United States Trade with Asia, APEC, and the Financial Crisis
Testimony before the Subcommittee on Trade Committee on Ways and Means
United States House of Representatives
United States trade with Asia is being significantly affected by a series of cross-cutting developments. On the one hand, the financial crisis is the region will have a substantial negative impact on our trade balance for the next year or so. On the other hand, APEC has accelerated the pace of its trade liberalization and the IMF programs in the region require even faster reduction of barriers in some cases. Hence the immediate, medium-term and long-run implications of current Asian developments for our economy are likely to differ substantially.
APEC and the IMF: Continued Liberalization in the Short Run
It is still too early for the financial crisis and policy responses to it to have had much impact on trade flows. Korea and Thailand have already shifted into current account surplus and our exports to Korea have fallen sharply in the last couple of months. Our own trade balance remains on the plateau of the past eighteen months, however, with the merchandise deficit running at an annual rate of about $200 billion and the current account deficit at about $160 billion. But major changes in our position will show up later this year and I will address them below.
The crisis has had some effects on trade policy, however, and to date they have been largely positive. Despite concerns in some quarters that liberalization of national financial markets was a cause of the crisis itself, the members of the World Trade Organization--including all of the crisis countries in Asia--agreed in early December to further opening of that key sector.1
The crisis in fact seems to have had a favorable impact. Weaknesses in financial sectors were a central cause of the difficulties in every Asian country. It was universally recognized that further reforms, including opening to foreign institutions, was a necessary component of adjustment programs that would restore confidence in the countries' currencies and economies.
The crisis promoted financial liberalization in two very direct ways. The heightened need for foreign investment, to finance continuing current account deficits in a sustainable manner and to recapitalize weak banking systems, added powerfully to the case for liberalization. And the International Monetary Fund strongly reinforced the WTO agreement, and in a number of instances required reforms that went much further in its support packages for the troubled countries.
A second positive development was the decision of the 18 APEC countries, at their annual summit in Vancouver in November, to designate 15 major sectors-- including automobiles, chemicals, energy goods and services, environmental goods and services, and medical equipment--for early liberalization. They also agreed that detailed plans for eliminating barriers in nine of these sectors, totaling over $1.5 trillion of global trade, should be agreed by the middle of 1998 and implemented in early 1999. Some of the Asian members of APEC are of course the countries hit most directly by the crisis and it is extremely encouraging that they were willing to continue, and even accelerate, their progress toward achieving the agreed APEC goal of "free and open trade and investment in the region" by 2010/2020.2
Despite the crisis, APEC thus remains one of the leading forces in the world for trade liberalization. Given the fact that its members account for half of the world economy, its commitment to achieve free trade by 2010/2020 remains potentially the most far-reaching trade agreement in history. Its creation played a central role in bringing the Uruguay Round to successful conclusion in the GAT in 1993. Its agreement to eliminate tariffs on a wide range of high-tech goods and services galvanized the global Information Technology Agreement in 1996. As noted, it played an important role in the global agreement on liberalization of financial services in 1997. APEC's Vancouver pledge to eliminate barriers in nine additional major sectors in 1998 represents the major progress toward freeing trade that is now being pursued anywhere in the world.3
To be sure, there has been some modest increase in trade barriers as well since the Asian crisis erupted. Most notably, Mercosur increased its common external tariff by 25 percent--from 12 to 15 percent--as part of its effort to avoid greater contagion from Asia. The failure of the United States to pass fast track legislation last year was also a negative development, to which I return later.
On balance, however, the bicycle of trade liberalization has continued to move forward over the past six to eight months despite the Asian crisis. APEC has been the most prominent factor in the progress despite its region's being the locus of the crisis, and continues to deserve strong support from the United States. The bottom line is "so far, so good."
A Better Policy Framework in the Long Run
The potential long-term silver lining on the current cloud is the considerable further liberalization that countries will have to adopt to restore their economic prospects and thus to overcome the crisis.
It is noteworthy that every problem country in Asia has clearly indicated its intention to move in this direction, whether with the IMF (Indonesia, Korea, Philippines, Thailand) or to avoid it (Malaysia, perhaps China). The reforms will include increased transparency and accountability of financial systems and corporate governance, reduction of impediments to trade and investment, and corresponding domestic measures.
