March 1, 2011

Lost Horizons

While the rest of the world has cobbled together new, growth-oriented supply chains, the United States has ignored trade agreements and lost valuable time.

Caterpillar Inc. makes giant mining equipment in Decatur, Illinois, for customers in Colombia. Sweden's Volvo Group makes giant mining equipment in Pederneiras, Brazil, for sale to Colombian mine operators.

Comparing design features of the biggest off-highway trucks and motor graders can be complex, but one distinction is quite simple: the $200,000 price advantage to the manufacturer that doesn't face Colombia's 10% tariff on an item worth $2 million.

Manufactured goods from the United States face the Colombian tariff wall. The same goods from Brazil do not, thanks to a free trade agreement (FTA) between Brazil and Colombia that dates back to 1980. President George W. Bush signed an FTA with Colombia in 2006, but the deal is held up in Congress along with similar agreements yet to take effect with South Korea and Panama.

What's more, while the appetite for FTAs has quieted in the United States, it has accelerated elsewhere around the world during the last decade. What's now at risk, say critics of U.S. complacency, is the relevance of the United States in global trade, the opportunity to expand our own economy and jobs through expanded exports, and the opportunity to build a modern supply chain formed with high-growth economies around the world.

“American exporters are at a disadvantage,” says Bill Lane, Washington, D.C., director for Caterpillar and a veteran trade lobbyist. “We need to take exporting seriously, and one of the key elements of that is making sure markets are fully open to American products.”

With $874 billion of exports of manufactured goods in 2010, up from $743 billion last year, per the U.S. Census Bureau, the United States is the third-largest exporter of manufactured goods, behind the European Union (EU) and China. But in 2009, the last year comprehensive statistics are available, the United States' share of world exports and imports of manufacturers goods declined to 9.6% from 13.8% in 2000. In the same period, the share of world manufacturing exports expanded in the EU, China, India and South Korea.

U.S. manufacturing exports grew at just a 2% annual rate in the 2000-2009 period, compared with 20% in China; 14% in India; 8% in South Korea; and 7% in the EU. Despite its top-tier rank as an exporter, the United States is well behind in the export growth fight as one of its weapons, FTAs, remains stuck in the quiver.

“By taking a time-out on trade, our trade policy has been that we are giving our competitors a competitive advantage in important export markets,” Lane says, reflecting the viewpoint of American business, the Obama administration and an increasing number of members of Congress. Still, “our biggest frustration is that when it comes to opening foreign markets, there is no sense of urgency” in Washington, Lane says.


The Big Deals

FTAs are bilateral or regional compacts to boost market access by reducing tariff and non-tariff barriers to imports and exports between the participating nations. They aren't treaties, and they require authorization by both houses of Congress to take effect. Trade among nations happens regardless of whether an FTA is in effect. But if goods from multiple nations are competing for the same markets, those that originate in nations that are partners via a trade agreement have an advantage that those from other nations do not.

The last completed free trade agreement by the United States was with Peru in February 2009. But since then, the rest of the world hasn't been standing still. Twenty FTAs have been implemented by other nations since February 2009, including deals by China, the EU, India, Japan, Canada and South Korea. Counterparties include high-growth nations in Asia and Latin America.

Overall, more than 250 FTAs have been registered with the WTO, with only 11 involving the United States. The Business Roundtable estimates that 50% of global economic product is covered by FTAs. The 11 U.S. FTA partners represent only 7.5% of global economic output but account for 42% of U.S. exports, says the International Trade Administration of the U.S. Commerce Department.

By comparison, FTAs in place with the EU cover 70% of European exports, including the EU's free trade agreement among 27 nations. And there's more to come as the EU implements proposed trade deals with Korea, India, Canada and Ukraine, say the Congressional Research Service and the WTO. Existing EU exports with free trade partners account for $3.4 trillion in value annually, compared to $520 billion in U.S. exports to free trade partners, the research service reported.

“The threat of falling behind is significant, especially with countries where we compete head-to-head for manufactured products,” says Doug Goudie, director of international affairs policy for the National Association of Manufacturers (NAM). “Europe continues to cherry-pick the most promising economies.”

