The weekly trade report by L.C.
Addressing the Economic Club of New York on June 4th, US Trade Representative Robert Lighthizer declared: “After the [pandemic] crisis is over, we have to have an industrial policy that assures the US has in any future crisis the ability to manufacture at home all the things that we need. We need a policy, be it subsidies or tariffs or whatever it takes. We have to have an industrial policy so we never find ourselves in this position again.”
This is a startling statement for a US official. The US has in the past rejected industrial policy as an unfair and ineffective game in which the government chooses winners and losers instead of allowing the free market to operate – and that inevitably leads to crony capitalism in which companies focus on rent-seeking (seeking government favors) rather than on enhancing their own competitiveness and dynamism.
In the 1980s, Washington argued that Japan was wrong to pursue an industrial policy and that it wouldn’t end well. (It didn’t.)
Contradicts demands being made of China
Opposition to government interference in the economy is at the core of the changes the US is demanding of China. Lighthizer’s promotion of industrial policy thoroughly undermines that demand. Bejing can now say, “See, we’ve been right all along. Government should direct the economy.”
Other countries, too, that may have listened when the US said that such government involvement distorts the economy, may now feel they can take the politically easy road of subsidizing their favored crony companies and industries.
Industrial policy runs counter to WTO rules, which largely prohibit specific subsidies and tax breaks to particular sectors or companies and tariff hikes – above agreed levels – aimed at keeping out competition. If the US goes in the direction of industrial policy and other countries follow, it will be a further blow to the WTO and rule-based trade. Nonetheless, Lighthizer was careful in his remarks to state that he doesn’t favor a US withdrawal from the WTO. How he remains to square that circle remains to be seen.
Pandemic supply shortages used as rationale
While Lighthizer tied his proposal to the pandemic during which the country found, for brief periods, that it lacked sufficient domestic production of needed supplies and had trouble getting them from abroad, his statement that we should “manufacture at home all the things that we need” indicates that he is using the crisis to promote a broader approach.
Lighthizer foreshadowed his industrial policy push with his May 11th New York Times op-ed in which he called for re-shoring industry. He attacked US corporations for focusing too much on profitability.
The lack of medical-related supplies early on in the pandemic spurred demand for boosting domestic production. That could have been accomplished through invoking the Defense Production Act, but it wasn’t. Instead, administration officials — including the president as well as Lighthizer and trade adviser Peter Navarro — immediately started speaking of the need to re-shore manufacturing, focusing on pharmaceuticals and medical supplies but then promoting the idea for industry more generally. That included discussion of incentives to attract factories back to the US.
Pharmaceutical vulnerability overstated
However, recent reviews have shown that the US is not as reliant as some fear on China or even India for most of its pharmaceuticals and drug ingredients. Ireland, for instance, is more important as a supplier, and domestic US manufacturing capacity is robust. There was a problem early on because some countries restricted export of medical goods, but that subsided quickly. The EU not only removed its export restrictions but is now calling for an international agreement on free trade in drugs and medical supplies.
The administration’s industrial policy push clearly goes beyond the medical sector. The British call for a “D10” group of countries to encourage rivals to Huawei would require an industrial policy — but that has a national security rationale. The problem is distinguishing valid defense concerns from opportunistic rent-seeking. Already, according to the Wall Street Journal, the US semiconductor industry is preparing a lobbying campaign to get what it expects will be billions of dollars in federal government funding for R&D and factories within the US to enable them to compete with the Chinese. If the government does openly embrace industrial policy, look for other sectors to follow suit.
USMCA
Late on June 3rd, the USTR also released the final US-Mexico-Canada regulations for how automakers and other manufacturers are to comply with the USMCA rules of origin (ROOs). Largely on US insistence, the US, Mexico, and Canada have agreed to have the USMCA enter into force on July 1st. The auto sector had pushed to have more time. It sees the changes from the less onerous NAFTA ROOs to the USMCA ROOs as disruptive. The manufacturers argue that adding the new rules to the already severe disruption of supply chains and markets caused by the pandemic puts North American vehicle-makers in a difficult position.
Although the July 1st start date remains, the regulations do provide a transition period until December 31st during which automakers can work with their suppliers to compile information and documentation that will be needed to comply with the new ROOs.
The new USMCA ROOs require that for a vehicle assembled in North America to qualify for duty-free treatment, it must contain – phased in over time – 75% USMCA regional content, including (when fully implemented) 70% of its steel and aluminum having been not just finished but melted and poured in the region, and 40% of its content made in North American plants with an average wage of at least $16 an hour.
The new rules require reconfiguration of supply lines and factory processes. It is speculated that some automakers might decide to simply accept paying the 2.5% US car duty rather than comply with the onerous new ROOs and their reporting and validation requirements. In either case, the added cost will be passed on to the US consumer.
USTR announces DST investigation
The USTR office is on firmer ground in announcing, on June 2nd, that it has initiated an investigation of the Digital Services Taxes (DSTs) adopted or under consideration by Austria, Brazil, the Czech Republic, the EU, India, Indonesia, Italy, Spain, Turkey, and the UK.
Trade Representative Lighthizer released a statement saying, “President Trump is concerned that many of our trading partners are adopting tax schemes designed to unfairly target our companies. We are prepared to take all appropriate action to defend our businesses and workers against any such discrimination.”
The move has bipartisan support and is not generally seen as an escalation of President Trump’s wielding of long-retired trade laws for protectionist purposes. It is seen as an understandable response to unfair foreign attempts to grab money from iconic American companies. It doesn’t mean that new tariffs will be imposed. There has to be the investigation first.
Pressure for a negotiated OECD resolution
One of the reasons the move was taken now is to put pressure on other countries to engage in the OECD talks to come up with agreed upon international guidelines for DSTs. “[A]s an extreme measure,” Peterson Institute for International Economics (PIIE) analysts report, “the US could invoke an obscure provision of US tax law, Section 891… to threaten double taxation of US income earned by European firms if the DST enters into force.”
Among the 10 targeted countries, Austria, India, Indonesia, Italy, Turkey, and the UK have already imposed DSTs, while the EU, Brazil, the Czech Republic, and Spain are considering imposing a DST. The Tax Foundation reports that 22 countries have enacted or are considering some form of DST. Even in Canada, it has been proposed by Trudeau’s Liberal Party. Kenya is also looking at a possible DST. This could disrupt the bilateral trade talks now expected to start next month.
L.C. reports on trade matters for business as well as Founders Broadsheet.
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