The Pacific Pivot

On November 12, 2011, I listened as President Barack Obama told business leaders attending the Summit of the Asia-Pacific Economic Cooperation forum in Honolulu that “we’ve turned our attention back to the Asia Pacific region” and announced two vehicles for that return. These were the Trans-Pacific Partnership (TPP) Free Trade Agreement, now under negotiation and to be concluded by the end of this year, and the Pivot to Asia, meaning a redeployment of American priorities and military forces away from Europe and the Middle East to Asia.

The president said that Asia will be central to America’s future prosperity and that it was imperative to correct unsustainable trade and financial imbalances while continuing to expand economic ties. This would require that all countries play by the same rules appropriate to the current global economy. The TPP, he said, would be a template for a “21st-century agreement” that would eventually be open to all the countries of the region. He emphasized that this kind of agreement can thrive only in an environment of security and stability, and he underscored that the Pivot to Asia “will allow America to keep its commitments to its allies” in a region characterized by competing territorial claims, uncertain energy supplies, and North Korea’s nuclear threats.

In closing, however, he stressed that neither the Pivot nor the TPP is aimed at any particular country—which, of course, meant that it is. The country is China. But these initiatives are also about responding to the pleas of Asian friends, the importuning of U.S. global corporations, papering over inconsistent goals, denying American commercial decline, and clinging to the quasi--American empire.

Obama accurately posed the challenges. But do these twin policies accurately define American interests? Are they plausible strategies for achieving them? These key questions have received surprisingly little attention.

As it has evolved so far at least, the TPP is anchored in the same orthodox free-trade philosophy that has inspired every U.S. trade negotiation and agreement since the end of World War II. It is also following the same negotiation process as all the old deals. Indeed, the agenda and initial text were largely lifted from the failed Asia-Pacific Economic Cooperation trade agreement of the 1990s and the more recent U.S.–Korea Free Trade Agreement. These texts have been broadened a bit to try to cover some new topics like state-owned enterprises, but essentially they are no different from what has gone before both in substance and procedure. We can’t know the result yet, but in the past, the U.S. trade imbalance has widened after each new agreement.

A New Sun

The foreign minister of a Southeast Asian country once told me that China is like a new sun entering the American solar system. All the planets, he said, are now shifting their orbital patterns, and the Asian planets especially are entering into orbit around the Chinese sun.

He was correct, and this fact has important implications for both the planets and the suns. This same foreign minister made the point that China’s is a hierarchical worldview in which each country and person has an assigned position that is either up or down. In this hierarchy, he said, my country’s position is definitely down, and we therefore prefer not to be controlled by China. On the other hand, he added, there are nice economic benefits in China’s orbit. So, we’d like to be in that orbit but with U.S. gravity keeping it wide and loose.

Just so. The rest of Asia is growing, thanks to its Chinese connections, but also fears being overwhelmed. This concern of smaller Asian nations has been exacerbated by the recent rapid displacement of U.S.–made products and technologies in world markets. Despite keeping several of its 11 aircraft carriers and more than 100,000 troops in the region and being the biggest buyer of Asia’s exports, America is said somehow to be ignoring Asia. Thus some governments, such as Singapore, Malaysia, and Vietnam, call for the U.S. to demonstrate renewed commitment by entering into more free-trade agreements and security arrangements. This is partly sincere but is also partly special pleading aimed at allowing them to continue their free ride on America’s unilateral security commitments and open markets.

 

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These countries, observing America’s mounting trade deficits with Asia, also fear a possible American shift toward protectionism. They hope to use free-trade agreements to lock in their access to the U.S. market. As for the United States, it has long treated the Pacific Ocean as an American lake and taken on unilateral responsibility for defending its Asian allies while patrolling the Chinese coast and keeping China confined within its own shores.

Anxious to keep the planets in proper orbit around the American sun, the U.S. foreign-policy establishment insists that there can be only one solar system and argues that China must become a “responsible stakeholder” in this American system, implying that China is somehow not yet fully civilized and that America must be both mentor and disciplinarian as it brings the Chinese celestial body into orbit around itself.

