Trump has shifted the trade paradigm — for the worse

With The 2016 ascendancy of President Donald TrumpDonald John TrumpProsecutors investigating Trump inaugural fund, pro-Trump super PAC for possible illegal foreign donations: NY Times George Conway: Why take Trump's word over prosecutors' if he 'lies about virtually everything' Federal judge says lawsuit over Trump travel ban waivers will proceed MORE, America’s decades-old free-trade model collapsed. While Trump made it clear he wanted to do away with “terrible” agreements, what would we replace them with?

Under successive Democratic and Republican presidents, the U.S. negotiated dozens of free trade agreements (FTAs) and new versions of the global World Trade Organization (WTO).

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The idea of these agreements was to bring down trade and investment barriers, creating opportunities for American commerce that would supply the world with goods and services supplied by a growing and prosperous American workforce.

Since the basic framework was well-established, U.S. trade negotiators were able to draft new agreements by simply tweaking the text of previous agreements. 

With the successful completion of the U.S.-Mexico-Canada Agreement (USMCA), U.S. officials have stated that USMCA will be the model for a “new paradigm” in trade policy, to be emulated in possible deals with Japan, the Philippines, some African countries, Vietnam and others.

It updates labor protections, digital trade rules, intellectual property protection and provides better access to Canada’s dairy market. Moreover, in both content and strategic purpose, USMCA signifies a major change of course. 

USMCA’s emphasis is on “balanced” and “reciprocal” trade, not free trade or open markets. The U.S. is clearly targeting the trade deficit. Gone is the old paradigm’s emphasis on creating opportunities for U.S. commerce, with companies free to choose how best to allocate production and trade flows.

The old paradigm held an implicit belief that what was good for American business was good for America and American workers. The "New Model Trade Agreement" seeks to rein in the tendency for U.S. companies (who have morphed into multinational corporations) to outsource production to countries with low wage costs.

What’s good for General Motors is not always good for American workers, and the New Model Trade Agreement serves as a counterweight to U.S. companies that outsource and downsize U.S. production. 

As a prime example of this new emphasis, the USMCA breaks with the old trade paradigm by imposing local content requirements, albeit by a different name. The agreement stipulates that motor vehicles benefitting from the agreement’s terms must be produced with a minimum of 75 percent from a high-wage area, i.e., the U.S. or Canada.  

Since this provision originated when the agreement was being negotiated solely with Mexico, it is clearly aimed at ensuring that a large percentage of motor vehicle production be done in the U.S. versus Mexico. This takes aim at Mexico’s key comparative advantage in trade — a relatively low-wage workforce.

In both function and intent, this provision is the equivalent of a local content requirement, which is illegal in most cases under WTO rules. The high-wage provision certainly transgresses the spirit of WTO rules, and it may transgress the letter of them.

Since the USMCA presumably will have to receive a most favoured nation (MFN) waiver from the WTO, it is an open question whether WTO members will challenge this thinly veiled departure from a basic WTO tenet.

We should not be surprised if this high-wage provision recurs in future trade deals negotiated by the Trump administration as a way of mitigating outsourcing to low-wage countries.

We may also see a revival of trade mechanisms that were popular prior to the 1980s: product specific import quotas, tariff rate quotas and so-called “voluntary restraint arrangements” on specific products that threaten to “unbalance” bilateral trade. 

The biggest surprise of the agreement is the requirement that any USMCA country must notify the other countries of its intent to negotiate a free trade agreement with a non-market country (read China).

Entry into a free trade agreement with China allows one or both of the other countries to then terminate the USMCA. This highly unusual provision presents obstacles to USMCA countries negotiating broad trade agreements with China. 

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It remains to be seen if our trading partners will find the New Model Trade Agreement an attractive proposition. For developing economies whose only comparative advantage is a highly affordable and available workforce and a desire to lift themselves out of poverty, the new model is problematic because it largely disallows that comparative advantage.

The new model basically rules out the post-war development strategy adopted by Japan, Korea and a host of others. Developed economies will find the new model less objectionable, but many may hesitate to restrict their future relations with unrelated countries like China.

While it may reduce the trade deficit somewhat, the New Model Trade Agreement is likely to slow the pace of world trade growth, and it signifies a stepping back from the highly successful post-WWII American-led project of fostering economic growth and reducing poverty through the creation of a global market.

Michael Delaney is a trade policy consultant for TransNational Strategy Group, a commercial, economic/political and policy consultancy providing services to private sector and sovereign government clients. Previously, Delaney served as a State Department foreign service economic/commercial officer for 30 years.