenges facing governments today.
CHAPTER I

INTRODUCTION

Over 90 countries joined together to launch the Uruguay Round of multilateral trade negotiations during a meeting of trade ministers in Punta del

Este, Uruguay, last September. The Uruguay Round is the eighth sponsored

by the General Agreement on Tariffs and Trade (GATT). It continues the

process of adapting the GATT framework of trade agreements to everchanging international economic conditions. Formal negotiations to determine the procedural format for the talks have already begun, and a fouryear deadline has been set to complete the talks.

The United States has led the drive for new multilateral trade negotiations. Other governments have joined in-some enthusiastically, some reluctantly. Although the United States has been the prime motivator for trade

liberalization since World War II, the intensity of its push for a new round

reflects concerns about the economic and political ramifications of recent

record trade deficits. Even though the U.S. trade deficits are primarily a

response to macroeconomic policies, certain U.S. industries have suffered

heavily from foreign competition. U The result has been political pressure

to redress the balance by establishing quotas or tariffs on certain imports as

well as by taking aggressive actions to reduce foreign barriers to U.S.

exports. Other countries have responded by pointing to the protective trade

policies of the United States. Some that are reluctant to enter a new round

of trade negotiations have done so rather than face the prospect of a

retaliatory trade war with this country.

Negotiators in the Uruguay Round will focus on extending the GATT

framework in two dimensions: to goods and services that are now not included, and--perhaps more crucially--to no ntariff barriers to trade (that is,

the broad range of nontariff national policies that have sizable impact on

international trade). Priority will be given to the following agenda: liberal1. For a clear analysis of the relationship between trade policy and the aggregate trade

deficit see Rachel McCulloch and J. David Richardson, "U.S. Trade and the Dollar:

Evaluating Current Policy Options," in Current U.S. Trade Policy: Analysis, Agenda,

and Administration, Robert E. Baldwin and J. David Richardson, eds., National Bureau

of Economic Research Conference Report (1985).

1 ill III. I
2 GATT June 1987

izing both tariff and nontariff barriers to trade in agricultural products, in

tropical and natural resource products, in textiles and apparel, in steel, and

in services; strengthening GATT rules and enforcement procedures, especially those related to subsidies; establishing GATT rules to protect intellectual property rights; and standardizing safeguard (escape clause) procedures

across countries. Since many of these issues deal specifically with policies

employed by developing countries, expanding the GATT framework in this

way will force a reassessment of the role of developing countries' policies in

the world trading system. And given the importance of international trade

as a stimulus to economic growth, the results of these talks will help shape

U.S. and worldwide economic prospects throughout the rest of this century. 2/ They may also affect the federal government's economic and budget policies for many years to come.

WHAT IS AT STAKE?

The Uruguay Round comes at a time when governments are increasingly

intervening in world trade to try to manage world markets for key products:

in some cases allotting national market shares and inhibiting competition;

and in other cases aggressively pursuing policies to enhance the competitiveness of particular industries. Many recent government actions—especially in the form of export subsidies, voluntary export restraints and other

nontariff barriers to imports, and bilateral agreements-contradict the

GATT principles that have successfully supervised international commerce

since World War II. As government intervention increases worldwide, additional protective measures become more easily justifiable, especially for

defensive purposes. Such a spiral of trade restraints could jeopardize world

economic growth and the welfare of nations.

Benefits of Free Trade

Economists have long extolled the benefits of free trade. Free trade is a

positive-sum activity-those who trade do so because of mutual benefit.

2. A number of books and articles have been written recently that deal with the Uruguay

Round of trade talks. Three that have been useful for the preparation of this report

and which are not specifically quoted in the text are: Michael Aho and Jonathan Aronson,

Trade Talks; America Better Listen! (New York: Council on Foreign Relations, 1985);

Gary Hufbauer and Jeffrey Schott, Trading for Growth: The Next Bound of Trade

Negotiations (Washington, D.C.: Institute for International Economics, 1985); and

William Cline, ed., Trade Policy in the 1980s (Washington, B.C.: Institute for

International Economics, 1983).
Chapter I INTRODUCTION 3

Free trade expands the range of products available for consumption;

broadens the markets for a country's producers; and increases a country's

productivity by encouraging greater specialization.

International trade can be a stimulus to economic growth in both

developed and developing countries. While larger countries can sometimes

grow for a time by exploiting their own internal economic diversity and

market size, as a rule a country cannot maintain high domestic economic

growth rates for long without increasing its foreign trade. The importance

of trade can be seen in the fact that the total volume of international trade

increased by 1.6 percent for every 1 percent increase in world economic

growth over the high-growth period 1950 to 1973. As worldwide economic

growth began to stagnate in the period 1973 to 1984, this ratio fell to

1.1 percent. §/

Foreign trade has played an increasing part in the U.S. economy over

the last 20 years. The ratio of imports or exports to total output (GNP) has

almost doubled over the last two decades. Sectors such as agriculture,

electronics, aircraft, certain types of machinery, and chemicals rely heavily

on foreign markets for sales, while many domestic producers and consumers

gain from the purchase of imports.

Difficulties with Free Trade

The strong argument for free trade summarized above ignores the fact that

free trade raises serious problems for governments. First, although free

trade improves the overall standard of living in a country, the benefits are

not distributed equally. The benefits are received by the most competitive

productive groups, who are often already relatively well off, while the costs

are borne by the least competitive groups. While gains to consumers more

than outweigh losses to producers, their gains are normally spread thinly

among many buyers. Moreover, if the shift of resources toward the more

competitive sectors leads to unemployment during the adjustment process

(and individual firms and workers lose some capital or skills specific to their

former employment), then the private loss for some groups in the economy

may be considerable. Unemployment introduces some social loss to the

economy as a whole. Rather than attempting to compensate the losers by

drawing upon the benefits of trade, governments often try to protect these

weaker segments of the economy from foreign competitors at a net cost to

the economy as a whole. Such protection generally forces consumers to pay

3. Annual Report of the General Agreement on Tariffs and Trade, 1984/85, p. 18.

TT"" lliBiiillll
4 GATT June 1987

higher prices, and retards structural changes in the economy that can lead

to higher productivity over time. I/ There may be much less costly and

more equitable ways to achieve these distributional goals than using trade

policies.

Another problem arises when one country uses trade policies to gain

advantage at the expense of its trading partners. £/ Beggar-thy-neighbor

policies can succeed if other countries do not retaliate. Retaliatory trade

wars reduce the overall standard of living of all countries involved. A

better course is to try to modify the unfair trading policies of other countries through negotiation rather than by retaliatory measures.

Government's Role in "Competitiveness". A new development in trade

policy is the recognition that governments can fabricate comparative advantage. The traditional economic model explained trade flows between countries as the result of differences in resource endowments. But an increasing

proportion of world trade now consists of the exchange of similar products

between countries with comparable resource endowments and production

technology. Success in this "intra-industry" trade relies more on such factors as economies of scale, business acumen, research and development, and

product innovation than on differences in wages and capital stock. Maintaining market share becomes essential for the long-run viability of this

type of trade. Since the margin of competitiveness is so narrow, traditional

government policies such as education, scientific and research grants, and

credit allocation can tip international competitiveness in favor of one country's producers against another's. The use of active government policy as a

fundamental determinant of dynamic comparative advantage muddles the

concept of "fair" trade policies. Just how far governments may or should go

to support their nations' industries is an important question underlying many

of the topics that will be discussed during these negotiations.

4. Instead of protecting industries from foreign competition, government can try to assist

them in adjusting to changes in demand. Theoretically, adjustment programs lower

many of the costs related to changes in trade flows, but such efforts in practice have

met with mixed success. The economics of the adjustment process are obscure. For

example, the many factors that influence a family's decision to change jobs or move

to another region have not been adequately modeled. In fact, there is a shortage of

information on even the magnitude of the problem. The most thorough examination

of labor displacement is: U.S. Congress, Office of Technology Assessment, Technology

and Structural Unemployment: Reemploying Displaced Adults, OTA-ITE-250 (February

1986).

5. Under certain conditions, optimal tariffs and other trade policies can be used to increase

the welfare of one country relative to its trading partners, but the loss in welfare to

its trading partners exceeds the gain to the country.
Chapter I INTRODUCTION 5

THE NEGOTIATING ENVIRONMENT

Multilateral negotiations allow countries to develop a common framework

for approaching trade problems and afford the opportunity for reciprocal

bargains that can make all parties better off. But negotiations often take

several years, and outcomes are generally phased in over time. Multilateral

talks rarely solve immediate trade conflicts. §/ Instead, negotiations

develop an enduring set of guidelines that moderate trade policy responses

to various economic and political pressures, while gradually reducing

restrictive trade policies already in place. GATT rules operate in a fashion

similar to domestic laws that regulate social relationships. During periods

of well being, GATT maintains a low profile and its negotiations encourage

steady, but rarely dramatic, trade policy reform. During periods of economic stress, as is the case now, the GATT framework works to restrain

governments from employing policies that they may later regret.

Previous rounds have induced developed countries to reduce dramatically tariffs on most manufactured goods imports: the average tariff rate

on dutiable imports into developed countries is now around 5 percent, compared with much higher average tariff rates (almost 60 percent for the

United States) when tariff liberalization talks first began in the early 1930s.

The negotiations, especially the most recent Tokyo Round, have also begun

the process of controlling the spread of nontariff barriers.

But a large proportion of international trade is still encumbered by

various governmental policies. Many kinds of nontariff barriers have been

erected that are not effectively controlled by GATT rules. These barriers

are especially high in agriculture and in services. Even where GATT

discipline is well established (for example, GATT rules designed to discourage dumping of manufactured products such as semiconductors), member

governments have been increasingly unable to resolve their differences.

The broad task facing participants in the Uruguay Round, therefore, is

to modernize the GATT framework of rules and procedures to cope better

with the new realities of international trade, and to use these rules to

achieve more liberal policies. This involves strengthening GATT authority

where it already exists, and establishing GATT rules and enforcement pro6. A major effort of the Uruguay Round, as discussed more fully in Chapter II, will be to

enhance GATT's institutional ability to handle day-to-day trade disputes.

{illinium
6 GATT June 1987

cedures for trade in nonmanufactured goods, for trade with developing countries, and for many nontariff trade barriers, none of which are now covered

adequately by GATT. Better rules, though, must be implemented to be

effective. Although previous rounds produced rules to govern the use of

several nontariff barriers, compliance with them relied mainly on the good

faith of members. GATT enforcement procedures are passive and weak.

There is little evidence that these procedures have significantly liberalized

trade. One specific task, therefore, will be to strengthen GATT's powers to

enforce compliance. If experience with tariff reduction is a reliable guide,

however, governments will be most likely to reduce trade barriers when a

tangible concession by one country can be roughly offset by a reciprocal

concession from a trading partner.

Negotiating Procedures

Deliberations leading to the Punta del Este Declaration and the initial talks

in Geneva have been dominated by jockeying to establish favorable positions

for the start of the substantive negotiations. Partly as a compromise to

achieve the broadest possible agenda, the Punta del Este agreement assigned

most of the major items on the agenda to separate working groups. 11

Although the mandate for many of these groups stresses rule-making and

enforcement procedures, concessional bargaining to liberalize existing policies may occur in a number of cases. Negotiations in most groups, at least

initially, are to be self-contained, thus limiting demands for reciprocal

concessions across groups. This arrangement, by impeding cross-issue

reciprocity, means that there will be less incentive to compromise, and thus

less likelihood of major concessions on some key issues (see box). Activities

in each group will be coordinated by a Trade Negotiations Committee

consisting of representatives from various participating governments. How

reciprocity is to be measured for a final agreement involving the many

issues on the agenda has yet to be determined.

7. All decisions in GATT must be approved by consensus. As more countries with diverse

interests participate in GATT activities, consensus forces administration by compromise.

To obtain the approval of several key developing countries to the Punta del Este

Declaration, developed countries agreed to separate negotiations on services and

manufactures trade. The developing countries demanded this in order to weaken any

reciprocity link between increased access by developing countries to manufactured

product markets in developed countries and reductions in trade barriers for service

trade by developing countries.
Chapter I INTRODUCTION 7

RECIPROCITY IN GATT NEGOTIATIONS

A hallmark of GATT negotiations is that each country enters voluntarily with

the prospect that nothing must be yielded unless matched by reciprocal actions

from its trading partners. Generally, each major negotiating team tries to achieve

a roughly equivalent level of multilateral reciprocity in any final agreement,

ensuring that each country can claim success when the deal is brought home.

Designing a scoring method that tallies reciprocity across thousands of tariff

classifications and numerous nontariff issues while remaining agreeable to the

many negotiating parties is not a simple matter. Different measures of reciprocity

may favor different countries. GATT does not specify how reciprocity is to be

measured. Rather, the terms of reciprocity are an integral part of each negotiation

process.

During the early rounds, when tariff reductions dominated the agenda,

multilateral reciprocity was measured by the value of trade covered by tariff

concessions, which were made on a most-favored-nation basis. In recent rounds,

the average depth of tariff cut also was employed to measure reciprocity. The

ultimate, but far too complex, criterion of equalizing gains in national welfare

was at best indirectly relevant. By the Tokyo Round, data became available that

allowed some countries to use economic models to estimate the effect of tariff

concessions on trade flows, domestic output and employment, and economic

welfare. More sophisticated reciprocity criteria, especially some allowing the

summation of national benefits and costs over numerous nontariff agreements,

may be used by many countries during the Uruguay Round.

Multilateral reciprocity was not used during the Tokyo Round negotiations

concerning codes of conduct for nontariff barriers. Instead, reciprocity was defined

independently for each code. Code reciprocity allowed a country to choose whether

to sign a code without prejudicing its bargaining power in other parts of the

negotiation. Limiting cross-issue reciprocity in this way made it easier for likeminded groups to enter into agreements. But it introduced two problems. Since

the agreement required that signatories apply the discipline of the code only to

trade with other signatories, it could potentially breach the principle of

nondiscriminatory treatment, which has been a cornerstone of GATT. Also,

parties often have unbalanced demands. One country may have little to gain

by reciprocally reforming policies in one particular issue, but much to gain from

concessions on another issue. By limiting trade-offs between issues, considerable

bargaining leverage is wasted.

HiiiniiHiii
8 GATT June 1987

As in previous rounds, each country accepts a "standstill and rollback

commitment." This commits negotiating governments not to initiate any

new trade polices inconsistent with GATT rules over the course of the talks

and to phase out by the end of the talks any trade policies currently in place

that are not consistent with GATT rules. The purpose of the standstill

commitment is to provide some order to the negotiations by stopping a

country from altering its trade policies so as to enhance its bargaining

power. In past rounds, however, both commitments served more as

statements of intent than enforceable promises. Various countries introduced new protection during the Tokyo Round--the U.S. trigger price policy

for steel, for example--and any policy rollback occurred as a result of

reciprocal bargaining.

The Economic and Political Environment

Trade issues are always politically sensitive, especially during periods of

economic stress. Economic performance in one country is increasingly

linked through international trade and monetary flows to activity in other

economies. These linkages have recently been under great strain, as witnessed by large swings in exchange rates, prolonged weakness in world commodity markets, huge trade account imbalances, and the developing-country

debt problem. World economic growth has been moderate at best over the

last several years, and seems likely to continue that way.

Macroeconomic Policies and International Markets. Most of the instability

in international markets can be explained by divergent macroeconomic policies in the United States, Japan, and the European countries. 2/ During the

early 1980s, emphasis shifted abruptly toward deflationary monetary policies, as key central banks refused to accommodate the second round of oil

price increases. Generally weak economic growth ensued. World commodity

prices plummeted, precipitating a crisis for many developing countries that

had borrowed heavily and that depended on commodity exports. At the same

time, U.S. fiscal policies produced record federal budget deficits, and key

foreign governments moderated their fiscal deficits. Together, these trends

contributed to a substantial appreciation of the dollar and a massive

increase in the U.S. merchandise trade deficit (see box). Although recent

changes in macroeconomic policies have reversed these trends to some

degree, the world economy is still faced with huge trade imbalances and

prospects in most countries for no better than moderate growth.

8. See Congressional Budget Office, The Economic and Budget Outlook: Fiscal Years 1986-

1990 (February 1985).
Chapter I INTRODUCTION 9

Foreign governments face the counterpart of the massive U.S. trade

deficit problem. Many of them have relied on large trade surpluses with the

United States to bolster their economies. High rates of unemployment exist

throughout Europe. The rapidly growing Asian developing countries depend

on trade surpluses with the United States, as do many debt-ridden Latin

American countries. Japan, despite its enormous U.S. trade surplus, has lost

its formerly high growth rate and is encountering problems characteristic of

a mature economy. Improvement in the U.S. trade balance will therefore

require a process of adjustment on the part of other countries, and the

stresses of this adjustment will complicate bargaining positions in the

Uruguay Round over the next several years.

Fundamental Shifts in Industrial Competitiveness. The industrial world has

undergone far-reaching changes over the last several decades. Dramatic

reductions in natural barriers to trade, such as communication and transportation costs, and the emergence of developing countries as competitive producers have increased the pace of international specialization. Many products from maturing and standardized industries in developed countries can

be produced more cheaply in low-wage developing countries. Lower costs

from large-scale production facilities encourage specialization even among

developed countries, as in the case of high-technology products.

The resulting changes in trade flows have forced many economies to

undergo major restructuring. Some workers, firms, and communities have

improved their economic positions; others have lost. In almost all cases,

though, there have been political repercussions.

Governments can seek to alter the situation with short-run policy

responses, either unilaterally or through agreements with other countries.

But such limited actions frequently do not resolve the causes of the root

problem, and often create new problems with third countries or in other

domestic sectors. 5/ Multilateral negotiations can take account more

directly of the many interactions between different countries and different

economic sectors that are inherent in the application of trade policies. But

as more parties participate in the negotiations, a wider range of interests

must be satisfied. The reciprocal concessions involved in multilateral

negotiations may cause additional dislocation in some sectors of each

economy.

9. See Congressional Budget Office, Has Trade Protection Revitalized Domestic Industries?

(November 1986).
10 GATT June 1987

THE U.S. TRADE AND BUDGET DEFICITS

>*

The record foreign trade deficits experienced by the United States have focused

attention on what causes them and how they can best be reduced. There have been

proposals to use trade policy to change the export-import balance, or alternatively

to try to negotiate a solution during the Uruguay Round.

Trade policy has had little to do with the emergence of the huge trade deficits, and

it cannot be expected to reduce them significantly. Governments can effectively

use trade policy to alter the composition of imports and exports by favoring certain

industries at the expense of other industries. But the large aggregate trade deficits

were caused primarily by macroeconomic conditions, and can be substantially

curtailed only by changing those conditions.

International trade at the product level depends primarily on the relative price

of a domestic product relative to similar foreign products and the real income of

potential consumers. When the price of a good falls relative to those of close

substitutes, or when real income increases, the demand for that product increases.

Demand for traded goods and services depends both on industry-specific factors,

such as changes in technology or the use of trade policies, and on economywide

factors, such as exchange rates and differences in inflation and real income growth

among countries, including those disruptions caused by the developing-country

debt crisis. Confusion sets in when the determinants of foreign trade at the product

level are used to explain net trade flows between countries.

The foreign accounts of an economy are directly linked to its saving and investment

relationships with other countries. These relationships can be characterized by

three sets of ratios, each defined relative to GNP: domestic and foreign private

saving as ratios of GNP in each country; domestic and foreign private investment

as ratios of GNP in each country; and domestic and foreign government budget

deficits as ratios of GNP. When these ratios diverge among countries, domestic

or international forces must respond to bring the relationships underlying them

back into equilibrium. Trade policy can affect the aggregate trade balance only

if it can affect these macroeconomic constraints--that is, only if it can alter the

net capital flow into an economy.

Each of the three macroeconomic constraint ratios may change in response to various

economic forces. Recent years have seen a dramatic increase in the U.S. government

budget deficit ratio coupled with significant, although less dramatic, declines in

many foreign government budget deficit ratios. The large U.S. government deficits

expanded U.S. demand for investment funds (savings) at the same time as many

foreign governments were creating new excess supplies of savings by reducing their
Chapter I INTRODUCTION 11

THE U.S. TRADE AND BUDGET DEFICITS

deficits. In a closed economy, excess domestic demand for savings would cause

interest rates to rise, crowding out some domestic investment and encouraging

new savings (and less consumption) until a new balance would be achieved. But

in the current environment, where international financial transactions costs are

negligible and exchange rates are flexible, the excess demand for savings in the

United States attracted massive net inflows of financial capital from abroad,

tempering any increase in U.S. interest rates. The increase in demand for dollars

as foreigners purchased dollar-denominated assets raised the value of the dollar,

causing the prices of U.S. goods and services to increase relative to foreign goods

and services. To satisfy the balance of payments constraint, the exchange rate had

to increase by enough to force the U.S. trade (current account) deficit to equal the

net capital inflow from abroad. In essence, access to international markets shifted

the domestic adjustment burden of the U.S. budget deficits away from interestsensitive segments of the economy to traded-goods segments.

Government budget deficits are not the only cause of trade deficits. Divergences

in private savings and private investment ratios across countries can also induce

changes in international trade and capital flows. U.S. calls for more vigorous foreign

growth are aimed at raising foreign private investment, which would both sop up

foreign savings and increase foreign demand for U.S. goods and services. A major

objective of the effort to relieve the developing-country debt crisis is to reduce

pressure on the U.S. trade balance. The debt crisis, manifested mostly in Latin

America, has forced these countries to limit imports severely, and to expand exports,

in order to service their foreign debts. Private investment ratios in these countries

have fallen, causing economic growth to deteriorate. The economic disruption

associated with the debt crisis has been aggravated by significant private capital

outflows from many of these countries, forcing them to produce even higher

merchandise trade surpluses. Since the United States is the major trading and

financial partner for most of the debt-constrained countries, the debt crisis has

been a major contributor to the U.S. merchandise trade deficit.

Recognition of the myriad factors affecting international trade and capital flows

has led some to call for expanding the scope of international economic cooperation

by conducting parallel negotiations that would seek to coordinate macroeconomic

policies, and thus stabilize exchange rates; remedy the debt crisis; and improve

the conduct of trade policy. Such coordinated actions face formidable obstacles.

Although GATT trade talks play a vital role in providing conditions that are

conducive to expanding international trade and economic growth over time, they

cannot be expected to offer a solution to the current U.S. trade deficit crisis.

TT
12 GATT June 1987

THE URUGUAY ROUND AND THE CONGRESS

The nature of the new trade talks raises a number of important issues for

the Congress. Most immediately, Congressional authority for the President

to negotiate tariff reductions expired in 1982 and authority for nontariff

barrier negotiations, with an expedited approval procedure, expires in

January 1988. The bills now before the Congress would extend the President's negotiating authority. Such an extension will be necessary before a

Uruguay Round agreement is completed. In the past, the Congress has

provided the President with authority to reduce tariffs up to a specified

amount over a fixed period of time without further Congressional approval.

Authorizing bills have also indicated the priorities of the Congress for the

negotiations. The Congress has always retained the right of final review for

nontariff agreements, but does so on a fast-track basis--meaning that no

amendments are allowed, and that a final vote on all the provisions as a

package must be conducted within 90 days of submission. IQj Since the

actual negotiating process is largely controlled by the Administration, and

since subsequent changes are limited by the fast-track procedure, the

authorizing bill will represent an important opportunity for the Congress to

influence the outcome of the Uruguay Round.

Because the Uruguay Round will focus more than ever before on the

impact of broad national policies on foreign trade, the final agreements

reached during the talks may require changes in these national policies and

may limit future Congressional policy options. For example, any major

reform in Eurpoean agricultural policies is likely to involve a demand for

reciprocal reforms in U.S. farm policies. Reductions in barriers to services

trade by foreign governments may require lower U.S. protection for manufactured goods such as apparel and steel; or they may require the United

States to change immigration laws or reorder traditional state and federal

responsibilities over the regulation of some services. Agreements limiting

the subsidizing or "targeting" of industries may impede science and competitiveness policies; Sematech, the proposed consortium of semiconductor

producers, for example, may be jeopardized by such an agreement. In any

event, closer attention will be paid to the foreign-trade ramifications of

national policies, both in the United States and abroad.

10. The crafting of a final GATT agreement involves a series of compromises between

countries toward reaching an acceptable level of final reciprocity. In order to limit the

unraveling of this process, fast-track authority prevents the Congress from changing

the specifics of any part of the agreement.
Chapter I INTRODUCTION 13

This report is designed to provide an overview of the key factors

affecting the role of the United States in the Uruguay Round of multilateral

trade negotiations and to examine how these talks may influence domestic

policy choices. It surveys the role of GATT in international trade relations,

placing the Uruguay Round in perspective as the most recent stage of an

ongoing process of trade liberalization. It then examines the potential

effects of further liberalization on four key sectors of the U.S. economy:

high-technology industries, agriculture, mature industries, and services. A

study of these sectors shows some of the constraints upon the U.S. negotiating team. Some sectors may gain, and others may lose during multilateral

negotiations. These distributional consequences of multilateral trade policy

negotiations, though, are not likely to outweigh the overall benefits to the

national interest resulting from a more open world trading system.

ITIBBBI

CHAPTER II

GATT NEGOTIATIONS IN PERSPECTIVE

Every round of multilateral trade negotiations represents a milestone in an

evolving process of trade policy liberalization. The agenda and procedures

for a new round of talks, therefore, are based on the legacy of previous

rounds. This chapter surveys the history of the General Agreement on

Tariffs and Trade (GATT), concluding with an overview of the key agenda

items established for the Uruguay Round.

Over the last four decades, GATT has played a key role in helping

developed countries reduce significantly their tariffs on imports: the average U.S. tariff on dutiable imports has fallen from almost 60 percent following the Smoot-Hawley Tariff Act in 1930 to around 5 percent currently.

Partly because of this success, though, nontariff policies have replaced

tariffs as the prevalent form of protection throughout the world. Member

countries have not provided GATT with the tools to liberalize nontariff barriers to trade. This often reflects fundamental disagreements among key

governments over what are acceptable nontariff trade policies-disagreements that are aggravated because many controversial nontariff barriers are

directly linked to national policy packages aimed primarily at domestic instead of international policy goals. Whether the Uruguay Round can successfully prod governments to reduce such barriers depends fundamentally

on the willingness of key governments, including some advanced developing

countries, to reform national policies that are harmful to international

trade.

THE GENERAL AGREEMENT ON TARIFFS AND TRADE

GATT is both a multilateral agreement (the General Agreement) and a corresponding international organization (the GATT Secretariat). Currently 93

countries, accounting for over four-fifths of world trade, are members of

GATT, and another 31 countries abide by its rules. I/

1. The Soviet Union, Taiwan, and the Peoples Republic of China are the only major trading

countries that are not members of GATT. The Peoples Republic has applied for

membership and will be allowed to participate on an equal basis in the Uruguay Round.

A recent application by the Soviet Union was rejected by GATT.
16 GATT June 1987

The General Agreement-including not only the original articles but

additions to them, as well as a number of protocols and the tariff schedules

of each member country-is a legal document that spells out the underlying

principles and operating rules agreed upon by the contracting parties to

regulate their conduct of trade policy. I/ Encouraging growth in international trade based on economic factors rather than on government policies

is the unifying premise of the General Agreement. The GATT Secretariat,

which acts on behalf of the contracting parties and their Council of Representatives, helps to administer the General Agreement by sponsoring multilateral trade negotiations, by monitoring trade flows and trade policies, and

by hosting consultations to help countries resolve trade disputes.

GATT has little independent power. Rather, it provides a forum in

which governments can reconcile trade policy conflicts, as well as a set of

principles that the members have agreed to be mutually beneficial. It plays

a passive role, reinforcing the desires of its members but rarely initiating

action. When member governments agree on the need for policy reform,

GATT helps facilitate the reform. But GATT cannot coerce countries to

change their policies against their will. Member countries have yet to agree

to yield sovereignty over national policy actions to an international body.

Although the General Agreement clearly states certain general principles, so many exceptions are allowed in qualifying articles that a wide-range

of policy actions--many of them contradicting the spirit, if not the letter,

of the GATT principles--can be justified. GATT enforcement procedures

rely mainly on suasion, ultimately depending on good faith and the fear of

retaliation. £/

The Origin of GATT

GATT originated in 1947 as a relatively minor element of an ambitious postwar plan to promote peace and economic well-being by limiting political and

economic tensions among countries. The World Bank and the International

2. See Kenneth W. Dam, The GATT: Law and International Economic Organization

(Chicago: University of Chicago Press, 1970), for a detailed examination of the General

Agreement.

3. Reciprocity, a cornerstone of GATT, is double edged-one country can offer a trade policy

concession in return for an equivalent concession by its trading partner, or a country

can implement a trade barrier in retaliation for an increase in another country's trade

barriers. GATT has been much more successful in encouraging the former than in

discouraging the latter.
CHAPTER H GATT NEGOTIATIONS IN PERSPECTIVE 17

Monetary Fund were designed to address developmental and international

monetary problems. An International Trade Organization (ITO) was proposed

to regulate trade relations among countries and to encourage trade liberalization. The General Agreement was devised as a provisional document to

hasten the start of multilateral tariff negotiations while the relevant

governments were ratifying the ITO charter. Despite the support of President Truman, however, the charter encountered opposition in the

U.S. Congress and failed to win enough votes for ratification. But Congressional approval was not required for the General Agreement, which Truman

approved through an Executive Agreement. Most of the ITO charter dealing

with commercial trade policy was incorporated into the General Agreement,

and it has remained the internationally accepted standard for the conduct of

trade policy.

As a weak substitute for the envisioned ITO, a GATT Secretariat, with

a very small staff, was created to oversee the General Agreement and to

manage multilateral trade negotiations. Since this modest inception, the

prestige and responsibility of the GATT Secretariat (now consisting of over

300 employees) has grown steadily as it has led the drive to liberalize trade

policies.

Fundamental Principles of the General Agreement

Literally, the General Agreement is a detailed legal document that defines

the responsibilities and operating rules agreed upon by member governments

to guide their conduct of international trade relations (see box). As stated in

its preamble, the goal of the General Agreement is to raise living standards

through "reciprocal and mutually advantageous arrangements directed to the

substantial reduction of tariffs and other barriers to trade and to the elimination of discriminatory treatment in international commerce."

Four key principles underlie the General Agreement:

o Member countries should work to lower trade barriers in general,

and to eliminate the use of quotas in particular.

o Any barrier to trade should be applied on a nondiscriminatory

basis to all member countries (most-favored-nation treatment).

o Once a tariff concession is made, it cannot later be rescinded

without compensating affected trade partners. Also, other forms

of protection cannot be employed to circumvent the effect of the

concession.

TIBB1BII
18 GATT June 1987

THE GENERAL AGREEMENT IN BRIEF

The Preamble of the General Agreement proposes to raise living standards by reducing

trade barriers and, in particular, by eliminating discriminatory trade practices. Part

I states the basic principle of nondiscrimination and legally binds members to comply

with their tariff concessions. Part II calls for the elimination of nontariff barriers, subject

to several qualifications. Part III contains procedural rules, most importantly condoning

the formation of free trade areas. Part IV, added in 1965, addresses the special needs

of the developing countries.

Parti

MFN. Article I provides that a tariff on an imported product should be applied

equally to all members. This affirmation of nondiscrimination is called most-favorednation (MFN) treatment.

Binding tariff schedules. Article II legally binds members to their tariff concessions.

It states that tariffs should not be increased above the rates in each country's tariff

schedule.

Partn

National treatment. Article III prohibits members from circumventing tariff

concessions by employing nontariff policies to offset the effect of a tariff reduction.

National treatment requires that internal taxes apply equally to domestic and

imported products and that regulations treat imported goods "no less favorably"

than similar domestic goods.

Customs regulations. Articles V and VII through X curb customs procedures that

impede imports. Such activities include rules of transit (article V), customs valuation

(article VII), customs fees and formalities (article VIII), and marks of origin (article

IX). Article X states that all laws and regulations regarding trade should be

formulated and applied in a transparent manner, which requires public disclosure

and the uniform and impartial administration of trade laws.

Antidumping and countervailing duties. Article VI defines dumping, states that

both dumping and injury to domestic producers must be proved in order to merit

an antidumping duty remedy, and specifies that antidumping duties should not

exceed the dumping margin. It provides similar rules for the countervailing duty

remedy to offset foreign government subsidies.

