Evaluating Trade Deals Like NAFTA 2.0

Evaluating Trade Deals Like NAFTA 2.0

Since NAFTA 2.0 builds on the base of the original NAFTA, the new deal had some advantages over the TPP.  For example, tariffs between the parties are already set at zero.  This remains, although do note that there are very complicated tariff rate quotas in place in NAFTA 2.0 that were not scrapped.  Indeed, the level of genuinely new market access granted to partners that have known and worked with one another for decades is vanishingly small.  While much focus, as an example, has been on Canada’s new market access for dairy, the total amount given amounts to barely 0.4%.  And the United States, in return, has an equally complex system of barriers in place to protect its own dairy industry from competition (as well as sugar, oranges, and others). The deeply problematic bits of the agreement can be found buried in the texts.  For instance, the rules of origin (ROO) are incredibly complicated.  Given that tariffs are zero, the only way to keep out goods is to craft ROOs that are impossible to follow. Clearly, for many products, this objective has been met. The level of NAFTA content required in fairly large swaths of products is extremely high.  Commentators keep focusing on the insane requirements for auto production, but note that for a wide range of goods, new NAFTA content rules require 50% or more content.  To make matters worse, in many products, these rules tighten after 3 years, rising to as much as 70% local (ie NAFTA) content.

Moving the TPP Ball Forward in Washington

Washington DC:   With the formal signing of all 12 members on February 4, 2016, in New Zealand, the Trans-Pacific Partnership (TPP) has crossed another milestone.  What is up next?

Officially, the member states remain focused on finishing up domestic procedures needed to trigger the entry into force for the whole deal.  In practice, most eyes are focused on Washington.

While domestic approval is not automatic everywhere else, most of the TPP member countries do not face the same set of hurdles as the United States. 

Malaysia, for example, just managed to clear two contentious days of parliamentary debate on the TPP at the end January.  While the government did not, strictly speaking, need MPs to grant approval for the deal, the government had promised a debate before signing the final texts.  In the end, MPs did not block the agreement. 

The country still has to change 26 different pieces of legislation to bring the country into alignment with new TPP requirements.

In most parliamentary systems, getting legislative approval is easier (assuming the government that negotiated the deal is the same government that is asking members of parliament to approve the final agreement). 

Most other TPP members are rapidly moving towards granting approval and making necessary domestic legislative changes to bring the agreement into force.  This likely includes Japan, which appears to want to finish approvals for the TPP ahead of this summer’s elections in the Diet.

The United States, by contrast, has a special problem.  The agreement was launched under a Republican administration, but negotiated under a Democrat.  Traditionally, however, Democrats have been less than enthusiastic about trade.  Hence the President has to get the opposition to do the heavy lifting to get the agreement through the legislature. 

To this mix, add a crazy electoral cycle, as an earlier blog post noted, where even the normally reliable pro-trade Republican party has been stepping out against trade.  Even a former USTR (trade minister), now a Republican Senator from Ohio, Rob Portman, just said he would vote against the TPP.  (Surprisingly, his photo at USTR seems undamaged so far…)

There are three issues of particular concern in DC.  First, the patent length for data protections for biologic drug continues to raise a ruckus. 

Think about that for a moment.  In an agreement that runs to 1200 pages with thousands of pages of specific schedules, the fight is literally over one number—should it be 12 or 8 or 5?  More amazing, this is a fight that has been highlighted for years.  It’s been in our blogs for more than a year with the clear warning that 12 years is simply a non-starter for the other parties. 

Astonishing, no? 

Anyway, issue number two is the onshoring of financial services data.  Until this week, I was not aware that it was the United States that caused this problem in the first place.  I thought there was another (unnamed) TPP member that was pushing for this policy.  No. US Treasury has some obscure rule about data flows for financial services that it wants to maintain for future policy space. 

Again, think about this for a moment—the TPP deal is potentially going to be derailed in Congress over a policy position that US Treasury has taken. 

Third, the “tobacco carve out” is a problem.  Tobacco is not carved out of the deal.  Tobacco is included.  What is carved out is the ability of tobacco firms to sue for expropriation (seizure of assets by government) under the investor-state dispute settlement mechanism. 

In doing the rounds this week in Washington, the consensus among many veteran trade watchers is that much of the fuss can be handled without “renegotiation.”  It appears to have finally sunk in that asking the other TPP member companies to reopen the deal for 3 things will put the US at risk of accepting 33 unpalatable changes in the agreement in return. 

Hence, people are furiously working behind closed doors to figure out some sort of domestic level solutions.  For example, in tobacco, maybe a commitment to not exclude tobacco (or any other sector) from ISDS in any future negotiation?

The general level of animosity in the town is clearly not helping.  Each side is accusing the other of “insufficient” attention.  The few objective observers in DC have said that there have been a lot of meetings between the White House and various members of Congress.  Whether these have been sincere or sufficient or include adequate listening or whatever is clearly a subjective call. 