 Thus the logic of the new Pacific initiative: a free-trade agreement that includes many of the Asia-Pacific nations along with the United States, but one that is too demanding for a developing and mercantilist nation like China to enter yet. The military Pivot, meanwhile, has America taking on responsibility for defending Asian claims disputed by China; our enhanced role keeps pace with the modernization of China’s forces and maintains U.S. hegemony until such time as China can be declared fully civilized, if ever. Unfortunately, the logic falls apart when the details of the TPP are measured against actual Asian economic practices and geopolitical threats.

The Japanese Role Model

The call for a 21st-century trade agreement also grows out of long--standing U.S. frustration with most of its late-20th-century trade relationships in Asia. This goes back to the U.S. postwar occupation of Japan. Then, U.S. leaders advised Japan to produce labor-intensive goods like clothing, because Japan’s plentiful supply of inexpensive labor would give it a cost advantage in those kinds of items. American free-trade doctrine held that countries should not protect or subsidize favorite industries but should rather specialize in producing what they could do best and cheapest while trading for the rest.

The Japanese rejected this advice. As former Ministry of International Trade and Industry Vice Minister Naohiro Amaya once told me, “We Japanese did the opposite of what [the American authorities] told us.” Thus, Japan rejected direct foreign investment, imposed high tariffs and other protective barriers, compelled a high rate of savings, and channeled the savings through the state-controlled banking system into capital-intensive industries with large economies of scale and rising technology input such as steel, shipbuilding, autos, and later semiconductors and consumer electronics, to name a few. Japan further intervened regularly in currency markets to keep the yen cheap versus the dollar as both a subsidy to Japanese exports and an extra tariff on imports. It also provided a wide range of special loan and investment facilities along with outright subsidies to promote investment in and exports by the targeted industries.

This was an export-led mercantilist growth model. Unlike the Anglo/American model in which market outcomes are ends in themselves, this model saw the market as a means to an end, as a tool that could be sharpened if it was not producing the desired result. It was also a tool that aimed to produce chronic trade surpluses and accumulation of dollar reserves.

Japan soon became a model for Asia. Singapore’s first prime minister, Lee Kuan Yew, advised his people to learn from Japan. They did, and so did the people of Korea, Taiwan, Malaysia, Hong Kong, and Thailand, which became known as the Asian Tigers as they duplicated Japan’s success. Then in 1992, China’s Deng Xiaoping declared that “to get rich is glorious,” and China became the last Tiger or perhaps the first Dragon.

What cannot be overemphasized about this progression is the fact that these countries all adopted an economic-development philosophy that is the opposite of America’s and of the free-trade doctrine on which the World Trade Organization (WTO) and its conception of globalization are based. While operating within a structure that presumes free trade is always a win-win proposition, most East Asian nations have embraced neo-mercantilism, which understands globalization frequently to be a zero-sum proposition (win-lose).

While producing miracles in Asia, this circumstance resulted in an unbalanced form of globalization in which the U.S. market was mainly open while Asian markets were relatively protected, and often-subsidized Asian products flooded U.S. markets. After more than 100 years of trade surpluses, the United States went into constant deficit in 1976. By 1981, when I became one of the main U.S. trade negotiators, the deficit was $16 billion ($11 billion with Japan). I was told that the deficit was unsustainable and that it was my job to fix it. By 1987, the U.S. textile, steel, auto, semiconductor, machine tool, and consumer electronics industries, among others, had all been savaged and laid off millions of workers as the U.S. trade deficit grew to $161 billion ($60 billion with Japan). After a dip following Japan’s U.S.–forced yen revaluation in 1986–1987, the U.S. trade deficit hit $230 billion in 1998. By the end of last year, it was $558 billion, of which $295 billion was with China and more than $400 billion was with all of Asia.

Behind these statistics is the loss of entire U.S. production industries such as consumer electronics and the loss of millions of jobs and billions in investment (the $558 billion deficit of 2011 represents a loss of six million to nine million jobs). These alarming trends led to virtually constant negotiations to open Asian markets and stop “unfair” trade. Trade talks were also initiated as a way to reward allies and entice doubters and adversaries toward our model. What these talks did not do was reverse Asian neo-mercantilism.