Quantitative restrictions. Article XI calls for the general elimination of quantitative

restrictions (QRs) to trade, subject to several qualifications. Most importantly,

QRs can be used to safeguard the balance of payments (article XII) and to provide

temporary escape clause relief for domestic industries (article XIX). Developing

countries can also use QRs to further developmental goals (article XVIII and Part

IV). Article XIII states that QRs, when employed, must be applied on a

nondiscriminatory basis, with some exceptions listed in article XIV. Article XV

regulates the use of currency controls to evade QR restrictions, and coordinates

GATT and IMF interests during balance-of-payments emergencies.
CHAPTER H GATT NEGOTIATIONS IN PERSPECTIVE 19

Part II

(Continued)

Subsidies. Article XVI discourages the use of subsidies in general, and calls for

the elimination of export subsidies for nonprimary products in particular. Export

subsidies for primary products should not cause a country to achieve more than

an equitable share of world export trade in that product.

State-owned enterprises. Article XVII asserts that state-owned enterprises should

choose among potential buyers and sellers according to normal business

considerations, especially in terms of prices, quality, and procurement.

Government assistance in developing countries. Article XVIII affords developing

countries exemptions to most of the requirements of the General Agreement, subject

to rigorous criteria. Because of its strict standards, these exemptions have rarely

been employed. Instead, developing countries have justified their use of policies

such as nontariff barriers and export subsidies as safeguards for balance-of-payments

problems.

Escape clause and other exceptions. Articles XIX through XXI provide additional

exceptions to the general rules. Article XIX, the escape clause, allows countries

to protect, through withdrawal of concessions or other measures, domestic producers

from injury resulting from increases in imports. Articles XX and XXI identify other

essentially noneconomic justifications for trade restrictions, such as for national

security protection.

Consultation and dispute settlement. Articles XXII and XXIII lay out the dispute

settlement process of GATT. Consultation between countries is emphasized, but

panels of experts can also be asked to review cases on a nonbinding basis.

Partm

Procedural issues. Procedural and other administrative matters are taken up in

articles XXIV through XXXV. Most notably: article XXIV addresses how free trade

areas are to be established; article XXVIII sets rules for modifying tariff schedules,

including a call for periodic tariff negotiations; and article XXXIII establishes

criteria for accession of new members.

Part IV

Trade and development--treatment of developing countries. Article XXXVI

acknowledges the special problems confronted by developing countries, and states

that developed countries should not expect reciprocity from developing countries.

Article XXXVII contains a statement of the intent of developed countries to

encourage developing country exports by unilaterally lowering trade barriers, and

article XXXVIII includes encouragement to stabilize and improve market conditions

for primary products.

Sources: General Agreement on Tariffs and Trade; International Trade

Commission; and Congressional Budget Office.
20 GATT June 1987

o Trade conflicts should be settled by consultation whenever possible, using as a guide a set of codified and mutually accepted

rules for the conduct of trade.

Trade Liberalization and the Elimination of Quotas. The General Agreement has always championed an open trading system. Consequently, it has

favored tariffs over quotas, and has sought to reduce tariffs over time.

Quotas are discouraged for two reasons: by limiting import quantities, their

protective effect can vary as market conditions change; and their impact on

prices cannot be directly observed. Their lack of "transparency" makes it

difficult to measure the protective impact of a quota and to compare its

effect with trade policies applied in other sectors or countries.

Most-Favored-Nation Treatment. Tariffs, or any other form of protection,

should be applied on a nondiscriminatory basis across all member countries.

Each country should be treated as a "most-favored nation." Nondiscrimination insures that imports will be supplied at the lowest cost by the most

competitive foreign suppliers. If domestic suppliers must be protected from

foreign competition, the form of that protection should not introduce additional distortions to trade. Discrimination may lead to wasteful trade

diversion; it also complicates trade negotiations and enhances the possibility

of retaliation. $J Unconditional most-favored-nation treatment reflects the

ideal of full nondiscriminatory treatment of all import suppliers. It precludes bilateral and preferential agreements that favor one or a group of

countries.

Insuring the Integrity of Tariff Concessions. To legitimize trade negotiations, governments must not be able to circumvent the effect of tariff reductions they have agreed to during reciprocal bargaining. The General

Agreement confronts this in two ways. First, during tariff negotiations,

countries promise to bind tariff rates for particular products at a certain

level--that is, promising not to increase those tariff rates in the future. If

a country decides to increase a tariff above the bound rate, it must notify

GATT and is liable for compensation to affected trading partners. Second,

no other type of government policy can be employed to offset the impact of

4. A policy is trade diverting if, in favoring one country over another, it diverts trade from

low-cost to higher-cost producers. Under competitive conditions, consumers in the home

market are not affected by trade diversion in the short run since landed import prices

remain the same, but resources are misallocated, inhibiting worldwide growth in the

long run. Where policies stimulate trade, policies can be trade creating, improving both

resource allocation and consumer benefits. Trade suppression results when policies

reduce total trade flows, injuring consumers and misallocating resources.
CHAPTER H GATT NEGOTIATIONS IN PERSPECTIVE 21

the concession. The General Agreement requires national treatment of imported goods, meaning that a country's internal taxes must be applied equally to both imports and domestic goods and that its regulations must treat

imports "no less favorably" than similar domestic products. Additionally,

the General Agreement discourages the dilution of another country's tariff

schedule by the use of government subsidies or through actions by private

firms (dumping) that cause exports to be sold at less than normal prices.

Effectively, countries are not allowed to gain through export subsidies or

nontariff barriers to imports what they could not gain through tariff negotiations.

Dispute Settlement. GATT plays a passive enforcement role, relying primarily on the good faith of its members to abide by its rules. Instead of

actively policing compliance, GATT responds only to complaints initiated by

members. When trade policy disputes arise, the GATT dispute settlement

process encourages members to employ consultation procedures to reconcile

the problem among themselves, using GATT rules as a guideline. If consultation fails, disputants have the right to call together a panel of third-party

representatives for a ruling on the case. Although the panel ruling is not

legally binding, it can be made binding if approved by the GATT Council. If

all else fails, a party can submit an argument to the GATT Council for

approval of retaliatory action. GATT Council approval of rulings and retaliatory actions requires a unanimous vote. As a result, any ruling or retaliatory action can be vetoed by any party to a dispute. Thus, there is

currently no coercive enforcement mechanism short of sanctioned retaliaK

tion, and even this can be vetoed by the offending party. 2J

Exceptions to the Principles of the General Agreement

As in any general body of rules, some exceptions are needed to handle special circumstances. When the General Agreement was conceived in 1947,

exceptions to the basic principles were made to allow countries to join

GATT without immediately negating existing domestic policies or limiting

5. Rulings by GATT, although generally not enforceable, carry some weight as citations

of improper behavior. For example, GATT ruled that the U.S. program of tax relief for

exports, the Domestic International Sales Corporation (DISC), violated GATT rules.

Although the United States refused to acknowledge the validity of the GATT ruling,

after a long process it replaced DISC with a new program- -the Foreign Sales Corporation

(FSC) - -that conforms with GATT. For a detailed discussion of the history and structure

of the FSC, see Joint Committee on Taxation, General Explanation of the Revenue

Provisions of the Deficit Reduction Act of 1984 (December 31,1984), pp. 1037-1070.
fiUBIUBlH

22 GATT June 1987

key future policy options. Several additional exceptions have been added.

These exceptions have now become so numerous and broad-reaching that, in

practice, few trade policy targets are hindered by the General Agreement. §/

Exceptions to the Trade Liberalization Principle. GATT's goal of trade

liberalization in general and the elimination of quotas in particular is

limited to trade in manufactured goods, excluding textiles and apparel,

among developed countries that do not have serious balance-of-payments

problems and in industries where imports do not cause serious injury to

domestic producers. Various national policies with foreign trade ramifications, such as health and safety regulations, and policies justified by national

security interests, are also excepted.

Trade coverage is limited because the General Agreement does not

cover trade in services and intellectual property, nor trade related to

foreign investment regulations and performance requirements. The General

Agreement, weakened by a 1955 waiver that permitted broad U.S. agricultural import quotas, allows nontariff barriers for many primary products.

Additionally, a multilateral system of import quotas on textiles and apparel

trade (the Multifiber Arrangement) has been permitted, and voluntary export restraints and orderly marketing agreements are not formally covered.

Developing countries are excluded from most of the rigor of the GATT

principles in recognition of their special need to fashion self-serving policies

that may speed development. Safeguards permit the use of quantitative restrictions during balance-of-payments emergencies and for temporary protection of sectors that have been seriously injured by increases in imports

(the escape clause). Z/

Exceptions to the Most-Favored-Nation Principle. The General Agreement

sanctioned discriminatory actions by permitting countries to continue colonial preference schemes that existed before GATT's establishment; to

6. As explained in more detail later in this chapter, codes of conduct were established during

the Tokyo Round to fortify GATT rules and procedures for several types of nontariff

policies. In practice, though, these codes have not significantly strengthened GATT's

role.

7. Safeguards were established initially to accommodate the widespread use of these

policies following World War II. Except for the United States, quotas were used liberally

to conserve and allocate foreign exchange during postwar balance-of-payments

emergencies. The escape clause was included mainly at U.S. insistence, since U.S. law

required the government to show that tariff concessions would not cause serious injury

to domestic producers.
CHAPTER H GATT NEGOTIATIONS IN PERSPECTIVE 23

develop programs for preferential tariff treatment for developing countries

(such as the Generalized System of Preferences in the United States); and to

form free-trade areas or customs unions such as the European Economic

Community. The Multifiber Arrangement uses bilateral quotas rather than a

nondiscriminatory global import quota. In addition, the safeguard actions

mentioned above often employ discriminatory remedies, as exemplified by

the recent rash of voluntary export restraints and orderly marketing agreements applied by several countries, especially the United States. §/

Exceptions to Defending the Integrity of Tariff Concessions. GATT's weak

restrictions on subsidies and other nontariff barriers allow countries to offset the effects of tariff concessions. Increasingly, escape clauses and unfair

trade actions are used to this end.

Ineffective Dispute Settlement Procedures. GATT's enforcement procedures lack clout. It has very limited authority to penalize governments that

break the rules. Moreover, its dispute settlement procedures are notoriously

slow, often taking several years for a final, yet still nonbinding, ruling.

When good-faith compliance to GATT rules fails, it is the threat of retaliation, not the GATT dispute settlement process, that looms as the main restraint to abuse. £/

Rules, Procedures, and Nontariff Barriers

As Kenneth Dam has pointed out, an effective body of law is more than "a

set of substantive rules. It is also a set of procedures, adapted to the subject

matter and designed to resolve disputes that cannot be foreseen at the moment when those procedures are established." !2/ For a legal system to be

8. The United States has recently negotiated voluntary export restraints (VERs) for steel,

autos, and machine tools. Orderly marketing arrangements (OMAs) were used by the

United States during the 1970s for non-rubber footwear and televisions. Although not

all of these policies were directly related to a safeguard action, each policy did set

different quota limits for different countries. Many European countries have also

employed these types of policies; most notably, many European countries have a VER

on automobiles with Japan. VERs and OMAs as trade policy options are not currently

covered by GATT rules, but they clearly violate the spirit of the GATT principles.

9. For a more thorough examination of this issue, see U.S. International Trade Commission,

Review of the Effectiveness of Trade Dispute Settlement Under the GATT and the Tokyo

Round Agreements, Publication 1793 (Washington, B.C., December 1985).

10. Kenneth W. Dam, The GATT: Law and International Economic Organization, p. 4.
24 GATT June 1987

effective, rules and procedures must be compatible, and adaptable to

circumstances. Strong rules limit procedural flexibility, but weak rules that

vaguely differentiate permissible activities hamper the most vigilant enforcement efforts.

The General Agreement is not a set of strong, substantive rules and

viable enforcement procedures. Rather, it provides a loose conceptual and

procedural framework that encourages countries to identify common interests so they will have a basis for entering into mutually advantageous agreements. In retrospect, a weak but flexible GATT has proved quite successful

in promoting tariff reduction and integrating a broad range of countries into

the world trading system. At the same time, frustration has mounted over

the inability of GATT to control nontariff barriers (NTBs), which are replacing tariffs as the primary mode of protection.

Nontariff barriers introduce a number of new problems for GATT.

They are inherently less transparent than tariffs, making it harder to identify those government policies that restrain trade. Even when NTBs are applied in a straightforward manner, as in the case of import quotas, their protective impact cannot be measured directly. To make NTBs more transparent, it will be necessary to develop common techniques for reporting and

quantifying NTBs that are consistently applicable across products, countries,

and types of trade policies. 11' Before liberalization of NTBs can even be

addressed, considerable effort will be needed just to place them on a commonly accepted tariff equivalent basis. Transparency can be achieved most

quickly by converting all nontariff barriers to ad valorem tariffs (or in some

cases by auctioning the quota rights). 12!

Rules must also be developed, and adapted over time, to delineate

national policies that constitute nonpermissible trade barriers. This task is

complicated by several factors. As economies become increasingly open to

international influences, a broader range of national economic policies influence foreign trade flows. But most countries do not want to invite international scrutiny of what they consider to be domestic policies. Moreover,

11. As examined more fully in the chapter on agriculture, producer and consumer subsidy

equivalents have been estimated for many countries' nontariff agricultural policies

in an attempt to achieve greater transparency.

12. See Everett M. Ehrlich and Raymond C. Scheppach, New Directions in Economic Policy:

An Agenda for the 1980s (New York: Praeger, 1984), pp. 183-188, for an overview of

the role of transparency in the trade liberalization process.
CHAPTER H GATT NEGOTIATIONS IN PERSPECTIVE 25

many regulations that affect trade, especially those related to services, are

controlled not by national governments but by state, local or provincial

governments. Defining "fair trade," then, places a premium on rules. Without more concrete rules, cheating cannot be well defined and therefore cannot easily be corrected.

But even the most precise rules must be backed by suitable enforcement procedures and penalties to be effective. Otherwise the principal sanction will be the threat of retaliation, which inherently favors the strong over

the weak. Current GATT procedures have not dealt adequately with enforcement of NTB rules. Designing more effective enforcement procedures

will be complicated by the lack of transparency inherent to NTBs and because strong international enforcement ultimately infringes on national control over key policy actions. Thus, a major focus of the Uruguay Round will

be the difficult task of sharpening and extending GATT rules and procedures

that deal with a wide array of nontariff barriers.

PREVIOUS ROUNDS: STAGE-BY-STAGE LIBERALIZATION

The Uruguay Round is the eighth GATT-sponsored multilateral trade negotiation since World War II and the first since the conclusion of the Tokyo

Round in 1979. Previous negotiations produced steady, if rarely dramatic,

progress toward the goal of trade liberalization. Over time, import tariffs in

developed countries have been significantly reduced and initial attempts

have been made to regulate the use of nontariff barriers. The agenda for

the Uruguay Round reflects the accomplishments, and failures, of these previous rounds.

The Early Rounds

The Smoot-Hawley Tariff Code of 1930 raised the average tariff rate on

U.S. dutiable imports to almost 60 percent (Table 1). M/ Most major

U.S. trading partners quickly retaliated by raising their own tariffs, further

stifling world trade. With the change in administration in 1933, the United

States reversed policies. The Reciprocal Trade Agreements Act of 1934

broke new ground by shifting most authority over tariffs from the Congress

13. For a good overview of U.S. trade policy through the Kennedy Round, see John W. Evans,

The Kennedy Round in American Trade Policy: The Twilight of the GATT? (Cambridge:

Harvard University Press,1971).
IIIBIllilftt

26 GATT June 1987

TABLE 1. U.S. TARIFF RATES, 1789 THROUGH 1984

(In millions of dollars and percentages)

Ratio of

Calculated Duties 5/

Year

1789-

1791

1800

1810

1820

1830

1840

1850

1860

1870

1880

1890

1900

1910

1915

1920

1925

1930

1932

1935

1940

1945

1950

1955

1960

1965

1970

1975

1980

1984

Imports

n.a.

91

85

74

50

86

164

336

426

628

766

831

1,547

1,648

5,102

4,176

3,114

1,325

2,039

2,541

4,098

8,743

11,337

14,650

21,283

39,756

96,516

244,007

322,990

Percent

Duty-Free

n.a.

n.a.

n.a.

n.a.

8.0

48.8

9.8

20.2

4.7

33.1

33.7

44.2

49.2

49.2

61.1

64.9

66.8

66.9

59.1

64.9

67.1

54.5

53.3

39.5

34.9

34.9

32.2

43.8

31.9

Calculated

Duties

4

9

9

15

28

15

40

53

192

183

227

229

327

206

326

552

462

260

357

318

381

522

633

1,084

1,643

2,584

3,780

7,535

12,042

Total

Imports

n.a.

9.9

10.6

20.3

57.3

17.6

24.5

15.7

44.9

29.1

29.6

27.6

21.1

12.5

6.4

13.2

14.8

19.6

17.5

12.5

9.3

6.0

5.6

7.4

7.7

6.5

3.9

3.1

3.7

Dutiable

Imports

n.a.

n.a.

n.a.

n.a.

61.7

34.4

27.1

19.7

47.1

43.5

44.6

49.5

41.6

33.5

16.4

37.6

44.7

59.1

42.9

35.6

28.2

13.1

12.0

12.2

11.9

9.9

5.8

5.7

5.5

Federal

Revenue

99.5

83.7

91.5

83.9

88.2

69.3

91.0

94.9

47.3

55.9

57.0

41.1

49.4

30.1

4.8

14.5

14.1

16.3

9.0

5.9

0.7

1.0

0.9

1.2

1.2

1.2

1.3

1.4

1.4

SOURCE: Stephen L. Lande and Craig VanGrasstek, The Trade and Tariff Act of 1984:

Trade Policy in the Reagan Administration (New York: Lexington Books, 1986),

p. 4; adapted from Bureau of the Census, Statistical Abstract of the United States

(various editions),

n.a. = not available.

a. Trade-weighted average tariff rates can change not only because of changes in tariff

policy, but also as the composition of imports shifts among products with different tariff

rates and as inflation lowers the ad valorem equivalent rate of specific tariffs. Also,

trade-weighted averages of tariffs are biased downward because trade flows tend to

be lower where the protective effect of a tariff is highest.
CHAPTER H GATT NEGOTIATIONS IN PERSPECTIVE 27

to the President, who was authorized to cut most rates by up to 50 percent

in exchange for reciprocal cuts by major trading partners. All tariff cuts

were to be extended on a "most-favored-nation" basis. The Presidential

authority was limited, though, by an agreement with the Congress to negotiate tariff cuts on a product-by-product basis, with no tariff to be cut if this

threatened serious injury to a domestic industry. Over the next 11 years, a

series of bilateral negotiations with major U.S. trading partners succeeded

in reducing the average Smoot-Hawley tariff by about one-third.

The first GATT-sponsored multilateral trade negotiation (MTN) convened in 1947. Although most of the negotiations remained bilateral and

product-by-product in nature, the interplay among the many partners resulted in significant further reductions in tariffs. M' On average, the existing U.S. tariff structure (scheduled rates) was cut by about one-third (see

Table 2, which includes only the impact of various negotiations on scheduled

tariff rates). By 1950, the average tariff on dutiable imports had fallen by

about 75 percent compared to Smoot-Hawley tariff levels (see Table 1,

which includes the impact of all factors on average realized tariff rates).

Although much of this drop can be attributed to the various tariff negotiations, changes in the composition of imports and the impact of inflation on

specific tariffs also helped to lower realized tariff rates over this period.

The Kennedy Round

GATT sponsored four more MTNs over the next 15 years. Little additional

tariff reduction was accomplished during this period, partly because of

political pressures in the United States against further cuts, but also

because considerable energy was spent on forming the European Community

(EC) and integrating it into the world trading system. Significant progress

14. In these early negotiations, the United States generally made larger cuts than did its

trading partners. Often, the main concessions by others were to bind their rates at then

current levels, rather than reducing them. The United States accepted this as reciprocal

treatment because many U.S. tariffs were considerably higher than those of its trading

partners at the time. In fact, in many cases, U.S. tariffs were so high that reductions

had little impact on trade flows. Since the United States ran a trade surplus in almost

every major industrial sector following World War II, it had little to lose and much to

gain in both economic and political terms by encouraging worldwide trade and economic

growth. The lack of a strong leader in the current international political environment

may retard liberalization efforts. See Robert E. Baldwin, "The Changing Nature of U.S.

Trade Policy since World War II," in Robert E. Baldwin and Anne 0. Krueger, eds., The

Structure and Evolution of Recent U.S. Trade PoZicyCChicago: University of Chicago

Press, 1984).
28 GATT June 19S7

TABLE 2. DUTY REDUCTIONS SINCE 1934 UNDER

THE U.S. TRADE AGREEMENTS PROGRAM

(In percents)

GATT Conference

Pre-GATT,

1934-1947

First Round,

Geneva, 1947

Second Round,

Annecy, 1949

Proportion

of Dutiable

Imports

Subjected to

Reductions

63.9

53.6

5.6

Average

Cut in

Reduced

Tariffs

44.0

35.0

35.1

Average

Cut in

All Duties

33.2

21.1

1.9

Remaining Duties

as a Proportion

of 1930 Tariffs §/

66.8

52.7

51.7

Third Round,

Torquay,1950-1951

Fourth Round,

Geneva,1955-1956

Dillon Round,

Geneva, 1961-1962

Kennedy Round,

Geneva, 1964-1967

Tokyo Round,

1974-1979

11.7

16.0

20.0

79.2

n.a.

26.0

15.6

12.0

45.5

n.a.

3.0

3.5

2.4

36.0

29.6

50.1

48.9

47.7

30.5

21.2

SOURCE: Real Phillipe Lavergne, The Political Economy of U.S. Tariffs (Ph.D. thesis,

University of Toronto, 1981).

n.a. = not available.

a. These percentages do not take account of the effects of either structural changes in trade

or of inflation on the average tariff level.
CHAPTER H GATT NEGOTIATIONS IN PERSPECTIVE 29

on lowering tariffs was accomplished in the sixth GATT-sponsored MTN, the

Kennedy Round, which lasted from 1964 to 1967. Not only were duties cut

on average by 36 percent, but the cuts were spread over the broadest set of

products to date--some cut in tariff being made on almost 80 percent of all

dutiable imports. Much of the success of this round is attributable to the

employment of a negotiating procedure that initially cut all tariff rates

automatically by 50 percent. HLf After that, the parties negotiated sectoral

and product-by-product exemptions.

The Kennedy Round was also important because, for the first time, an

agreement was reached to resolve conflicts over nontariff barriers. It took

the form of an Antidumping Code and an agreement to eliminate the

U.S. system of American Selling Prices. !£/ Although the Congress blocked

both of these, they were accepted in the next MTN.

One major economic sector, agriculture, was not a part of these

liberalization efforts. A waiver that permitted broad quantitative restrictions on agricultural products was granted the United States in 1955, and

this served as a precedent for other countries to protect their agricultural

sectors as well. Also, developing countries, which have played a minor role

in GATT negotiations, did not reduce their trade barriers over this period.

The Tokyo Round

During the late 1960s, economic growth abated and inflation surged. Relatively high U.S. inflation, along with fixed exchange rates, caused the dollar

to appreciate significantly in real terms. The resulting deterioration in the

U.S. trade accounts led to the breakdown of the fixed exchange rate system

15. A 50 percent linear cut emerged after a spirited debate about the merits of a linear versus

a harmonized formula for cuts. Harmonization cuts higher tariff rates by a greater

percentage than lower rates, pushing overall rates toward the average. Representatives

of the European Community argued that the U.S. tariff schedule included a larger

amount of above-average tariffs than did that of the EC, yielding significant protection

to these products. EC tariffs tended to be more even because, during the formation of

the EC, the common external tariff was calculated by averaging the tariffs of each

member country.

16. The American Selling Price (ASP) system applied a tariff rate for certain imports to

a dutiable value set artificially high to equal the price of a competing good produced

domestically instead of to the import's actual invoice price. ASP was applied to a

relatively small portion of total imports, mainly benzenoid chemicals and rubber

footwear.

74-479 0-87- 2
30 GATT June 1987

in 1971. The high real value of the dollar exacerbated a U.S. decline in world

markets as Europe regained competitiveness and as Japan and developing

countries became competitive. U.S. producers lost ground not only in foreign markets, but also in many domestic markets.

The economic and political environment during this time, especially

after the tripling of oil prices by OPEC in 1973, was more conducive to

expanding protection rather than reducing it. Nevertheless, in 1974 the

Congress provided the President with authority to enter the Tokyo Round of

multilateral negotiations to liberalize trade policy. ±L/ This act gave the

President power to cut all tariffs by up to 60 percent (and to eliminate rates

under 5 percent). The Congress also directed the President to negotiate

agreements with other countries on nontariff barriers, recognizing their increasing use throughout the world. Unlike tariff reductions, though, any

agreement on nontariff barriers had to be approved by majority votes in

both the House and the Senate.

The major accomplishment of the Tokyo Round may have been to restrain major increases in protection. Nevertheless, the negotiations succeeded in lowering tariff rates for many goods and in producing a number of

agreements on codes of conduct for nontariff barriers.

Tariff Reductions. Average U.S. tariff rates were again reduced by almost

one-third, from about 6 percent to about 4 percent on dutiable imports,

using a compromise automatic formula with some harmonization effect !§/.

Average U.S. tariff rates for industrial products were cut from 6.4 percent

to 4.4 percent, while average tariffs on industrial products in the European

Economic Community and Japan were cut from 6.6 percent to 4.7 percent,

and from 5.5 percent to 2.8 percent, respectively (see Table 3). Nevertheless, each country excluded a number of key products from any tariff

reduction. Table 4 shows the average Tokyo Round tariff cuts by broad

industrial groups for the United States, the EC, and Japan. Although it is

17. The 1974 Trade Act followed a failed attempt to produce a trade bill with GATT

authorization in 1972. The compromise that generated the 1974 act included provisions

that made it easier for industries to receive trade adjustment assistance benefits and

to obtain affirmative rulings for escape clause actions. Also, a new trade policy tool,

provided under Section 301 of the act, gave the President the power and obligation to

initiate unilaterally negotiations to reduce foreign trade barriers that restricted U.S.

exports. Reciprocity in the form of retaliation could be employed if foreign governments

did not appropriately cooperate.

18. As had been done in most previous rounds to reduce domestic adjustment costs, these

cuts were phased in over time. In this case, the phase-in period was eight years,

beginning in 1980.
CHAPTER H GATT NEGOTIATIONS IN PERSPECTIVE 31

TABLE 3. TOKYO-ROUND TARIFF CUTS BY STAGE OF

PROCESSING FOR THE UNITED STATES, THE

EUROPEAN COMMUNITY, JAPAN, AND CANADA

(In percent)

Country

and Period

All Industrial

Products

Raw

Materials

SemiManufactures

Finished

Manufactures

United States

Rates Before Tokyo 6.5 0.9 4.5 8.0

Rates After Tokyo 4.4 0.2 3.0 5.7

Percent Cut 31 77 33 29

European Community

Rates Before Tokyo 6.6 0.2 5.1 9.7

Rates After Tokyo 4.7 0.2 4.2 6.9

Percent Cut 29 15 27 29

Japan

Rates Before Tokyo 5.5 1.5 6.6 12.5

Rates After Tokyo 2.8 0.5 4.6 6.0

Percent Cut 49 67 30 52

Canada

Rates Before Tokyo 13.6 1.0 14.8 13.8

Rates After Tokyo 7.9 0.5 8.3 8.3

Percent Cut 42 48 44 40

SOURCES: Director General of GATT, The Tokyo Round of Multilateral Trade Negotiations,

Volume 11 Supplementary Report (Geneva, 1980), p. 33; and the Congressional

Budget Office.

hard to estimate the protective impact of changes in nominal tariffs, post-Tokyo

Round tariffs remain above 7 percent for a number of industries in each country,

most notably for textiles, apparel, and footwear,

19. Nominal tariffs increase the price of imports relative to domestically produced goods.

The protective impact, however, is measured by how the quantity and price of imported

and domestically produced goods change in response to a change in tariffs. This response

depends most importantly on the reaction of consumers to changes in the relative prices

of the imported goods and their domestic substitutes (price elasticities) and on the levels

of tariffs on final goods compared to the levels of tariffs on intermediate inputs (the

effective rate of protection).

I III III II
TABLE 4. TOKYO- ROUND TARIFF CUTS BY INDUSTRY FOR THE

THE EUROPEAN COMMUNITY, AND JAPAN (In percent)

Agriculture, Forestry, and Fisheries

Food, Beverages, and Tobacco Products

Textiles

Wearing Apparel

Leather Products

Footwear

Wood Products

Furniture and Fixtures

Paper and Paper Products

Printing and Publishing

Chemicals

Petroleum and Related Products

Rubber Products

Nonmetallurgical Mineral Products

Glass and Glass Products

Iron and Steel

Nonferrous Metals

Metal Products

Nonelectrical Machinery

Electrical Machinery

Transport Equipment

Miscellaneous Manufactures

Pre-Tokyo-Round

Tariff Rates

U.S. EC Japan

2.2 7.1 18.4

6.3 12.4 25.4

14.4 9.8 3.3

27.8 16.8 13.8

5.6 3.7 3.0

8.8 11.7 16.4

3.6 3.3 0.3

8.1 8.5 7.8

0.5 7.3 2.1

1.1 3.2 0.2

3.8 11.5 6.2

1.4 1.2 2.8

3.6 5.3 1.5

9.1 5.2 0.6

10.7 9.9 7.5

4.7 6.2 3.3

1.2 2.6 1.1

7.5 7.9 6.9

5.0 6.5 9.1

6.6 9.9 7.4

3.3 10.2 6.0

7.8 7.7 6.0

UNITED STATES,

Post-Tokyo-Round

Tariff Rates

U.S. EC Japan

1.8 4.9 18.4

4.7 10.1 25.4

9.2 7.2 3.3

22.7 13.4 13.8

4.2 2.0 3.0

8.8 11.6 15.7

1.7 2.5 0.3

4.1 5.6 5.1

0.2 5.4 2.1

0.7 2.1 0.1

2.4 8.0 4.8

1.4 1.2 2.2

2.5 3.5 1.1

5.3 3.7 0.5

6.2 7.7 5.1

3.6 4.7 2.8

0.7 2.1 1.1

4.8 5.5 5.2

3.3 4.4 4.4

4.4 7.9 4.3

2.5 8.0 1.5

4.2 4.7 4.6

Percent Cut

U.S. EC Japan

-18 -31 0

-25 -19 0

-36 -27 0

-18 -20 0

-25 -46 0

0 -1 -4

-53 -24 0

-49 -34 -35

-60 -26 0

-36 -34 -50

-37 -30 -23

0 0 -21

-31 -34 -27

-42 -29 -17

-42 -22 -32

-23 -24 -15

-42 -19 0

-36 -30 -25

-34 -32 -52

-33 -20 -42

-24 -22 -75

-46 -39 -23

SOURCES: Alan Deardorff and Robert Stern, "The Effects of the Tokyo Round on the Structure of Protection," in Robert Baldwin and Anne Krueger,

eds., The Structure and Evolution of Recent U.S. Trade Policy (Chicago: University of Chicago Press for the National Bureau of Economic

Research, 1984), pp. 370-375; and the Congressional Budget Office.

NOTE: Average tariff rates are calculated using own-country import weights over each country's detailed tariff schedule. Post- Tokyo-Round rates

are being phased in over an eight-year period that began in 1980.

co

to

O

3

C*

C

<D

H^

8

<l
CHAPTER H GATT NEGOTIATIONS IN PERSPECTIVE 33

Even though the average tariff across all imports is relatively low for

the major developed countries, grouping average tariffs by stage of processing (see Table 3) shows that tariff rates are significantly higher for final

products than for raw materials. Such "tariff escalation" provides protection

to manufacturing processes often far in excess of the nominal tariff rate on

the good in question. %Qj Although average tariff rates have been reduced

steadily over the last two MTNs, tariff escalation remains an important

distortion of trade for several major sectors in the developed countries, an

issue of particular interest to developing countries.

Codes of Conduct for Nontariff Trade Policies. The Tokyo Round was distinguished most clearly from previous MTNs by its success in negotiating a

series of agreements (codes of conduct) to regulate how governments apply

a number of nontariff trade policies. Many of these codes extend or refine

obligations implied in GATT articles, but which were the subject of dispute

as governments interpreted the GATT rules to their own advantage. Codes

of conduct were established for the following government policies: antidumping rules, subsidies and countervailing measures, government procurement practices, customs valuation, technical standards, and import licensing. Additionally, nontariff barriers were liberalized in two product categories-civil aircraft and several types of agricultural trade, mainly for

meat and cheese. Dispute settlement procedures were installed for each of

the major codes. After much debate, no agreement was reached on safeguards for domestic industries (the U.S. escape clause). Late-starting negotiations on commercial counterfeiting policy were not concluded.