For example, South Korea, where the economy grew by a robust 6% last year on an inflation-adjusted basis, already has FTAs with India and several Asian nations. The EU has implemented an FTA with South Korea, giving European exporters a head start if Congress fails to follow suit quickly. Congress and the Obama administration often appear to be on the same page regarding the value of FTAs and the threat of losing the global race to sign FTAs. Pro-trade lobbyists in Washington say first-term Republican members of Congress tied to the Tea Party movement are generally pro-trade. Democratic opposition remains, much of it motivated by opposition to FTAs by organized labor, but it has not widened.

The story of Washington's current deliberations over FTAs as the favorite, but by no means the only, solution for expanding trade includes a complex history, a mix of political and economic motivations, an intricate set of indisputable benefits, frustrating costs and an uncertain future.

FTAs seem to be win-win arrangements for all sides simply through increased commerce across borders. But, say critics, the case for FTAs as a contributor to economic growth and business profitability can be overstated.

 For major industrial countries, they say, FTAs offer, at best, a marginal boost to international commerce. At worst, they divert business planning and public policy debates from a more substantial source of trade benefits. Multinational companies are developing, with the aid of governments all over the word, global chains of commerce that maximize innovation, efficient production and large-scale marketing. National borders play little if any role in this process, in which the multinationals can, and often do, act almost like sovereign entities in their negotiations for competitive advantage.


A History of Trade Growth

Since World War II, FTAs among particular nations have proliferated, even as trade negotiators implemented multinational agreements, notably the 1947 General Agreement on Tariffs and Trade (GATT) and eight “rounds” of GATT amendments (most named for a locale of the talks, such as the Tokyo Round ended in 1979 and the Uruguay Round ended in 1994). The agreement creating the WTO was completed in 1995.  The Doha Round of the GATT, the latest attempt at an updated multinational agreement, has been under discussion since 2001 within the WTO, with no resolution in sight.

FTAs took a different path, although the WTO today recognizes most FTAs. In 1951, France, Germany, Italy, Belgium, the Netherlands and Luxembourg formed the first major FTA, the European Coal and Steel Community, to facilitate access across their borders to steel and coal. The organization evolved into today's EU, a broad FTA comprising 27 nations. In 1976, the EU organized a community of iron and steel producers, called Eurofer to help assert Europe's iron and steel trade relations with the rest of the world.

For the United States, Canada and Mexico, the greatest FTA is the hard-fought North American Free Trade Agreement (NAFTA), implemented in January 1994. The agreement encompasses $17.6 trillion of gross domestic product, compared with $14.9 trillion in the EU and $9.9 trillion in China, say Central Intelligence Agency estimates for 2010.

The United States is party to 10 other FTAs, with Australia, Bahrain, Chile, Israel, Jordan, Morocco, Oman, Peru, Singapore and six Central American nations in one agreement, the Central American Free Trade Agreement (CAFTA). CAFTA includes the Dominican Republic, Costa Rica, Guatemala, Honduras, Nicaragua and El Salvador. Together, the GDP of these countries totals $2.53 trillion. The combined GDP of South Korea, Colombia and Panama is $1.94 trillion, led by South Korea, with $1.47 billion.

Economics in Focus

Often, the economic benefits in lowering tariffs lie at the margin. But it can be an expensive margin, as the competition between Caterpillar and Volvo in the Colombia market illustrates. Colombia would be Caterpillar's biggest prize among the three pending trade deals in Washington, says Caterpillar's Lane. But Caterpillar, with a history of producing superb and innovative products, hasn't suffered unduly because of the lack of an FTA with Colombia. In the first nine months of 2010, Caterpillar sold $3.06 billion in machinery, including mining equipment, in Latin America, compared to $465 million in Latin American sales by Volvo's construction equipment division.

“We export seven times more product to Colombia than we do to Korea,” Lane says. “They have some of the largest coal mines in the world and they have an ambitious infrastructure program underway.”

Caterpillar isn't the only mining equipment maker with a stake in a U.S.-Colombia FTA. Tokyo-based Komatsu Ltd. makes its giant off-highway trucks in Peoria, as well, and has its own customer base
in Colombia.

But Komatsu, with $3.4 billion in construction, mining and utility sales in North and South America in the nine months ended Sept. 30, realizes that its sales of other mining equipment to Colombia might face a competitive disadvantage to Caterpillar. Most of Komatsu's super-size mining equipment is made in Japan, Germany and the United Kingdom, which do not have FTAs with Colombia.

