What does “reciprocity” in trade negotiations actually mean?
Among several issues raised by the Administration’s unfolding approach to trade policy, one really caught my eye last week when Representative Sean P. Duffy of Wisconsin proposed granting the President new executive powers to raise tariffs on U.S. imports, stating on Fox News that the legislation would give him, “…the tools to go product by product, so that we can be reciprocal…” and, “…We can mirror the tariffs they have on our products…” (The New York Times, January 17, 2019).
Whether the President should be given additional powers to implement tariffs is a discussion for another day, but Representative Duffy and members of the Administration apparently do not understand the concept of reciprocity that has driven successive rounds of trade negotiations in the post-war period under the General Agreement on Tariffs and Trade (GATT), the predecessor to the World Trade Organization (WTO).
In a recent article co-authored with my Ohio State colleague, Professor Daniel Chow, we argue that the Administration’s focus on reciprocity is based on their misunderstanding of exactly how the GATT/WTO has functioned historically and also its economic logic (Chow and Sheldon, Vanderbilt Journal of International Law, forthcoming, 2019). In particular, the GATT/WTO approach to reciprocity is not the same as that touted by the Administration. The GATT/WTO allows for what is termed first-difference (marginal) reciprocity where trade negotiations focus on balancing concessions on tariffs. By contrast the Administration seeks full (mirror image) reciprocity in trade negotiations. The latter approach is very straightforward – the United States currently applies a 2.5% tariff on imported automobiles, while the EU and China apply 10% and 25% tariffs respectively. This is considered discriminatory, and, therefore, both the EU and China should reduce their automobile tariffs to the same level as that in the United States (The Economist, July 12, 2018).
This approach to reciprocity ignores the dynamics of trade liberalization. Essentially in trade negotiations, countries trade off increased access to their own markets through tariff cuts in exchange for access to export markets, i.e., the concerns of those lobbying for the import-competing sectors are balanced by those lobbying for the export-competing sectors. In other words, negotiations in the GATT/WTO have proceeded on the basis that there will be a balance of trade concessions between member countries, measured in terms of increased market access, but in the final deal, each member country continues to protect a set of politically-sensitive sectors that will likely differ across countries.
Therefore, Representative Duffy’s argument for full reciprocity ignores the political reality of trade negotiations. By contrast, first-difference reciprocity recognizes that if the United States seeks a lower tariff on its exports of automobiles to China it can offer to lower the U.S. tariff on imports of footwear, a deal that works if there is a commensurate increase in each country’s export market share. Economic losses in the U.S. footwear sector are balanced by economic gains in the automobile sector, i.e., “…Trade liberalization is a sort of jujitsu that uses exporter’s determination to get into foreign markets to overwhelm domestic lobbies that would sooner keep home markets closed…” (The Economist, July 27, 2006).
So why has first-difference reciprocity worked in the GATT/WTO? At the risk of sounding like a “pointy-head” – here is a simplified version of the explanation offered by trade economists, assuming that the United States exports automobiles to China, and China exports footwear to the United States. If there were free trade, and ignoring transport costs, there would be no difference between the local (U.S. and Chinese) and world prices of both automobiles and footwear. However, if each country sets a tariff in order to protect its import-competing sector, the local price of the imported good increases, while its price on the world market decreases. To use the economics jargon, both the United States and China try to improve their terms-of-trade, i.e., a tariff allows them to source the imported good more cheaply from the world market. The problem is that the improvement in one country’s terms-of-trade necessarily results in a worsening of the other country’s terms-of-trade. For example, the United States in using a tariff to drive down the world price of footwear necessarily worsens the terms-of-trade of China who exports footwear. In other words, in the absence of a trade agreement between the United States and China, each has a unilateral incentive to shift some of the cost of their protection onto the other.
First-difference reciprocity means that for the United States and China to offer a tariff concession in trade negotiations, they both require a tariff concession from the other country, i.e., any terms-of-trade effects would be neutralized. Of course, the idea that trade negotiators are concerned with terms-of-trade effects is unrealistic, but this concept can also be expressed in terms of market access. For example, a tariff on footwear, while creating a terms-of-trade benefit for the United States, also results in a loss of export market share for China. In other words, from a practical standpoint, trade negotiations are about mutual concessions on market access, i.e., the United States allows greater access to its market for Chinese footwear, and China allows greater access to its market for U.S. automobiles. It should come as no surprise that trade negotiations favoring one country over another are unlikely to be successful.