The Tokyo Round grappled with many of the problems associated with

unfair trade practices and other impediments to "trading on a level playing

field." Most prominent was the issue of subsidies, especially export subsidies. Almost all governments subsidize domestic producers to some degree.

Most domestic subsidies-such as those for education, for assistance to lowincome regions of a country, or for research and development-attack internal social and economic problems. Other subsidies explicitly favor exports or

domestic producers of import substitutes. As economies become more open

20. For example, if the tariff on a final good is 5 percent, but the tariff on intermediate inputs

to the production of that good is zero, then (assuming that intermediate goods make

up about 50 percent of the total production cost of the final good) the effective rate of

protection for the production of the domestic good is 10 percent. That is, domestic

producers can produce-add value to--at up to 10 percent higher costs than foreigners

because of the above structure of protection. Note that consumers still pay only 5 percent

more for the final good. See W.M. Corden, The Theory of Protection (New York: Oxford

University Press, 1971), for the classic examination of effective rates of protection.
34 GATT June 1987

to foreign trade, the distinction between domestic and foreign trade subsidies becomes increasingly blurred.

The subsidy code clarified and modestly strengthened GATT rules,

stated in articles III, VI, XVI, and XXIII, which permit subsidies "for the

promotion of social and economic policy objectives," but which discourage

those that impinge on trade. The code established criteria to help differentiate between a domestic and an export subsidy. Export subsidies for nonagricultural products were prohibited. M/ Almost any domestic subsidy that

treats domestic and export activities equally is allowed, but policies that

injure foreign producers should be avoided.

When export subsidies are found to injure producers in another country, countervailing duties can be applied by the offended country to offset

the impact of the subsidy. The code established two criteria-validation of

an export subsidy and proof of material injury to a domestic industry—that

must be satisfied before countervailing duties can be implemented. M/ The

size of the countervailing duty cannot exceed the amount of the subsidy. It

is not meant to be retaliatory, but only to offset the export subsidy.

The subsidy code extends GATT's prohibition of export subsidies to

include not only trade in manufactured goods but also, for the first time,

raw material trade. The rules are to be applied fully for trade in minerals.

For agricultural trade, export subsidies are tolerated, but should not allow

the exporting country to gain "more than an equitable share of world export

trade," and subsidized products should not be sold below the going market

price.

21. Subsidized export financing arrangements are not covered by GATT. Such actions by

developed countries are covered by agreements of the Organization for Economic

Cooperation and Development. Also, input subsidies for downstream export industries,

often for natural resources, are not covered by GATT.

22. Once it is agreed which subsidies are prohibited by GATT, the use of these actions must

still be halted. Distinction is made in this debate between prohibiting the use of illegal

nontariff trade barriers, and stopping only those illegal practices that cause injury to

offended countries. By requiring injury tests, many insignificant cases (especially from

small developing countries) can be filtered out of the process so that attention is

concentrated on the most onerous actions. By sanctioning petty offenses, however, overall

GATT discipline is threatened. For a thorough examination of subsidies in international

trade, see Gary Hufbauer and Joanna Shelton Erb, Subsidies in International Trade

(Washington, D.C.: Institute for International Economics, 1984).

23. This subsidy code forced the United States to add an injury test for its countervailing

duty cases. Injury tests now consider changes in both the quantity and prices of imports

and similar domestic products ensuing from the foreign subsidy. The prohibition of

export subsidies should have the greatest impact on other countries, which tend to use

export subsidies more aggressively than the United States.
CHAPTER H GATT NEGOTIATIONS IN PERSPECTIVE 35

The Tokyo Round antidumping code sharpened article VI of the General Agreement by clarifying the standard for determining injury and by

establishing an international dispute settlement procedure. The antidumping

code, like the subsidies code, allows antidumping duties matching the dumping margin when foreign firms sell their products below normal prices in

foreign markets.:

The government procurement code requires that firms of other signatory countries be treated no less favorably than domestic firms when

governments purchase goods. The equal treatment obligation applies only to

those government entities specified in the Agreement, and governments bargained over which entities were to be included. Most importantly, national

defense purchases were excluded. Also, procurement should be conducted in

an open and transparent way.

Many countries apply technical standards to products before they can

be sold. These standards, such as labeling, safety, pollution, and quality requirements, are also applied to imports. The standards code states that

governments should apply these standards in a way that does not discriminate against imports.

The customs valuation code dictates that the dutiable value of imports

be based in general on their actual transactions prices. This updates obligations spelled out in article VII of the General Agreement (on Valuation for

Customs Purposes). One important aspect of this code is that it forced the

United States to stop using the American Selling Price technique. The import licensing code makes the process of obtaining import licenses transparent and not overly burdensome.

Codes of Conduct Procedures. In negotiating the codes of conduct for nontariff barriers, the Tokyo Round also established a set of guidelines for

administering them. The codes stress the regulation of specific government

policies; they do not provide a framework for actually liberalizing these

trade barriers on a product-by-product basis. In this sense they differ fundamentally from the approach used successfully to reduce tariffs. GATT's

24. The technicalities of determining when firms sell products below normal prices are

notoriously complicated. Common definitions of dumping include selling in foreign

markets at lower prices than in domestic or third-country markets, or charging prices

below production costs. Dumping by exporters from non-market economies, or stateowned enterprises in general, poses special problems, since the relationship between

costs and prices is often not known.

IliilJB
minimi i

36 GATT June 1987

tariff reductions emphasized product-by-product liberalization on a reciprocal basis across all products, using rules to reinforce, but not lead, the

liberalization process. Implementation of the codes, however, relies mainly

on good-faith compliance by the signatories to each code.

When one country questions the good-faith compliance of another

country in nontariff issues, the codes set forth dispute settlement procedures to help resolve the differences. These procedures operate along the

same principles as those generally available under the provisions of the

General Agreement, stressing passive oversight and adjudication of legal

issues by panels.

During the Tokyo Round, negotiations on nontariff barriers were separated from the negotiations on tariffs. Separate working groups were established for each nontariff issue, most taking several years to complete their

work. Final agreement on each code was based on code reciprocity, a restricted form of conditional most-favored-nation treatment. Under code

reciprocity, each country could choose whether to sign the code and agree

to abide by the code's discipline. Countries that did not sign a code were

sometimes excluded from the benefits of the code, but they were not generally penalized in other parts of the negotiations. Almost all developed countries signed these codes, while most developing countries did not. £§/

It is difficult to assess the effectiveness of the codes of conduct, since

this depends on changes in policies and government actions that are hard to

monitor or quantify. ±27 The prevailing level of conflict between countries

over these nontariff barriers suggests that the codes have not significantly

25. In order to induce developing countries to sign the various codes, those countries were

exempted from the immediate prohibition on export subsidies and from limitations

on many other nontariff barriers, including government procurement rules. But these

exemptions were contingent on guarantees that such practices would be phased out

over time. Most developing countries opted not to sign the codes initially, though many

subsequently signed the subsidies code. They signed that code because, since an injury

test was not required for the application of countervailing duties to export subsidies

of nonsignatories, they were not protected when the United States threatened to place

countervailing duties against export subsidies for textile and apparel products, even

though most developing country exports were not large enough to cause material injury

to the U.S. industry.

26. See Robert M. Stern, John H. Jackson and Bernard M. Hockman, An Assessment of the

Implementation and Operation of the Tokyo Round Codes, Thames Essay No. 55

(Aldershot, New York: Gower for the Trade Policy Research Centre) for an assessment

of the Tokyo Round Codes.
CHAPTER H GATT NEGOTIATIONS IN PERSPECTIVE 37

restrained the use of such barriers. The Tokyo Round codes probably can be

best viewed as the beginning stage in a long process of developing common

ground, and eventually some discipline, in this area. Most of the codes,

especially the subsidies code, will be reassessed in the Uruguay Round.

LOOKING AHEAD: THE URUGUAY ROUND AGENDA

Trade ministers from over 90 countries joined in consensus last September

to issue the Punta del Este Declaration, launching the Uruguay Round of

trade negotiations. Included in this declaration are a list of agenda items

and several negotiating procedure agreements. To a greater degree than in

the past, this declaration stresses the need to control better the use of

nontariff barriers and to expand GATT discipline to nonmanufacturing products, most importantly to trade in agriculture and services.

Each of the major negotiating groups will approach the Uruguay Round

from a different perspective. The United States has been the driving force

behind the negotiations, seeking to open foreign markets to its exports and

to limit foreign subsidies of imports into its home market. Consequently,

the United States has insisted that the agenda include efforts to open agricultural and service markets, protect intellectual property rights, and limit

export subsidies. These goals would require major concessions by the European Community, Japan, and many developing countries. For any concession

in agriculture, the EC wants equivalent reductions in what it perceives as

U.S. farm subsidies. Japan, which has manufacturing trade surpluses with

almost every trading partner, has taken a much more defensive stance, attempting to maintain the status quo.

Care was taken in the Punta del Este Declaration to maintain the

developing countries' traditional nonreciprocal role. But since many of the

issues concern policies frequently used by developing countries, especially

newly industrialized countries, those countries are expected to become more

involved than they were in past negotiations. Developing countries demand

more open access to U.S. markets for natural resources and manufacturing,

especially for many labor-intensive products such as apparel and electronics.

The Uruguay Round is expected to be the most difficult of all the

rounds. Most nuisance trade barriers (that have little impact on trade flows)

in developed countries have been eliminated. Significant trade policy reform now implies changes in national policies that have often been in place

for many years and have strong domestic constituencies. The agenda can be

separated into three groups of issues: those that have been discussed in

previous GATT rounds; those being negotiated for the first time; and issues

of concern to developing countries.
38 GATT June 1987

Agenda Items With a Negotiation History

The dimensions of problems previously addressed are likely to be reasonably

clear early in the negotiations, although the legacy of unresolved conflict

presents difficulties. Hope for breakthroughs arises from the burdens that

many of these policies impose on governments and consumers. Multilateral

reforms, offering reciprocal benefits, may make major domestic policy reforms more palatable.

Barriers to Agricultural Trade. Despite considerable effort, previous

rounds have done little to reduce government interference in the production

and trade of agricultural products. As described in Chapter IV, import barriers or export subsidies in agricultural trade are often associated with

domestic policies to support farm prices and incomes. Thus, any reform in

agricultural trade implies changes in those domestic policies. For this reason, the negotiations will focus on the farm policies of the three largest

agricultural markets in the free world, the United States, the European

Community, and Japan. The United States and the EC, at great expense,

subsidize and protect domestic production. All three restrict agricultural

imports, most notably Japan. Other exporters, such as Canada and

Australia, have relatively open agricultural policies, and complain that

GATT does not recognize the rights of agricultural exporters who are

seriously affected by the policies of rival exporters such as the United

States and the EC.

Barriers to Trade in Tropical and Natural Resource Products. Trade in

tropical and natural resource products receives special attention in the

GATT negotiations because commodities such as coffee, rubber, tin, and

copper make up a large proportion of total exports for many developing

countries. Previous rounds have reduced developed-country tariffs on many

of these products, but protection remains in some areas, especially for sugar

and for commodities in the early processing stages. Developing countries

see the elimination of all trade barriers on tropical and natural resource

products, both raw and semiprocessed, as essential to their continued

development.

Tariff Reductions. While average tariff rates in developed countries have

been reduced dramatically in past rounds, they are still significant in a

number of sectors, especially when the protective impact of tariff escalation is taken into account. (Table 4 shows the current, post-Tokyo Round

average tariff rates by economic sector for the United States, the EC, and

Japan.) Moreover, tariff protection in many developing countries is exten-
CHAPTER H GATT NEGOTIATIONS IN PERSPECTIVE 39

sive. The major goal of the tariff negotiations will be to reduce tariff rates

that are disproportionately higher on final products than on the raw

materials used by domestic manufacturers (to harmonize tariff schedules)

while continuing to reduce overall tariff rates in developed countries. 227 In

many cases, major tariff reductions in particular sectors may be addressed

in conjunction with efforts to lower nontariff barriers in those sectors.

Considerable pressure will be exerted on newly industrialized countries to

offer some tariff concessions in return for tariff cuts by developed

countries.

Nontariff Barriers to Trade. Some nontariff barriers are relatively

straightforward, as in the case of explicit import and export quotas, orderly

marketing agreements, and voluntary export restraints. Others--including

various financial subsidies, government procurement practices, and export

targe ting--are often less obvious. By basic GATT principles NTBs are recognized as particularly damaging forms of protection, but GATT has been

unable to persuade member governments to discontinue them. 28.

At a minimum, the negotiations will attempt to make nontariff barriers more transparent and to hold existing ones at current levels. In some

cases, new rules will be devised to regulate such practices. Since many

existing NTBs are used to protect certain industries, meaningful reform of

these will likely depend on sectoral negotiations and some tradeoff of reciprocal concessions across sectors. On a more technical level, rules may be

developed to regulate the use of orderly marketing arrangements and

voluntary export restraints, which are currently outside the purview of

GATT discipline.

A Code of Conduct for Escape-Clause Procedures. Escape-clause actions, a

type of safeguard, allow governments to suspend GATT rules temporarily in

order to protect domestic producers from injury resulting from surges in

imports. Qualification for escape-clause relief requires proof that a domestic industry has sustained serious injury from increases in imports. No proof

of unfair trade practices is needed. GATT rules acknowledge the right of

27. The negotiations to lower tariffs may be limited until a major effort to harmonize tariff

classifications among countries is completed in 1988.

28. For a good survey of nontariff barriers employed by the United States, Canada, and

Japan, see Gary Saxonhouse and Robert Stern, "An Analytical Survey of Formal and

Informal Barriers to International Trade and Investment in the United States, Canada

and Japan," paper presented at the Conference on U.S.-Canadian Trade and Investment

Relations with Japan, Ann Arbor, Michigan, April 2-3,1987.

niiiBiiiiiiii'
40 GATT June 1987

countries to use the escape clause to justify increases in protection, but

offer little guidance on how escape-clause actions should be administered.

As a result, escape-clause standards and procedures vary considerably

among countries. Many governments--especially those of developing countries--claim that escape-clause actions in developed countries substitute

protection for market adjustment, particularly in response to chronic shifts

in comparative advantage. Also, the increasing use of such remedies as

voluntary export restraints and orderly marketing agreements raises the

fear that developed countries will increasingly resort to managed market

schemes instead of competition to determine trade flows in key sectoral

markets.

During the Tokyo Round, efforts to put together a code of conduct for

escape-clause procedures were unsuccessful. ±£/ Standardizing the escapeclause process will require rules for determining when imports are the cause

of injury; what constitutes serious injury; what should be the appropriate

length and form of the remedy (including whether remedies can be applied

selectively to some, but not all importers of a product); whether the

domestic industry should be required to make any adjustments; and how such

determinations are to be made.

A Reassessment of the Tokyo Round Codes of Conduct. Several of the

codes of conduct for nontariff barriers that were instituted during the Tokyo

Round will be reassessed during the Uruguay Round. Governments perceive

that many of the trade policies that these codes were designed to eliminate

have continued unabated. They complain about the vagueness of the rules

and the general impotence of the GATT dispute settlement process. Dissatisfaction is most apparent over the subsidies code. QQj Part of this

frustration is directed at subsidies in sectors that the codes were not intended to affect, most importantly agriculture and services. More funda29. The major stumbling block to an agreement was whether trade policy remedies mandated

by safeguard procedures could be applied selectively to some, but not all, exporters of

a product. Selectivity violates the GATT principle of most-favored-nation treatment.

The EC favored selectivity, but Japan and many developing countries feared that they

would be the countries most often selected against. Current United States policy uses

some selective remedies. For an overview of current U.S. import procedures, see U.S.

International Trade Commission, Summary of Statutory Provisions Related to Import

Relief, USITC Publication 1972 (Washington, D.C., April 1987).

30. It is this frustration that has led the United States to increasingly use the powers

provided by Section 301 of the 1974 Trade Act, which authorizes the President to open

negotiations to stop foreign trade barriers to U.S. exports. Section 301 actions generally

operate outside of GATT's jurisdiction.
CHAPTER H GATT NEGOTIATIONS IN PERSPECTIVE 41

mentally, though, there is disagreement over when permissible domestic

subsidies, including government procurement and state-owned enterprise

activities, cross over to become detrimental export subsidies and import

barriers.

Generally stricter rules for these government actions may resolve

some problems, but general rules are not likely to be flexible enough to take

account of special conditions in some sectors. To overcome this deficiency,

sectoral negotiations may be most productive. Product-by-product negotiations would also offer the potential for tangible concessions negotiated on

a reciprocal basis across sectors and countries. 2±/

Institutional Strengthening of GATT. The primary role of GATT in the

world trading system is to facilitate trade liberalization over time. The

rules and principles in the General Agreement represent consensus agreements by members on how governments should carry out trade policy. By

most accounts, GATT has been a successful forum for major reductions in

tariff protection. The Uruguay Round will debate how GATT can evolve

into its next stage--when it can come to grips with nontariff barriers. A

strengthening of GATT's role in regulating such trade practices will depend

fundamentally on the member countries. To change the present system of

passive enforcement into a more aggressive policing of stricter rules would

require a significant transfer of power from member countries to GATT. An

intermediate position would be for member countries to enact some GATT

rules into domestic law.

New Issues

New issues in the Uruguay Round pose many of the same problems as the

others, but with the additional burden that the dimensions of these problems

31. Governments subsidize domestic producers in many ways. Increasingly, though, a broad

range of government programs—including educational, manpower, and financial

assistance and regulation-affect foreign trade flows. As international competitiveness

depends more and more on technological innovation and highly skilled work forces,

many infrastructural policies that have been traditionally considered purely domestic

matters now are viewed as matters related to international competitiveness. Moreover,

consolidated government programs targeted at specific industries can affect competition

between countries even where these programs do not explicitly subsidize exports.

32. See Robert E. Baldwin, "Alternative Liberalization Strategies," Working Paper No.

2045, National Bureau of Economic Research, October 1986, for a more detailed

examination of the benefits of product-by-product multilateral negotiations to reduce

nontariff barriers.

HllliiBM
42 GATT June 1987

are not well understood, both because of inadequate data and for lack of

clear analysis. In many cases, the parties have not yet formulated detailed

positions. Negotiations on some of these issues should be expected to take

at least several years.

Barriers to Trade in Services. At the insistence of the United States, barriers to international trade in services will be dealt with for the first time

by GATT during the Uruguay Round. Regulating government policies that

affect trade in services introduces a number of new problems. Data on

service trade flows are inadequate to guide negotiators. Barriers to service

trade are closely linked to domestic federal and state regulation in such

politically sensitive areas as labor (immigration); investment, finance, and

banking; national security; and health and safety rules. Finally, services

span such a broad range of economic activities that liberalization can have

very uneven effects on different types of services.

Intellectual Property Rights. These rights involve most importantly copyright, patent, and counterfeiting protection for both goods and services.

Since intellectual property, such as new technologies or artistic work, is

often easy to duplicate, such rights can be protected only by laws.

Among developed countries, a series of agreements exist outside of

GATT protecting most intellectual property rights. Efforts will be made

during the Uruguay Round to incorporate these arrangements into the GATT

framework. Much of the conflict over this issue relates to actions by

developing countries, which have resisted such limitations on the ground

that they are an unfair deterrent to the transfer of technology.

Investment Restrictions and Trade. Laws restricting foreign investment

often affect international trade in goods and services. A firm's ability to

compete in a foreign market sometimes hinges on the opportunity to establish subsidiary operations in that market, especially where close buyer-seller

relationships are required. National restrictions on foreign investment commonly include: provisions limiting foreign ownership participation or prohibiting the establishment of foreign operations altogether; performance requirements that force subsidiaries to export certain amounts of their output,

or to use certain amounts of domestic inputs; and prohibitions on currency

conversion. Both developed and developing countries restrict foreign investment. Governments, both bilaterally and in bodies such as the Organization

for Economic Cooperation and Development, have negotiated agreements

monitoring policies that inhibit foreign investment flows. But such restrictions remain commonplace. Since the Uruguay Round will represent the

first GATT-sponsored attempt to deal with investment-related trade issues,

much of the initial effort will likely be in cataloging and analyzing the

problem, and then developing some common ground for negotiations.
CHAPTER H GATT NEGOTIATIONS IN PERSPECTIVE 43

The Uruguay Round and Developing Countries

An important set of issues concerns developing countries, especially the

newly industrializing countries (NICs). Although the integration of developing countries into GATT negotiations and discipline is not a formal issue on

the agenda for the Uruguay Round, it may prove to be one of its most

important contributions. ££/

Special Treatment for Developing Countries. Developing countries generally face constraints on growth that are different from those of developed

countries. They may need to develop their economic, social, and political

infrastructures concurrently, making them both reliant on and vulnerable to

foreign influences. To pay for the financial and physical capital, and the

technology, that are vital to the development process, they must earn

foreign exchange by exporting commodities and (increasingly) manufactured

goods to developed countries. To overcome this foreign exchange constraint,

developing countries often seek to stimulate exports and manage imports as

an integral component of their development strategies. As a result, they

tend to rely more on aggressive trade policies and access to foreign markets

than do developed countries. M/

The General Agreement takes account of these special circumstances

by its treatment of developing countries, effectively exempting them from

most of the discipline of GATT. M/ Developing countries have not been

expected to provide reciprocal concessions for tariff reductions by

developed countries, and have not been seriously penalized for government

policies that violate GATT rules. Since developed countries have less incentive to reduce trade barriers on products supplied principally by developing

33. For a good overview of problems facing the United States and developing countries in

new trade negotiations, see Ernest Preeg, ed., Hard Bargaining Ahead: U.S. Trade Policy

and Developing Countries (Washington, D.C.: Overseas Development Council, 1985).

34. The debt crisis has exacerbated the foreign exchange problem for many developing

countries. In order to earn the foreign exchange needed to satisfy debt-servicing

requirements, the countries must increase their trade surpluses. The International

Monetary Fund has made this a key condition for loans to debtor countries. Trade

surpluses can be achieved either by increasing exports or reducing imports, almost

always requiring active trade policies. Since imports can be more easily manipulated

than exports, many developing countries have been forced to curtail key imports from

developed countries. These actions have tended to lower economic growth rates, and

they have stimulated domestic production of import substitutes. The debt crisis will

thus have shaped future trading patterns between developing and developed countries

long after the crisis itself has been resolved.

35. An entire section dealing with developing countries was added to the General Agreement

in 1966. This section, Part IV, laid out the basis for the special treatment of developing

countries.

III Hill
I Hill!

44 GATT June 1987

countries if the latter do not respond with reciprocal concessions, the

General Agreement included a unilateral commitment by developed countries to reduce trade barriers to imports from developing countries.

Developing countries have played a minor role in previous rounds.

They have looked to the United Nations Conference on Trade and Development, rather than GATT, to express their demands for more stability in

commodity markets, for preferential treatment of their exports to

developed countries, and for improved access to developed-country markets

in general. Some developing countries actually fought the tariff reductions

achieved by the developed countries during the Tokyo Round on the ground

that lower tariffs to everyone eroded the advantages of the Generalized

System of Preferences (GSP) that were applied only to imports from

developing countries. ^6/ Developing countries see GATT's acceptance of

trade restrictions by developed countries on textiles and apparel, and on

agricultural products such as sugar, as proof of a bias against developing

countries. Consequently, most developing countries have not actively participated in previous rounds, even though this has inhibited their ability to

secure tariff reductions for their exports and to influence codes of conduct

for nontariff barriers to their benefit.

A New Role for Developing Countries in GATT? Developing countries, led

by the newly industrializing countries, are now fully competitive in a broad

range of manufactured goods markets and are sometimes the principal suppliers of such goods. They also provide important markets for the developed

countries' exports. But not all developing countries have shared in this

success. Increasingly, the interests of the poorer developing countries differ

from those of the more successful. The latter are being drawn into the

GATT system, somewhat against their will, by the force of their success in

world trade. The poorer developing countries, on the other hand, still require substantial assistance and special treatment.

In principle, a key task of the Uruguay Round should be to integrate

the more successful developing countries into the GATT system. Although

36. Baldwin and Murray estimated that the significant cuts in tariffs achieved during the

Tokyo Round, applied on a most-favored-nation basis, provided benefits to developing

countries that far outweighed their losses from the erosion of the GSP preference

advantage. The authors found, however, that this result held more strongly for newly

industrializing countries than for the poorer developing countries, who were rarely

restrained by GSP import limitations. See Robert E. Baldwin and Tracy Murray, "MFN

Tariff Reductions and Developing Country Trade Benefits Under the GSP," The Economic

Journal, no. 87 (March 1977), p. 30-46.
CHAPTER H GATT NEGOTIATIONS IN PERSPECTIVE 45

the Punta del Este Declaration emphasizes that reciprocity is not required

for developing countries, clearly the successful resolution of many of these

issues will require some concessions from them. In fact, a number of issues

on the agenda-including intellectual property rights, trade in tropical and

natural resource products, and various nontariff barriers to trade in goods

and services-are predominately conflicts between developed and developing

countries as blocs. The first step, then, is for the newly industrializing

countries to agree to abide more fully by the basic GATT rules and to enter

the Uruguay Round negotiations as peer participants willing to make at least

some reciprocal concessions.

Numerous practical problems must be overcome to integrate the more

successful developing countries into the GATT system. They must be persuaded to forgo their present privileges as developing countries. It will be

necessary to define the point at which a developing country qualifies for the

rigor of graduation. Must graduating countries abide immediately by the

full force of GATT, or will the rules be applied more leniently to

them--possibly in different degree across products or types of policies--with some transitional phase-in period? Should special consideration

be provided for those countries that bear particularly vexing foreign debt

burdens? Should developing countries be able to shelter infant industries,

especially service industries, until they become internationally competitive?

How can GATT most effectively target benefits toward the most needy

developing countries? Although not all of these issues will be dealt with

explicitly in the Uruguay Round, most will arise during negotiations on the

many agenda items in which developing countries are important players.
lUHHIlfBLl
CHAPTER III

HIGH-TECHNOLOGY TRADE

The Uruguay Round is unlikely to see major breakthroughs in high-technology

trade, most of which already falls within the scope of GATT. Discussion will

focus on reducing the nontariff barriers that hamper trade in this field.

U.S. negotiators will emphasize three such barriers: targeting by governments

of particular industries for development; restrictions on the access of foreigners

to domestic markets; and failure to protect rights to intellectual property such

as patents and copyrights.

Targeting is the coordination of government policies to encourage the

development of particular industries. This often includes subsidies for research

and development, restrictions on government procurement, protection of

markets, and restraints on investment. The extent to which governments ought

to engage in R&D will require further definition. The European Community's

use of substantial R&D subsidies as a development vehicle for its hightechnology industries is likely to be a negotiating point.

Restrictions on market access are often used to favor domestic manufacturers

of high-technology goods. Technical standards often function as import barriers,

as do "buy national" requirements in government procurement. So do laws

that restrict investment by requiring a firm to export a certain amount of its

output, or to use a certain proportion of local materials. The Uruguay Round

will have to strengthen GATT's technical standards and government

procurement protocols to resolve these problems. Japan is likely to be pushed

to expand access to its markets, while the EC and the United States will be

pressed to phase out their restrictions on government procurement.

Intellectual property rights are most often breached by producers in the

developing countries, where patent and copyright protection is uneven or

nonexistent. A major focus will be on bringing existing intellectual property

rights procedures into the GATT and strengthening them.

High-technology manufactures include the following industries, in whole or

in part: computers, communications equipment, electronic components,

Pharmaceuticals, aerospace, and instruments. This list should be considered

illustrative rather than exhaustive, I/

1. For a detailed discussion of the definition of high technology, see Congressional Budget

Office, Federal Financial Support for High-Technology Industries (June 1985) and

references therein.
IB Ml

48 GATT June 1987

High-technology industries tend to be fast-growing and highly productive, qualities that are vital to economic development. Competition in the

intensely innovative market environment places a premium on product

research and development, as well as on flexible and efficient production

techniques. When world markets for high-technology products are expanding, firms from many countries can share in the benefits of large-scale

production. When demand slumps, as has been the case recently, the battle

for market share intensifies.

CURRENT PROBLEMS IN HIGH-TECHNOLOGY TRADE

The recent deterioration in the trade performance of U.S. high-technology

industries has been attributed by many to the policies of foreign governments that seek to aid their industries by stimulating exports or inhibiting

imports. U.S. negotiators have made reducing barriers to trade in hightechnology products a high priority for the Uruguay Round of negotiations.

Unlike trade in agriculture and services, however, high-technology trade

does not constitute an easily defined sector. As a consequence, issues

related to trade in high-technology products will most likely be addressed

under several policy-oriented agenda topics.

Government Policies

Government policies that most critically influence trade in high-technology

products can be grouped in three broad categories: the practice of making

certain industries the targets of favorable government policies that increase

their competitiveness; the creation of nontariff barriers to trade; and the

protection of intellectual property rights. Tariffs are not a significant issue

in most high-technology product trade, which is already covered by GATT

rules for tariffs. But the GATT rules offer weak or in some cases no remedy

against targeting and nontariff barriers. In addition, trade in hightechnology services, such as computer software services, and the protection

of intellectual property rights have never been considered by GATT.

Some countries have entered into international agreements to guide

policy in these areas, but there is little consistency overall. Many government policies influencing trade in high-technology products are integrally

linked to national development and growth strategies. The underlying question is how far governments can or should go in assisting their strategic

industries to become more internationally competitive.
Chapter m HIGH-TECHNOLOGY TRADE 49

If the Uruguay Round succeeds in strengthening the GATT rules and

reducing barriers for high-technology products, U.S. producers should gain

on balance. Most important, perhaps, would be the establishment of clear

criteria as to what types of government policies are permissible. Given the

basic competitiveness of U.S. producers, the United States stands to gain

considerably by expanded trade in high-technology products and by better

protection of intellectual property rights.

Underlying the entire discussion must be some conception of how new

industries are created. Few major industries have arisen in the 20th century

without some degree of governmental participation. I/ As they develop,

moreover, high-technology industries offer so much promise for economic

growth that governments can ill afford to ignore them. 5/ For these

reasons, the development of new industries is unlikely to be a private matter

in the future. Some balance must be found between the right of every

country to participate in growth and the desire of those already in these

developing industries to enjoy the benefits of their past investment.

Recent Trends

Although the United States appears to have a comparative advantage in the

production of high-technology goods, the trade surpluses that accompany

such advantage have declined significantly--from $27.4 billion in 1980 to

$11.7 billion in 1986 (see Table 5). While this performance is clearly better

than that of the overall merchandise balance of trade, which declined nearly

sixfold over the same period, it largely reflects the high exports of the

aerospace industry. As shown in Table 5, the balance of trade for hightechnology industries excluding aircraft and parts was in deficit by $1 billion

in 1986.

The decline in the high-technology trade balance is primarily the

result of increased imports: while high-technology exports grew by 40 percent over the 1980 to 1986 period, imports grew by 105 percent. The greatest import pentration has been in computers and office equipment, elec2. See Richard R. Nelson, ed., Government and Technical Progress: A Cross-Industry

Analysis (New York: Pergamon Press, 1982).

3. For a discussion of why governments view high-technology industries as central to

economic growth, see Congressional Budget Office, Federal Financial Support for HighTechnology Industries (June 1985), pp. 1-17, and references therein.

HHIIBI
TABLE 5. HIGH-TECHNOLOGY BALANCE OF TRADE FOR SELECTED YEARS

(In billions of current dollars)

Industry (Standard 1980

Industrial Classification) Exports Imports Balance

Drugs(283) 2.0 1.0 1.0

Industrial Organic Chemicals (286) 6.4 2.2 4.2

Computers and Office Equipment (357) 8.7 2.5 6.2

Communications Equipment (366) 2.7 2.5 0.2

Electronic Components (367) 6.2 5.3 0.9

Aircraft and Parts (372) 14.6 2.7 11.9

Scientific Instruments (380) 7.8 4.8 3.0

Total 48.4 21.0 27.4

Exports

2.6

6.0

11.7

3.7

7.7

14.6

8.5

54.8

1983 1986

Imports Balance Exports Imports Balance

1.3 1.3 3.1 2.3 0.8

2.9 3.1 6.9 4.1 2.8

6.2 5.5 16.1 13.5 2.6

4.5 -0.8 4.3 6.3 -2.0

8.0 -0.3 9.2 13.4 -4.2

2.6 12.0 18.4 5.7 12.7

6.1 2.4 9.7 10.7 -1.0

31.6 23.2 67.8 56.1 11.7

SOURCE : U.S. Department of Commerce , Bureau of the Census.

