The Rise of the New Mercantilism (Part I)

When many of the trade enforcement tools were established by the U.S. Congress 30 or more years ago, the international trading regime was quite different than it is today. Services accounted for a small fraction of cross-border trade. A larger percentage of goods trade was in commodity-type products.

Many other nations — especially developed nations — focused their economic and trade policies on promoting natural resource production and commodity goods assembly. No nation — not even Japan — was so large that it could dictate terms of trade to multinational companies.

As a result, competition between nations for investment exerted at least some discipline on nations’ worst mercantilist impulses. And when countries erected mercantilist trade policies designed to unfairly gain competitive advantage, these usually consisted of tariffs, quotas or other relatively blunt means of protectionism that were easy to detect and confront. For example, in the 1970s and early 1980s, the Japanese government limited imports of semiconductors to no more than 10% of domestic consumption.

All of these factors worked to keep the U.S. trade deficit at relatively minimal levels.

Thirty years later, the global trading system is significantly different. With the rise of information technology and global communication networks, services trade has expanded significantly. While commodity-based goods are still traded, a growing share of goods trade is now in technology-based products.

And with the entry into the global trading system of nations with very large markets — like China and India — the relative balance of power has shifted away from multinational companies toward these nations, who increasingly use access to their huge and growing markets as leverage to dictate the terms of trade.

Moreover, a large share of nations, including developing nations, see the royal road to growth in shifting their economies more toward high value-added, innovation-based goods and services — the very sectors upon which the United States’ competitive advantage is based.

And indeed, a growing share of nations have turned to discriminatory mercantilist policies to gain jobs in those sectors, and in the process targeted U.S. technology jobs. Not surprisingly, the U.S. trade deficit has ballooned to record levels — as we have become the “importer of last resort” for most of the rest of the world.

Because the nature of trade has changed and because the stakes are so much higher, nations are able to employ a much wider array of complex and relatively non-transparent means of gaining unfair advantage in the global trading system — and they have much stronger motivations to do so.

In short, mercantilist trade policies have become the policy of choice for many nations.

The U.S. trade enforcement system has not kept pace with these changes — and it has failed to adequately respond to either the magnitude or the nature of the challenge.

As technology- and knowledge-based industries become a more important part of the global economy — and a key source of high-paying jobs — many nations have established policies to grow their technology industries. Many of these policies are quite legitimate and consistent with market-based competition.

These include policies such as research and development (R&D) tax incentives, government investment in research, efforts to increase education and skill levels (particularly in science and technology fields) — and spurring telecommunications development.

It would be one thing if that were all these nations were doing to compete for technology-based jobs. After all, there is nothing inherent about the United States’ competitive advantage in these sectors.

If the United States is to maintain its advantage, we Americans will have to work for it, in part by boosting our innovation policies — such as expanding the R&D tax credit and increasing support for federal research.

But the other nations’ efforts go far beyond legitimate and market-based innovation policies. Many have decided that to compete they have to erect a whole host of unfair and protectionist policies focused on systematically disadvantaging foreign, including U.S., companies in global competition.

Perhaps the most troubling part of this is that nearly all of the nations engaging in these unfair and distorting trade practices targeting U.S. technology leadership are members of the World Trade Organization (WTO). These nations made a free decision to join the WTO and when they did they agreed to reduce — if not end — mercantilist practices.

In fact, many of these nations saw membership in the WTO as an avenue to exporting to the United States without committing to their responsibilities as WTO members. Here are a few tell-tale examples:

1. Tariffs: For example, The WTO’s 1997 Information Technology Agreement (ITA) was supposed to eliminate tariffs that distort trade flows on a wide variety of high-tech goods, including computers and telecommunications equipment.

Nevertheless, ten years after its passage, countries such as India and Indonesia still maintain tariffs on imported IT goods despite being signatories to the ITA — and maintaining high trade surpluses with the United States.

2. But it’s not just developing nations that are violating the letter and spirit of the ITA. The European Union has also decided that it must erect barriers to high-tech imports covered by the ITA. In recent years, it has been slapping tariffs as high as 14% on products — simply because companies have improved those products and added innovative features. These products include computer monitors and multi-function printers.

The argument that the EU makes for its tariffs is that these are new products and therefore they do not fall under the list of covered products under the ITA agreement. The real reason for their action is to erect a tariff wall so that high-tech production will move to economically disadvantaged regions of Eastern Europe.

The Office of the United States Trade Representative announced in late May 2008 that it intends to bring a case before the WTO on this issue.

3. India applies a 12% excise duty on computers that local manufacturers (either domestic or foreign) can offset against their value-added taxes (VAT). But foreign manufacturers are nonetheless at a disadvantage because they also pay a 4% countervailing duty (CVD), which the Indian government has specifically imposed to protect domestic computer manufacturers.

4. China recently created a tax scheme that blatantly violated the WTO when it applied a 17% VAT to both foreign and domestically produced integrated circuits (ICs) used in the semiconductor industry, and gave a rebate on most of the VAT only to companies producing ICs in China for export, but not to companies importing ICs.

5. Intellectual Property Theft: As a net exporter of manufacturing know-how as intellectual property, the United States is more dependent on protection of intellectual property (IP) than other nations. Over 50% of U.S. exports depend on some form of IP protection, compared to less than 10% 50 years ago.

But this very strength is also a key vulnerability, for unlike physical property — which is relatively difficult to steal — IP theft or forced transfer is much easier. Many nations either turn a blind eye to IP theft or actually encourage it as a way to gain competitive advantage.

China is one of the most egregious violators. Not only does China fail to enforce its own intellectual property laws, but it also has implemented measures to block the trading and distribution rights of producers of U.S. entertainment products. Even the Chinese government continues to support theft of U.S. intellectual property.

For example, although China’s State Council ordered all government agencies to use only legal software in 1999, widespread lack of enforcement or monitoring ensures that the Chinese government still favors pirated software, as is reflected in its low levels of government purchases.

Computer software theft is just the tip of the iceberg. The entertainment software industry (e.g. video games), in which the United States leads, suffers from rampant piracy in China. Over 90% of video games consumed in China are pirated. But China doesn’t just copy them — it is a leading producer and exporter of pirated cartridge-based entertainment software.

Yet China is by no means the main offender. Russia also is a distribution center for pirated entertainment software into Central and Eastern Europe. Malaysia is a primary source of pirated CDs, DVDs and console games — with a capacity of producing over 300 million disks per year.

Editor’s Note: This is first in a two-part series. Part II will appear on The Globalist tomorrow.