Is Strict Reciprocity Required for Fair Trade?

Author:Chow, Daniel C.K.

TABLE OF CONTENTS I. INTRODUCTION 2 II. INTERNATIONAL TRADE AS A ZERO-SUM GAME 9 A. The Trump Administration's View of International Trade 9 B. International Trade as a Positive-Sum Game 11 III. TRADE DEFICITS ARE CAUSED BY TRADE AND ARE A DIRECT LOSS TO THE US ECONOMY 19 A. Bilateral Trade Deficits as a Direct Loss to US GDP 20 B. A Closer Look at Trade Deficits 21 IV. NONRECIPROCAL TARIFFS AS CAUSING A LOSS TO THE US ECONOMY 29 A. Tariffs under the WTO 30 B. Nonreciprocal Tariffs and Trade Losses 31 C. Reciprocity and the GATT/WTO 33 V. JUSTIFICATION FOR US TRADE SANCTIONS 38 VI. CONCLUSION 41 I. INTRODUCTION

The election of Donald J. Trump to the US presidency has led to the revival of economic nationalism as the guiding policy of US international trade relations. (1) Economic nationalism posits international trade as a zero-sum game in which a gain in trade by one nation must be accompanied by a corresponding trade loss to another nation. (2) This modern expression of the political economic philosophy of mercantilism (3) (i.e., that a nation should increase its exports and decrease its imports) was the basis on which the Trump administration was able to win significant political support. (4) Trump incited dissatisfied voters by claiming that the United States has too often been the loser in a zero-sum game and that it will dictate the terms of all new trade agreements to ensure that the United States is the winner in trade deals at the expense of its trading partners, if necessary. (5) As for existing trade agreements that compromise US interests, the United States will impose wide-ranging punitive tariffs (i.e., customs duties on imports) (6) on its trading partners to force them to come to the table and to concede to new terms. (7) The aggressiveness of the US position has shocked and antagonized other nations that have responded with threats of retaliation. (8) Friendly trading nations and allies of the United States seem genuinely shaken by US threats, and the entire world economy seems to be bracing for a destructive global trade war. (9)

US economic nationalism is based on three major assumptions that are examined and analyzed in this Article. In each of these assumptions, the concept of reciprocity plays a key role. The Trump administration often argues that reciprocity in trade flows and in the terms and conditions of trade are conditions of "fair" trade (10) and that the current lack of reciprocity in US trade relations is evidence of how the United States is being harmed by trade. For example, President Trump recently claimed on Twitter that "Fair trade is now to be called Fool trade if it is not reciprocal." (11)

The administration's appeal for "fair" trade is not new to US political discourse. Since the 1980s, "[c]ongressmen, businessmen, editorialists and the media have repeatedly emphasized fairness in trade, 'level playing fields' and reciprocity as a pre-condition for a trade regime to be acceptable to the United States." (12) As an economic concept, reciprocity can be traced back centuries further to the foundational ideas of the economists Adam Smith and David Ricardo, further discussed below, (13) who espoused that mutual advantage--a type of reciprocity--was inherent in trade. (14) However, the Trump administration goes beyond classic economic theory to espouse a concept of absolute or strict reciprocity in the sense that each side in a trade relationship must derive benefits that are either exactly the same or that are mirror images of each other. (15) The United States' insistence on mirror-image reciprocity in trade is not only impossible in practice but is based upon a serious misunderstanding of basic economic concepts, as further explained below. (16)

The US insistence that strict reciprocity is required in its trade relations is one reason why the United States is not asserting this claim in the World Trade Organization (WTO) dispute settlement system--the WTO does not recognize strict reciprocity as a WTO obligation. (17) Rather, together with the principle of National Treatment (NT), (18) the WTO is built on the edifice of the Most Favored Nation Principle (MFN), (19) a principle of nondiscrimination, (20) which has the effect of multiplying trade benefits to all WTO members under a positive-sum game theory of international trade. (21) Unable to assert a claim under the WTO, the United States has decided to act unilaterally and outside of the WTO in imposing punitive tariffs, infuriating its trading partners and undermining the continuing viability of the WTO. (22)

The validity of the US assumptions about reciprocity is essential because if absolute reciprocity is required for free trade, then its absence in US trading relationships is proof of unfairness and thus provides the justification for the United States to impose punitive tariffs on its trading partners to correct the unfairness. By contrast, if absolute reciprocity is not required for fair trade, then its absence does not provide a justification for the use of trade sanctions. From a normative standpoint, the United States then must provide an alternative justification or withdraw the sanctions.