§

a

H

D

(D

CO

oo

-a
Chapter m HIGH-TECHNOLOGY TRADE 51

tronic components, and scientific instruments (SIC 357, 367 and 380, respectively). Imports in these categories, together, rose nearly 300 percent.

If the deterioration of the high-technology trade balance can be partly

explained by foreign industrial development policies, most of it seems to be

the result of economic factors affecting trade in general. The hightechnology balance has not declined as severely as the overall merchandise

balance of trade, suggesting that the high value of the dollar and the

strength of the U.S. economy should be considered as leading factors. This

is not to say that individual trade practices are trivial or should be ignored,

but rather to place them in proper perspective.

In recent years, other countries have challenged the virtual monopoly

U.S. firms had enjoyed in high-technology markets. At the same time,

demand in many of these markets has grown at a slower pace or even contracted. Thus, there are more suppliers than ever in markets that are

growing less rapidly than had been expected.

The challengers, while violating many current U.S. sensibilities regarding proper trade policy, see their actions as not essentially different from

measures the United States has taken in support of high technology. They

ascribe the U.S. lead in this field to its space and military programs. They

point out that the federal government has subsidized research and development (R&D) through lucrative defense contracts; that it has guaranteed

markets through "Buy America" amendments to procurement legislation; and

that on many occasions the government has even provided physical capital

to manufacturers of these goods.

The major trade policy issues of concern to the United States in the

high-technology areas are well known:

o Targeting by other governments of industries in which the United

States has a technological lead;

o Restrictions placed on access to overseas markets; and

o Lack of protection for intellectual property.

These issues have been at the heart of high-technology trade disputes

throughout the 1980s. U.S. firms claim that they are excluded from markets

abroad, that they are systematically underpriced in the U.S. market, and

that their products (which are expensive to research and develop) are copied

lew HI
52 GATT June 1987

by foreign manufacturers without appropriate recompense. Moreover, they

believe that although U.S. consumers may reap temporary gains from such

foreign practices as targeting or dumping, the long-term interests of the

U.S. economy are hurt by them.

The prominence of these issues does not mean that the traditional

tariff questions have vanished from the agenda. The European Community's

tariffs on semiconductors average over 15 percent. U.S. computer tariffs of

4.6 percent offer some level of support for domestic manufacturing, especially at the lower end of the market. In addition, many developing countries have substantial tariffs on high-technology goods. But much progress

has been made. The United States and Japan have agreed to reduce their

semiconductor tariffs to zero, ahead of GATT's schedule. Nontariff barriers, however, remain much more significant impediments to trade.

TARGETING

Perhaps no issue in high-technology trade is receiving more attention than

targeting-which may be defined as the coordinated attempt by a government to direct productive resources to selected domestic industries so as to

make the industry more competitive internationally. I/ The intent of the

government is paramount, since it is the coordination of many policies that

gives targeting its reputed power. Targeting policies have many components. They may include any or all of the following: a protected market;

preferential financing; subsidies of various kinds; tax benefits; investment

restraints to keep foreigners out; government coordination of R&D; and

special treatment of intellectual property rights. The protected market

need not include the entire country, although it often does; it may be

limited to government procurement, if that constitutes a large fraction of

the market. Often preferential financing is available to the targeted

industries, although it may be difficult to distinguish targeting from

conventional economic development policies. Since high-technology

industries characteristically require large R&D investments, assistance in

financing R&D is of great benefit. Efforts to break into world markets are

costly because the industry is rarely initially competitive and suffers

substantial losses. For this reason, governments are often moved to

subsidize it, as the European Community has with Airbus. Consumers of

high-technology goods may be given tax benefits: for instance, in Japan

4. See International Trade Commission, Foreign Industrial Targeting and Its Effects on

U.S. Industries; Phase I: Japan (October 1983), p. 17.
Chapter HIGH-TECHNOLOGY TRADE 53

purchasers of robots can depreciate

may be used to keep foreigners ou

Japanese semiconductor industry, o

domestic capital. Governments oft

making to prevent costly duplication

cartelizing the domestic market:

ment coordination followed by brut

necessary to obtain the requisite te

ment practices that abrogate or

(for example, by limiting licensing fees

them rapidly. Investment restraints

; entirely, as was the case with the

to make them junior partners with

:n intervene and coordinate decisionof R&D. This may or may not entail

Jaban has been characterized by govern1 domestic competition. When it is

tmology from abroad, laws or governredtice foreign intellectual-property rights

may be part of the targeting effort.

Brazil's Informatics law provid

government policies for the benefit

small and mid-sized computer industry

has four components. First, it imp

tions. For example, 70 percent of

voting power must be local. Seco

licenses to foreign firms producing j

essence, this policy grants local m

still in their technological infancy.

 r

.

tration of this law has thus far been

have complained of unexplained over

ning impossible. Fourth, the Brazilia

intellectual property rights: softwar

and the proposed software law ha

that apply to foreign technology limi

tion of intellectual property.

s a clear example of coordination of

f a chosen industry--in this case, the

The Brazilian Informatics strategy

ses very stringent investment regulate ownership and 100 percent of the

id, the government will deny import

oods that can be produced locally. In

nopolies to Brazilian companies often

bird, the foreign access to the adminislimited. For instance, U.S. companies

light changes in policy that make plangovernment has placed restrictions on

5 is currently not covered by copyright

severe deficiencies; other regulations

both the payments for and the protecJapanese Targeting

Some observers of Japan have argu

derstood phenomenon. In essence,

trying to use its Ministry of Inter:

compensate for the lack of institutional

Most Japanese high-technology comp

and government finance agencies,

rather than from the equity marke

technology appears, venture capital!

technology into new products, signal

is an area of potential rewards. IV

signaling to bankers and corporation

called, that it favors certain investrr

d that Japanese targeting is a misunthey say, the government of Japan is

ational Trade and Industry (MITI) to

flexibility enjoyed by U.S. firms,

nies obtain their financing from banks

which tend to be very conservative,

In the United States, when a new

,s compete with each other to turn the

ng to the rest of the economy that this

TI plays an equivalent role in Japan,

s through its "visions," as its plans are

ents. However, for the most part, U.S.

i nun i
54 GATT June 1987

venture capitalists are quicker in responding than are the MITI bureaucrats.

In fact, there is some indication that MITI follows the movements of

U.S. venture capitalists as guides for investment strategy. §/

The cooperative R&D projects sponsored by MITI--the VLSI project

earlier, and now the Fifth Generation Project--are similarly misperceived,

according to this view. The Japanese educational system, combined with

lifetime employment guarantees, produces researchers who are not as wellrounded in their technical background as U.S. personnel in comparable positions. Their primary loyalty is to the firm, not the profession; the movement of personnel among firms, and the informal exchanges that are typical

among employees in U.S. high-technology firms, do not occur in Japan.

Technological cross-pollinization has been central to U.S. advance. In order

to imitate it, MITI has encouraged firms to participate in cooperative

research programs. §J

Another aspect of Japanese targeting that has often been misperceived, according to this view, involves the cost of capital. Targeted sectors are thought to have access to cheap capital, giving them an advantage

over foreign firms. But most of the funds available to targeted industries

have been available to all major industries; special government funds for

targeted industries tend to be small by U.S. standards. The reason for lower

capital costs in Japan is that the old system of capital controls gave

Japanese households very little choice in deciding what to do with their

savings. The result has been a massive transfer of income from households

to the corporate sector as a whole rather than to specific industries.

Governmental subsidies to Japanese industry, either through credit or

through the tax system, have been relatively small. In both Europe and the

United States, subsidy programs are much larger. Moreover, the larger

Japanese subsidies go to declining industries. Even in the targeted hightechnology industries, the subsidies have often been directed at products

5. This discussion is largely taken from Gary Saxonhou.se, "What is All This About

'Industrial Targeting' in Japan," World Economy (September 1983), pp. 253-273. See

also Gary Saxonhouse, "The Micro- and Macroeconomics of Foreign Sales to Japan,"

in William R. Cline, ed., Trade Policy in the 1980s (Washington, D.C.: Institute for

International Economics, 1983), pp. 259-304.

6. Despite the "success" of Japanese research cooperatives, the evidence for extensive

firm participation is not substantial. Japanese firms that participate in governmentsponsored research cooperatives can depreciate assets used in this research in one year.

In 1982 the cost of this provision of Japanese tax law was only $17 million, suggesting

minimal participation. See Saxonhouse, p. 266.
Chapter HI HIGH-TECHNOLOGY TRADE 55

rather than firms. For instance, special depreciation provisions are allowed

for purchases of industrial robots--even if the robot purchased is not of

Japanese origin. Z/

The principal function of Japanese targeting has been to prevent foreign access to a market until the domestic industry reached the point at

which it no longer needed this level of protection. Even here, however, the

role of the government should not be overstated. The Japanese government

rarely erects formal barriers to trade anymore; its tariff rates on hightechnology goods are as low as or lower than those of the United States (see

Chapter II), and formal quotas have been abolished in these goods. Whether

because of the homogeneous culture or as a result of years of strict government regulation, foreign firms seem to have great difficulty breaking into

Japanese markets. Considering the high degree of interfirm competition in

Japanese high-technology industries, collusive behavior seems unlikely even

though it has been widely reported. Most recently, a MITI official reportedly admitted that efforts to develop a domestic supercomputer industry

meant that U.S. companies, which now dominate the world industry, would

no longer find buyers in Japan. The report has since been denied, and the

official has stated that he merely said U.S. supercomputer companies "need

to change their respective philosophies and policies" to compete in

Japan. §/ Subsequently, the government of Japan submitted a plan to the

Diet for increasing imports, involving the procurement of $1.0 billion worth

of foreign goods--including supercomputers and aircraft--mainly during

fiscal year 1987.2/ Whether this is merely a gesture to diffuse trade frictions or a serious effort to liberalize procurement policy remains to be seen.

Private actors also seem to behave in a discriminatory manner.

U.S. semiconductor manufacturers report that their markets dry up as soon

as Japanese equivalents to their chips become available. The U.S. independent producers' share of the Japanese semiconductor market has been

remarkably constant at around 10 percent--which, given the changing

7. International Trade Commission, Foreign Industrial Targeting and its Effects on

U.S. Industries, Phase I: Japan (October 1983), p. 9.

8. Makoto Kuroda, in a letter to the editor of the Washington Post, May 23,1987, p. A21.

For the text of the State Department cable on the Japanese official's comments, see

the Washington Post, April 28,1987, p. C2.

9. Sally Solo, "Japan Economic Package Seen Raising Imports $5B," Electronics News,

June 1,1987, p. 4.

I ll II HI
56 GATT June 1987

relative positions of the Japanese and U.S. industries, seems more the result

of a compact than of the working of free trade, IQj

A final misconception about Japanese targeting is that it always

succeeds. Non-Japanese observers who often complain about the ineptness

of their own government's policies attribute almost superhuman economic

powers to Japan, and especially to MITI. The government of Japan has

subsidized the aircraft industry for years, but Japan has not yet become a

major force in that industry, although it is becoming important in subcontracting, li/ On the other hand, the Japanese aircraft industry has been

treated differently than other targeted industries in that it is prohibited

from exporting many products and has to face competition from firms with

protected markets of their own. MITI's failures are best seen in more

mature industries such as aluminum, petrochemicals, and shipbuilding.

Similarly, many of the Japanese successes in automobiles have come about

because their automakers ignored MITI's guidance.

R&D Subsidies

Subsidies for research and development have become an issue in hightechnology trade mainly because they are widely used by countries in

targeting one or another high-technology industry for preferential development. Whether R&D subsidies are viewed as legitimate depends on the

context in which they occur. Most economists (and industry observers)

believe that a government has to step in to encourage R&D, especially at

the basic level, because if left to its own devices the market is not likely to

devote sufficient resources to R&D. 1%J Because other firms can imitate

the inventing firm and capture a share of the market and the profits, the

benefits from an invention to the inventing firm may be less than the

benefits to society as a whole. Consequently firms devote less resources to

10. The relative shares of Japanese and U.S. semiconductor companies in each country's

market is a matter of some contention. Most U.S. industry estimates overstate the

Japanese share in the U.S. market by excluding IBM and other companies that produce

for internal use. Similarly, they understate the U.S. presence in Japan. See

Semiconductor Industry Association, Japanese Market Barriers in Microelectronics

(June 14,1985).

11. International Trade Commission, Foreign Industrial Targeting, and its Effects on U.S.

Industry, Phase I: Japan (October 1983), pp. 126 and 155-163; Aerospace Industries

Association of America, Aerospace Facts and Figures, 1986-1987, p. 132.

12. See Congressional Budget Office, Federal Financial Support for High-Technology

Industries (June 1985), pp. 1-3.
Chapter m HIGH-TECHNOLOGY TRADE 57

inventive activity than the good of society may suggest. The mere act of

supporting R&D is not seen as an illegitimate government activity. But the

extent to which governments ought to do this, especially when there are

international repercussions, is a matter yet to be settled.

Much depends on the kinds of R&D being performed and on how the

results are disseminated. Money spent on basic research, or even on generic

industrial research, has broad applicability and represents less of a threat to

the high-technology industries of competing nations than does an effort to

develop a specific high-technology product for export. Similarly, if research

results are widely available, questions regarding the propriety of the

research effort are less likely to be raised. ±27

Many governments pursue massive R&D subsidy programs in an effort

to develop high-technology industries. European countries have joined to

support first the Concorde, then Airbus, and now Esprit and Eureka

(European Community programs on information technology and on advanced

technologies in general); hundreds of millions, if not billions, of dollars have

gone into each effort. South Korea is spending hundred of millions to

develop a semiconductor industry. Taiwan is also making efforts on behalf

of its electronic industries. By contrast, Japanese subsidies are small: the

government has concentrated on providing seed money to involve private

actors, but the sums have not been large compared with those spent by other

countries. In fact, more funds have gone to declining industries and agriculture than to high-technology R&D.

U.S. government agencies also fund large amounts of research for

military and other purposes, and this has some relevance for high-technology

markets. A recent CBO analysis found that, in 1983, federal agencies spent

$8.4 billion on programs to enhance productive capabilities in high-technology industries--not including the large expenditures by the Department

of Defense (DoD) and the National Aeronautics and Space Administration

(NASA) on R&D for goods being purchased for agency use, such as weapons

research, which would obviously add tens of billions to this total.!!/ The

13. The U.S. government has recently begun to move away from giving free access to

federally generated technology. The Administration concluded that the reason federal

patents were licensed less often than privately generated patents was that the lack

of exclusive rights gave private actors no incentive to invest in commercializing federal

technology. In response, the Congress passed the Technology Transfer Act of 1986, which

permits exclusive licensing under some circumstances.

14. Congressional Budget Office, Federal Financial Support for High-Technology Industries

(June 1985), p. 31. See subsequent pages in that work for a discussion of the nature

and successes of these programs.

i nun i
58 GATT June 1987

purchase of high-technology equipment for the defense and space programs

is not done to aid high-technology exports. The government will have to

continue funding such research in order to accomplish its military and space

missions. At the same time, however, it must be recognized that technological advances are often stimulated by military and space spending. In fact,

Japan and the European Community often point to the large amount of

U.S. military and space R&D spending in defense of their own programs,

which are much smaller. In material describing their R&D programs, they

often mention the DoD and NASA as standards to emulate.

Since targeting depends on government intentions, rather than on the

amounts spent, any discussion of it must focus on the tactics used by

governments to target: nontariff barriers, export subsidies, restrictions on

intellectual property rights, and the like. Simply stated, GATT cannot

legislate intentions; it can, however, proscribe actions. Although the

Uruguay Round is unlikely to produce a protocol on targeting per se, the

issue will underlie many specific negotiations- -particularly negotiations on

strengthening the Tokyo Round codes on subsidies and government procurement and negotiations on intellectual property rights.

ACCESS TO MARKETS

The very nature of high-technology goods often makes trade in them prone

to disruption by governments anxious to exclude such imports from the

national market. First, a large part of demand is from governments or

government-controlled entities, such as the national telephone and telegraph

systems, national airlines, defense ministries, and health systems. Second,

because many of the products are new, standards of health, safety, and

performance may not have been fully developed, and this provides another

means of excluding them.

Government Procurement

Broadening the scope and enforcement of GATT's government procurement

code, and liberalizing government procurement in general, are of special

importance to U.S. high-technology industries. As noted above, governments and government-controlled entities covered by the procurement code

buy a disproportionate amount of high-technology equipment, most importantly for their telecommunications systems. On the one hand, the

Administration and concerned U.S. firms have been pressing for open pro-
Chapter m HIGH-TECHNOLOGY TRADE 59

curement processes. On the other hand, exclusive contracts are seen by

many industrialized countries as a means of encouraging development of

their own high-technology industries, and they may be loathe to relinquish

this device.

Another weakness in the U.S. bargaining position on this issue is that

U.S. adherence to the covenant has been mixed. Although in passing the

Trade Agreements Act of 1979 the Congress implemented the agreement on

government procurement and the other protocols negotiated during the

Tokyo Round, the United States continues to exclude foreign firms from

participating in many government procurement contracts. The code calls

for most-favored-nation treatment in this sphere--that is, it requires signatory governments, in making procurement decisions, to grant products

originating in any other signatory country treatment no less favorable than

that afforded to domestic products or to the products of any other country.

The whole procurement process, including the drawing up of specifications,

was to become more open. Only military arms purchases and contracts of

small amount are exempt from these requirements.!^/ Despite these requirements, the Congress has on several occasions passed laws restricting

procurement contracts for such items as highway and mass transit construction materials to U.S. firms. Public works bills since 1979 have also contained Buy America clauses.

At first glance U.S. firms may seem to have more to gain from the

procurement agreement than those of other countries, but if the treatment

of weapons procurement changes radically, U.S. firms may find themselves

challenged in the profitable U.S. military markets for the first time. Currently, exempted weapons procurement plays a large part in U.S. government procurement; of the $99.6 billion the federal government spent on

goods of all sorts in 1985, $66.8 billion was spent on the acquisition of military equipment. IZ/ Thus two-thirds of U.S. government purchases are

exempt from the GATT procurement code. If the next round of talks continues to exempt military equipment, U.S. firms stand to gain. Other

nations want to remove this exclusion, however.

15. Congressional Budget Office, The Effects of the Tokyo Round of Multilateral Trade

Negotiations on the U.S. Economy: An Updated View (July 1979), p.26.

16. For a list of recent Congressionally-imposed restrictions on government procurement,

see Raymond Ahearn and Alfred Reifman, "Trade Policymaking in the Congress," in

Robert Baldwin, ed., Recent Issues and Initiatives in U.S. Trade Policy (Cambridge,

Mass: National Bureau of Economic Research, 1984), pp. 47-49.

17. An additional $13.4 billion was spent on structures.
[•HILL

60 GATT June 1987

Change, when it comes, should favor U.S. exporters. In 1984, the

European Community spent roughly $10 billion on telephone equipment, and

U.S. exports accounted for only $120 million of this. I°/ The relatively low

sales of U.S. equipment reflect the fact that government procurement

regulations tend to dominate these purchase decisions in the EC. Deregulation is reducing the level of government involvement in telecommunications,

but progress will be slow. Moreover, the government of West Germany,

which controls the largest single market in the EC, is in no hurry to

deregulate its telephone system.

Some large U.S. firms are already participating heavily in the EC

market, through subsidiaries. The German subsidiaries of U.S. companies

produce roughly 20 percent of the equipment for the German telephone

monopoly (Deutsche Bundespost). But this limits U.S. participation in the

EC market to firms old enough or large enough to have foreign subsidiaries.

Many of the relatively small or new telecommunications equipment manufacturers may find themselves excluded from these markets.

Technical Standards

The Tokyo Round also produced a technical standards code, which, much like

the government procurement code, obligates signatories not to use technical

standards as barriers to trade and to make those standards (and the

processes establishing and applying them) more accessible. Technical

standards are used most often to impede imports in the pharmaceutical and

the telecommunications equipment industries. ±£/ Some countries have

standards that are incompatible with those used by others; in France, for

example, the standard for color television is different from that used

elsewhere and has permitted the development of a national industry. In

other instances, standards are also often set so that their noncritical

parameters favor local producers. Exterior dimensions may be used in this

way. For instance, West German health standards sometimes specify

lengths of electronic keyboards, which do not correspond to lengths used

internationally.

18. The U.S. export figure is slightly understated in that it does not include ground station

or microwave equipment.

19. For a more complete discussion of the use of technical standards in restraint of trade,

see Robert Cohen, Richard Ferguson, and Michael Oppenheimer, Nontariff Barriers

to High-Technology Trade (Boulder, Colo.: Westview Press, 1985), pp. 23-31.
Chapter m HIGH-TECHNOLOGY TRADE 61

Enforcement procedures also impede high-technology imports. First,

if technical standards are not compiled in a readily accessible manner, the

time and cost of learning them may discourage companies from attempting

to penetrate the market. Second, the standards may be more stringently

enforced on imports than on domestic products. Third, obstacles may be

placed in the way of a company seeking technical certification--for

example, by requiring it to repeat all its testing within the importing

country. In the case of drugs, where tests take years, this requirement can

be prohibitive. Also, repeating tests discriminates against small firms,

which can less easily bear the costs. In some cases, companies have been

required to show that each batch of products meets the technical standards,

rather than doing the tests once and then certifying that subsequent

production is according to specification.

Other Market Barriers

Two other nontariff barriers are used by governments to restrict access to

high-technology markets: import licenses and performance requirements. 20/ Import licenses are used throughout the developing world for a

wide variety of purposes: restricting imports of luxury goods, conserving

foreign currency reserves, and protecting or encouraging local industries.

Performance requirements are not directed against importers per se,

but are imposed on firms that want to invest in a country. They stipulate

things the entrant must do in order to be allowed to set up shop, such as

exporting a certain amount of its output or using a certain proportion of

local materials.

INTELLECTUAL PROPERTY RIGHTS

Intellectual property rights are of great concern to high-technology industries. The United States is laboratory to the world, and high-technology

industries perform a large fraction of this task. The major areas of concern

are product and process patents (including extending such coverage to

Pharmaceuticals and biotechnology), copyrights (especially for computer

software), and trademark law.

20. Intellectual property rights may also be used to limit access; they are discussed in the

following section.

F1HI!
62 GATT June 1987

U.S. companies have suffered disproportionately from the lack of

rigorous and uniform international standards for intellectual property rights.

Foreign manufacturers have been able to mimic a wide range of U.S. namebrand goods, and even invade the U.S. market with them. In some countries,

manufacturers licensed to provide U.S. products for the local market- -for

example, Pharmaceuticals--export them to the U.S. market at lower prices.

Because they do not have to recapture R&D or marketing costs, these producers can sell them to U.S. consumers as generic drugs at a fraction of the

prices charged by name-brand producers. fLL/ The U.S. International Trade

Commission estimates that infringement of intellectual property worldwide

cost $8 billion to $20 billion in lost U.S. sales.

The less-developed world takes a different view of the issue, however,

and even among industrialized countries there have been differences of

opinion. Developing countries view weak intellectual property right laws as

a vehicle for technology transfer. They argue that even major technological

developments are properly viewed as elaborations of past contributions,

which are the property of society as a whole. They do not assign as much

weight to individual contributions as do industrialized countries. Moreover,

they do not have a great deal of intellectual property to lose. They note

that when the United States was a developing country, it did not recognize

other countries' copyright restrictions. Only at the beginning of this century, when it had become one of the major industrial powers, did it agree to

abide by other countries' copyrights. Furthermore, the United States still

does not adhere to the Berne Convention, the major international institution

regulating intellectual property rights, in part because the convention gives

authors too much control over their works. M/

A recent bureaucratic struggle in Japan illustrates some of the frictions within the industrialized world regarding intellectual property rights,

and the fragility of even the current level of protection. MITI wanted to

change the treatment accorded computer software from straightforward

copyright to a hybrid form of protection that would be administered by

21. Of course, many generic drugs are not produced this way, but are simply standard

chemical compounds sold at low markups.

22. International Trade Commission, The Effects of Foreign Product Counterfeiting on

U.S.Industry (January 1984), p. xiv.

23. Recently the Administration has signaled its intent to join Berne. See Report of the

President's Commission on Industrial Competitiveness, Appendix D. A Special Report

on the Protection of Intellectual Property Rights (December 1984), p. 335.
Chapter m HIGH-TECHNOLOGY TRADE 63

MITI. This would have substantially lowered the current standard of

protection, and would also have given MITI the authority to require

compulsory licensing should it deem this in the national interest. Fortunately for U.S. computer software companies, the Ministry of Education was

successful in its attempts to retain control of the copyrighting function.

The problems faced by U.S. high-technology firms in the newly industrializing countries are legion. Mexico and Brazil limit process patents on

some industrial processes. In South Korea and Taiwan, patent law does not

cover chemicals or Pharmaceuticals. Further, in South Korea, computer

software cannot yet be copyrighted, although such a law is currently being

negotiated with the United States. In most of these countries, new technologies, such as biotechnology and satellite communications, are not

covered by law.

A related issue, that of counterfeiting, is much less divisive than the

conflicts over patents and copyrights. While not all governments are willing

or able to devote a lot of resources to combating counterfeiting, many

recognize that it should not be tolerated. Patent and copyright policies, on

the other hand, involve more complex trade-offs between development

needs and individual rights. The Administration has been trying through

bilateral negotiations to encourage countries with the most active

counterfeiting industries to put a stop to them. Its biggest success has been

the recent anticounterfeiting law in Taiwan, the country that has led in the

unauthorized duplication of U.S. goods. Whether enforcement of the law

will be satisfactory to U.S. interests remains to be seen.

BARGAINING POSITIONS IN THE URUGUAY ROUND

While the United States imports high-technology goods from or exports them

to virtually every other nation, this trade is predominantly with Western

Europe, Japan, and some newly industrializing countries. Japan heads the

list in most categories, both as buyer and seller. In many cases, however,

the most vexing trade problems are not with major trading partners but with

developing countries, especially in issues of intellectual property rights.

Japan is second to Canada as an importer of U.S. high-technology goods,

even though it maintains a net export surplus in them. In 1985, it bought

$5.1 billion worth of U.S. high-technology goods and sold $12 billion worth of

its own high-technology goods to the United States.
64 GATT June 1987

Japan's position as a high-technology exporter is likely to make it a

reluctant participant in the expansion of GATT in some of these areas. By

and large, it has benefited from the practices that are of concern to the

United States: Japanese targeting of high-technology industries has often,

though not always, proved successful; and its high-technology industries

benefit from nontariff barriers. On the other hand, given their drive to

improve their software industry, and their success in biotechnology, the

Japanese may have acquired an interest in protecting intellectual property

rights that they did not display during the Tokyo Round.

Recent U.S. experience in negotiating the semiconductor accord with

Japan illustrates the difficulty GATT may face in breaking new ground on

targeting and NTBs. Japanese penetration of the U.S. semiconductor

memory market led several U.S. semiconductor manufacturers and the U.S.

government to begin antidumping proceedings against the Japanese

semiconductor exporters. Faced with threats of antidumping duties, the

Japanese government finally agreed to have Japanese companies sell semiconductor memories at "fair market value" both in the United States and in

third markets, and to encourage domestic consumers to buy semiconductors

from U.S.-based companies so as to increase the U.S. share of the Japanese

market. Japanese companies complied with the provisions forbidding

dumping in the United States (the aspect of the agreement the U.S. government could most easily enforce), but as of March 1987, MITI had been unable

or unwilling to make them sell at similar .prices in third markets or to open

the domestic market further to U.S. companies. Consequently the U.S. government imposed duties on several dozen Japanese imports. The Japanese

responded with concern, and trade relations deteriorated. Considering the

leverage the U.S. government had over Japan in this case, the portents for

GATT are not favorable.

It is of interest that the U.S.-Japan semiconductor accord has been

challenged by the EC under GATT. The EC argues that the accord cartelizes the world semiconductor market. (Between them, the United States

and Japan produce upward of 75 percent of world semiconductor output.)

The EC also claims that the accord gives U.S. semiconductors preference in

the Japanese market. This challenge shows how unsatisfactory bilateral

solutions can be; no matter how well they may address immediate problems,

they ignore far-reaching multilateral implications.

Recently the Japanese government has made clear its intention to

move into two new high-technology areas--communications satellites and

jet fighters. If past experience is any guide, substantial Japanese technological success in these areas may be followed by the disappearance of the
Chapter m HIGH-TECHNOLOGY TRADE 65

Japanese market for U.S. satellites and jet fighters. In some sense, the

ability of GATT to open the Japanese market to foreign high-technology

goods will be the touchstone of its ability to broaden access to markets;

without success in this case, any other GATT initiative will have missed the

central issue.

Newly Industrializing Countries

It is difficult to generalize about trade relations with a group as heterogeneous as the newly industrializing countries (defined for the purposes of

this discussion to include Mexico, Brazil, South Korea, Taiwan, Hong Kong,

and Singapore). In 1985, the United States had a $5 billion high-technology

trade deficit with these seven countries. To a large extent, this trade

imbalance results from the small internal markets in these countries. Very

often U.S. exports to these countries are goods undergoing production, to be

reexported to the United States or some other country for finishing and sale.

The level of U.S. exports to these countries is also limited because of the

international debts owed by Mexico and Brazil, which are obliged to restrict

imports as part of the austerity measures imposed on them by the international banking community, with the consent of U.S. authorities. Nevertheless, these countries employ a wide range of government policies to

manipulate high-technology trade, including nontariff barriers and the

limited protection given intellectual property rights.

Developing countries have varying reasons for keeping imports out.

Some, in their efforts to imitate the Japanese industrial success, are beginning to target specific industries as "strategic" to their economic development. Among other techniques, they use nontariff barriers to restrict

imports so as to guarantee the targeted industry a market for its output.

Other countries employ the older import substitution strategy, which also

requires keeping foreign products out for the sake of industrial development.

In other cases, imports are kept out as part of austerity programs designed

to help relieve foreign debt problems. Whatever their reasons, a large number of these countries have nontariff barriers: according to one survey, 59

percent of upper-middle-income developing countries have government

import controls on all or a large number of products.

24. J.M. Finger and Andrzej Olechowski, "Trade Barriers: Who Does What to Whom" (June

1986, processed).

¥
66 GATT June 1987

Many newly industrializing countries use investment restraints that

systematically discriminate against foreign investors. These restraints can

range from a total ban on direct foreign investment in certain industries to

local majority ownership requirements. There may also be local content

regulations, export requirements, and/or restrictions on repatriation of profits. To a large extent, these regulations stem from the belief that foreign

investors often did not act in the best interests of the host nation. They are

seen as using transfer pricing, foreign sourcing of inputs, and profiteering to

extract wealth without delivering economic development in return.

The United States and other industrialized countries have proposed

that discussion of investment restraints be included in the Uruguay Round.

The U.S. position has been considerably weakened by its recent response to

Fujitsu's attempted purchase of the Fairchild Semiconductor company.

Although the Administration took no action, its very publicized deliberations

caused Fujitsu to withdraw the offer.

Efforts to eliminate nontariff barriers within the GATT framework

will encounter resistance for the reasons mentioned above. A more effective approach might be within a bilateral context of mutual concessions and

progressive liberalization. Governments may be more willing to lower their

barriers to U.S. imports selectively than they would be to lower barriers to

all imports if the latter course meant being flooded by imports from Japan,

with which many of these countries already have trade deficits. For

instance, Taiwan already gives preferences in import licenses to U.S. goods

over Japanese goods. Since U.S. high technology imports from this area exceed U.S. exports to the region, bilateral reduction would be in the

U.S. interest. But bilateral arrangements would mean moving away from

the most-favored-nation system of trading, which has historically been a

principle of U.S. trade policy.

Another major issue facing the newly industrializing countries is

whether they are ready for graduation from their special status in GATT.

Their favorable high-technology trade balance has come from trade with the

industrialized world, where they enjoy some benefit from the generalized

system of preferences. ±2/ While U.S. pressure is forcing individual coun25. Whether or not these allegations are true is not completely relevant, since they are

perceived as true in much of the underdeveloped world and, to that extent, influence

the policies of the governments.