Negotiating American Commercial Decline

Between 1960 and today, there have been four full-fledged rounds of global negotiations under the aegis first of the General Agreement on Tariffs and Trade (GATT) and then of the WTO that engaged the United States and the Asia-Pacific countries. In addition, there was a continuing series of talks with Japan under rubrics such as the Market Oriented Sector Specific Initiative (MOSS, ridiculed as More of the Same Stuff), the Semiconductor Negotiations, the Nippon Telegraph and Telephone talks, and more. There was the creation of the Asia-Pacific Economic Cooperation association, founded in the early 1990s to spread liberal democratic ideals within the Pacific Rim through trade and investment. There were the negotiations both to bring China into the WTO and for America to grant it permanent “most favored nation” treatment. The North American Free Trade Agreement and bilateral free-trade agreements with Peru, Chile, Singapore, Australia, and Korea are also part of this saga of trade deals that only widened trade imbalances.

 

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Each of these projects had its causes, purposes, and dynamics, but certain critical patterns repeated. The premise was that all participants embraced the same free-trade philosophy and rules and that if the rules were set properly, the results would automatically be satisfactory for all. The fundamental difference in philosophy between laissez-faire, free-trade America and export-driven Asia was never directly confronted. One reason for this was that free trade was a kind of religion of U.S. policymakers, for whom any management of results was original sin. Another was that America was long considered economically invulnerable. Yet another was that the purpose of the deals was usually more to cultivate geopolitical allies, to stimulate development of struggling neighbors, or to facilitate U.S. investment abroad. But the agreements were always sold to the U.S. Congress and public as arrangements that would increase U.S. exports, reduce trade deficits, and create jobs.

They never did. Rather, the trade deficit relentlessly rose, offshoring of U.S.–based production and jobs accelerated, and trade became a drag on growth of U.S. gross domestic product as well as a cause of rising income inequality. As economic strategy, the trade deals and their logic were unsuccessful, or irrelevant, or both.

Enter China

Nothing illustrates this folly better than the case of China. By the turn of the century, negotiations to bring China into the WTO had been going on for more than a decade and were now coming to conclusion. The big question was whether the United States would accord China the same permanent most-favored-nation (rebranded as PNTR, or permanent normal trade relations) treatment it accorded other members of the WTO. Some analysts warned that the then–$68 billion trade deficit with China would grow dramatically. But their testimony was drowned out by that of laissez-faire economists, CEOs, trade negotiators, think-tank heads, and political leaders, all of whom emphasized that China was no Japan; the Chinese actually welcomed foreign participation in their economy. The China lobby further argued that America’s exports to China were bound to increase more rapidly than China’s to America because China would be dramatically reducing its tariffs and trade barriers, while America would be making no cuts at all.

That, of course, turned out to be utter nonsense. By the time China joined the WTO in 2001, its trade surplus with the United States had jumped to $83 billion. As noted above, by the end of 2011, it had climbed to $295 billion despite an endless series of “strategic and economic dialogues” and cabinet-level trade and development discussions reminiscent of the Japan experience. The reality is that U.S.–Asia trade imbalances tend to grow and accelerate regardless of negotiations and deals—or more likely because of them.

But since the charade of shared principles means that failure to fulfill the rosy forecasts cannot be attributed to systemic differences, it has to be blamed on flawed agreements, which then requires negotiation of new agreements covering more items such as protection of intellectual property, banking regulations, or other elements that might possibly serve as market barriers. Thus have talks and deals proliferated, providing few jobs for America aside from lifetime employment for its trade negotiators.

Why U.S. Trade Policy Fails

There are, however, two clear purposes that all the deals have served. The first is the geopolitical grand strategy objectives of the United States. By making the United States the market of last resort, the trade agreements have helped persuade allies to accept U.S. hegemony. The second purpose served is that of U.S. businesses that profit immensely from outsourcing and offshoring to Asia but that need the security provided by Uncle Sam to do so. These realities reveal the flaws in U.S. trade efforts—misplaced priorities, a false doctrine, and false assumptions.

Most misplaced has been the geopolitical priority with its subordination of long-term economic interests to short-term political/military objectives. Washington continually makes concessions, refrains from insisting on application of the GATT/WTO rules, or backs away from taking actions to counter mercantilism on national--security grounds. In the 1980s, the Reagan administration declined to invoke GATT rules against European subsidization of the Airbus, because Secretary of State George Shultz said doing so would shatter the North Atlantic Treaty Organization. Today, Washington declines to respond to China’s blatant currency manipulation. Why? It thinks it needs the Chinese to help with problems like Iran and North Korea. It doesn’t understand that erosion of U.S. wealth-producing capacity is the most important national--security threat.