At the end of the day, the trade and investment climate should be considerably stronger throughout Asia as a result of the crisis and policy responses to it. As Senator Roth and I concluded in our recent op-ed on the topic, "the crisis will accomplish enormously more for trade expansion than decades of effort by US negotiators."4
A word on China is appropriate in this context. China had avoided being hit directly by the crisis because its currency is inconvertible on capital account and is therefore not subject to direct market attacks. Nevertheless, it has clearly read the message of the markets and has substantially accelerated the pace of its marketization reforms. Premier Li Peng has in fact set a goal of full marketization of the Chinese economy by 2010.
China has not yet moved far enough to qualify for membership in the WTO. It is making rapid progress in the right direction, however, and is in fact the main hero of the current crisis by avoiding the temptation to devalue its currency as well as speeding its internal reforms. This is another beneficial long-term effect of the crisis for the United States and for the world trading system.
Trouble in the Medium Term
There may be major problems in the medium run, however, both in the crisis countries themselves and in the rest of the world, as a result of impact of the crisis on trade flows. Over the next year or so, the huge currency depreciations in Asia will sharply improve the competitive position of virtually every country in the region. These exchange rate swings, along with the recessions that are likely to hit every northeast and southeast Asian economy in 1998, will produce very large changes in national trade balances.
A new study by my Institute colleagues Marcus Noland and Ligang Liu, along with Sherman Robinson and Zhi Wang, uses a computable general equilibrium (CGE) model to assess the prospects for trade even if the Asian currencies rebound to some extent from their present levels.5 Their results include:
- an increase of about $50 billion in the United States deficit in dollar terms6 and as much as $100 billion in real terms;
- a similar reduction in the surplus of the European Union;
- an increase of about $50 billion in the surplus of Japan; and
- a similar swing of almost $50 billion in the position of Korea, converting it from large deficit to large surplus.
These swings will occur at a time when trade policy is already under substantial pressure in many countries. The Congress of course failed to approve new "fast track" negotiating authority in 1997 despite the stellar performance of the American economy, and the prospects seem dim for resurrecting the legislation this year.7 Europe continues to face very high unemployment and is preoccupied with the creation of the euro and the expansion of its membership. As noted, Brazil and its Mercosur partners raised their common external tariff by a quarter as part of their effort to avoid contagion from Asia.
The largest problem is Japan. As the world's largest surplus and creditor country, it should be reducing its trade surplus sharply rather than increasing it. In addition to proposing new funds that would make more capital available to the rest of Asia, it should be importing billions of dollars' worth of additional products from the region. China, Taiwan and Hong Kong could also afford to run modest deficits, rather than their current sizable surpluses, to help the regional adjustment process.
The first trade policy casualty of this process will probably be the second Summit of the Americas, in Chile in April. Negotiations to create a Free Trade Area of the Americas, as agreed at Miami in December 1994, could still be launched but nothing serious will happen until the United States obtains fast track authority and Mercosur decides to extend its liberalization beyond the grouping itself. A second casualty could be the WTO Ministerial Conference in Geneva in May; the fiftieth anniversary celebration of the GATT/WTO could be reduced to nostalgic platitudes rather than commencing serious planning for Sir Leon Brittan's proposed Millennium Round.
A third casualty, of particular importance for this hearing, could be the APEC liberalization program cited above. The United States needs new negotiating authority to pursue a number of the sectoral initiatives that were agreed in Vancouver. The program cannot proceed without the United States and some Asian countries may even retreat from it if the United States is unable to participate effectively.
It would be the height of folly if the United States were to let the APEC liberalization program collapse. American exporters have enormous opportunities in a number of the sectors that our APEC partners have agreed to liberalize, both because of the strong competitive positions of our firms and because many of the Asian countries still have high barriers in these industries. Even if the Congress is unable to pass full fast track authority, it should authorize the Administration to pursue the agreed APEC sectors on that basis.
More broadly, the United States and European Union will have to accept temporary deteriorations in their trade balances to enable the emerging market economies in Asia to successfully engineer the needed improvements in their own external positions. Congressional rejection of fast track authority would signal that the United States may not be prepared to do so. This could induce Asian policymakers to reconsider their commitment to market-oriented strategies--jeopardizing both their prospects for resolving the current crisis and the favorable long-term outlook cited above. Indeed, the major long-term risk from the current crisis is that some of the most important emerging market economies might turn their backs on the liberal policy approaches that they need to accelerate instead. We certainly do not want to take steps that would foster that outcome.