26. See Chapter II for a fuller discussion.
Chapter m HIGH-TECHNOLOGY TRADE 67

tries to bring their conduct into line with the practices of industrialized

nations, these efforts are on a country-by-country, issue-by-issue, sometimes industry-by-industry basis. It is not in the U.S. interest to exhaust its

good will (and trade staff) in negotiating on a piecemeal basis; consequently,

the United States and other industrialized countries may press this issue

with the newly industrializing countries. It will not be easy for those countries to make such a change. In many cases their current industrial policies

are part of complex domestic political compromises and represent their only

perceived avenue of growth.

The European Community

Substantial expansion of the GATT into the area of subsidies, government

procurement, and other nontariff barriers would present a major challenge

to the EC's high-technology programs. The Europeans view themselves as

falling behind the United States and Japan in the race for new markets.

Like Japan and the United States, the EC has a highly trained work force of

engineers and technicians, and the research infrastructure needed by these

industries. The Europeans feel that their competitors have enjoyed special

ad vantages--the United States from its massive military and space effort,

and Japan from its protected domestic market. While the EC has imposed

restrictions of its own on high-technology trade, it has allowed U.S. hightechnology firms to operate freely there. To keep from falling farther

behind, the Europeans feel they need to imitate U.S. development policy and

provide additional government stimulus for technological development.

To this end, the EC has embarked upon communitywide research programs rather than continue national subsidization of splintered industries

and markets. These programs include Airbus, the European Space Agency,

the European Strategic Program for Research into Technology (ESPRIT), and

the European Research Coordinating Agency (EUREKA). These programs

enjoy a substantial degree of government subsidy and direction. The French

and British governments have already approved $1.7 billion for development

of the next generation of Airbus. As of the end of May 1987, the West

German government was considering adding another $1 billion to that

figure. ^Z/ ESPRIT alone is projected to cost the 10 member governments

$650 million over the next 10 years. 2§/ The vast majority of the Com27.Steven Greenhouse, "Airbus Offensive Threat," New York Times, May 28,1987.

28. Pierre-Henri Laurent, "Renaissance Through Technology: The European Community

Decision on ESPRIT," Fletcher Forum (Winter 1985), p. 159.

rum
68 GATT June 1987

munity's R&D funds, however, are still allocated at the national level.

Even here, however, member countries are moving away from the traditional "technology push" strategy of flagship electronic companies and

protected national telecommunications markets. ^O/ In some sense, the EC

could be said to be moving away from individual protected markets and

subsidized industries--which are not in the spirit of GATT--to regionally

protected markets and subsidized industries, which are also not in the spirit

of GATT.

The United States

While the United States has been in the forefront of the drive to expand

GATT into new high-technology areas, it is likely to encounter problems of

its own from such an expansion--principally with respect to government

procurement and subsidies for R&D. In addition, as the U.S.-Japan semiconductor accord illustrates, U.S. impatience with the GATT may lead it into

agreements that are themselves violations of the GATT.

In the United States, the "buy national" restrictions on federal procurement have been extended to goods far beyond the purlieu of national

defense. Removing such restrictions on government purchases of nonmilitary goods both here and abroad should be in the interest of U.S. high-technology firms; they would gain in sales to foreign markets, while the losses in

domestic markets would be suffered mainly by mature industries. In this

sense, the choice facing the Congress is whether it wants to protect domestic textile, steel, and cement markets at the cost of foreign telecommunications equipment and aerospace markets. Government procurement of structures and nonmilitary equipment is on the order of $50 billion per year,

much of it covered by "buy national" clauses. Such a large market would

indeed tempt foreign competition.

If a GATT government procurement code was extended to military

equipment, at either the prime contractor or subcontractor level, the tradeoff would be more difficult. The military has already expressed concern

about foreign-sourced electronic components. Any move to increase foreign

sourcing would exacerbate this concern.

29. Klaus W. Grewlich, "EUREKA- eureka?" Aussenpolitik (1986), p. 27.

30. A.N. Duff, "EUREKA and the New Technology Policy of the European Community,"

Policy Studies (April 1986), p. 45.
Chapter m HIGH-TECHNOLOGY TRADE 69

U.S. government expenditures on defense and space R&D and procurement are often viewed by other governments as targeting exercises. The

Department of Defense has been present at the creation of entire industries.

In semiconductors, for example, federal agencies paid for most of the early

R&D, trained a substantial part of the work force, bought the entire output,

and occasionally provided the physical capital.!!/ Even now, the federal

government is taking a series of actions--in response to perceived Japanese

targe ting--that could easily be described as targeting the U.S. semiconductor industry. The semiconductor accord guarantees a certain domestic floor

price and some access to the Japanese market. A proposal exists, and is

likely to be funded, that would form a government-subsidized consortium

with the expressed purpose of coordinating private efforts to enhance the

commercial manufacturing technology of the industry. Federal agencies

continue to provide hundreds of millions of dollars for semiconductor

research annually. Federal agencies have opposed foreign investment in the

U.S. semiconductor industry. In addition, the Department of Defense is

investigating ways to reduce use of foreign semiconductors in governmentprocured weapon systems.

Both relatively and absolutely, the U.S. government spends more on

R&D in high-technology industries than any other industrialized country.

Efforts to extend the GATT subsidy code to R&D are bound to run afoul of

the government's current effort to enhance the commercial usefulness of

federal research.

In the area of intellectual property rights, some European Community

members have notified the GATT that they consider Section 337 of the

U.S. Tariff Act of 1930 to be a trade barrier. Section 337 gives the federal

government the authority to restrict imports that infringe on U.S. copyrights or patents if such imports harm a domestic industry. The EC's complaint is that if a U.S. firm violates a patent or copyright, it can be sued;

whereas if a foreign firm is believed to be violating a patent or copyright it

can be sued and also charged with a Section 337 violation, concurrently or

sequentially. This double jeopardy is felt to discriminate against imports.

IMPLICATIONS OF LIBERALIZED TRADE

The Uruguay Round does not aim to produce major breakthroughs in the

treatment of high-technology trade. As noted above, the bulk of high-tech31. Philip Webre, "Technological Progress and Productivity Growth in the U.S.

Semiconductor Industry" (Ph.D. dissertation, American University, 1983), pp. 93 - 111.

IBlBll
.1111'

70 GATT June 1987

nology trade is already covered by GATT. The hope, rather, is to reduce

some of the frictions that beset trade in this field. If the negotiations were

to reduce the nontariff barriers the way previous rounds reduced tariffs,

they would greatly improve the international climate for high-technology

trade. On the other hand, since U.S. high-technology companies already

have some access to all major markets for their goods, even the most favorable outcome that can be realistically foreseen would bring only a marginal

improvement in the high-technology balance of trade. A substantial opening

of Japanese high-technology markets would indeed prove beneficial, but

there is little in postwar Japanese commercial practice to encourage hope

for such improvement.

A substantial reduction in nontariff barriers will be hard to achieve in

the current round. Unlike tariffs, these have as much to do with intent as

with practice. Efforts to open these markets will run counter to national

policies in both developing and developed countries, with the likelihood that

as one set of nontariff barriers is proscribed, others will be found to replace

them. The major exception to this lies in the secular trend toward privatization of telephone and telegraph systems in Western Europe and Japan,

which promises to lower the barriers to trade in telecommunications

equipment in the aggregate. $£/

An area in which the Uruguay Round may make some substantial progress is that of intellectual property rights. A number of ineffectual

organizations currently deal with intellectual property rights disputes,

including the World Intellectual Property Organization, the Berne Convention, and the Universal Copyright Convention. Since intellectual property

rights are part of the Uruguay Round's agenda, ways of integrating them will

have to be found.

32. On the other hand, U.S. telecommunications-equipment exports to Japan have fallen

since Nippon Telephone and Telegraph was privatized.
CHAPTER IV

AGRICULTURE

Governments throughout the world have for many years pursued agricultural

policies that support farm prices and incomes. In deference to such policies,

GATT has permitted the use of import quotas and export subsidies in

agricultural trade. Recently, however, large increases in government farm

budgets and the recognition that national farm policies in many countries have

been a principal cause of the prolonged depression in world agricultural markets

have spurred key national leaders to action. They have agreed, in principle,

to negotiate reductions in national agricultural support levels and to change

their domestic farm policies so as to make them more responsive to world market

conditions.

These negotiations will have important consequences for world agriculture.

If they stalemate, current tensions could easily escalate into a full-scale trade

war in agriculture and possibly spill over into other sectors. In order to succeed,

however, major changes in national farm programs may be required, probably

involving lower overall support for prices and incomes. A major goal of the

reforms--to reduce the production incentives incorporated in most farm

programs, or alternatively to break the link between farm income support and

production altogether--may require entirely new farm programs. Allowing

market conditions to guide farm prices and output would benefit most countries

greatly, but some farmers would be made worse off, at least in the near term.

This applies most profoundly to farmers who cannot produce at competitive

prices, but also for many farmers who currently gain from income supports and

subsidies.

Short-term schemes to compensate injured farmers might be required for

equity and political reasons. Adjustment costs could be lessened by phasing

in any agreement over a long period of time, and by allowing each country

flexibility in how long-run targets were met. Losses to farmers would also be

less if all countries simultaneously opened their markets through a multilateral

agreement. This approach would tend to increase export possibilities and raise

world prices for many farm products.

Hopes are high that important agricultural policy reforms can be accomplished during the Uruguay Round. After repeated failures in past GATT

negotiations, key national leaders have agreed, in principle, to reforms in

their national farm programs that would reduce the impact of those

programs on agricultural trade flows and prices.!/ Negotiators will at1. This was stated in a May 13, 1987, communique from the Council of the Organization for

Economic Cooperation and Development.

IIIIIINBI
72 GATT June 1987

tempt not only to liberalize agricultural trade policies, but more fundamentally, to reduce the production incentives and consumption disincentives

incorporated in the national farm programs; it is these that ultimately

motivate most agricultural trade policies. Significant liberalization will

also require that GATT's long-standing special treatment of agricultural

policy be rescinded.

The major parties in these talks, which have already started, will be

developed countries—particularly the United States, the European Community, Japan, Canada, and Australia-since they account for over twothirds of worldwide agricultural trade. Several of these countries have

already begun to reformulate their agricultural policies unilaterally, especially the United States. But farm policies in most countries are still out of

step with world market conditions, and lack the flexibility to adjust quickly

when market conditions change-especially when world prices fall.

RECENT TRENDS IN AGRICULTURAL TRADE

For the world as a whole, the supply of agricultural products has grown

faster than the demand for them in recent years. The result has been to

force down the prices of most agricultural commodities on world markets.

China, the European Community, and to a lesser extent India have emerged

as major exporters, while U.S. exports have declined substantially.

In value terms, world agricultural exports declined by about 11 percent

between 1980 and 1985, compared with an increase of over 450 percent

during the 1970s (see Figure 1). Most of the change in export values

resulted from large swings in agricultural prices: unit values rose by almost

300 percent in the 1970s, while export volumes increased by 41 percent. 2!

2. Prices in world agricultural markets tend to be highly volatile in the short run because

of rigidities in national markets and erratic weather conditions. Governments often

stabilize or support domestic agricultural prices in an effort to insulate their farm

economies from the "disruptive" effects of international markets. This process limits

the number of people worldwide who actually buy and sell at world prices. Even when

domestic prices are allowed to change, agricultural producers and consumers tend to

respond slowly and weakly to new prices. Thus, when international market conditions

vary, world prices must move substantially to induce a sufficient response in domestic

markets to relieve market pressures.

These same factors can prolong often extreme conditions in world markets by limiting

adjustment in domestic markets. Over several years, producers and consumers—

especially the former-can respond significantly to large and persistent changes in price.

Once momentum is built up, however, it is often difficult to reverse. It can take a number

of years for a large and protracted swing in world prices to bring about a meaningful

turnaround in world market conditions.
Chapter IV AGRICULTURE 73

Figure 1.

World Agricultural Exports

1975 1980 1985

SOURCES: Congressional Budget Office; General Agreement on Tariffs and Trade, International

Trade 85-86.

In the 1980s prices have fallen by about 18 percent, and export volumes

increased only about 6 percent. Stockpiles of agricultural commodities,

another indicator of weak market conditions, have increased significantly

during the 1980s. 3/

3. The agricultural boom in the 1970s reflected increases in real per capita income

(especially in developing countries), a prolonged real depreciation of the U.S. dollar,

easy access to financial credit, and policy changes favoring agricultural imports by

centrally planned countries. A reversal in these factors, together with farm policies

in many countries that maintained production incentives even as world demand declined, led to the subsequent depression in world agricultural markets in the 1980s.

Good weather in many key producing areas over this period, especially in Europe, also

weakened markets. Another reversal in several of these factors, in particular the recent

depreciation of the dollar and changes in several countries' farm policies, may over time

improve agricultural trade conditions somewhat.
[•Ill Jil l

74 GATT June 1987

The Decline in U.S. Exports

World market shares of key agricultural producers have shifted in the 1980s,

especially for the United States. The decline in the U.S. share of world

markets has been especially large for wheat and coarse grain exports. The

U.S. share of the world wheat market fell from about 45 percent in 1981 to

about 30 percent in 1986, while its share in coarse grains-such as corn,

barley, and sorghum—dropped from about 65 percent to about 44 percent

(see Table 6). Australia and Argentina were the largest gainers of market

share in wheat exports over this period, as were China and Western Europe

in coarse grains.

The value of U.S. agricultural exports has fallen significantly in

nominal terms over the last five years-from a record level of $43.3 billion

in 1981 to just $26.1 billion in 1986 (see Table 7). This decline can be attributed almost equally to reductions in agricultural prices and to reduction in

export volume. Major reductions in agricultural export values occurred for

almost every important export product except animal products. Grains,

which made up almost 45 percent of the total value of U.S. agricultural

exports in 1981, contributed only about 26.5 percent by 1986. The United

States has suffered not only from the stagnant world market for agricultural

products, but it has also lost some of its share in world markets for almost

every major commodity group. The United States, nevertheless, is still the

world's largest exporter of agricultural products-predominantly exporting

food grains such as wheat and rice, coarse grains, oilseeds and products,

cotton, tobacco, and animal products.

The largest single purchaser of U.S. agricultural exports is Japan, although sales to the combined European Community exceed those to Japan

(see Table 8). Other key markets for U.S. agricultural products include:

East Asian countries such as South Korea and Taiwan; the Soviet Union and

Eastern European countries; Latin America, especially Mexico; and Canada.

Developed countries buy about half of all U.S. agricultural exports, while

sales to developing countries contribute about another 40 percent. Sales to

centrally planned economies have decreased in relative importance during

the 1980s.

The Rise in U.S. Imports

While U.S. exports have fallen, U.S. imports have increased steadily during

the 1980s (see Table 7). The chief agricultural products imported by the

United States are: coffee and cocoa; animal products, including dairy
Chapter IV AGRICULTURE 75

TABLE 6. WORLD MARKET SHARES FOR WHEAT AND COARSE

GRAINS IN TRADE YEAR 1985/1986 (In millions of

metric tons, shares in percent)

Country

Production

Trade

as Percent

of ProducTrade tion §/

Share of

World Trade

1980/ 1985/

1981 1986

World 499.0

Major Exporters

United States 66.0

Canada 24.3

Australia 16.1

EC-12 71.7

Argentina 8.5

Major Importers

USSR 78.1

China 85.8

Japan 0.9

Wheat

84.9 17.0

25.0

16.8

16.0

15.6

6.1

15.7

6.6

5.5

37.9

69.1

99.4

21.8

71.8

17.1

7.1

85.9

Coarse Grains

World 844.6 83.4 9.9

Major Exporters

United States 274.9 36.4 13.2

Argentina 17.1 9.7 56.7

EC-12 88.3 8.0 9.1

China 82.3 7.1 8.6

Canada 25.0 5.8 23.2

Major Importers

Japan 0.4 21.5 98.2

USSR 100.0 13.5 12.1

EC-12 88.3 5.7 6.4

44.5

18,

11.

16

4.1

17.0

14.7

6.2

64.2

13.2

5.5

0.0

5.1

17.2

21.8

18.3

29.4

19.8

18.8

18.4

7.2

18.5

7.8

6.5

43.6

11.6

9.6

8.5

7.0

25.8

16.2

6.8

SOURCES: U.S. Department of Agriculture and Congressional Budget Office.

NOTE: A trade year for wheat covers activity between July and June. For example, trade

year 1985/1986 covers the period from July 1985 through June 1986. A trade year

for coarse grains is from October to September. Trade years are adjusted for different

production seasons in the Northern and Southern Hemispheres.

a. Trade as a percent of production for exporters is the ratio of exports to production, and

for importers the ratio of imports to total domestic utilization. Production is not adjusted

for stock carryover. For example, allowing for stock carryover, Australia generally exports

between 80 percent and 90 percent of its wheat production.

I
TABLE 7. U.S. EXPORTS AND IMPORTS OF AGRICULTURAL

(In billions of dollars)

Year

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

Exports S/

Oil

Seeds

Coarse Food and

Totals' Grains Grains Products Cotton

7.7 1.0 1.3 2.2 0.6

9.4 1.5 1.8 2.4 0.5

17.7 3.5 4.7 4.3 0.9

21.9 4.6 5.4 5.7 1.3

21.9 5.2 6.2 4.5 1.0

23.0 6.0 4.7 5.1 1.0

23.6 4.9 3.6 6.6 1.5

29.4 5.9 5.5 8.2 1.7

34.7 7.7 6.3 8.9 2.2

41.2 9.8 7.9 9.4 2.9

43.3 9.4 9.6 9.6 2.3

36.6 6.4 7.9 9.1 2.0

36.1 7.3 7.4 8.7 1.8

37.8 8.1 7.5 8.4 2.4

29.0 6.0 4.5 5.8 1.6

26.1 3.1 3.8 6.5 0.7

Tobacco

0.5

0.7

0.7

0.8

0.9

0.9

1.1

1.4

1.2

1.3

1.5

1.5

1.5

1.5

1.5

1.2

COMMODITIES, 1971-1986

Animals

and

Products

1.0

1.1

1.6

1.8

1.7

2.4

2.7

3.0

3.8

3.8

4.2

3.9

3.8

4.2

4.1

4.5

Total £/

5.8

6.5

8.4

10.2

9.3

11.0

13.4

14.8

16.7

17.4

16.8

15.3

16.6

19.3

20.0

21.1

Crops,

Fruits,

and

Vegetables

0.6

0.7

0.8

0.8

0.8

0.9

1.2

1.5

1.7

1.6

2.0

2.3

2.3

3.1

3.5

3.5

Imports

 b/

Animals

and

Products

1.5

1.8

2.6

2.2

1.8

2.3

2.3

3.1

3.9

3.8

3.5

3.7

3.8

4.1

4.2

4.5

AgriculCoffee tural

and

Cocoa

1.4

1.5

2.0

2.1

2.2

3.5

5.2

5.4

5.4

5.1

3.8

3.6

3.6

4.4

4.7

5.6

Trade

Balance

1.9

2.9

9.3

11.7

12.6

12.0

10.2

14.6

18.0

23.9

26.6

21.3

19.5

18.5

9.1

5.0

SOURCES: U.S. Department of Agriculture and Congressional Budget Office.

NOTE:

a.

b.

c.

In most cases, the United States predominantly exports or imports a certain agricultural product, meaning that gross export and import values

in this table also approximately represent net trade flows. This does not hold for the following commodities, where imports roughly offset exports:

animals and products; fruits, nuts, and vegetables; and tobacco.

Exports are valued at the U.S. port of exportation.

Imports are valued at the foreign port, thus excluding international shipping costs and U.S. duties.

Totals include items not shown separately.

•a

a>

tn

CH

3

n

H*
Chapter IV AGRICULTURE 77

products; fruits and vegetables; and tobacco. Developing countries, dominated by Latin America, supply almost two-thirds of imports into the United

States. Among developed countries, the European Community is the largest

supplier.

The fall in exports and the rise in imports have brought a substantial

decline in the U.S. agricultural trade surplus, from $26.6 billion in the peak

year of 1981 to only $5.0 billion in 1986 (see Table 7). For several months in

1986, the United States actually imported more agricultural products than it

exported.

TABLE 8. U.S. AGRICULTURAL EXPORTS BY REGION,

FISCAL YEARS 1981 AND 1986

(In billions of dollars)

Importing Region

Western Europe

European Community

Other

Eastern Europe

Soviet Union

Asia

Middle East

South Asia

Southeast and East Asia

Japan

China

Canada

North Africa

Other Africa

Latin America

Oceania

Total

Developed Countries

Developing Countries

Centrally Planned Countries

Total

1981

11.8

8.9

2.9

2.0

1.7

16.1

1.8

0.6

4.8

6.7

2.2

2.1

1.5

1.3

6.9

0.2

43.8

20.9

16.9

5.9

43.8

1986

6.8

6.4

0.4

0.4

1.1

10.5

1.2

0.5

3.5

5.1

0.1

1.5

1.4

0.7

3.6

0.2

26.3

14.0

10.7

1.6

26.3

Change from

1981 to 1986

(In percent)

-42

-28

-86

-80

-35

-35

-33

-17

-27

-24

-96

-29

-7

-46

-48

0

-40

-33

-37

-73

-40

SOURCES: U.S. Department of Agriculture and Congressional Budget Office.

74-479 0-87- 3

1H1HB11
•Ill

78 GATT June 1987

NATIONAL FARM POLICIES AND INTERNATIONAL TRADE

One problem dominates international agricultural markets: present and prospective world supplies of most products far exceed the amounts demanded

by consumers. Stockpiles here and abroad have expanded, and world prices

have fallen dramatically. At the same time, the government expenditures

required to maintain farm programs in many countries have soared. There is

an increasing recognition that the current crisis in agricultural conditions

results primarily from the national farm programs employed by governments

throughout the world. Most such programs give farmers incentives to increase production even as world market conditions deteriorate. It has become evident that these production incentives must be reduced if the conditions of oversupply are to be reversed.

The fundamental problem for policymakers, therefore, is how to devise

national farm programs that respond to changes in market conditions, especially in terms of supply incentives, while still recognizing the needs of

politically important domestic farm sectors. The task is not just to relieve

current imbalances in agricultural markets, but also to reduce the likelihood

that they will recur in the future. The United States and, to a lesser extent,

the European Community have recently moved in that direction, but their

farm policies as well as those in most other countries are still not in line

with world market conditions. The need for further change has been recognized. Key governments have agreed to negotiate on how to coordinate

long-term reforms in their overall farm programs-not just in their agricultural trade policies-during the Uruguay Round.

This section focuses on how GATT rules will have to be changed to

accommodate reform; how various national farm programs operate; and how

these programs compare in their effects on producers.

GATT's Treatment of Agricultural Trade

Agricultural trade policy has long received special treatment in GATT. The

GATT rules allow a wide range of nontariff barriers in agricultural trade,

especially import quotas and export subsidies, that are not permitted for

trade in manufactured products. Over the years GATT members, led by the

United States, the European Community, and Japan, have refused to expose

their farm programs to meaningful international negotiation.

Although not specifically mentioned in the original GATT documents,

import quotas and export subsidies for agricultural products have come to be
Chapter IV AGRICULTURE 79

permitted by GATT. The general prohibition on import quotas was explicitly

breached in 1955 when the contracting parties agreed to a waiver (often

called the Section 22 waiver) permitting U.S. import quotas that were

needed to sustain domestic farm supports, as legislated in Section 22 of the

Agricultural Adjustment Act of 1933. Other countries, such as the European

Community and Japan, whose goals during the 1950s and 1960s were to

increase self-sufficiency in food products, devised various restrictions on

agricultural imports that were not covered explicitly by the GATT rules.

The use of export subsidies for agricultural products became increasingly important as Europe's farm production began to exceed demand in the

1970s. Rather than stockpiling its surplus, the EC through its Common

Agriculture Policy developed a system of export subsidies to dispose of surpluses on world markets. An agreement on subsidies during the Tokyo Round

legitimatized export subsidies for agricultural products, with the qualification that the subsidized products not acquire "more than an equitable share

of world trade." Tacitly, this agreement sanctioned market-sharing agreements for agricultural products. Recently, the United States has also resorted to explicit export subsidies.

GATT principles are further stretched in agricultural trade by the use

of bilateral trade agreements and the extensive role in some countries of

state trading monopolies. Significant agricultural trade reform would require that all agricultural trade policies be fully covered by GATT rules and

procedures, making necessary several amendments to the General Agreement to remove all special treatment for agriculture. !/

U.S. Farm Programs

The long-standing aim of U.S. farm policy has been to stabilize and support

farm prices and incomes over time, especially when market conditions are

weak. Programs are currently in place to support prices and incomes for

producers of the major field crops-wheat, coarse grains, soybeans, cotton,

and rice~as well as for sugar, milk, tobacco, wool, peanuts, and honey. H/

4. The key parts of the General Agreement in which agriculture receives special treatment

are: article 11, which prohibits import quotas; article 16, which prohibits export

subsidies; and the Tokyo Round Code on Subsidies and Countervailing Duties, which

is the basis for the "equitable share" criterion. The 1955 waiver to article 11 mentioned

above is particularly important.

5. See Congressional Budget Office, Crop Price-Support Programs: Policy Options for

Contemporary Agriculture (February 1984), and Diversity in Crop Farming: Its Meaning

for Income-Support Policy (May 1985).

llllilillHl
80 GATT June 1987

Price and income support programs vary, depending on whether the

United States exports or imports a commodity. In general, the major field

crops are competitive on world markets and do not require protection from

foreign imports. Producers of these products rely heavily on strong demand

in world markets. For these export crops, U.S. farm policy is designed

mainly to protect farm incomes when world market conditions deteriorate.

Support is provided primarily through direct government subsidy rather than

by maintaining high consumer prices. For farmers who cannot produce at

internationally competitive prices, such as many sugar and dairy producers,

prices are kept high and defended by import quotas and government purchases. For these products, domestic consumers subsidize farmers through

high prices, and the protective policies reduce the farmers' exposure to fluctuations in world markets.

During the 1980s, the combination of weak demand and generous support levels caused U.S. exports to decline, government stocks to increase,

and federal budget expenditures on farm programs to reach record levels

(see Table 9). The Food Security Act of 1985 revamped U.S. farm policy,

primarily for the export crops, by lowering price support levels (and thus

TABLE 9. U.S AND EC OUTLAYS FOR PRICE AND INCOME

SUPPORTS, 1977-1987 (In billions of dollars)

Year

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986 */

1987 £/

United

States

3.8

5.6

3.6

2.7

4.0

11.6

18.8

7.2

17.6

25.7

24.6

European

Community (EC-10)

8.0

11.5

14.9

16.6

12.9

12.8

14.7

15.0

15.7

21.8

26.2

SOURCES: U.S. Department of Agriculture; European Community,

a. Estimated.
Chapter IV AGRICULTURE 81

world prices) substantially in an attempt to revive U.S. exports, while maintaining the generous income supports of previous policy. To offset the incentives to increase production that are inherent in the producer price and

income support system, program participants were required to reduce the

acreage planted in these crops. New export incentives were also introduced

to stimulate demand for U.S. farm products. Current farm policy is examined in more detail below.

Policies for Export-oriented Program Crops. Major field crops comprise

the bulk of U.S. agricultural exports. The policy generally allows consumers

to pay world market prices, although the government stands ready to buy

commodities from participating farmers at a support price (the nonrecourse

loan rate), which has the effect of establishing a domestic market price

floor. 01 The government uses the nonrecourse loan program to support

prices for wheat, soybeans, and coarse grains. (Cotton and rice producers

are also eligible for nonrecourse loans, but marketing loans for these crops

offset the impact of nonrecourse loans on market prices.) Under many

conditions, this program also creates a price floor in world markets. II

The government also supports the incomes of producers of these crops,

except soybeans, through deficiency payments. Deficiency payments are

direct government subsidies that provide farmers with the difference between a "target price" for a commodity and its market price (or nonrecourse

loan rate, whichever is higher). For 1986 crops, the target price for wheat

is about 80 percent and for corn about 60 percent higher than the support

6. A participating farmer may receive a nonrecourse loan at a specific per-unit rate (the

loan rate), using the crop as collateral. If market prices are high enough when the loan

comes due in 9 to 10 months, the farmer will repay the loan with interest and sell the

crop. If market prices are too low, the farmer will forfeit the crop to the USDA at no

penalty. In this way, nonrecourse loans can set a floor for U.S. market prices. Crop

forfeiture forces the government to accumulate stockpiles of commodities, which are

normally withheld from the market until prices improve.

7. Just as Saudi Arabia plays the role of swing producer in world oil markets, the United

States is the residual supplier for many international agricultural markets. When

prices on world markets for these commodities fall near the U.S. loan rate, other exporters

can sell their output at prices just below the U.S. loan rate, leaving only the residual

world demand for U.S. exports at the loan rate price. As a result, the loan rate effectively

establishes a floor for world prices. Not only does this situation reduce U.S. exports

and increase government stocks, but, by keeping world prices higher than otherwise,

it exacerbates the problem by dissuading foreign producers and consumers from reducing

supply and increasing demand.

nuiiBiii
82 GATT June 1987

price. Deficiency payments are based on historical acreage bases and

yields, which can be adjusted by the Department of Agriculture as market

conditions change. Typically, the deficiency payment system has provided

incentives for many farmers to increase output levels, although current

policy has recently reduced these incentives substantially.

Government support for major crops expands substantially when market conditions worsen, as has been the case recently, and contracts when

markets boom, as was the case during the 1970s. This system of price and

income floors accomplishes relatively well the goal of supporting farm incomes when market conditions deteriorate, but at the cost of encouraging

greater output. Government production incentives are greatest when markets are weakest, thus worsening and prolonging weak markets and increasing government expenditures.

The government tries to offset overproduction in two ways: by imposing production controls as a condition for participation in these programs

and by seeking to expand demand, particularly for exports. Unpaid crop

diversion requirements for 1987 program crops have been expanded substantially: participants must divert 20 percent to 35 percent of their

acreage planted in various program crops to other uses. Coarse grain producers also have the option of idling an additional 15 percent of their

acreage base in exchange for direct government payments. In addition, all

farmers with erosion-prone land can receive payments for long-term

acreage diversion through the conservation reserve program.

The government promotes demand for these crops by keeping consumer prices relatively low and by measures to increase foreign sales such

as export financing assistance, humanitarian relief to developing countries,

and market development activities. 2J Recently, as part of the 1985 Food

Security Act, additional export incentives have been provided: the Export

Enhancement Program subsidizes foreign purchases of U.S. commodities,

primarily wheat and flour, by compensating U.S. exporters who sell to

foreign buyers at prices below the U.S. market price (effectively the loan

8. Some agricultural exports are financed directly by government credits and others by

federal guarantees on commercial loans. Exports to developing countries under P.L.

480, the Food for Peace Program, include sales underwritten by concessional, long-term

financing and by donations. About 8 percent of all U.S. agricultural exports in fiscal

year 1986 were accounted for by P.L. 480 exports, and about one-fourth of all P.L. 480

exports were donated. The Targeted Export Assistance program funds foreign market

development activities.
Chapter IV AGRICULTURE 83

rate). £/ This program has been expanding rapidly, notably through the sale

of at least 4 million metric tons of wheat to the Soviet Union at a subsidy of

about 33 percent. Marketing loans, which allow producers to sell their output at market prices but to be compensated up to the loan rate by the

government, are available for cotton and rice sales to both domestic and

foreign purchasers. Both of these programs allow market prices to drop

below the U.S. nonrecourse loan rates.

Policies for Import-Competitive Agricultural Commodities. Some products

that compete with imports, most importantly milk and sugar, are supported

at price levels above world market prices. This support makes it necessary

to restrict imports of such products through quotas. In this case consumers,

rather than the government, pay the bulk of the subsidy to producers

through high domestic prices. For sugar, where domestic demand exceeds

supply, only import quotas are used to defend the support price. No government expenditures can be made on the sugar support program by law. World

sugar prices have been depressed by the U.S. import restrictions and by the

export subsidies employed by other countries, especially the European Community. Recently the U.S. import quota has declined sharply, primarily

because high domestic sugar prices have stimulated production by domestic

suppliers of corn and noncaloric sweeteners.

Since U.S. milk production is greater than domestic demand, the price

of milk is supported both by limiting imports of dairy products and by

government purchases of excess supplies of dairy products. In an effort to

reduce the costs of this program, the 1985 Food Security Act introduced a

dairy diversion program, which compensates farmers for slaughtering their

herds and then remaining out of the dairy business for at least five years.

More than one million cows, nearly 10 percent of all dairy cows, have been

slaughtered under this program.