Executive branch staff members are also fanning out across the country and holding meetings everywhere.  One staff member joked that if there were three people in a Starbucks somewhere who wanted to discuss TPP, he would be there on the next airplane.   The various business organizations are actively and intensively working the ground in some districts. 

The timing of the US vote is going to be interesting.  The idea seems to be to work out the “fixes” to the specific problems and objections of members that can be addressed.  Then the package will be ready to go with all the necessary implementing legislation while everyone furiously counts votes.  The minute the votes are thought to be ready, the whole thing will be put forward.

The earliest date this might happen is probably May.  The ITC has to report on the expected benefits of the agreement with a target date of May 18.  This could be sooner, although if I were the ITC, I would not try to rush what is going to be a highly contested report.

Most people are expecting the vote in the lame duck session.  However, this is risky, as noted earlier.  Timing is tight.  Depending on who wins, it is not automatic that getting it done then is easier.

One other point of note for TPP watchers from this week—even if all 11 TPP parties managed to complete their own “domestic procedures” by summer and the US somehow miraculously got the Congressional votes in June, the deal does NOT happen 60 days later.  This is because the American domestic procedures also include another element—certification. 

The United States has to certify that all parties have sufficiently carried out the necessary legislative steps to implement the deal on day one.  In practice, this means USTR has to notify Congress that, for example, Malaysia did pass the 26 pieces of legislation to comply with TPP rules.  Only when this certification is finished can the United States declare that it has sufficiently completed its own procedures to trigger entry into force.

This process could be speedy, but likely not just 60 days.  Hence, if all 12 parties appeared to ratify in mid-2016, the agreement would likely enter into force around January 2017. 

Of course, lots of things—like the death of a Supreme Court Justice, perhaps—could easily throw the entire process into complete disarray and either speed up or derail the trade agenda entirely.

***Talking Trade is a blog post written by Dr. Deborah Elms, Executive Director, Asian Trade Centre, Singapore***

Gearing Up for the TPP Text Release

The moment trade geeks have been waiting for is nearly here—after close to six years, the texts and schedules of the Trans-Pacific Partnership (TPP) are supposed to be released this week. 

The release will be accompanied by much hyperventilating by a handful of companies and NGOs that believe they have been negatively affected or who believe that the TPP agreement is insufficient in one way or another.  The TPP is a carefully crafted deal that managed the nearly impossible task of making all 12 participating countries equally satisfied (or unsatisfied) with the results.  It cannot be reopened and, I would argue, if it were, some member states risk losing substantial benefits elsewhere in an ultimately futile attempt to make everyone happy.

The best quote of the year, courtesy of New Zealand Trade Minister Tim Grosser, assessed the TPP outcomes this way: “It means both of us are swallowing dead rats on three or four issues to get this deal across the line.”  The art of compromise is critically important to reach an agreement with 12 member states in so many areas.

Firms and sectors (and consumers) that are likely to benefit from the deal will be more muted, particularly because they may actually be trying to read the agreement.  It will run to hundreds of pages of dense legal language accompanied by thousands of pages of various member country schedules.  Decoding it all and sorting out what the TPP might mean for any particular company will take some time and considerable effort. 

Because the TPP is not a standard trade agreement (certainly compared to many in Asia), determining the implications of TPP commitments for companies is tougher than might be expected.

As an example, let me use a firm I met with last week at a YPO event in Jakarta.  This company creates industrial lubricants in Vietnam.  They seem to be enthusiastic users of free trade agreements (FTAs), since tariffs on many of their products can be substantial enough to cut into profits.  But using existing agreements is not straightforward.

To qualify for benefits, firms have to show that goods were manufactured in or use materials from FTA member countries.  Without strict rules of origin (ROOs) in place, companies could import goods from somewhere else, relabel the products, and export using the FTA benefits.  This would be very problematic for competitors that are trying to legitimately use the agreement to support domestic production.

The firm currently has to carefully formulate or reformulate every product in their inventory depending on the final destination of each item.  Products shipping to Japan, for example, require one type of formulation to meet the requirements of the ASEAN-Japan FTA.  The same item going to Australia may need a slightly different set of raw materials or require the items to be sourced from different places to meet the criteria of ASEAN/Australia/New Zealand (AANZFTA). 

To add to the complications, the paperwork needed to track each product is extensive.  The firm has to ensure that it carefully meets each and every rule in different FTAs or it could be subject to substantial fines for non-compliance (and even face retroactive enforcement of past mistakes).

Under the TPP, however, this firm will have just one rule of origin to meet for each item in its inventory that it intends to ship to all 12 TPP member markets.  The exact same product can go to Japan or to Australia without a change.  Just as important for this firm, the paperwork is identical (and the firm might qualify for an additional benefit that obviates the need for special customs paperwork at all). 