A corollary is the false premise that mercantilists who intervene to distort markets should not face retaliation because they are only hurting themselves and will eventually see that and abandon their policies. Studies have shown that the Airbus subsidies helped rather than hurt the European Union economy. The Airbus killed off all the U.S. commercial aircraft makers except Boeing and cost the U.S. economy many thousands of jobs that won’t be recovered even if Europe stops the subsidies. All the evidence of the past 200 years suggests that mercantilism works and that mercantilists win.

Keys to the Kingdom

The trade deals that the U.S. has been negotiating do not reach the most important elements of Asian mercantilism. For starters, because of foreign-currency intervention policies, the dollar tends to be chronically overvalued versus the currencies of most Asian countries. Although the WTO vaguely calls for not using currency policy to offset tariff reductions, the truth is that currency policy is not seriously covered by any international trade agreement. Thus currency manipulation can be and is used to keep markets protected in the face of apparent market-opening agreements.

A second major element is a set of investment packages aimed at inducing the offshoring of production and research-and-development facilities. China, Singapore, Malaysia, and many others offer big tax holidays, free land, cut-rate utilities, free worker training, sweetheart loans, and big capital grants to companies as enticements to invest. Nor are the Asian countries alone. Others such as France, Ireland, and Israel play the same game. In the United States, some of the individual states do this, but their resources and authority (they can’t grant holidays on federal taxes) are limited, and Washington doesn’t play. So it often happens that businesses whose U.S. operating costs are internationally competitive will nevertheless offshore production in order to get the incentives. These packages are not covered in any of the free-trade agreements.

A third element is antitrust or competition policy. The biggest barrier to getting into many markets is control of distribution chains by powerful cartels that often have cozy ties to governments. Take autos. In America, foreign automakers can sign up any Detroit auto company dealer to sell its cars as well. Not so in Japan or Korea. Again, antitrust is not covered by any of the free-trade deals.

Fourth are “buy national” and indigenous technology-development policies aimed at giving advantages to domestically based production and making market access conditional on developing designated technologies in the market. WTO rules on this apply unevenly, and many countries in Asia exert pressures that favor those producing and developing locally. General Electric, for instance, recently transferred its avionics business into a Chinese joint venture to ensure access to China’s state-controlled aircraft market. Even when banned by agreements, these policies operate in practice because countries with strong bureaucracies wielding broad discretionary authority can easily intimidate companies.

Value-added taxes, which tax transactions at each stage of production and distribution, are common in most countries and are rebated for exports while being added to imports. They thus constitute a kind of subsidy for exports and an additional tariff on imports. Because it has no value-added tax, the United States is particularly disadvantaged in international trade.

There is also the implicit economic nationalism of public exhortation that plays to cultural pride. The leaders of Asian countries constantly preach the importance of making things domestically, attracting investment, developing indigenous technology, buying locally, and contributing to the national welfare. This is somewhat intangible and yet very powerful. It is, of course, not covered in agreements and probably can’t be. But it is a game that the United States simply doesn’t play and should.

Right Impulse, Wrong Strategy

America needs to try something new. The Obama administration is right to be seeking a comprehensive 21st-century U.S. trade and globalization policy. Such an effort should begin with a reassessment of national security and geopolitical priorities. It should recognize that the decline of U.S. influence in Asia is not due to lack of military power and presence but rather to eroding competitiveness. Regaining economic strength has become a matter of the highest geopolitical priority. We can no longer subordinate trade to national-security considerations, because trade is national security.

A 21st-century treaty would include provisions to prevent or counter currency manipulation. Measures could range from emergency tariffs to surcharges on foreign buying of U.S. Treasury securities to application or development of alternative international currencies. The point is to do something beyond whining.

Similarly, a 21st-century deal would include some disciplines on investment incentive packages that countries use to encourage offshoring. These are nothing more than indirect export subsidies and a way to circumvent the WTO prohibition of direct export subsidies.

In the same manner, any new deal should include strong anti-cartel provisions that would be adjudicated and enforced by impartial institutions and would measure actual market access to previously closed systems.