European Community Farm Programs

The countries of the European Community have integrated their farm programs into a Common Agricultural Policy (CAP). The CAP is based on three

9. The compensation is now in the form of generic commodity certificates that can be sold,

exchanged for government-owned stocks, or exchanged for cash. This program has been

targeted toward buyers where U.S. exporters compete with other exporters who engage

in what the U.S. government deems to be unfair trade practices. The recent sale to the

Soviet Union under this program makes this eligibility requirement somewhat less

meaningful. The total subsidy value under this program cannot exceed $1.5 billion

during the fiscal year 1986-1988 period.

lilHIBBII
•I 111 Hil l

84 GATT June 1987

principles: common pricing, Community preference, and common financing.

Common pricing attempts to set a single level of price support for each

commodity throughout the EC. Community preference ensures that EC

products have a competitive advantage over imported products. Common

financing requires the EC to fund all CAP activities. IP-/

The CAP relies mainly on price supports to sustain farmers' incomes;

it makes only limited use of direct income payments and other forms of

support. Consumers bear much of the burden through the high support

prices, although some input subsidies are used to lessen the impact of high

raw material prices on refiners of many agricultural products. The CAP

maintains internal price support levels above world price levels. It subsidizes exports to dispose of community surpluses (through so-called restitution payments determined by the difference between domestic support

prices and export prices). And it defends the high support prices by means

of intervention purchases and variable import levies.!!/ The CAP applies

most importantly to grains, milk and milk products, beef, and sugar. The

supply of sugar and milk is held down through production quotas and marketing limitations; producers of these commodities are taxed to help finance

the disposal of surpluses.

The CAP has encouraged production of many commodities far in excess of domestic need: self-sufficiency ratios are 120 percent for wheat,

107 percent for coarse grains, and well over 100 percent for most milk

products in 1985/1986.1!/ The EC was a net importer of many of these

10. Most funding for CAP is provided by a communitywide value-added tax and import

levies. The CAP is responsible for all price supports in the EC, but member nations

also employ various non-price support programs, including research and extension

programs. See Commission of the European Communities, Report by the Commission

to the Council and Parliament on the Financing of the Community Budget, February

28,1987.

11. Variable import levies are tariffs that change over time to assure that prices of imports

are always at least as high as domestic prices. When domestic demand exceeds supply,

foreign products are imported, but total demand for the product is kept down by the

high domestic price. If domestic supply exceeds demand, variable levies act to essentially

ban imports, and EC intervention purchases are used to sustain the support prices.

12. Production increased for a number of reasons. Not only were internal support prices

set far above world prices, but until recently these prices rose steadily, providing farmers

with a guaranteed price horizon, and encouraging investment in farming. Also,

significant research and development expenditures contributed to large increases in

agricultural yields, especially for soft wheat, as did the consolidation of many small

farms into larger, more efficient, plots. Weather conditions have also been favorable

recently.
Chapter IV AGRICULTURE 85

commodities as recently as the early 1970s. From being a net importer of

6.8 million metric tons of wheat in 1970, it had become a net exporter of

12.7 million metric tons in 1985-1986, accounting for about 18 percent of

world wheat exports. IQj The EC also now exports dairy products, poultry,

eggs, beef, sugar, and wine.

As surpluses have accumulated, the governmental cost of maintaining

the CAP has increased significantly, almost doubling from 1982 to 1986 (see

Table 9). Export subsidy costs have soared in response to lower world prices

in U.S. dollars coupled with the large appreciation of EC currencies. Internal pressure for policy reform has mounted. Change has been slow in

coming, however, partly because it requires unanimous agreement by all 12

EC members, but several adjustments have been made. Recent reforms

include the imposition of production quotas on milk, co-responsibility levies

paid by dairy producers to finance surplus disposal, and more stringent grain

intervention arrangements. For the 1986/87 crop, grain support price levels

have been reduced or frozen, and grain farmers will pay co-responsibility

levies for the first time. The accession of Spain and Portugal to the EC,

limiting access to these markets, has led to new conflicts with some trading

partners, especially the United States.

Japanese Farm Programs

Japanese farm policy is dictated by the desire to achieve high levels of selfsufficiency in staple food products such as rice, while also sustaining a large

number of small farms as a social policy, even though domestic farm production costs far exceed those of foreign suppliers. M' Seventy percent of

all agricultural production is covered by support prices, which are often

significantly higher than world prices~in the case of rice, from two to three

times higher. Various other income support policies, including deficiency

payments, are also employed.

13. Self-sufficiency ratios, defined as the ratio of domestic production to consumption, and

European Community wheat export levels are from U.S. Department of Agriculture,

World Agricultural Supply and Demand Estimates, June 9,1987, and unpublished USDA

sources.

14. Another goal of overall food policy in Japan is to discourage the consumption of meat

for dietary and health reasons. For a good overview of agricultural policies in Japan,

the United States, the European Community, and Canada, see D. Gale Johnson, Kenzo

Hemmi, and Pierre Lardinois, Agricultural Policy and Trade: Adjusting Domestic

Programs in an International Framework, A Task Force Report to the Trilateral

Commission (1985).

Fimni
86 GATT June 1987

High support prices are implemented in several ways. For rice, the

government uses intervention purchases that withdraw excess supply from

the market. As long as domestic output exceeds demand, imports of rice

are kept at minimal levels, but export subsidies are not used. For most

products, however, Japanese demand is much greater than domestic supply,

even at high support price levels; in these cases, import restrictions are used

to limit supply and elevate prices. Only state trading companies can import

rice, wheat, barley, milk, butter, and tobacco; the state companies adjust

their import levels to achieve the domestic price-support goals. Imports of

beef, oranges, cheese, peanuts, and orange juice are limited by quotas, while

a variable levy is used for sugar and a tariff quota for corn. In addition to

these measures, Japan imposes tariffs on agricultural products averaging

about 18 percent-more than six times the average tariff on industrial imports, and much higher than those of any other developed country. Tariffs

are particularly high for oranges, meats, tobacco, and processed foods.

Most of the cost of the Japanese farm support system is passed directly to consumers through higher prices. Some of the remainder is financed

out of profits made by the state trading companies when they buy imports at

low world prices and release them on the domestic market at the higher

support prices. For these reasons, Japanese government farm expenditures

have not increased during the 1980s. Pressure to reform Japanese farm

policies comes primarily from foreign suppliers, although Japanese consumers are increasingly expressing dissatisfaction with the high prices they

must pay for food . I§/

Despite these high protective walls, Japan is still the world's largest

importer of agricultural products. If the barriers were eliminated, the

prices of rice, wheat, and barley would fall by an estimated 75 percent;

imports of agricultural products, especially rice and beef, would increase

significantly.!^

The Cairns Group

Thirteen other key exporters have joined together to form the Cairns Group

to represent their interests in the policy debate. 1Z/ For each of these

countries, agricultural exports are a large proportion of total exports, mak15. Japanese farm policy, by keeping large amounts of land in farm use, is also a major

contributor to the very high price of housing.

16. Johnson, Hemmi, and Lardinois, Agricultural Policy and Trade.

17. The Cairns Group includes Argentina, Australia, Brazil, Canada, Chile, Colombia,

Hungary, Indonesia, Malaysia, Philippines, New Zealand, Thailand, and Uruguay.
Chapter IV AGRICULTURE 87

ing them quite vulnerable to slumps in world agricultural markets. Moreover, their supply of most agricultural export products far exceeds domestic

demand, so that changes in domestic output are virtually identical to

changes in the amount available for export-making farm incomes heavily

dependent on export sales. Australia, Canada, and Argentina are major

exporters of wheat and meat products; New Zealand, of meat and dairy

products; Thailand, of rice and corn; Brazil and Argentina, of soybean

products; and Brazil, Colombia, Indonesia, Malaysia, the Philippines, and

Thailand, of a wide range of tropical products, most importantly coffee,

sugar, rubber, palm oil, and coconut products. (Australia is also the world's

third largest exporter of sugar.)

Farm programs differ among all these countries, but policies affecting

key export products tend to reflect international market forces. Most

export products sell at about the same price in home markets as they do for

export. 101 Since most of these countries do not intervene to support

domestic prices, almost all surplus output is exported at world prices and

little is stockpiled. !£/ Even though changes in world prices are passed

through quickly to domestic producers, it can take several seasons of low

prices to persuade farmers to reduce their output. Many of these countries

use state marketing monopolies to implement their agricultural policies and

to market exports. Canada subsidizes transportation costs from farm to

port. Every country in the group protects some high-cost commodities from

foreign competition.

Comparing Key National Farm Programs: The Issue of Transparency

If the parties to the Uruguay Round agree to liberalize their agricultural

policies, they must determine how to compare the effects of their diverse

farm programs on production, consumption, and foreign trade. 22.' To do

18. For a number of developing countries in this group, exports are taxed to raise revenues.

This causes domestic prices to be less than export prices.

19. In some cases, especially for the developed countries, a substantial decline in world

market prices will trigger income and price supports, as has occurred recently.

20. Farm programs provide price incentives in three ways: by changing the prices that

farmers receive for their products (through producer subsidies or taxes); by changing

the prices that domestic consumers pay (through consumer subsidies or taxes); and by

changing the prices at which exports can be offered on world markets (through export

subsidies or taxes). The policy instruments employed are various, ranging from

government purchases of commodities and the establishment of import quotas (both

of which subsidize producers and tax consumers) to direct government payments to

producers (which do not affect consumers).

mnimi
IIBJIII11L1

88 GATT June 1987

this, they must measure the impact of nontariff barriers in a consistent

manner across commodities and countries—often referred to as the issue of

transparency. Although there is no single way of measuring the overall

economic impacts of all farm programs, a set of metrics has been developed

and estimated by the Organization for Economic Cooperation and Development and the U.S. Department of Agriculture. M/

Producer Subsidy Equivalents. A producer subsidy equivalent (PSE) has

been developed to measure the total income transfer to farmers provided by

government programs. It provides an estimate of the revenue that would be

needed to compensate producers if existing government programs were

eliminated. PSEs are calculated by combining all direct government payments to farmers with estimates of the subsidy paid by consumers to producers resulting from policies that raise consumer prices, such as import

quotas, variable levies, and government price supports. (Some direct input

subsidies are also included.) A PSE can be measured in percentage form by

dividing the revenue estimate by the cash receipts, including direct government payments, of the relevant producers. Similar measures can be made

for consumer subsidies and taxes, and for producer taxes.

Although PSEs provide an invaluable tool for comparing the effects of

government programs across commodities and countries, certain technical

problems may limit their effectiveness as a negotiating standard. ^! Most

importantly, PSEs measure the transfer of income to farmers by farm programs, not necessarily the amount of trade distortion. They do not differentiate between farm programs that directly affect trade flows, such as

export subsidies, and programs such as research and development and market extension that have a much less direct and immediate impact on trade

flows. This becomes particularly important in any effort to devise production-neutral income transfers to replace outright production subsidies, since

21. For a detailed description of the methodology used to calculate producer subsidy

equivalents, see Organization for Economic Cooperation and Development, Ministerial

Mandate on Agricultural Trade Draft Report to the Council (with annexes) (May 1987),

and U.S. Department of Agriculture, Government Intervention in Agriculture:

Measurement, Evaluation and Implications for Trade Negotiations, FAER-29 (April

1987). All PSE results presented in this paper come from the USDA report.

22. See Nancy Schwartz, "Is There a Role for Producer and Consumer Subsidy Equivalents

in Trade Negotiations?", paper presented at the International Agricultural Trade

Research Consortium in El Batan, Mexico, December 13-18,1986.
Chapter IV AGRICULTURE 89

these would be treated equally by the PSE measure described above. Over

time, the methodology of these calculations can be improved, especially in

terms of their usefulness to the GATT negotiators. M/

Comparing Producer Subsidy Equivalents Among Commodities and Countries. Producer subsidy equivalents for many agricultural products and

countries have been calculated by the OECD for the years 1979 to 1981.

The U.S. Department of Agriculture has updated many of these estimates to

cover policies in effect between 1982 and 1984. Unfortunately, many farm

policies have changed since this period, as have many exchange rates. Most

importantly, under the current regime, PSEs would be considerably higher in

most countries because world prices have declined while many farm supports

have not. The large appreciation of European Community and Japanese

currencies relative to the U.S. dollar would increase PSEs for these countries substantially relative to the United States, Canada, and Australia.

Subject to these qualifications, the PSEs calculated by the USDA offer the

best available overview of the impact of key national farm programs.

Tables 10 and 11 confirm that developed countries actively subsidize

their farmers, but often at different levels for different commodities. In

Table 11, Japan stands out as by far the largest subsidizer of its farmers,

with a weighted average PSE of 72 percent. The European Community's

average subsidy is considerably less at 33 percent, but significantly higher

than the 22 percent rates for the United States and Canada. Australia's

farm policies provide relatively little support for farmers, estimated at 9

percent.?.!/ Table 11 also summarizes the main policy instruments

employed by various countries to support key agricultural products.

BARGAINING POSITIONS IN THE URUGUAY ROUND

In the Uruguay Round negotiations on agricultural reform currently under

way, the chances for major agricultural trade liberalization appear much

23. Other measures of producer subsidy have been recommended that take account of many

of these problems. See Gorden Rausser and Brian Wright, Alternative Strategies for

Trade Policy Reform, Department of Agricultural and Resource Economics, University

of California, Berkeley, April 1987.

24. Weighted-average PSEs for several other countries are: 18 percent for Taiwan,

64 percent for South Korea, 8 percent for India, -22 percent for Argentina, -9 percent

for Nigeria, 40 percent for Mexico, and 7 percent for Brazil.

74-479 0-87- 4

illlllllBIl
TABLE 10. RANKING OF PRODUCER SUBSIDY EQUIVALENTS BY COMMODITY AND COUNTRY, 1982-1984 §/

Producer

Subsidy United European South

Equivalent^/ States Australia Canada Community Japan Taiwan £/ Korea £/ Mexico

Oto9

10 to 24

25 to 49

50 to 74

75 to 99

Beef

Pork

Poultry

Soybeans

Corn

Cotton

Dairy

Rice

Wheat

Sugar

Beef

Cotton

Pork

Poultry

Sheep

Wheat

Wool

Cane

sugar

Rice

Milk

Beef

Corn

Pork

Soybeans

Poultry

Rapeseed

Wheat

Sugar

Dairy

Corn

Common

wheat

Pork

Dairy

Wheat

Poultry

Rapeseed

Rice

Sheep

Soybeans

Sugar

Beef

Poultry

Beef

Pork

Soybeans

Sugar

Milk

Rice

Wheat

Pork

Corn

Soybeans

Sugar

Beef

Dairy

Poultry

Rice

Tobacco

Wheat

Poultry

Pork

Beef

Corn

Milk

Rice

Soybeans

Wheat

Corn

Brazil

Poultry

Cotton

Soybeans Cotton

Wheat Rice

Wheat

SOURCE: U.S. Department of Agriculture, Government Intervention in Agricluture: Measurement, Evolution and Implications for Trade Negotiations,

FAER-29 (April 1987).

NOTE: Commodities in boldface are primarily exported. Other commodities tend to be imported.

a. Some products lack data for some years. References to poultry and sheep are to meat, not live animals.

b. Ratio of value of policy transfers to gross domestic value of production including direct payments, in percent, based on data for 1982 through 1984..

c. Impacts of input subsidies not included.

§

o
TABLE 11.

Country

Japan

European

Community

Canada

United States

Australia

WEIGHTED AVERAGES OF PRODUCER SUBSIDY EQUIVALENTS BY COUNTRY,

WITH MAJOR SOURCES OF ASSISTANCE, 1982-1984

Weighted

Average Major Sources of Assistance to Producers

PSE Grains and Dairy

(In percent) 2/ Oilseeds Products Livestock

72 £/ Grains: Price support through Beef:

State trading government stock- Quotas, tariff,

Oilseeds: holding and border domestic price stabiDeficiency restriction. Also lization scheme

payments some deficiency Pork: Variable levy

payments Poultry: Tariff

33 Grains: Variable Variable import Variable import

import levies levies, export levies and export

Oilseeds: Defi- subsidies, and subsidies

ciency payments government purchases

22 Wheat and barley: Domestic price Beef and pork:

Transport subsidies support (maintained Tariffs, inspecand income stabili- with import quotas tion services

zation payments and direct payments) Poultry:

Corn: Tariff Quota, price supOilseeds: Transport port, and tariff

subsidies and income

stabilization payments

22 Grains: Price supports main- Beef: Tariff

Deficiency payments tained by tariffs. Other:

PIK entitlements, quotas, and govern- General (R&D,

CCC inventory ment purchases inspection, etc.)

operations, and

commodity loans

Oilseeds: CCC inventory

operations and

commodity loans

9 Domestic consumption Domestic consumption Input subsidies and

pricing pricing inspection services

Sugar

Tariffs, surcharges,

and rebates

Variable import

levies and export

subsidies

Tariff, stabilization payments

Price supports

and quotas

Domestic consumption

pricing

SOURCE: U.S. Department of Agriculture, Government Intervention in Agriculture: Measurement, Evolution and Implications for Trade Negotiations,

FAER-29 (April 1987).

a. Weighted average producer subsidy equivalent (PSE) includes several commodities not listed under country headings in Table 4.

b. Excludes citrus.

O

I

1— (

o

3

o

r

H

CO
1HHEBI

92 GATT June 1987

better than in the past. The interests of many of the key parties have now

converged. In both the United States and the European Community, commodity stockpiles and government expenditures have spiraled. All major

agricultural exporting countries have suffered from low world prices. And

even some net importing countries that gain from low prices find that their

domestic producers have been placed at a disadvantage.

These common interests also reflect tensions, as exporting countries

vie for shares in stagnant world markets. There is widespread concern that

an agricultural trade war has already begun, as seen in the expansion of U.S.

export promotion programs and other U.S. policy changes that have driven

down world prices while maintaining domestic income support levels; in the

Canadian imposition of countervailing duties on U.S. corn exports; and in

governmental pronouncements expressing concern about foreign trade restrictions, especially in Japan.

To help defuse tensions, a standstill agreement has been proposed for

the first stage of the talks. It would require countries not to expand existing agricultural programs or initiate new ones during the negotiations. The

standstill approach is not supported by all U.S. policymakers, some of whom

feel that U.S. actions such as expanding export subsidies, while inconsistent

with the government's longer-term goals, are needed to spur other countries

to negotiate major reductions in agricultural supports. The United States

has suggested that the talks be accelerated in an attempt to reap an "early

harvest" agreement in two years rather than four, but the European Community has not endorsed the idea.

Each of the participants has much to gain, but also something to lose,

by policy reform. Balancing these internal considerations may prove as

difficult for many countries as coaxing concessions from foreign bargainers.

A final agreement for multilateral reforms will likely aim at some broad

commitment by all countries to liberalization, leaving each government considerable discretion as to which programs to change and how fast, and with a

phase-in period over a number of years. A parallel task will be to reformulate GATT rules for agricultural trade to accompany any new agricultural

agreement.

The United States

Reiterating the high priority that it has set for agricultural policy reform in

this round, the United States has offered to table all of its farm programs

for negotiation in return for equal consideration by others. The U.S. posi-
Chapter IV AGRICULTURE 93

tion is based on the assessment that overall U.S. agricultural interests will

be enhanced by open markets. Accordingly it stresses reducing foreign producer subsidies and export subsidies, and import barriers. In particular, the

United States wants Japan to lower its import barriers substantially, and the

European Community to reduce its domestic price supports (and variable

levies) and export subsidies. To induce such concessions, however, the

United States will have to consider overhauling many of its farm support

programs. Most importantly, it may have to rescind its GATT waiver (the

so-called Section 22 waiver) permitting it to impose import quotas; lower its

price and income supports; and terminate export subsidies.

The United States also favors strengthening the GATT dispute settlement procedure for agricultural cases.

The European Community

The emergence of the European Community as a surplus producer and major

exporter of many agricultural products has raised considerably the budgetary costs of its farm policies. It has also increased the EC's exposure to

other countries' farm policies in its competition for world markets. Many

leaders in the European Community now perceive that their countries stand

to gain somewhat by multilateral policy reform. France, a long-time proponent of high support prices, favors reform. The EC position is complicated, however, by the need to obtain agreement from all 12 members for

any policy change (West Germany opposes most reform).

The European Community appears committed to maintaining the

structure of its Common Agricultural Policy, though it may be willing to

reduce support levels somewhat to mitigate its problem of oversupply. It

favors arrangements to share markets, while it hangs back from rules that

would define the acceptable trade policies that can be used to achieve those

shares. Any major reduction in the EC's farm support levels would have to

be matched by similar concessions by the United States as a matter of

principle-even when such concessions would not be of direct benefit to the

EC. The Europeans, like the United States, are exerting considerable pressure for agricultural reform in Japan.

Japan is the only developed country in the negotiations that is strongly

against major agricultural policy reform. Japan holds that since it is the
iHfiaiiiiiiiiiiini

94 GATT June 1987

world's largest importer of many farm commodities, its highly protective

national farm policy does not seriously distort world markets and therefore

should not be a subject of negotiation. Exporting countries do not accept

this position, noting that Japanese import levels would be considerably

higher if protection were reduced, thus expanding world demand for many

farm products. An undercurrent to the negotiations on Japanese farm policies is the possibility that a refusal by Japan to open its agricultural markets might lead other countries to retaliate against Japanese exports of

manufacturing products.

The Cairns Group

Agriculture is far and away the most important issue in the Uruguay Round

for most of the 13 members of the Cairns Group. These countries depend

heavily on agricultural exports for the viability of their farm sectors and for

foreign exchange earnings. They have suffered considerably from the depression in world commodity prices, much of which they attribute to other

countries' farm programs. z!l' The Cairns Group want the United States and

the EC to lower production incentives for grains, and Japan and other countries to lower import barriers. They also want GATT revised so as to enhance the rights of third countries that are injured by the unfair trade

policies of rival exporting countries. Australia refused to reduce nonagricultural protection significantly during the Tokyo Round because of lack of

progress in agricultural reform, and it has restated this position for the

Uruguay Round as well. New Zealand has undertaken significant reforms in

agricultural policies unilaterally, and wants to receive reciprocal credit for

these actions during the multilateral talks. Developing countries, both in

and out of this group, want increased access to developed-country markets,

especially for tropical products and processed agricultural products.

Each of the developed countries in the Cairns Group, especially

Canada, supports and protects some commodity producers, and would be

expected to liberalize these programs. Developing countries in the group

may be asked to reduce some of their agricultural protection, but on a much

smaller scale than the developed countries.

25. The Cairns Group countries were much less concerned over U.S. agricultural policies

during the early 1980s when the United States acted to prop up world prices. But the

U.S. policy change in the 1985 farm bill that substantially reduced world prices for grains

elicited an angry response. These countries have consistently fought against EC farm

policies.
Chapter IV AGRICULTURE 95

IMPLICATIONS OF TRADE LIBERALIZATION

FOR U.S. AGRICULTURE: TWO SCENARIOS

The consequences of agricultural trade liberalization would depend on the

degree, form, and pace of policy change agreed to, on conditions in domestic

and world economies, and on the agricultural policies that would have

existed in the absence of a negotiated agreement. A major shift in farm

policies would affect not only farmers but consumers, merchants, processors

of farm products, and suppliers of agricultural inputs. This section examines

two scenarios for liberalization that have received prominent consideration.

Trade Liberalization Scenarios

The primary objective of both scenarios is a substantial decrease in governments' involvement in agricultural markets, especially in giving farmers incentives to produce well in excess of need. One scenario is a phased

rollback of current domestic subsidies. This approach would maintain the

same price and income support structure currently employed by national

farm policies, but would reduce the support levels significantly over time.

The second scenario, often called "decoupling," would entail a fundamentally

new policy framework; it would phase out current policies (such as deficiency payments, price supports, and acreage controls in the United States)

and replace them with direct payments that would be unrelated to production levels and might be based on economic need.

Effects of the Scenarios on U.S. Agriculture. Current programs induce

overproduction and, in the case of U.S. acreage controls, lead to misallocation of resources. Curtailing such programs would yield overall benefits for

almost every country. At the same time, where government support levels

are high, net farm income could drop considerably. For example, well over

half of the net income of many U.S. producers of wheat and corn comes

from direct government payments. M/ Declines in farm income could be

ameliorated somewhat by the improvement in world market conditions that

would probably result if such reforms were made simultaneously in all major

trading countries.

26. This possibility does not imply, however, that reducing government payments to these

farmers, along with acreage controls, would reduce their net income by the same amount.

Acreage controls offset the benefits of the support payments, so that net farm income

would likely fall by less than the drop in government payments.
96 GATT June 1987

Agricultural employment would probably decline somewhat if government support policies were reduced significantly. Some adjustment aid,

including training and financial assistance, might be provided to farmers

leaving agriculture; and some of the savings derived from reducing farm

supports could be redirected to diversifying rural development. But agricultural employment, and the proportion of farm family income earned in

farming activities, have been declining for many years because of better job

opportunities elsewhere. In the long run, cutbacks in support policies would

not affect the general tendency for returns to employment in agriculture to

approach returns outside of farming.

The main long-term impact of reduction in government support

policies would be on the value of assets tied to agricultural production,

particularly land. Land prices would drop to the extent that expectations of

continued government support are capitalized into the value of the farmland. Present farmers would lose the most because the value of their farms

incorporates the expectation of continued federal support, and some of the

value of this expected government support was reflected in the price they

paid for their farms. Land prices have fallen precipitously in recent years,

partly reflecting expectations that current high levels of support, at least

for grains and cotton, could not be maintained. These declines may already

have absorbed much of the loss from future policy reform.

The effect of worldwide reductions in agricultural support on prices

would vary among commodities, depending mostly on the type and extent of

present protection here and abroad, and on the reforms that were adopted.

The prices of dairy products and sugar, the commodities that receive the

most price protection in the United States, would decline as import restraints were reduced and as domestic price support levels fell. World

prices of these commodities would increase, at least in the short run, because of declining world production and increasing world consumption. The

U.S. dairy industry would probably contract. Similar, although probably

more significant adjustments, might be required in the U.S. sugar industry.

Beef prices would tend to increase here and abroad, in the short term,

as lower levels of protection in Japan and the European Community led to

increased consumption. The effect of liberalization on prices of other major

commodities is less clear. One recent study estimated that the net effect

of complete liberalization of agricultural trade in the developed industrial

market countries would be relatively small increases-less than 5 percentin U.S. and world prices for wheat and coarse grains. £Z/ However, the base

27. Rodney Tyers and Kym Anderson, "Distortions in World Food Markets: A Quantitative

Assessment" (background paper for the World Bank's World Development Report, 1986).
Chapter IV AGRICULTURE 97

period for this study was 1980; at the current low prices for most grains,

policy reforms would be likely to increase grain prices by much more.

Effects of the Scenarios on U.S. Farm Programs and Federal Spending. The

historical commitment of the U.S. government to its agricultural sector

would not be likely to end if trade was liberalized. A decoupling of production subsidies from income supports would allow the government to continue

assisting farmers while removing some of the existing incentives to excess

output and inefficient production. Transition payments could be provided to

all farmers to assist them in the shift toward freer markets. More permanent forms of assistance could be designed for purposes of social welfare or

rural development.

Current U.S. programs for grains and cotton have some characteristics

of decoupling: deficiency payments are not now tied to current production,

and some portion of them may be received without producing the supported

crop on all permitted acres. Also, for most grains and cotton, once the

effect of marketing loans and the export enhancement program is taken into

account, market prices would probably not fall substantially if U.S. price

supports were withdrawn. This means that most of the adjustment under a

decoupling scenario would entail changes in the form, and amount, of

government payments, and not in prices—at least as long as current market

conditions continue.

Decoupling in dairy and sugar farming would involve somewhat different procedures, since consumers now pay much of the cost of the subsidy

to these producers. Market price supports would have to be reduced, and

compensation for all or part of the income loss could be made through direct

government payments, which might be phased out over time or continued

indefinitely. In the case of the sugar program, which now entails no cost to

the government, any payment made to current producers would require an

increase in government spending. Full compensation for lost income to

sugar producers would be quite costly. The President's 1988 budget included

a proposal to cut sugar price supports by one-third and to provide nearly full

compensation to current producers during the first year through direct

government payments. The payments would be reduced annually and eliminated in the fifth year. This program, which resembles what might happen

in the event of trade liberalization, would cost the government nearly $700

million in the first year, though gains to consumers would be even greater.

It has not received serious attention by the current Congress, perhaps because it would increase federal outlays. However, it might gain support as

part of a broader trade liberalization package.

\\w\\m.\
98 GATT June 1987

For dairy farmers, full compensation for lost income could also be

quite expensive to the government because much of their current support is

paid by consumers through high prices rather than directly by the government. Fully compensating the losses to grain, cotton, and soybean producers

would probably reduce federal spending, since most support for these crops

currently comes from the government rather than from consumers, but this

would depend critically on the scope of the compensation scheme.

If, instead of decoupling, the current set of U.S. farm programs was

simply adjusted downward, federal expenditures would be affected in diverse

ways. Government expenditures would probably fall, although it is impossible to estimate by how much without knowing how these programs are to

be curtailed. Federal outlays for current farm programs are projected to

average roughly $20 billion annually over the next five years. Additional

federal spending on agriculture includes credit programs, federal subsidized

crop insurance, and research and education programs.

Other federal programs are designed to stimulate exports. These include the Export Enhancement Program (EEP), export credit guarantees, and

food aid to developing countries. The EEP, which subsidizes exports of

grains, especially wheat, costs between $200 million and $300 million annually. Full elimination of this program would reduce federal spending by

the same amounts. Export credit guarantees, which help to finance export

sales of agricultural commodities, involve federal outlays only when loans

are defaulted. Past outlays for this program have been around $250 million

annually, but it is budgeted to spend between $500 million and $600 million

annually in the next two years. The cost of food products given as in-kind

aid to developing countries is minimal, but there are some processing and

transportation costs associated with this program. It is unlikely that cutbacks in export credit guarantees or in food aid will be addressed during

these negotiations.
CHAPTER V

MATURE INDUSTRIES: AUTOMOBILES, STEEL,

TEXTILES AND APPAREL

Import restraints and export subsidies have been important in shaping trade

in mature industries such as textiles, apparel, steel, and automobiles. These

industries, so important to many developed economies, have suffered from

diminished growth in demand, displacement by new technologies, and

competition from producers in other countries.

The General Agreement on Tariffs and Trade was designed to limit government

protection of firms competing in international markets. GATT permits a

government to restrict imports temporarily, however, to allow an industry to

adjust to increased international competition stemming from trade

liberalization. GATT also permits certain kinds of subsidies, although it

prohibits direct subsidies of exports.

Thus many government efforts to defend mature industries violate the spirit

if not the letter of the General Agreement. For example, countries frequently

agree to limit their exports at the request of an importing country; such voluntary

export restraints are not prohibited by GATT, which applies only to unilateral

restraints imposed by importing countries. Likewise, GATT permits countries

to subsidize an industry so long as the subsidies do not injure firms in other

countries. Such subsidies do not directly stimulate exports, but affect producers

in other countries by increasing world supplies and lower ing prices.

Participants in the Uruguay Round will discuss ways of reducing trade

restraints and subsidies and will try to develop rules to limit their future use.

They will be mindful, however, that international competition may lead to further

restructuring of some mature industries and will seek ways to reduce the costs

of "adjustment." Since GATT imposes less stringent standards on developing

countries, the Uruguay Round will also consider how to apply the rules of

international trade to newly industrialized countries as they mature.

The automobile, steel, textile, and apparel industries are among the oldest

and largest industries in the United States and other industrially developed

countries. Over the last several decades, however, they have faced increasing international competition. Governments have sought to aid these

and other mature industries by giving them subsidies and creating barriers

against imports. Similar policies have been used by developing countries in

the hope of speeding the growth of their economies.