“Except for super-large dump trucks made in Peoria, our other mining equipment might have a disadvantage compared to our competitors' products,” says a Komatsu spokesman.

Moreover, it's hard to argue that tariffs make or break most trade deals, especially for high-end manufactured goods. In his career as head of P&H Mining Equipment, a unit of Joy Global Inc., in Milwaukee, Mark Readinger sold a lot of mining equipment from his Wisconsin factory to Chile's mining companies. The implementation of a U.S.-Chile FTA in 2004 was good news but not a breakthrough.

“I can't say it had any noticeable impact on our company, only because when the economics are compelling for a buyer to go a certain way, they are going to do it. If there happens to be a favorable country trade policy, that's icing on the cake, but I don't recall anybody [at a Chilean mining company] mentioning that we're doing this because of the free trade agreement,” says Readinger.

Reflecting the view of many manufacturing executives, Readinger — now retired — says the engineered quality, safety and productivity of the equipment — attributes known as value-added — make the sale. “When something comes along that is going to reliably and predictably lower the cost of ton extracted, they will jump on the bandwagon.”

As Caterpillar and Komatsu can attest, a lack of FTAs doesn't block exporters, says William Reinsch, president of the National Foreign Trade Council in Washington. “We're not excluded; we're discriminated against,” he says.

And there's more than a marginal benefit on import taxes at stake. The FTA competition race is about who gets to deepen economic relations with high-growth nations first. The race is on. “Once you get customers switching suppliers because they've been given preference in a trade agreement, it can be tough to win them back even of you get your own free trade agreement later on,” says Douglas Irwin, a professor of economics at Dartmouth College and veteran scholar of trade relations.

Roy Samuelson, president of Paulson Manufacturing Corp. of Temecula, California, cites two additional benefits of FTAs. Samuelson, whose company posted sales of $13 million last year, has been successful in selling highly engineered safety headgear and body armor to industry, law enforcement and fire fighting agencies in 80 nations. But, “I have a broad spectrum of products that will come to bear in markets with FTAs,” he says. “What you're going to see is that buyers [in Korea, Colombia and Panama] will go from buying only the higher-technology or more difficult to obtain items to a broader spectrum of my safety equipment product line. The closer an item is to a commodity product, the more important the tariff becomes.”

A second economic incentive to win the race for FTAs, Samuelson says, concerns product standards in the target country. If the EU beats the United States to an FTA with Korea, “they are going to go in and get their standards written into Korean [regulations] as a way to keep everybody else out. They will get their rules and regulations in place, and we'll have another trade barrier.”

In this regard, Samuelson says, the “other side” in trade talks with emerging economies is not the emerging economy but the EU and other industrial powerhouses, each with their own FTA agenda.

But to exploit trade agreements as a buyer or seller, manufacturers new to the trade game face economic hurdles that might curb their enthusiasm. For example, a critical component of trade agreements are the so-called rules of origin. Rules of origin are complex. They are designed, in brief, to prevent a company from importing goods from a low-cost country and selling the goods to a free trade partner, even though that partner has no preferential agreement with the actual source nation.

To obey rules of origin standards, which vary from agreement to agreement, buyers and sellers of products in international trade must establish the extent of local content or local transformation in each product.

If you are seeking international sources of parts by exploiting FTAs, prepare for a tedious process, says Nathan Pieri, senior vice president for marketing and product management at Management Dynamics, Inc., of East Rutherford, New Jersey, a consulting firm that provides software-based compliance solutions to companies engaged in international trade.

 “It starts with soliciting suppliers, collecting proper documentation about the products they are providing to you to make sure you have the right certificates of origin across all purchased parts to comply with the rules to legally claim the duty savings,” he says. “It's a lot of work for suppliers and for manufacturers. There are hundreds of preferential trade agreements out there. They all have different terms on how they are implemented.”

Such intricacies may be, in effect, protectionist trade barriers. Resolving disputes falls to separate enforcement agencies established under each FTA. The number and complexity of FTA enforcement regimes is a powerful argument to complete a true multinational trade system, says Caterpillar's Lane.

“The only way to leapfrog this current phenomenon is to have an ambitious WTO agreement,” he says. “The WTO has been successful with regard to resolving trade disputes, far more so than I ever thought it would be.”