A 21st-century agreement would include strong penalties for violations of market-access commitments. Even the existence of five-year industry-planning schemes, for example, should trigger investigation of market-access impact.

Finally, the primary goal of any 21st-century deal must be to reduce the U.S. trade deficit, to increase production in and exports from America in a measurable way, to increase the flow of technology and investment to America, and to increase U.S. competitiveness. It needs to be results--oriented, not just based on nominal compliance with processes.

The TPP and the National Interest

How does the TPP measure up? Poorly is the answer. For starters, it is more of a geopolitical effort than a trade/globalization effort. At a White House meeting last year, I asked why we were doing a TPP in view of the fact that we already have free-trade agreements with four (Peru, Chile, Australia, Singapore) of the eight other countries included in the current talks and that those four plus the United States account for more than 85 percent of the trade at stake in the TPP. The reply was that we needed to demonstrate our commitment and engagement in Asia. There was no mention of creating jobs or contesting mercantilist policies that disadvantage our economy.

The countries currently participating are an unlikely group, with mostly small economies excepting the United States. They are playing a charade in talking free trade but not practicing it in the sense that American leaders mean the term. Australia, New Zealand, America, Peru, and Chile largely share a free-trade philosophy, but the likes of Singapore and Malaysia embrace strategic industrial policy and export-led growth, and Vietnam is dominated by state-owned enterprises.

The negotiating agenda is a list of familiar tunes: better intellectual-property protection, further tariff reduction, government procurement, rules of origin, etc., ad nauseam. Nothing on currencies, investment incentives, antitrust, pressure tactics, or anything else that might impede the continued practice of mercantilism under the facade of a free-trade agreement. The chapter on labor practices is likely to be minimal, while the capital rights will help dismantle important regulatory protections. There is no way that this deal could serve as a meaningful template and docking agreement for creating a truly integrated 21st-century free-trade area around the Pacific Rim. Nor is there any apparent economic benefit to the United States. There may be benefits for the U.S. companies seeking to invest and produce in Asia, but is that in the American national interest?

Pivot or Pirouette

The TPP also fails as geopolitics. What exactly is the threat the Pivot is meant to counter? Is China going to invade America? Is it going to patrol our coastlines as we patrol its shores? Is it going to invade Japan and Korea? No, no, and no. What about North Korea: Is it going to invade us? Can its bombs reach us? No, and no. Might it invade South Korea or shoot a bomb at Japan? Barely possible, but we already have troops and weapons in place to deal with that. Moreover, North Korea is surrounded by powerhouses like Russia, China, South Korea, and Japan. So why the need for a flexing of U.S. muscles?

One answer is that China is modernizing its forces and that while they may not threaten America directly, they have threatened certain claims of countries friendly to us, like the Philippines. We therefore need to support our friends. Maybe, but the rights and wrongs of claims over reefs in the Pacific are unclear. We need to be careful, and, anyhow, nothing is preventing our friends from allying to resist Chinese pressure—except, of course, one thing. They all are doing business like crazy in China and don’t want to risk antagonizing it. So they find it convenient to urge Uncle Sam to increase its security presence while they concentrate on getting rich. Out of habit, pride, and the priority given to geopolitics, America’s knee-jerk reaction is to saddle up.

It’s a bad response. For starters, it puts us in a no-win position. China is growing and has a rising stream of wealth and capabilities. It will easily be able to increase and modernize its forces. Conversely, we must reduce military spending. Why give China reason to think we are challenging it to an arms race while our position weakens and theirs strengthens? We could well wind up doing a pirouette rather than a pivot, simulating a get-tough policy with little to back it up. But more important, America’s main job now must be to invest and make more in America. The Pivot not only distracts from that, it is like writing a military insurance policy against the risks of offshoring for all the companies moving production and jobs to Asia. Why do that when we want them to produce and hire in America? By taking full responsibility for Asian security, we are subsidizing the very mercantilists whose competitive inroads we’re trying to reverse.

It’s clear that America does need a new 21st-century set of rules for trade and globalization as well as new national-security policies and priorities. It’s also clear that the combination of the TPP and the Pivot are not that. Sadly, they look suspiciously like more of the same old stuff. 

 

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