Fl
100 GATT June 1987

Such policies have to some extent shielded mature industries from the

recent dramatic changes in trade patterns. Though the U.S. trade deficits in

automobiles, steel, textiles, and apparel have been large and, with the

exception of steel, increasing, other industries have accounted for a larger

part of the deterioration in trade during the 1980s. In 1981, for example,

these three industries ran a combined trade deficit of $28 billion, while

overall U.S. manufacturing recorded a narrow surplus (see Table 12). By

1985, the balance of trade for all U.S. manufacturing had declined by

$117 billion, and these three industries accounted for one-third of the

deterioration. In the European Community, the trade surplus of these

industries grew by 1 percent between 1981 and 1985, while that for all

TABLE 12. TRADE BALANCES BY PRODUCTS AND COUNTRIES

(In current dollars)

Year

1981

1982

1983

1984

1985

1981

1982

1983

1984

1985

1981

1982

1983

1984

1985

SOURCE:

NOTE:

All

Manufacturing

5

-11

-38

-87

-112

99

94

89

89

96

115

104

110

128

134

,

,

,

>

,

,

,

,

,

,

,

,

,

,

,

010

102

987

933

088

982

635

456

718

248

777

269

649

283

480

,513

,917

,566

,576

,215

,863

,322

,027

,235

,013

,291

,225

,306

,515

,345

Automobiles

United States

-13,187,312

-18,164,291

-22,853,218

-30,341,355

-39,293,177

European Community

17,858,418

18,017,718

15,804,283

16,556,211

18,388,893

Japan

31,948,491

29,204,066

31,027,939

35,673,449

40,920,934

Textiles

and Apparel

-6

-7

-10

-15

-18

-1

-1

2

2

2

2

1

,324,

,884,

,452,

,993,

,101,

,687,

,448,

-597,

-32,

869,

,994,

,194,

,993,

,236,

,759,

556

105

276

459

751

212

884

258

949

398

779

812

576

095

826

-9

-8

-5

-10

-9

13

9

8

9

10

15

14

11

11

12

Steel

,268,

,187,

,933,

,510,

,965,

,191,

,658,

,450,

,703,

,482,

,602,

,429,

,494,

,940,

,086,

United Nations and Congressional Budget Office.

"All manufacturing" includes Standard International Trade Classifications

858

905

614

576

951

542

090

895

867

929

124

255

579

355

342

5, 6,

7,8, and 9.
CHAPTER V MATURE INDUSTRIES 101

manufacturing declined by 4 percent. In Japan, where the overall trade

balance improved, two of the three industries remained flat and only

automobiles increased its surplus. In the newly industrialized countries, the

trade balance improved markedly, going from a deficit of nearly $5 billion in

1981 to a surplus of over $20 billion in 1985. Industry data for these countries, however, were not available.!/

Nevertheless, the developed nations have had only limited success in

shielding these industries from the discipline of the marketplace. Competition from abroad has been a factor, but it is rarely the only reason for a

protected industry's difficulties. A slowdown in the growth of domestic

consumption, coupled with increased productivity and changing tastes, often

plays a critical role. Trade restraints in themselves frequently afford only

limited protection. In the case of quotas, the most important trade barrier,

foreign producers not covered by the restraints tend to increase their

exports while those who are constrained by them tend to shift their product

mix toward more expensive goods.

This chapter scrutinizes the use of subsidies and nontariff trade barriers to protect mature manufacturing industries. Negotiations in the

Uruguay Round over these policies will be of particular importance to the

automobile, steel, and textile and apparel industries.

CURRENT PROBLEMS IN MATURE-INDUSTRY TRADE

When the sales of an industry decline and force it to contract, most of the

costs of adjustment are borne by the labor employed in the industry.

Government can aid the industry by directly subsidizing it or by erecting

barriers against its foreign competitors. These policies impose costs on

producers in other nations, because subsidies and trade restraints increase

the world's supply of the product and put downward pressure on world prices.

Despite the gains to the aided industry, these policies also impose costs on

the nation employing them, particularly by discouraging resources from

moving to sectors where they might be more productively used. The costs

of the policies will increase if other countries retaliate by imposing trade

restraints or providing subsidies to help their own firms.

1. The newly industrialized countries include Brazil, Hong Kong, South Korea, and

Singapore. Data on their trade balances is from Wharton Economic Forecasting

Associates, World Economic Service Historical Data (Philadelphia: Wharton, January

1987).
102 GATT June 1987

Trade Restraints

Barriers to trade generally take the form of tariffs or quotas. In the industries considered here, quotas are widely used.?/ Quotas, or quantitative

limits on imports, are often arrived at by mutual agreement in which the

exporting country agrees to limit its exports to the importing country. §/

Such voluntary export restraints are not covered by GATT, which applies

only to unilateral restraints imposed by importing countries. GATT gives

developing countries even wider latitude in protecting their industries. The

developing countries have been largely exempt from previous rounds of

tariff reduction, and they have also erected numerous nontariff barriers to

foster the growth of emerging industries. Increasingly, the United States

and other developed countries have begun to retaliate or to threaten retaliation against trade barriers erected by developing countries.

GATT permits trade restraints for only a limited time, to give an industry a chance to adjust to increased international competition, i/ In the

three industries considered here, however, trade restraints have tended to

persist. Moreover, the restraints are often extended to other products or

countries as time goes by. And restraints imposed by a major country such

as the United States (or a bloc of countries such as the European Community) often elicit similar actions from other countries.

The Quasi-permanence of Trade Restraints. The persistence of restraints

can be seen in many mature industries. Since the 1950s, restraints on

textile and apparel products have expanded principally through a series of

multilateral agreements--of which the current one is the Multifiber

Arrangement--that establish rules by which developed countries can limit

imports from developing countries. Although these agreements and arrangements always have expiration dates, the parties invariably renew them. This

system has developed in spite of the fact that tariffs in these industries are

2. Under GATT, a country can impose quotas unilaterally only to rectify balance-ofpayments difficulties. GATT permits trade restraints in aid of an industry that has

been injured or threatened with serious injury by trade liberalization.

3. Though mutually-agreed-upon quotas are often announced, there are apparently

instances in which limitations on exports are the result of nonpublic understandings

between governments. In addition, countries have sometimes quietly taken unilateral

administrative actions, such as restrictive customs or inspection procedures, to impede

imports.

4. When a nation protects an industry that has been injured by a trade liberalization,

Article XIX of GATT allows affected countries to withdraw equivalent concessions that

they had made.
CHAPTER V MATURE INDUSTRIES 103

higher than in other manufacturing industries. As originally conceived, the

agreements were intended only to facilitate more orderly trade, not to

provide permanent protection. As now administered, both by the United

States and by the European Community, the aim seems to be to preserve the

size of the domestic industries. §/ In the United States, for example, the

outputs of the textile and apparel industries have remained relatively stable

since the Multifiber Arrangement was put into place in 1974. §/ While

employment has declined, this has been largely the result of increased

productivity, which has been especially rapid in the textile industry. Similar

trends are evident in Europe. 2j

Quotas in the automobile industry have appeared more recently and

are aimed mainly at Japan. While they have not been the product of a

formal multilateral process, as in textiles and apparel, they are also proving

to be long lasting. This is most clearly illustrated by the experience in the

United States, the largest export market for Japanese cars. The 1980 recession, coupled with rising gasoline prices, contributed to a nearly 30 percent

decline in domestic car sales with unprecedented industry losses. During

that same year, sales of Japanese imports rose by 40 percent. In the spring

of 1981, President Reagan negotiated a voluntary restraint agreement with

Japan. Although the arrangement was to be temporary, it was renewed in

each of the following three years; since then, Japan has unilaterally restricted its automobile exports to the United States. §/

5. Clayton Yeutter, the U.S. Trade Representative, has claimed that the President was

committed to relating "total import growth to the rate of growth of the domestic market."

Seventy-seven Senators and 302 House members had sent letters to President Reagan

to limit growth to the rate of growth of the domestic market. See Inside Trade, July

11,1986, p. 2.

6. See testimony of Walter Lenahan, Deputy Assistant Secretary, Department of Commerce,

before the Subcommittee on Commerce, Consumer and Monetary Affairs of the

Committee on Government Operations, March 6,1985.

7. Between 1976 and 1985, EC production of textile, clothing, and leather declined at an

average annual rate of less than 1 percent per year. Employment declined at an average

annual rate of approximately 2.5 percent.

8. Japan agreed to export 8 percent fewer cars to the United States in the year ending

March 31, 1982, than it had in 1980. Japan later agreed to maintain the same level

of imports for another year. The level was increased by 10 percent for the next two years.

Despite the expiration of the voluntary agreement in 1985, Japan elected to continue

restricting its exports. With the decline in the value of the dollar, and increased car

production by Japanese firms in the United States, the quotas may have little impact

on U.S. imports during 1987.

MUM
104 GATT June 1987

The United States is not alone in restricting the sale of imported cars.

In 1976, Italy limited Japanese imports to 2,200 cars per year; in July 1986,

it raised the limit to 3,300 per year. France does not permit Japanese

imports to exceed 3 percent of domestic new car sales. $J Both Spain and

the United Kingdom have had restraint agreements with Japan to limit

Japanese auto imports. Because sales of Japanese cars in other European

markets have been increasing, the EC has apparently prevailed upon Japan

to limit voluntarily its car exports to Europe beginning in 1987. IP-/

In addition to explicit limits on trade, a number of countries have

established "local content" regulations that effectively prohibit the sale of

imported cars. For the most part, these regulations were adopted before

Japan emerged as an important supplier of automobiles. For example, 85

percent of the value of cars sold in Australia must come from domestic

parts and labor. Spain has had a local content requirement of 55 percent,

which it agreed to phase out with its entry into the European Community, il/ Such local content requirements are also widespread in developing countries and in Latin America.

Although steel trade is not governed by a multilateral trade agreement, most major steel-consuming nations have imposed some restraints.

The United States has protected the steel industry on three different

occasions, l^/ Most recently, in the fall of 1984, it negotiated voluntary

export restraints with countries that are its principal steel suppliers.

Voluntary export restraints had previously been negotiated with the EC and

Japan in the late 1960s; these were renewed once, and expired in 1974. In

1978, the United States established trigger prices; imports below those

levels were subject to accelerated anti-dumping proceedings.

9. See "Japanese Makers Gain Market Share in Europe," Automotive News, July 7, 1986,

p. 35.

10. See "Company Brief; Toyota Learns to Sprint," Economist, January 12,1987, p. 75.

11. See International Trade Commission, The Inter nationalization of the Automobile Industry

and its Effect on the U.S. Automobile Industry, Publication 1712, June 1985.

12. The United States imposed countervailing duties in a number of cases after it was found

that foreign firms sold steel below cost. And allegedly there have been a number of

informal agreements to limit imports at times when explicit restraints were not in effect.

See Gary Clyde Hufbauer and others, Trade Protection in the United States (Washington,

B.C.: Institute for International Economics, 1986), pp. 170-174.
CHAPTER V MATURE INDUSTRIES 105

Europe has also restrained trade in steel over a period of years. In

1979, as conditions in the industry deteriorated, the Commission of the

European Communities declared a "manifest crisis" under the Treaty of

Paris. M/ This enabled the Commission to establish minimum prices and

quotas for steel products sold in Europe, as well as requiring that subsidies

and expansion plans be approved by the Commission.!!/ The European

Community also negotiated bilateral agreements with 14 major supplying

countries and established minimum import prices for other foreign suppliers.

Though these measures were meant to be temporary, the Europeans have not

yet completely shed them.

Although Japan no longer explicitly limits steel imports, it imports

little steel from Korea, which emerged as an important low-cost producer in

the 1980s. Also, an official of the EC has recently complained about

restricted access to the Japanese market. Hi/

The Increasing Scope of Trade Restraints. A quota established to protect

an industry usually applies to the industry's principal competitors and rarely

to all the world's producers; it thus conflicts with the principle of nondiscrimination, which is basic to GATT. One result of such discrimination is to

give firms in unconstrained countries an incentive to increase exports to the

protected market. Moreover, producers that are subject to the constraints

often respond by focusing on higher-valued products under the quotas and

also by increasing their sales of substitute products that are not covered.

The importing country often reacts by broadening the scope of a quota to

cover additional countries and products, as well as by defining products

more precisely to limit upgrading by foreign producers.

Experience in the textile and apparel industry vividly illustrates how

restraints tend to expand. At first, quotas covered only exports of cotton

products from Japan to the United States and the United Kingdom. The

13. Under the Treaty of Paris, many European countries have delegated substantial

authority to the Commission at times of "manifest crisis." See Raymond Levy, "Industrial

Policy and the Steel Industry," in William James Adams and Christian Stoffaes, eds.,

French Industrial Policy (Washington., B.C.: Brookings Institution, 1986), pp. 63-74.

14. See International Trade Commission, Foreign Industrial Targeting and Its Effects on

U.S. Industries, Phase II: The European Community and Member States, Publication

1517 (Washington, D.C.: April 1984).

15. See "EEC Intends to Ease Restraints," American Metal Market, December 3,1986, p. 3.
106 GATT June 1987

subsequent growth of cotton exports from Taiwan, Korea, and other countries led to restraints on those. As imports of non-cotton products

expanded, quotas were first placed on synthetics and wool, then on silk,

linen, and ramie. In addition, the number of cotton and textile products

subject to quotas also increased. Thus, over time, both the number of

countries and the number of products covered by restraint agreements have

increased.

A similar expansion has occurred in steel, where U.S. restraints on

steel imports have covered an increasing number of countries. The first

round of restraints included only Japan and the six original members of the

European Community. The most recent round involves substantially more

countries, and several of the agreements contain detailed product

classifications. !§/

How Protection Breeds Protection. A government's decision to limit

imports gives the constrained exporters incentives to divert their output to

other countries. This in turn increases the pressure on other governments to

impose trade restraints.

At the time the United States entered into its voluntary restraint

agreement with Japan to limit imports of Japanese cars, West Germany was

given assurances that Japan would not divert the cars to its market. These

assurances apparently did not last as long as the restraints on Japanese car

sales in the United States, because sales of Japanese cars in Germany and

other European countries have increased in recent years. The restraints on

exports to the United States may have accelerated the growth of Japanese

exports to Europe and contributed to the recent agreement that limits

Japanese car exports to the EC.!!/

A similar pattern may be at work with textiles and apparel. Despite

the framework of multilateral agreements, quotas are negotiated bilaterally. Some maintain that the runup of textile and apparel exports to the

United States during the 1980s stemmed from the more restrictive quotas

the EC negotiated in the 1980s. l^J While the value of U.S. apparel imports

from developing countries increased by more than 90 percent between 1980

16. See Congressional Research Service, The President's Steel Import Program: One Year

Later, October 16,1985.

17. See "Company Brief: Toyota Learns to Sprint," Economist, January 17,1987, p. 75.

18. Thomas Howell and William Noellert, The EEC and The Third Multifiber Arrangement:

A Study Prepared for the Fiber, Fabric, and Apparel Coalition for Trade (Washington,

B.C.: Dewey, Ballantine, Bushby, and Wood, 1986).
CHAPTER V MATURE INDUSTRIES 107

and 1984, Europe's imports from these countries (measured in dollars)

declined by 13 percent. Similarly, U.S imports of textiles from developing

countries increased by 70 percent, while European imports declined by 20

percent. As a result, the U.S. textile and apparel trade deficit with

developing countries swelled, while the EC's declined (see Figure 2). 1$J

Also important, of course, were the strength of the dollar and the more

rapid growth of the U.S. economy during this period.

In any case, the higher textile and apparel imports into the United

States created pressure to provide the industry with more relief. For example, the Congress passed a bill, vetoed by President Reagan, that would have

placed tighter limits on imports from developing countries. Before the most

recent extension of the Multifiber Arrangement, the United States negotiated much tighter quota limitations with a number of its major suppliers.

Subsidies

Negotiations in the subsidy panel of the Uruguay Round are likely to have a

profound influence on mature industries. GATT is more ambiguous on the

issue of subsidies than on trade restraints. While acknowledging that subsidies to firms competing in international markets distort trade flows, the

General Agreement recognizes the right of a country to subsidize firms to

"promote important objectives of social and economic policy." ?_2/ It notes,

for example, that subsidies can legitimately be used to help economically

disadvantaged areas, to facilitate restructuring, or to maintain employment.

GATT tries to balance the rights of nations to subsidize an industry

with its own goal of promoting international competition. It therefore

maintains different standards for different types of subsidies, and imposes

less stringent standards for developing nations. GATT flatly prohibits subsidies that lower the price of an exported manufactured product below its

domestic price. ?.!/ It prohibits other subsidies, however, only when they

19. A sharp decline in the EC's textile exports more than offset the fall in imports, so its

textile trade balance deteriorated by roughly the same amount as the United States'

textile trade balance.

20. Gary Hufbauer and Joanna Erb, Subsidies in International Trade (Washington, D.C.:

Institute for International Economics, 1984), pp. 13-16. Appendix A of that book

reproduces the relevant articles of the GATT and an agreed interpretation of those

provisions.

21. See Article XVI:4 of the General Agreement. Limited export subsidies are permitted

in the case of some primary products.
108 GATT June 1987

Figure 2.

Apparel Industry: Trade Balances of the United States and the

European Community with Developing Countries

-2

-10

-12

. European Community

—» /

United States

1965 1970 1975 1980 1985

SOURCES: Congressional Budget Office; United Nations.

NOTE: The trade balances are exports to developing countries minus imports from them. The

developing countries include all apparel-exporting countries that are not mature industrial

countries.

cause or threaten to cause material injury to firms in other countries.

After finding material injury, the government of the injured party can

impose countervailing duties in the amount of the subsidy.

Developing countries' use of export subsidies is limited only to the

extent that they adversely affect firms in other countries. In such a case,

the developing country is obliged only to "endeavor to enter into a commitment to reduce or eliminate the subsidy." It can continue to provide other

types of subsidies as long as it adheres to the commitments it has made

under the agreement.

22. Evidence of material injury includes falling output, profits, or employment. Subsidies

that merely reduce the rate at which an industry's output or profits grow do not violate

the agreement.
CHAPTER V MATURE INDUSTRIES 109

From the perspective of international trade, only those subsidies that

result in expanded output are harmful to producers in other countries.^/

Yet determining the magnitude, let alone the effect, of a subsidy is a

difficult task. ±z/ It is made more difficult when firms are owned by

governments. For example, chronic operating losses do not prevent a

nationalized firm from undertaking investments that a private firm would

believe to be uneconomic. Similarly, government ownership may make a

firms's capacity and production decisions less responsive to market signals.

While European governments have provided subsidies to firms in all

three of the industries considered here, support of the steel industry has

been especially noteworthy. Between 1980 and 1985, the members of the

EC reported over $35 billion in government subsidies to steel manufacturers. 2!L/ More than half of those were earmarked for operations, and 30

percent for investment. Government assistance was at least partly responsible for the increase in Europe's steelmaking capacity despite declining

consumption during the 1970s (see Figure 3). The combination of increased

capacity and declining domestic sales increases the incentives of European

steel producers to depend on foreign markets. ±27

The subsidies to EC's steel industry were announced as part of a

"manifest crisis" in 1979, and were supposed to end by 1985. Subsidies

continued, however, helping to preserve substantial redundant capacity. In

the United Kingdom, Italy, and Germany, in particular, political pressures

are apparently keeping unnecessary capacity in operation. *'

23. For example, government subsidies of high-cost upstream producers, such as coal

producers, would not adversely affect the downstream market, such as steel, so long

as the subsidies did not exceed the coal producers' cost disadvantage. The subsidies

would, however, affect the coal market by stimulating the production of coal by marginal

producers.

24. Signatories to the GATT, upon written request, agree to furnish information on the

nature and the extent of the subsidies they provide that directly or indirectly increase

exports or reduce imports of a product.

25. 15th Report On Competition Policy (Brussels: Commission of the European Community,

1985).

26. For a discussion of these issues, see International Trade Commission, Foreign Industrial

Targeting.. .The European Community; also "Government Aid to the Steel Industry

of the European Communities," prepared by Verner, Liipfert, Bernhard, McPherson

and Hand for Bethlehem Steel Corporation and United States Steel Corporation.

27. See "Europe Pays On," Economist, July 13, 1985, p. 72, and International Trade

Commission, Operation of the Trade Agreements Program, 1985, Publication 1871 (June

1986), p. 144.
110 GATT June 1987

Figure 3.

European Community: Steel Production, Consumption, and Capacity

220

180

140

100

60

//_

Capacity

\ Xv "*—

 Consumption

1970 1975 1980

SOURCES: Congressional Budget Office; International Iron and Steel Institute; Organization for Economic

Cooperation and Development.

Government support has also been important to a number of European

automobile manufacturers. The French government owns Renault, and the

British government owns Rover; it is doubtful whether either firm could

produce at its current scale absent government assistance. Renault might

very well have gone bankrupt at the end of 1985 had not a law prohibited it

from doing so and had not the government provided it with aid. ^ After

Rover was nationalized in the 1970s, because it was failing as a private

firm, its capacity, work force, and wage rates were reduced. Nevertheless,

the government has provided $3.25 billion of aid to Rover since 1975. 2$J

Subsidies are also evident in the textile and apparel industries. Several European governments have subsidized inefficient plants and have invested in industry modernization. Because of their cost, many of these

28. See "France Plans to Alter Renault's Protected Status," Automotive News, November

17,1986, p. 2.

29. See "Britain's Rover Pins Hope on American Love of Luxury," Wall Street Journal,

February 19,1987, p. 32.
CHAPTER V MATURE INDUSTRIES 111

subsidy programs have been curtailed. / Nevertheless, Italy continues to

provide substantial operating and investment subsidies to a major stateowned producer, ANIC-Fiber. France nationalized Rhone-Poulenc in 1982

and has subsidized textile and apparel workers' social security contributions.

The United States has been much more reluctant than other countries

to subsidize its ailing firms. The only significant direct U.S. government

subsidy of a firm in a mature industry was the $1.5 billion loan guarantee to

Chrysler made in January 1981.

Japan has used a combination of subsidies and trade protection in an

effort to help its industries become established in international markets. It

nurtured the automobile industry under restrictive trade barriers and

through loans, grants, and tax incentives. £i/ It employed similar policies in

the steel industry. In both cases, these measures were apparently discontinued once the industry was able to compete effectively.

Several of the newly industrializing countries employ measures similar

to those used by Japan to bolster certain manufacturing industries. Korea

and Brazil have recently completed large integrated steel mills; in a reversal of historic patterns, both have had positive trade balances during the

1980s. Korea and Taiwan are using a combination of trade restraints and

subsidies to establish automobile industries. Many developing countries, as

well as some of the newly industrialized countries, have provided interestrate subsidies and other grants to promote growth in their textile and apparel industries. 5^7 Moreover, a number of developing countries have also

established import restrictions in order to bolster their textile and apparel

manufacturers.

30. For a discussion of these programs, see Organization for Economic Cooperation and

Development, Textile and Clothing Industries (Paris: OECD, 1983), p. 133; Thomas

Howell and others, The Textile and Apparel Trade Crisis: A Study Prepared for the

Fiber, Fabric and Apparel Coalition for Trade (Washington, B.C.: Dewey, Balantine,

Bushby, Palmer and Wood, 1985), pp. 110-145; International Trade Commission, Foreign

Industrial Targeting and its Effects on U.S. Industry, Phase II: The European Community

and Member States (Washington, D.C.: ITC, 1984), pp. 148-153. For a further discussion

of France's policies, see John Zysman, Governments, Markets, and Growth (Ithaca:

Cornell University Press) pp. 154-157.

31. See, for example, International Trade Commission, Foreign Industrial Targeting and

its Effects on U.S. Industries, Phase I: Japan, Publication 1437 (October 1983), p.129.

32. See International Trade Commission, Foreign Industrial Targeting and Its Effects on

U.S. Industries, Phase III: Brazil, Canada, The Republic of Korea, Mexico, and Taiwan,

Publication 1632 (1985), pp. 70-72, 170-172, and 280-281. Also see Thomas Howell and

others, The Textile and Apparel Trade Crisis, pp. 40-106.
112 GATT June 1987

BARGAINING POSITIONS IN THE URUGUAY ROUND

The basic industries considered in this chapter are shifting from the industrialized areas of North America, Europe, and Japan to the industrializing

countries of the Third World. The process is occurring more rapidly in some

industries and countries than in others. Even if the importance of these industries in the industrialized countries continues to decline, they will retain

a footing there either for technological reasons or to be close to markets.

The spread of basic industry is driven by the standardization of technology, the lowering of global transportation costs, and the advent of transnational firms that can reorganize production across national boundaries.

The bargaining positions of the nations involved in the Uruguay Round will

reflect their positions in this shift and their national policies toward it.

The newly industrialized countries, as large potential exporters of

basic manufactured products, generally seek a liberalization of trade in

these industries. They are joined, to a large extent, by Japan, which has

been a successful producer of basic manufactured products (although Japan,

too, faces competition from other nations of the East Asian rim). On the

other side of this issue are the United States and the European Community,

which stand to lose the most from a liberalization of trade in these goods.

This division holds by and large for the three basic industries of textiles and

apparel, steel, and automobiles. Some exporting countries, however, may

prefer that the Multifiber Arrangement be continued as a way of limiting

the growth of competing textile and apparel producers in other countries.

But the Uruguay Round discussions will be concerned with more than

just the liberalization of trade. One important issue concerns "adjustment"

programs for ailing industries. A second issue concerns the preferential

treatment of developing countries.

Adjustment Programs

Article XIX of the General Agreement permits programs of import relief to

enable industries to adjust to difficulties so long as the programs are

temporary and conform to the most-favored-nation principle. Increasingly,

however, protection is targeted at specific nations and lives beyond its

original intended life. In response to this fact, various authors have

encouraged stricter adherence to a formal procedure for industry adjust-
CHAPTER V MATURE INDUSTRIES 113

ment in this country. / Such a program would sanction temporary protection for industries hurt by international trade if predicated on a plan to

eliminate excess capacity, reduce and retrain the labor force, change work

rules, and modernize existing facilities. Once the adjustment was completed, they would return to free trade. The program could be financed out

of general revenues or by tariffs on relevant imports.

Proponents of such a program in the United States contend that it

would meet the demand for more protection without creating new (and often

permanent) barriers to trade. Opponents maintain that all of the basic

industries considered in this chapter have been involved in sequential episodes of protection, but none of them has improved its prospects to the

point where it is ready to face unrestrained competition. ^4/ Trade

restraints tend to become permanent, as has been the case in textiles and

apparel with the Multifiber Arrangement and may yet be the case in steel

and automobiles. Opponents also contend that temporary protection would

be subject to political abuse and would produce a result no less protectionist

than the existing system. They note that such programs in Western Europe

have not significantly improved the mobility of resources in those economies, and that even Japan has had difficulty when confronted with the need

to downsize its larger industries.

Preferential Treatment

The second issue concerns newly industrializing countries, and how long they

should be permitted to continue subsidies and trade barriers in the name of

development. The rationale for such measures was to encourage production

by basic industries that would substitute for imports. Many developing

countries have now become exporters of such products, and no standard

exists to determine when the relevant subsidies should be phased out. Some

of the newly industrializing countries would argue that export earnings in

any one industry are not indicative of their level of overall development,

which should be the criterion for determining whether export subsidies are

33. See E.M. Ehrlich and R.C.Scheppach, New Directions in Economic Policy (New York:

Praeger, 1984); see also G.C.Hufbauer and J.J.Schott, Trading for Growth: The Next

Round of Trade Negotiations (Washington, D.C.: Institute for International Economics,

1985).

34. For a discussion of the effectiveness of trade protection in improving these industries'

international competitiveness, see Congressional Budget Office, Has Trade Protection

Revitalized Domestic Industries? (November 1986).
I IMIIIIP

114 GATT June 1987

to continue. Others would argue that the issue should be settled on an

industry-by-industry basis. Thus, if a large and efficient steel industry

emerges in a developing country, that country should no longer limit steel

imports or provide its steel producers with export subsidies. It could, however, continue to employ subsidies to foster growth in other industries.

IMPLICATIONS OF LIBERALIZED TRADE

Putting an end to trade barriers and subsidies would clearly have an adverse

effect on U.S. industries that have benefited from such policies. The shock

would be lessened, however, if all countries were to step collectively away

from trade restraints. The problem of automobile imports into the United

States, for example, may be made worse by the fact that the European

Community is far more closed to Japanese automobile production than is the

United States. Limiting access to this significant market gives Japanese

producers greater incentives to sell in the United States.

Currency movements may also moderate the dislocating effects of

trade. As a country's exports increase, the value of its currency tends to

rise--making its exports more expensive in terms of other currencies. If

currency values were generally allowed to be influenced by trade flows, this

would mitigate the effects of trade liberalization on the United States. But

some developing countries choose to lower their currency values in order to

stimulate exports--sometimes in the name of development, sometimes as

part of a program to repay foreign debts. Liberalization of trade in

manufactured goods would make this type of interference a matter of

greater concern for the industrialized nations.

The degree of international competition varies among industries.

Textile and especially apparel industries are labor-intensive, and the low

wages in developing countries have given firms there an important competitive advantage. A number of newly industrializing countries have also

become significant exporters of steel, and are on the point of emerging as

important automobile producers, because of raw material, capital, and other

cost advantages.

Apparel manufacturers in developed countries would probably be the

most adversely affected by trade liberalization, since with their higher wage

rates they cannot match the costs of firms in developing countries. Textile
CHAPTER V MATURE INDUSTRIES 115

producers have a smaller cost disadvantage. Certainly some major sectors

of these industries would remain viable even without the protection of the

Multifiber Arrangement. Tariffs in developed countries for textile and

apparel products are substantially higher than for other products. Moreover,

technological advances hold the prospect of dramatically reducing the labor

intensity of some apparel production. M/ Also, in the United States,

cooperative agreements among retailers and manufacturers are permitting

the domestic textile and apparel industries to respond more rapidly to

changes in consumer tastes. Such actions enable retailers to tailor their

inventories more precisely to competitive conditions, and may help to compensate for domestic firms' higher manufacturing costs.

The steel industries in the developed countries would probably suffer

heavily in the event of a substantial liberalization of trade. Despite

substantial modernization, many of the largest U.S. producers are still

saddled with old and inefficient production facilities. Moreover, minimills,

which do not produce raw steel, are a profitable and rapidly growing sector

in the United States; even in the absence of imports, the growth of these

minimills could place competitive pressures on the integrated producers.

Largely because of government subsidies, European steel producers have

more capacity in large modern and efficient mills than do U.S. producers.

Nevertheless, there is far too much steel capacity in the world and a

substantial liberalization would probably cause significant financial distress

to steelmakers in all the developed countries.

The automobile industry shares a number of characteristics with steel.

Other developed countries are the principal exporters, and the United States

has proved to be an attractive destination. Unlike steel, however, automobiles require the assembly of numerous components: automakers have

the flexibility to purchase rather than manufacture many parts and subassemblies. Moreover, unlike steel producers, automobile manufacturers

make differentiated products. For these reasons, the industry is characterized by a broad line of products and by multinational operations. All the

principal Japanese manufacturers now have, or are in the process of establishing, production facilities in the United States, as U.S. manufacturers

have done in other countries. Many Japanese parts suppliers are also establishing plants in the United States. Similar trends are also evident in

Europe. This strongly suggests that the industry will continue to flourish in

developed countries even as it expands in developing countries.

34. See "Getting Competitive," National Journal, June 7,1986, pp. 1360-1365.
116 GATT June 1987

Many of the European car manufacturers specialize in producing relatively small and inexpensive cars like those Japan used to enter the U.S.

market. This is one reason why Europe has not imported more Japanese

cars. Japan's European penetration has also, however, been limited by a

variety of explicit and implicit import restraints. If these restraints were

relaxed, there would almost certainly be a significant increase in Japanese

car exports to Europe.

Many nations that would gain from liberalization of trade in basic

manufacturing allow practices that would not be permitted in the United

States. Foreign producers often use processes or product designs that would

be prohibited under U.S. laws for environmental or safety reasons. Some

foreign producers deny workers the right to organize; some countries have

maximum wage laws, and place other restrictions on workers' bargaining

power. If these issues were brought into the GATT negotiations, or, perhaps

more realistically, if the United States were to pursue agreements on them

through its own diplomacy, their resolution might offset some of the negative consequences of trade liberalization.

Budgetary Implications

Liberalization of trade in the products of mature industries could have a

significant impact on the federal budget. Mature industries receive some

direct federal support, primarily for specific research and development

projects. Q!L/ Indirect support is also provided from the budget through

credit programs such as the Export-Import Bank, and through the tax

system--although tax reform has diminished the latter. Agreement to limit

subsidies or to scrap or amend the Multifiber Arrangement could diminish

the justification for these programs.

But the most significant budgetary effects of potential GATT actions

would fall primarily in two policy areas: federal adjustment assistance programs, and trade protection through quantitative restraints on imports. In

the first area, liberalization of trade would be likely to increase budget

outlays; in the second, it would lead to increased revenue.

35. For an analysis of total federal support for commercial activities, see Congressional

Budget Office, Federal Support of U.S.Business (January 1984). In that report, direct

on-budget expenditures for all industries were calculated to be $13.7 billion in 1984.

