The Trump Trade Team’s Vocabulary Problem

Chad P. Bown (PIIE) and Alan O. Sykes (Stanford Law School)
May 14, 2017

President Trump finished his 100th day in office much as he started his first—with a rally denouncing trade agreements that echoed his inaugural address reference to American “carnage.” He also announced a new executive order targeting the World Trade Organization (WTO). Mr. Trump’s trade policy thus far features clear disdain for the multilateral, rules-based WTO. He has indicated that any trade deals negotiated by his administration will be country-by-country. Both history and economics suggest this strategy is doomed to fail.

In April Commerce Secretary Wilbur Ross put forward the clearest articulation to date of the administration’s anti-WTO sentiment: “If there’s a country that has relatively few barriers against us, we should have relatively few against them. The only problem is, the World Trade Organization has what’s called a ‘most-favored-nation clause,’ meaning that of all the countries with whom we do not have a free-trade agreement, we must charge the same tariff on the same item to each of those countries as we charge to the others. So, that’s a significant impediment toward getting to anything like a reciprocal agreement.”

This statement reflects a misunderstanding of the MFN clause. American negotiators adopted MFN with the Reciprocal Trade Agreements Act of 1934, as they sought a way out of the Great Depression. Historically, attempts by European countries to negotiate and sustain trade deals without MFN had largely failed.

To illustrate why, consider a simple hypothetical. Suppose that before any trade agreements the United States, Japan, and China each apply import tariffs of 25 percent. Then the United States sits down with Japan and negotiates a deal to cut tariffs to 10 percent, but only with each other. In other words, there is no MFN clause requiring US or Japanese negotiators to give that same 10 percent rate to China.

Now suppose Japan negotiates a second deal, with China. They reach an agreement lowering tariffs to 5 percent, again only with each other. Clearly the United States loses. American companies will be unable to compete with Chinese exporters in Japan’s market. The United States therefore gains little in exchange for reducing tariffs on Japanese goods.

Without MFN, policymakers can’t prevent trading partners from going out and striking better deals with competitors.

Without MFN, policymakers can’t prevent trading partners from going out and striking better deals with competitors. With MFN, if Japan and China agree to a subsequent deal that gives China better terms, Japan has to give those same terms to the United States.

But what is to prevent President Trump—after he strikes the 10 percent deal with Japan—from subsequently offering a better deal to China? Japan would anticipate this “America First” move from the beginning. Without MFN to protect its exports, Japan wouldn’t sign the first US deal.

In short, MFN provides an incentive for countries to sign long-term deals. It protects a country’s exporters from losing out when trading partners subsequently negotiate deals with other countries. Before MFN was introduced in 1934, some trade negotiations went nowhere. Others concluded with deals that ultimately unraveled.

Trump administration officials have made frequent appeals to the necessity of “reciprocal agreements.” Mr. Trump himself said recently that trade deals “have to be fair, and somewhat reciprocal, if not fully reciprocal.” But the principle of reciprocity does not mandate that countries must respond to a 10 percent US import tariff on cars with 10 percent auto tariffs of their own. That would be what some have called “full reciprocity.” What really matters to economists, according to Columbia University’s Jagdish Bhagwati, is “first-difference reciprocity,” or matching concessions from initial conditions.

Think of it as reciprocity at the margins. If the United States wants China to reduce its auto tariff to 10 percent, negotiators must offer something of value, such as a reduction to the current 37.5 percent US tariff on footwear. The deal is attractive and sustainable if both sides can expand exports commensurately.

As a historical note, not everyone in President Franklin Roosevelt’s administration was sold on MFN and reciprocity. The 1930s also featured a boisterous White House debate, with significant resistance to the idea coming from presidential adviser George N. Peek and Agriculture Secretary H.A. Wallace. Luckily, Secretary of State Cordell Hull managed to win Roosevelt over.

The result of US commitment to MFN and reciprocity has been an open, nondiscriminatory, and rules-based trading system that has served the American and global economy well for decades.