The World Trade Organization will also be severely challenged by the new trade policy threat. It has completed the carryover business from the Uruguay Round with its sectoral agreements on telecommunications, information technology and financial services. New initiatives are now needed to keep the bicycle moving forward and the still-new institution from becoming moribund for a prolonged period, as its predecessor GATT did after completion of the Kennedy and Tokyo Rounds.
At a minimum, the major industrial countries--the United States, the European Union, Japan and Canada--should agree to avoid adopting any new trade restrictions in the wake of the Asian crisis. The OECD members took a similar "trade pledge" after the oil shock of 1973 when they realized that it would be foolish to try to pass around the resulting deficits among themselves. The impact of the Asian crisis could be at least as sizable as that initial oil shock and the OECD membership, at its upcoming Ministerial meeting, should resolve to avoid beggar-thy-neighbor trade responses.
All this implies a major challenge to the continued march of globalization. Anti-globalization forces are mounting in both the industrial countries, where they are celebrating the defeat of fast track negotiating authority in the United States as a "historic turnaround in attitudes toward international integration," and in many emerging market economies due to the onslaught of yet another financial crisis. Both the intellectual underpinnings of globalization, and the policies to implement it, are likely to be questioned more severely than at any other time in the past two decades. The global outcome for several decades ahead will turn on the outcome.
There are thus a number of potentially significant trade implications from the Asian crisis. We will shortly be moving into the period where countries both inside and outside the region may be tempted to turn to trade restrictions, or at least to avoid new trade liberalization, to help them through the difficult adjustment period.
In such a situation, the best defense is a good offense. The crisis countries must liberalize further, to restore market confidence in their economies and to fulfill their IMF programs. The industrial countries need to do so too, to make clear that they will accept increased Asian exports and to encourage the Asians to maintain their market-oriented adjustment strategies. New initiatives to maintain the momentum of liberalization are acutely needed, particularly in the WTO but in regional contexts such as the FTAA and especially APEC--which has already made very specific commitments to liberalize further--as well.
The United States must lead this process. For all our problems, we have by far the strongest economy in the world. Our large trade deficit is in fact a reflection of the strength of our economy, compared with the ongoing sluggishness in many of our major markets abroad, rather than of American weakness.
Moreover, some of our major competitors (including Japan) have now been weakened substantially by the crisis. Hence further trade liberalization is highly desirable from our standpoint because it will enable us to fully exploit our strong competitive position. Any US backing away from our previous commitments, particularly the pursuit of free trade in the Asia Pacific region and the Vancouver commitment to reduce barriers substantially further in 1998, would send an enormously counterproductive signal to weaker economies that they too could--and even should--backslide.
Hence the coming year or two will present both major challenges to, and major opportunities for, the trade policy of the United States. I urge this Committee to continue its strong leadership of a constructive approach that will enable the world, as well as the United States itself, to emerge from this period in an even stronger position. Rapid passage of fast track authority, along with the provision of resources for the International Monetary Fund, is the place to start.
1. A comprehensive analysis will be presented in Wendy Dobson and Pierre Jacquet, Evaluating the Financial Services Agreement, Washington: Institute for International Economics, forthcoming April 1998.
2. It should be noted that APEC has also played a very important role in responding directly to the financial crisis. The Vancouver summit endorsed the Manila Framework, worked out a few days earlier by Deputy Finance Ministers of the bulk of the APEC countries, that invented the IMF's new Supplemental Reserve Facility, which was used to provide rapid disbursement of a much higher level of IMF resources to Korea than would have been available previously, and set up a new regional surveillance mechanism that will try to head off future crises by generating peer pressure on countries to take preventative action when trouble is brewing.
3. For an appraisal of the current status and outlook for APEC see C. Fred Bergsten, Whither APEC? The Progress to Date and Agenda for the Future. Washington: Institute for International Economics, October 1997.
6. The nominal impact will be less because of large favorable changes in the US terms of trade, i.e., as the dollar strengthens considerably with respect to the Asian currencies and enables us to buy more imports with fewer dollars. Changes in the real impact are what count for GDP growth and job creation, however, and thus probably for trade policy sentiments as well.
7. An analysis that includes the full spectrum of Congressional views will appear in Restarting Fast Track, Washington: Institute for International Economics, forthcoming April 1998, a special report on a conference held on Capitol Hill on February 3.