Over half of that, however, was directed to agriculture. Of the remainder, the programs

most affecting mature industries focused on research and development support. See

also Congressional Budget Office, How Federal Policies Affect the Steel Industry

(February 1987), pp. 25-31, for an analysis of direct federal funding of steel research,

amounting to about $26 million annually.
CHAPTER V MATURE INDUSTRIES 117

Adjustment Assistance. As discussed in Chapter I, trade liberalization,

while improving the overall standard of living, often concentrates losses on

the weakest competitive groups in the economy. In the past, trade adjustment assistance has been seen as a tool that would allow a smoother shift of

resources from, losing sectors to gaining ones. In practice, the U.S. Trade

Adjustment Assistance (TAA) program has emphasized cash assistance to

overcome temporary dislocation, rather than the retraining of unemployed

workers that would increase their mobility.

The TAA program is authorized at $29.9 million for fiscal year 1987;

Title III of the Job Training Partnership Act (JTPA) of 1982 also provides

about $200 million in funding for training so-called dislocated workers. The

Administration's 1988 budget proposal would combine the TAA and JTPA

programs and increase the combined budget to $986 million in the first year.

Trade liberalization, which might create greater worker dislocation, would

increase the demand for such adjustment programs.

Quantitative Restraints. The Congress has recently considered auctioning

existing U.S. import quota rights to the highest bidder—in effect, converting quotas to a form of tariff. Such a policy might arouse greater

interest if the GATT negotiations were to produce an agreement either

limiting the use of quantitative restraints or replacing them with

tariffs. M/ Current U.S. policies include voluntary export restraints for

such mature industries as textiles, apparel, steel, and machine tools.

(Japanese export restraints on autos are excluded because they have not

been formally agreed to by the U.S. government.) The Congressional Budget

Office has estimated that auctioning existing quotas (or imposing an equivalent tariff) could increase revenues by $3.9 billion in fiscal year 1988 and

$4.7 billion in 1989.

36. Under most conditions auctioning quota rights would have the same effect as an

equivalent tariff. Moreover, for purposes of analysis, the two may be calculated in the

same way.

37. See Congressional Budget Office letter to Chairman William H. Gray, Committee on

the Budget, February 26, 1987. See also C. Fred Bergsten, Jeffrey Schott, Wendy E.

Takacs, and Kimberly A. Elliott, Auction Quotas and United States Trade Policy

(Washington, D.C.: Institute for International Economics, forthcoming). It should be

noted that estimates in this book differ from CBO estimates; notably, they include

$2.2 billion in revenues achievable in 1984 through the auctioning of quotas on autos.

Current market conditions suggest that even if these restraints were to be formalized

by the Congress, the revenue gain might be close to zero.

1:1111111;

CHAPTER VI

TRADE IN SERVICES

Expanded trade in services would offer the same benefits as for goods: greater

efficiency through specialization. Services trade is not covered by the GATT.

The barriers to services are not tariffs or quotas, but national policies that have

often been established for other purposes. Efforts to liberalize services trade

are hampered by the difficulty of defining services and by the lack of adequate

information about them.

Barriers to trade in services vary according to the way services are delivered.

Some that are conveyed like goods, such as shipping and air transportation,

are already regulated by international agreements. Others that are conveyed

through legal arrangements (such as film leasing, or franchises) and those

involving the movement of people (such as professional business and financial

services) are generally regulated unilaterally by the importing countries. Many

of these unilateral regulations create barriers to trade, though not all of them

are deliberately established for that purpose.

Bargaining in GATT over services tends to align developed countries against

developing countries (although individual countries within these blocs may

hold different positions on specific issues). The developed countries, especially

the United States, favor liberalizing measures because they have advantages

in providing many services that are capital-intensive and require highly skilled

labor. Developing countries see little to be gained from this since their advantages

lie primarily in low labor costs: for them to provide labor-intensive services

to the developed countries, the latter would have (among other things) to

liberalize their immigration practices, which they have been reluctant to do.

The service sector has become increasingly important in the U.S. economy.

In 1985, services accounted for 50 percent of gross national product, up

from 40 percent in 1965. While the United States has seen a dramatic

increase in its merchandise trade deficit, it continues to experience a

positive balance of trade in services. With services becoming an increasingly important part of its economy, the United States has an interest in

promoting freer trade in this area. So far, there is no encompassing

multilateral agreement that applies to trade in services; GATT focuses

almost exclusively on manufactured goods.
.JliBBUILJL

120 GATT May 1987

In services trade, the important barriers are not tariffs and quotas.

For this sector, policies regarding immigration, investment, currency controls, and regulation loom much larger. Nations often establish policies in

these areas for reasons other than commercial advantage. Hence, efforts to

liberalize trade in services may reach into other fields of activity, and

improvements may come very slowly. This chapter provides an overview of

some of the important service sector issues. !/

DEFINING SERVICES

The definition of a service is elusive. The service sector includes all activities bought and sold in the marketplace that do not involve tangible goods,

but it also includes some activities associated with the production of tangibles, such as a consultant's report or a movie. Historically, the collection of

statistics on the service sector treated it as a residual category encompassing all output not produced in the merchandise sectors: agriculture, mining,

manufacturing, and structures.

A distinguishing feature of most services is that they are usually sold

directly by the producer to the consumer, and are not traded over long

distances--examples being haircuts, auto repairs, and dining. ~/ Another,

related feature is that services are commonly produced and consumed simultaneously, and cannot be stored--for example, an airplane flight or a banking transaction. Yet neither of these features is definitive; some goods

share these characteristics, but not all services share them. In short, the

distinction between services and goods is somewhat arbitrary.

Most goods and services have a component of the other in their production processes. Thus the production of steel requires services such as

transportation, engineering, and marketing. Only services traded in markets

1. The discussion treats services genetically. Little attempt is made to deal with many

of the issues that are unique to specific service industries. Yet, negotiations will

necessarily have to take into account both the generic and specific impediments to trade.

2. See Jagdish Bhagwati, "International Trade in Services and its Relevance for Economic

Development," 10th Annual Lecture of the Geneva Association, 1985. For further

analysis of how services and goods may differ, and their implications for international

trade, see the same author's "Economic Perspectives on Trade in Professional Services"

(March 1986, processed) and "Trade in Services and the MTN" (November 1986,

processed).
Chapter VI TRADE IN SERVICES 121

(that is, purchased from outside a firm or individual household) are counted

as such in government statistics; services performed "in-house" are not distinguished from goods production. Generally, the important traded services

are: travel, transportation, tourism, and leisure; professional business; construction-engineering; telecommunications; information and data-processing; and finance and insurance.

It is generally agreed that the data system for international trade in

services is inadequate and that more current, detailed, and comprehensive

data are needed in both the public and private sectors. ?_/ The Commerce

Department divides data on trade in international services into two broadly

defined catagories: "business services" and "other services." Business services are dominated by transportation, travel, tourism, and leisure services,

and include activities that are provided to foreigners by domestic firms,

whether in the United States or elsewhere. The second Commerce Department category, "other services," encompasses interest, profits, and dividend

remittances from foreign affiliates to parent firms. "Other services" also

includes repatriated profits of domestic firms' foreign manufacturing facilities as well as dividends paid to domestic owners of foreign common stock.

Thus it is difficult to determine how much of these "other services" actually

come from service activities, and how much is a return on past manufacturing investment.

RECENT TRENDS IN SERVICES TRADE

In 1985 the net balance of trade in services was in surplus by $21.8 billion

(see Table 13). I/ This figure, however, was dominated by a net surplus of

so-called "other services"--predominantly a return on past investment--of

$21,4 billion. The category of "business services" showed a positive balance

of about $0.3 billion.

4. Efforts are under way in the Executive Branch to improve services trade data, in

accordance with the Trade Act of 1984 (Public Law 98-573).

5. Data in this section are based on U.S. Department of Commerce balance of payments

data. The Office of Technology Assessment (OTA) has reestimated U.S. service trade

data, and concluded that federal balance of payments statistics significantly

underestimate both exports and imports of services. According to OTA's midrange

estimate, 1984 services trade may be understated in official statistics by about $12

billlion. For alternative approaches to improving services trade statistics, see Office

of Technology Assessment, Trade in Services (Special Report, 1986).
122 GATT May 1987

As seen in Table 14, from 1975 to 1981 service exports expanded from

$48.6 billion to $138.7 billion, while rising as a share of total exports from

31.2 percent in 1975 to 36.9 percent in 1981. In 1985, service exports

equaled about 40 percent of total export earnings. Similarly, service

imports rose rapidly between 1975 and 1981, and have more recently leveled

off at just under 27 percent of total imports. These trends allowed for a net

surplus in the U.S. balance of trade in services, with net U.S. service

receipts peaking at $41.7 billion in 1981 (see Table 13).

The fall in net services trade is largely the result of a decline in

business services, which decreased from $9.6 billion in 1981 to $0.3 billion in

1985 mainly because of greater imports of travel and transportation services. Investment income receipts, although falling by about one-third from

1981 to 1985, now make up almost 99 percent of the total service surplus. If

present trends continue, a service trade deficit is likely.

The Office of Technology Assessment (OTA) recently released an

important reestimate of services trade data. This estimate expanded both

the base of reported transactions and the level of industry detail. The report

found that:

TABLE 13. NET BALANCE OF TRADE IN SERVICES

(In millions of dollars)

Category 1981 1982 1983 1984 1985

Business Services

Travel and fares

Other transport

Fees and royalties

Other services

9,631

58

86

6,633

2,854

8,764

-1,599

607

4,558

5,198

6,421

-4,595

-9,632

4,502

6,146

2,190

-7,570

-1,023

4,583

6,200

338

-9,172

-1,956

4,976

6,490

Other Services

(Includes investment) 32,111 27,465 23,535 16,023 21,408

Total 41,742 36,229 29,956 18,213 21,746

SOURCE: U.S. Department of Commerce, Balance of Payments Accounts.
Chapter VI TRADE IN SERVICES 123

o The current system of reporting services in the balance of payments is subject to large errors. Business service exports for 1984

were reported by the Commerce Department to be $43.8 billion,

but may have been over twice that amount, between $69 to $91

billion by OTA's estimates.

o Trade in services has made a significant positive contribution to

the U.S. balance of payments. Official statistics show the U.S.

with a net surplus of business service exports of $2.3 billion in

1984, while OTA estimates this surplus at about $14 billion.

o Sales of services in foreign markets by the overseas affiliates of

U.S. firms exceed direct exports of services. Thus, any examination of total services trade must consider both direct sales and

sales through investment.

o The leading services exported directly from the United States

were transportation, travel, construction, and licensing. Leading

service imports were in transportation, travel, and insurance.

o The domestic output of most U.S. service industries far outstrips

foreign sales, and in many cases a few large firms earn the dominant share of export earnings.

CURRENT PROBLEMS IN INTERNATIONAL SERVICES TRADE

Merchandise exports are generally produced in one country and consumed in

another. In contrast, service exports may be consumed in either the exporting or importing country. Thus, foreigners' purchases of domestic hotel and

tourist services are considered exports, and sending workers temporarily to

a foreign location to provide a service is also an export.

In goods trade, the tangible product is usually counted (and may be

restricted) as it is transported over national boundaries. In services trade,

on the other hand, there is often no tangible output to exchange, thus limiting a government's ability to restrict imports. Rather, a service is

performed and exchanged over international boundaries in one of the

following ways:

o Cross-border transactions, in which services are transferred from

one country to another. This includes the transmission of voice,

video, data, or other information, and the transportation of passengers and goods.

1 l
124 GATT May 1987

o Cross-border transactions, in which services are transferred from

one country to another. This includes the transmission of voice,

video, data, or other information, and the transportation of passengers and goods.

o Contractual arrangements granting rights to use intellectual

property and franchises, including transmission of patents, trademarks, films, and broadcast and recording rights.

TABLE 14. U.S. EXPORTS AND IMPORTS, SELECTED YEARS

(In billions of dollars)

Category 1975 1980 1981 1982 1983 1984 1985

Exports

Merchandise 107.1 224.3 237.1 211.2 201.8 219.9 214.4

Services 48.6 118.2 138.7 137.5 131.5 140.2 144.1

Total

Percent of Total

Merchandise

Services

Merchandise

Services

Total

Percent of Total

Merchandise

Services

155.7

68.8

31.2

98.2

34.6

132.8

73.9

26.1

342.5

65.5

34.5

249.8

83.2

333.0

75.0

25.0

375.8

63.1

36.9

Imports

265.1

96.9

362.0

73.2

26.8

348.7

60.6

39.4

247.6

101.3

348.9

71.0

29.0

333.3

60.5

39.5

268.9

101.5

370.4

72.6

27.4

360.1

61.1

38.9

332.4

122.0

454.4

73.2

26.8

358.5

59.8

40.2

338.9

122.3

461.2

73.5

26.5

SOURCE: U.S. Department of Commerce, Balance of Payments Accounts.
Chapter VI TRADE IN SERVICES 125

In-migration, providing services to foreigners who are temporarily

residing in the exporting country. These include hotel accommodations and meals, education, and medical treatment.

Out-migration, or travel of individual producers to an importing

country. This includes services provided to foreign clients by business consultants, engineers, lawyers, and so forth. Many of the

services transacted in this manner are provided through foreign

affiliates, either by choice or to circumvent barriers to direct

imports.

Barriers to Trade in Services

For the government that wants to protect domestic service firms from

foreign competition, the particular means of trade used by various service

providers create both obstacles and opportunities for action. Although they

may not be directly aimed at limiting imports, the most common barriers

that restrain trade in services include restrictive regulations and standards,

employment rules such as citizenship and residency requirements, investment-related rules such as right-of-establishment requirements and operating/ownership restrictions, foreign exchange and credit controls, and

inadequate protection for intellectual property. The following sections

discuss how these barriers are used to block trade for each class of service.

Cross-Border Transactions. Cross-border transactions are conducted in

much the same manner as goods trade except that the movement of goods,

passengers, or messages in itself constitutes the service traded. Thus,

cross-border transactions provide the widest scope for protective government actions, and at the same time for government agreements to limit or

define acceptable restrictions. Trade in the telecommunications and transportation industries, for example, is generally limited by government regulation, and the rights of firms to engage in cross-border transactions are generally established in bilateral treaties between countries.

Many of the services included in cross-border transactions—notably

communications and transportation-enter markets where there are longstanding government interests and regulations. Domestic transportation and

communication systems in most countries are either controlled or owned by

the government, and foreign firms are generally prohibited from providing

domestic services. In many instances, regulations and restrictions are

designed to achieve certain social goals such as national security or to bring

about economies of scale, rather than merely to shield public communication monopolies from international competition, although this may also be a

'nun
126 GATT May 1987

factor. In some cases, regulations are justified by the need to limit the use

of scarce resources and provide for public safety.

Some services are already regulated in international commerce. For

example, the rights to transport people and goods are established by

bilateral international agreements. Frequently, these agreements limit the

routes that can be operated between the two countries. They also often

place limits on the number of carriers that can operate between the countries and give governments the ability to regulate fares. Foreign carriers

are generally prohibited from providing domestic transportation, and severe

restrictions are placed on a carrier providing transportation between two

foreign points. Additional restrictions are sometimes placed on foreign

airlines operations. These include requiring airlines to use existing baggagehandling facilities and to assure nondiscriminatory access to the domestic

carriers' reservation systems.

Contractual Agreements. Contractual arrangements generally involve intangible output in the form of ideas and know-how, although leasing of film,

broadcast, and recording rights is also included. The common characteristic

shared by these services is that they are transmitted internationally through

legal arrangements.

Many of these arrangements involve intellectual property. Many U.S.

firms complain that they are accorded inadequate copyright and trademark

protection in other countries. §/ This problem arises mainly with newly

industrialized countries such as Korea, Brazil, and Singapore. §/ Several of

these countries are not members of either the Universal Copyright Convention or the Berne Convention, so foreign firms are not automatically

protected against piracy and counterfeiting in these countries. 1j

While copyright infringement is not a barrier to trade in and of itself,

it amounts to a loss of exports. For example, the U.S. publishing industry

estimates that 1984 sales of unauthorized copies of books and technical

journals in Korea were approximately $70 million, while authorized imports

were only $5 million to $8 million. §/ The United States recently signed a

5. See Chapter III on high-technology trade.

6. Office of the United States Trade Representative, National Trade Estimate: 1986 Report

onForeign Trade Barriers, pp. 35,171,227.

7. The United States abides by the Universal Copyright Convention, but not the Berne

Convention. See Chapter III.

8. Office of the United States Trade Representative, National Trade Estimate: 1986 Report

onForeign Trade Barriers, p. 171.
Chapter VI TRADE IN SERVICES 127

bilateral agreement with Korea that will protect American firms against

trademark and patent violations and open Korean insurance markets to U.S.

firms. Despite heavy lobbying efforts on the part of the computer manufacturing industry, the agreement did not cover the computer software industry. It allowed Korea to enact a separate law covering computer software

that is expected to be consistent with copyright protection.

Similarily, adequate trademark protection is essential to businesses

involved in franchising. Franchisors frequently have difficulties conducting

business in a country if their emblem or organization symbol has been

previously registered as a mark in that country. Private registration

effectively limits foreign access to domestic markets. Franchisors may also

run into ownership or foreign investment restrictions, and regulations

restricting the repatriation of profits.

Motion pictures or television are often leased for transmission in foreign countries. These services also embody a form of intellectual property,

and at the same time face some unique barriers because of characteristics

they share with goods. They may enter countries much as do goods, and may

in fact be embodied in goods. A movie or television show that entered a

country on film or videotape would be a good, but if it entered only for

lease, the leasing of it would be considered a service. One that entered via

satellite transmission would also be a service.

The close connection between motion pictures and goods trade is

emphasized by the fact that the GATT (in Article 4) explicitly recognizes

that countries may regulate foreign films, and maintain quotas on them. It

limits such regulations to screentime quotas that may require a certain

percentage of films exhibited to be of national origin. Such quotas, which

are used by many countries to limit the showing of American movies and

television shows, are open for negotiation or limitation under the GATT.

In-migration and Out-migration. As previously noted, most services require

interaction between provider and consumer. Some services involve the

movement of people across national borders. In some far-flung service

industries, such as computer consulting and engineering, local on-site offices

are necessary to provide the service. These service industries face a unique

set of barriers.

Services traded through in-migration primarily provide travel, tourism,

and educational services in which the consumers travel to the exporting

country. Domestic firms face minimal, if any, trade restrictions on these

kinds of services.

BHIl
128 GATT May 1987

Services traded through out-migration, such as accounting and engineering, are provided by professionals with special expertise who must be

present wherever the service is marketed. Thus, primary barriers to trade

serve to restrict the ability of producers to set up professional practice in

the importing country. Typical barriers include the requirement of work

permits for professional and technical personnel; the stipulation of minimum

percentages of local employees; hiring restrictions or quotas; and citizenship

or licensing requirements for foreign engineers, lawyers, and other professionals. Other more rigid barriers such as outright bans or quotas are

enforced by some countries in specific industries. For example, American

lawyers may not open law offices in Japan or consult indirectly on American

or international law through existing Japanese law firms. £/ In Brazil all

foreign firms providing technical services, particularly in construction, are

barred unless it can be shown that no Brazilian firm is able to perform the

equivalent service. Moreover, all technical service contracts in Brazil must

be approved by the Industrial Property Institute, where substantial delays

are typical.

More generally, firms relying on out-migration may encounter national

policies restricting migration, investment, and conversion of currency.

Investment and right-of-establishment laws are important barriers because

they require providers of many services to establish local facilities in order

to compete. Immigration laws must be reckoned with because a company

needs people familiar with its operations to staff these facilities initially

and to train local labor. Finally, a firm must be able to repatriate its

earnings, which will bring it up against currency control provisions.

According to the Office of Technology Assessment report cited above,

over half of all service export earnings come from sales through foreign

affiliates. In 1983, for example, nonbanking business services produced by

U.S. firms (domestic or affiliates) were estimated by OTA to be in the range

of $152 billion to $169 billion. Affiliate sales were estimated at $87.5 billion to $97.3 billion; direct exports were an estimated $61 billion to

$75.1 billion. Services in which affiliate sales bulked largest were: account9. In May 1986, Japan approved legislation to open its system to foreign lawyers on April 1,

1987. The effectiveness of the new law remains to be seen. Loc. cit., p. 157.

10. Recently, grievances of this nature have also been expressed with respect to Japan.

The U.S. Trade Representative's Office is pressing an unfair trade practice case against

the Japanese for denying U.S. firms an "opportunity" to bid on an $8 billion airport

construction project in Osaka. According to administration officials, Japanese

procurement practices have totally excluded U.S. firms. Ibid.
Chapter VI TRADE IN SERVICES 129

ing, advertising, data processing, engineering, insurance, investment banking/brokerage, leasing, and retailing.

Exisiting U.S. Agreements

At present, there is no comprehensive and coherent system of rules governing both service trade and investment. Various sectoral agreements,

mechanisms, and organizations exist that govern trade on a bilateral or

multilateral basis. Many of these are specific in nature, regulating trade

between partners in a particular industry. Others are more inclusive, providing standards of treatment with respect to the establishment and operation of foreign business partnerships in various industries. Existing U.S.

investment agreements tend to be of the latter nature: multisectoral and

bilateral. In contrast, U.S. service trade agreements tend to be unisectoral

and multilateral.

The broadest and longest-standing of bilateral agreements are the

Treaties of Friendship, Commerce and Navigation (FCN). These were

designed to establish a framework for mutually beneficial economic relations between two countries, and emphasize investment issues such as the

right of establishment. Currently, the United States is party to FCN-type

treaties with 43 nations, most signed in the late 1960s.

More recent are the Bilateral Investment Treaties (BITs), which cover

investment issues in four main areas: national and most-favored-nation

treatment for investors; standards for compensation in the event of expropriation; provisions for the transfer of profits and other funds associated

with investments; and procedures for settlement of disputes. ±±J BITs generally apply to all industries in the merchandise and service sectors, but

usually include escape provisions for exceptional industries. To date, the

United States has signed such treaties with three countries-Panama, Egypt,

and Senegal~and has reached preliminary agreements with Haiti and Costa

Rica. Negotiations are under way with 11 other countries.

Bilateral agreements applying only to U.S. service trade are few and

involve specific industries requiring special equipment or facilities for conveying services from one country to another. These agreements are

designed primarily to ensure technical and regulatory compatibility in industries such as aviation, shipping, and telecommunications.

11. These treaties were discussed in a study submitted to GATT by the U.S. government,

U.S. National Study on Trade in Services, p. 41.
130 GATT May 1987

Agreements in service trade are for the most part multilateral, and

operate through international bodies and organizations. All such agreements

are sector-specific. In several industries more than one agreement is necessary to cover adequately all the issues involved in trading that service.

On a more informal level, the Organization for Economic Cooperation

and Development (OECD) has attempted to liberalize trade in services and

investment through its Code of Liberalization of Current Invisible Operations and its Code of Liberalization of Capital Movements. Both codes

commit members of the OECD to abolish restrictions on long-term capital

flows and barriers to invisible transactions and transfers, although neither

code is strictly enforceable. The Invisibles Code applies explicitly to only a

limited set of service industries, although most others are indirectly

covered. For instance, education and franchising are not explicitly listed

but many aspects of both are covered under generic headings such as profits

remittances. Moreover, both the Invisibles Code and the Capital Code lack

provisions regarding issues of consequence to service trade such as the right

of establishment, the right to conduct business, and national treatment.

Although these topics are expected to be incorporated into the Capital Code

shortly, as of now it is mainly concerned with capital flows for both

manufacturing and services.

BARGAINING POSITIONS IN THE URUGUAY ROUND

The United States has been the leading advocate of negotiations to expand

the GATT to cover services. The European Community and Japan favor this

in principle, but have been reluctant and unsure. Third-world countries have

been opposed to discussing services liberalization because they see little

gain in such negotiations.

The European Community

The governments of the EC began only recently to recognize services as an

integral part of their economies, and to appreciate the importance of the

financial and tele-informatic sectors to future growth. They have already

engaged in multilateral talks, both among themselves and with the United

States, to liberalize certain aspects of services trade. The OECD codes and

the numerous bilateral investment treaties are the results of such talks.

The EC agrees with the United States, in principle, that the GATT

should cover services, but has not taken a firm stance on specific conceptual
Chapter VI TRADE IN SERVICES 131

issues such as whether agreements should cover all services or only specific

subindustries such as insurance, banking, and telecommunications. To some

extent, its negotiating position seems to be a response to that of the United

States: if the United States has so much to gain by services liberalization,

the European Community may have a lot to lose and therefore has reason to

proceed cautiously.

The EC has indicated, however, a willingness to reduce present quantitative restrictions on some Japanese goods if the Japanese make reciprocal

concessions in insurance, finance, and management consulting. This offer

has also been extended to several of the newly industrializing countries.

The Japanese also appear to support the notion that GATT should include

services, but are reluctant to seek any change in the status quo because of

the concessions that will be required. They have experienced very rapid

growth in recent years in the financial services sector, and might gain from

an agreement specifically targeted at financial services. But they have

been hesitant to push toward any specific position on services generally,

appearing to want to wait and see what kinds of tradeoffs may be involved.

Developing Countries

The developing countries are opposed to including services in the next

round, l^/ A frequently stated position is that the existing merchandise

agreement has been a failure in many ways, and efforts should be made to

strengthen it before expanding its coverage. Underlying this is the belief

that the developing countries have little to gain and much to lose in services

negotiations, since they do not have service industries that are sufficiently

developed to be competitive in a world market. Significant reductions in

their service barriers would open their domestic markets to foreign penetration. The governments of these countries face strong political and cultural

pressure to protect vital domestic service sectors, such as banking, telecommunications, and professional services.

12. As with nearly all issues, the developing countries are not likely to put forward a

unanimous position. Some, such as Singapore and Hong Kong, may be agreeable to

developed-country positions; most, however, will oppose them.

IHHI
132 GATT May 1987

Moreover, the developing countries have little confidence that the

industrialized countries will open their markets significantly in sectors such

as textiles and steel, or even in labor-intensive services such as agricultural

fieldwork or construction where developing countries may have a comparative advantage. They fear that negotiations over services could end in an

agreement linking services trade to goods trade in such a way as to allow

developed countries to retaliate against developing countries' goods exports

in response to what are perceived as barriers to developed countries' services exports. In short, they see themselves losing in services negotiations

because this is an area in which they are not competitive, and in which they

may be penalized by the developed countries if they try to become so.

IMPLICATIONS OF LIBERALIZED TRADE IN SERVICES

A liberalization of trade in services would involve costs as well as benefits

to the United States. For example, an increase in service exports would

require domestic firms to hire foreign factors, so that the gains to the U.S.

balance of trade might be substantially less than the increase in gross overseas sales. Also, relaxing barriers to service trade could invite a substantial

increase in the services offered by foreign firms in the United States. Freer

trade in services would be likely to require adjustments in U.S. rules

regarding immigration, investment, currency conversion, and other forms of

commercial regulation. This section examines some implications of trade

liberalization in services.

Expansion of Services Trade

In general, the benefits to the U.S. economy from trade liberalization would

be the same for services as for goods: the realization of greater efficiency

through specialization in areas of comparative advantage. Since many

service industries employ the same resources--notably, specialized labor

and capital--that have sustained U.S. competitiveness in other products, and

because many U.S. service firms already dominate international markets, it

is reasonable to assume that some of these industries would expand under a

liberalized trade regime. Such services include (among others): most of the

highly skilled professional and business services, air transport, telecommunications, and financial services.

Liberalization would allow service firms to expand more rapidly than

they would otherwise; it would also draw more new firms and resources into
Chapter VI TRADE IN SERVICES 133

the service sector. As a result, the U.S. economy would become even more

service-oriented than it is now. In the past decade, over 90 percent of new

job growth has been in the service sector. Under trade liberalization,

service firms would also have greater access to the capital neccessary to

sustain their growth.

Some of the growth in the service sector would be a net addition to

the economy, but some would be at the expense of goods production. Goodsproducing industries, however, might also receive ancillary benefits to the

extent that they are tied closely to service output. Such industries include

those supplying the service sector with computers, aircraft, telecommunications equipment, and the like, and those having tie-ins to services, such as

producers of industrial equipment that U.S. engineers and other business

consultants may recommend or prefer to use when they operate overseas.

Moreover, many diversified firms have direct links between their service

and manufacturing activities, resulting in joint sales.

Removal of service trade barriers might not, however, be as beneficial

for the U.S. economy, or even for certain service industries, as at first

appears. In cases where services are traded through out-migration, particularly where investment is a necessary requirement of doing business, much

of the gain from trade leaks to the importing country. This is because

service production tends to rely more heavily than merchandise production

on local factor inputs, notably labor. Employment data based on U.S.

investment overseas indicate that foreign subsidiaries of U.S. firms predominantly rely on local rather than U.S. labor. 1$J

Thus removal of service trade barriers might not benefit the U.S.

economy as much if liberalization led U.S. firms to increase sales through

overseas affiliates rather than through direct exports. This could occur if

trade negotiators focused on liberalizing investment regulations but failed

to make progress on issues such as immigration rules or other regulations

that are closely tied to direct cross-border transactions.

Moreover, liberalization would offer foreign firms a more favorable

climate in the United States, where many obstacles to foreign penetration

of service fields now exist. For example, liberalization would imply a relaxation of immigration laws to allow freer access for foreign producers to

13. Although data were only available for majority-owned nonbank affiliates, it is highly

probable that affiliates that are not majority-owned also hire fewer U.S. citizens than

majority-owned affiliates. Department of Commerce, U.S. Direct Investment, 1982

Benchmark Survey Data, p. 251.
11BUIU1

134 GATT May 1987

U.S. markets. In that case, construction firms in low-wage countries might

find it easier to bid on domestic construction projects. Similarly, foreign

accountants might be able to provide basic bookkeeping and auditing functions more cheaply than domestic firms. Significant increases in service

imports might result, given the large supply of both skilled and unskilled

workers from more populous developing countries who would be able to earn

higher wages in the United States than at home.

Liberalization of trade rules for services may raise issues of federalism. State governments are responsible for regulating and licensing many

service activities, particularly in such fields as banking, accounting, insurance, and legal services. The federal government may not be able to

negotiate binding international agreements governing trade in these areas

without impinging upon traditional state authority. U.S. trading partners

are certain to want clarification of the issue of federal-state authority over

services before joining in agreements.

Strategies to Include Services in the GATT

When the GATT was drafted at the end of World War II, services were not

seen as important in international commerce. Negotiations focused instead

on lowering the primary barriers to goods trade: on multilateral tariff

reductions, quota restrictions, and dumping regulations. Consequently, with

the single exception of the motion picture industry, GATT rules do not apply

explicitly to service industries; they extend to them only insofar as services

are involved in the production or trade of goods.

GATT could be altered in several ways to include the service sector.

First, the existing rules and principles governing goods trade could be

applied to services trade in their existing form--that is, by counting all

practices that violate GATT in goods trade as violations in service trade.

Dispute and settlement procedures designed to address unfair practices in

goods trade would apply in the same manner to services trade. This option

would not require elaborate negotiations; it would take advantage of the

existing binding, contractual nature of GATT provisions. Only matters

pertaining to services, such as investment and immigration, would have to

be added to the GATT provisions. On the other hand, many GATT provisions

are not directly applicable to services trade, and would not adequately deal

with unfair trade practices. Moreover, use of the existing GATT provisions

would probably not affect all countries equally, giving some an incentive to

evade the rules.
Chapter VI TRADE IN SERVICES 135

Another approach would be to address services trade on an issue-byissue basis through dispute-settlement procedures similar to those currently

in place in the GATT. Complaints concerning unfair trade practices in

services would then be addressed under GATT auspices, leaving the other

existing agreements and treaties in force. This approach would enable the

GATT to deal with the service sector a bit at a time, addressing each specific industry separately. Given the varying prospects for growth in different service industries, many people believe this is a much more practical

approach and one that would hasten negotiations tremendously. Its primary

drawback is that it would not create a unified, comprehensive services trade

policy that would be viable for years to come. Moreover, it would

overburden an already inadequate dispute settlement process.

Finally, a new service-oriented set of rules and procedures could be

designed and negotiated under the GATT framework. This option would be

viewed by many negotiators as too radical and costly, requiring long negotiations and research. They would argue that current grievances need to be

addressed in a timely manner, rather than waiting for a whole new set of

rules. Proponents believe, however, that existing GATT articles cannot be

directly applied to service industries as a whole, for conceptual reasons.

Negotiating a service-oriented set of articles would extend to that sector

the basic tenets embodied in the GATT, and would make them binding upon

all parties.

irmnm
IIIIIIIBIIIIIIllllll