Turning to the three assumptions of absolute reciprocity, the first assumption is that international trade is a zero-sum game in which there can be only one winner and one loser in every trade deal. (23) This position holds that each gain in trade by one nation must lead to a mirror-image or reciprocal loss in trade by another nation. (24) This position ignores a large body of empirical and theoretical work in international economics created in the past five decades or more that supports the view that international trade is a positive-sum game in which cooperative trade arrangements can increase the size of the pie and generate increased trade volumes for the multilateral trading system as a whole and for each nation individually. (25) Under a positive-sum game, the concept of strict reciprocity does not play a role. (26) Ignoring the voluminous evidence to the contrary, (27) the Trump administration insists that the United States has been harmed in a zero-sum game by the trade agreements entered into under the auspices of the General Agreement on Tariffs and Trade (GATT) (28) and its successor, the WTO. (29)

If the Trump administration ignores this existing body of theory and empirical evidence, then on what evidence does it base its position that international trade harms the United States? The current administration seems to rely on the next two assumptions as the evidence of harm to the United States. The Trump administration assumes that, in order for trade to be fair, there must be strict reciprocity in trade volumes or a trade balance between the United States and its trading partners. (30) (This assumption is the second of the three basic assumptions underlying the requirement of strict reciprocity in trade.) Currently the United States does not enjoy reciprocity in its trade relations with many of its trade partners but has a trade deficit with many partners, including its closest allies, such as Mexico ($71.1 billion), Japan ($68.8 billion), and Germany ($64.3 billion). (31) In the view of the administration, a trade deficit indicates an economic loss to the nation that incurs the deficit, while a trade surplus indicates an economic gain to the nation that enjoys the surplus. (32) In 2017, the United States had a $375 billion deficit in trade in goods with China. (33) President Trump views this as evidence that the US economy incurred a net loss of $375 billion in 2017 as a result of trade with China, which enjoyed a net gain of $375 billion to its economy. (34)

The third assumption is that the terms and conditions of trade must be strictly reciprocal in order to be fair. (35) Tariff rates must be mirror images of each other; nonreciprocal tariffs indicate a loss to the nation that has the lower tariff. (36) For example, the US tariff for imported automobiles from China is 2.5 percent, while China has a tariff of 25 percent for imported automobiles from the United States. (37) The Trump administration claims that the difference between these two tariff rates indicates that the United States is suffering a loss in automobile trade with China. (38) If the entire US tariff schedule has on average lower tariffs than the Chinese tariff schedule, the United States is suffering a loss in its trade with China, and the tariff rate differential is therefore claimed by the United States to be one cause of its massive trade deficit with China. (39)

These three assumptions, all based on a view that strict reciprocity is a condition of fair trade, have a certain intuitive appeal to a large segment of the US population, which helped to propel Trump to the US presidency. The Trump administration continues to frequently cite the lack of strict reciprocity in the media to incite the public (40) and to justify tariffs and other extreme measures, such as publicly berating high government officials of close US allies, such as the European Union (EU). (41)

This Article will demonstrate that the claim that strict reciprocity is required for fair trade is fallacious by proceeding in four Parts. The first three Parts will examine the three assumptions of US economic nationalism in detail and analyze their validity. Using the existing economic literature, Part II demonstrates that trade is not a zero-sum game, as asserted by the United States, but instead is a positive-sum game that can, under the right conditions, create mutual benefits for numerous trading partners. Part III demonstrates that the US claim that trade with China causes the US trade deficit and creates a direct loss to the US economy is a fallacious argument. The causes of the US trade deficit are tied to macroeconomic policies, such as saving and consumption, not trading with a specific nation. Part IV demonstrates that requiring identical tariff rates and...

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