The Politics of Trade

In 2007, President George W. Bush's hopes of signing an FTA with Panama were sidetracked by a murder investigation. The newly elected leader of the Panama National Assembly, Pedro Miguyel Gonzales Pinzon, was accused of killing an American soldier and wounding another on the eve of a visit to Panama by Bush's father in 1992. Officials in the U.S. State Department and Congress made it clear to Panama that a trade agreement was in jeopardy. The agreement was never concluded, thanks in part to the Pinzon incident.

The Pinzon incident is more dramatic than most of the non-economic issues that affect the development of FTAs, but the role of politics looms large in all of them, particularly between major industrialized countries and emerging economies.

In January, Democratic Senator Max Baucus of Montana said he was not ready to authorize the U.S.-South Korea trade deal because of a dispute over U.S. beef exports to South Korea. Baucus chairs the Senate Finance Committee, which has jurisdiction over U.S. trade agreements.

“A lot of these trade agreements are political agreements,” says Michael Hart, professor of international affairs at Carleton University in Ottawa and a former trade negotiator for Canada. For example, in January Canada began negotiating an FTA with Morocco on the heels of a U.S.-Morocco FTA that went into force in 2006. Canadian wheat farmers were annoyed that U.S. wheat farmers had an advantage, Hart says. But “Canada trades as much with Morocco in a year as it trades with the United States in a morning.”

Geopolitical concerns motivate FTAs as well as special interest pleadings. Often the pressure for these new compacts with emerging economies comes from political strategies of the major economy, says Hart. For example, the first U.S. free trade agreement in the post World War II era was inked with Israel in 1985. U.S. exports to Israel in 2009, the last year for which figures are available, totaled just $9.3 billion.

Caterpillar's Lane speculates that talks of a U.S. FTA with Egypt might get a boost in the near future, depending on how the political crisis in Egypt unfolds. Egypt-U.S. trade totaled $8.4 billion in 2008, the last year for which figures are available. The amount of trade generated by many FTAs is really quite small, Hart noted.

On the other hand, “when you have a big agreement such as between Canada and the United States, that's a different matter. That had a great impact on Canada. It provided Canadian industry with the incentive to restructure and become more oriented to the south,” Hart says.

The 24 mature economies in the Organization for Economic Co-operation and Development (OECD) already have fairly liberal trade agreements among themselves. “In most of the OECD countries, tariffs on imports are pretty low, but when we're talking about developing countries, they tend to have higher tariffs, so we're talking about creating new opportunities,” says Dartmouth's Irwin.

From the viewpoint of emerging economies, an aggressive campaign to sign FTAs promises benefits beyond imports and exports of goods and services. For smaller economies, Lane says, FTAs can be a way of signaling to the world the nation is open for business and eager to take its place in the world.

 FTAs are an intangible “validation that these countries are good places to do business,” Lane says. “If it's a good place to invest, that may be the greatest benefit: a place that has confidence in its future.”

Ironically, emerging countries that once embraced protectionist tariffs to defend local industries and collect tariff revenues are now “embracing trade liberalization on a much more aggressive scale than what the United States is doing,” Lane says. This kind of changing places is a move the United States can ill-afford, he says.

Yet, U.S. and Canadian politics include voices of those who charge that FTAs cost jobs at home and validate the harmful labor and environmental policies of the free trade partner.

But in May 2007, Democrats in Congress negotiated labor and environmental provisions with the Bush administration for the pending U.S. trade agreements with Peru, Colombia and Panama, which was a major step toward resolving labor and environment concerns in emerging economies.

Language in those agreements guarantees the right of workers to organize and bans child labor and forced labor in countries that are partner to the deals. Regarding the environment, the May 2007 bipartisan consensus incorporated multinational environment agreements (MEAs) in the three FTAs.

The MEAs address such issues as endangered species, ozone depleting substances, marine pollution and wetland protection. The labor and environmental standards are to be enforced in the same manner as commercial violations of the FTA.

Only the Peru deal has been implemented. It's unknown whether the May 2007 political accord will apply to future FTAs, but there's no doubt labor and environmental issues will be on the list of Congressional priorities.

 “I don't make it a practice to vote for these trade bills,” says eight-term Democratic Congressman Bill Pascrell, Jr., of New Jersey, a member of the House Ways and Means Committee, which has jurisdiction over FTAs. “I did vote for Peru, because I thought there were tremendous improvements in some of the things I feel strongly about. Some of our people went to Peru to make sure it is being implemented. They reported back to Ways and Means members that is has been.”

But other problems exist. Pascrell noted that the proposed U.S.-Korea trade agreement has looser rules of origin regarding local content than the comparable agreement between Korea and the EU.

“A product that's made mostly in China, that's not what we're looking for,” he says. “I'm not anti-trade. I simply want to be fair and help American workers.” Pascrell says he wants more assurances on local content rules before he votes for the agreement.

In the eyes of the NAM and other pro-trade lobbyists, taking a hard look means costly delay. “The threat of falling behind is significant,” says NAM's Goudie. “Our competitors in Europe, Canada, Korea, Japan, China, Australia and other industrialized nations have not been in a pause. They have been on a tear.”

On the Drawing Board

The Obama agenda for trade agreements includes crafting an FTA through the Trans-Pacific Partnership, comprising the United States, Australia, Chile, Malaysia, Brunei, New Zealand, Singapore and Vietnam. An even more ambitious topic not formally on the drawing board is an NAFTA-EU trade agreement, which has been endorsed by the NAM. The idea originated in the mid-1990s in statements by Stuart Eizenstat, U.S. ambassador to the EU, and Canadian Prime Minister Jean Chretien.

Beside such giant undertakings, dozens of free trade talks between countries and regions around the globe are underway (see opening graphic). But the value of FTAs as the sole solution to economic growth in the international arena is still up for debate.

“If Mr. Obama is so keen to negotiate FTAs, the first thing he needs to do is ask Congress for negotiating authority,” Hart of Carleton College says.

The ability of a president to negotiate FTAs, subject to the consent of two-thirds of the U.S. Senate, ran out in 2007. With FTAs “Congress can interfere with an agreement with a sovereign country,” Hart says. “The United States is capable of negotiating an agreement but is not capable of negotiating a commitment that Congress will implement as it is negotiated.”

Late last year, Obama renegotiated the U.S.-Korea agreement, first signed by President Bush in 2007, thereby winning the endorsement of the United Auto Workers, which had strongly opposed the Bush deal. He did not gain support from another involved union, the United Steelworkers.

Moreover, FTAs rarely live up to their name. Many are written to benefit certain sectors of a participant country's economy, but not all. The WTO says FTAs should cover substantially all trade between participating countries, but that rule is not enforced, says Reinsch of the National Foreign Trade Council.

“While there are hundreds of these agreements, few if any of them actually meet that standard. Very few countries have negotiated FTAs that cover agriculture because everyone wants to protect their own farmers. Most of these agreements are either aspirational or they are limited to specific sectors and product categories.”

Hart says the future of FTAs needs to be examined in light of actual, pragmatic progress in trade relations between companies and governments, not between governments. Political acknowledgement of the growing private-sector role in stimulating trade would be a Sputnik moment in Washington.

“The structure of production has changed sufficiently so that companies have choices,” he says. “Companies sit down with governments and say, 'We're thinking of making a big investment here but there are some real problems that need to be overcome.' That's a lot faster than waiting for the U.S. Congress to hold hearings. That's what smart governments are doing.”

A leading example is Intel Corp.'s decision in 1996 to build semiconductor assembly and testing facilities plant on a free-trade and tax-advantaged zone in Costa Rica. By 2006, the investment by Intel reached nearly $600 million and employed nearly 5,000 workers in direct and indirect jobs.

 “Intel has given an implicit seal of approval to Costa Rica's [business] operating environment,” says a report on the project by the Multilateral Investment Guarantee Agency, a unit of the World Bank. “The endorsement of one of the most respected and emulated corporations in the world caused other investors to take notice.”

Companies big and small benefit from the evolution of what Hart calls the global value chain of production. A major U.S. multinational manufacturer, such as Boeing, can use its clout to arrange access for smaller America companies as suppliers to countries where Boeing parts are made, he says. Even the notorious “Made in China” exports contain parts, designs and other substantial economic values contributed from other nations, including the United States, he says.

U.S.-based design and engineering innovations often find a home in non-U.S. product designs. In the future, local content measurement will become a needless and even meaningless political gesture as private companies source ideas, materials and production globally, Hart says.

In the meantime, no one wants to lose the race for FTAs among nations.