If these were the only benefits for the firm, sorting through the TPP texts and associated schedules might not be challenging.  But since the TPP is deep and broad, benefits for the firm could be scattered across multiple chapters.  The company will also have better access to TPP services providers, potentially providing improved legal or accounting services or logistics or distribution services.  Its investment opportunities will expand dramatically.  Other provisions in the agreement could result in fewer tests for products, as the firm might be able to submit test results from one jurisdiction directly into another without retesting.

Figuring this out will take some time.  In addition, savvy firms will also be trying to anticipate what the TPP will do to overall trade flows in their particular sector.  They may be figuring out what the TPP might do (or not) to their competitors.  The impact could vary by market.  In short, it will be complex but for most, the benefits ought to be significant.

For nearly all the other firms that are likely to squeal loudly when the texts get released, the TPP could still represent an improvement off the status quo.

As an example, consider dairy.  There will be deep unhappiness in some export markets about the fact that dairy is not completely opened across TPP member countries.  The academic in me, of course, would like to have seen full access with no exclusions.  But the real world often demands compromises and the final agreement has to be compared with the current status quo.

Compared to now, dairy exporters still come out ahead.  Tariffs will fall over time.  Quotas are expanded.  (Neither, I might add, happen so quickly in some markets that vulnerable domestic firms will not have time to adjust to new market conditions.)  The agreement creates a benchmark for potential improvements at some future negotiation. 

Another complaining industry will be pharmaceuticals who will bang on loudly about renegotiation needed to give further protection to biologic drugs.  This is frankly crazy.  The United States fought for more than five years and nearly derailed the entire agreement with a dogged insistence on moving patent extensions to 12 years. 

Twelve years is a non-starter.  The other TPP member countries refused to budge, no matter what sort of promises and threats the Americans employed. 

Again, compare the TPP to the status quo.  Currently, five member countries do not protect biologics at all.  Four members have five years of protection.  Only two (Canada and Japan) provide eight years of protection now.  The United States law provides 12 years of protection, but the budget covers seven years only. 

This math alone suggests no compromise at 12 years would ever be possible.

Any attempt by disaffected firms to insist that the deal be renegotiated risks opening up a Pandora’s box of changes.  It will not just be one member that wants something else included/excluded. 

This is the deal. 

After we have all poured over the texts and schedules, we can have a discussion about the gains and losses that will actually accrue in implementation.  Enjoy your reading!

***Talking Trade is a blog post written by Dr. Deborah Elms, Executive Director, Asian Trade Centre, Singapore***

Defending the Indefensible in TPP

As the Trans-Pacific Partnership (TPP) trade negotiations head towards conclusion, I am increasingly fielding questions from people about the challenging final issues that remain.  This post covers a range of topics that stem largely from officials trying to defend policies that appear indefensible to outsiders.  Most are rooted in specific local politics or interpretations of domestic conditions that may be under threat in the TPP.

Why is Japan fighting so hard for rice protections?  My interviewer on CNBC this week asked again why Japan’s government is ready to fight to the finish over issues of rice.  After all, the agricultural sector in Japan contributes a tiny sliver to overall economic output.  The average age of Japan’s farmers is heading towards 70 and very few farm full-time.  In exchange for historical protections that include a rice tariff of 777 percent to keep out foreign polished rice, Japanese consumers pay extraordinarily high prices for rice and agricultural products of all sorts.

This situation is not unique to Japan.  Like many countries, the political system has been stacked in favor of rural voters, who are overweighted in the parliament relative to their population size. 

Mansur Olsen, the Nobel-prize winning economist, highlighted problems of collective action several decades ago.  While it is true that consumers as a whole would benefit from lower rice and agricultural prices, the problems of collective action mean that these diffuse interests rarely result in activity by large groups that would receive modest benefits.  By contrast, Japanese rice farmers clearly grasp the competitive challenges that they will face from the removal of barriers to trade.  They have every incentive to make their unhappiness known in loud and clear terms to political leaders.

In Japan, these concentrated agricultural producer interests can be further funneled to politicians and bureaucrats through a strong and entrenched bureaucracy of their own.  Japanese farmers are also brought together by JA Zenchu, an agricultural cooperative that (for the moment) comes with large numbers of staff and considerable economic strength.  They can mobilize significant numbers of voters and ensure that their supporters make it to the polls on election day.

Why are the Americans fighting so hard on auto tariff reductions?  The United States currently levies a 2.5% tariff on imported passenger cars.  In the TPP, Japan is pushing hard to get this tariff eliminated as soon as possible.  Like all TPP rules, it would apply to TPP member firms only and would not be extended (through the TPP) to other country companies.

What makes American opposition to tariff reductions so puzzling is that much of Japan’s auto production now takes place inside the United States and the rest of North America.  As a result of the rules set down more than 20 years ago in the North American Free Trade Agreement (NAFTA), auto producers that want to take advantage of the agreement must produce a substantial percentage of the final vehicles in NAFTA countries.  Hence, few Japanese autos are likely to benefit from a lowering of tariffs on autos in the TPP since most are already created inside the American domestic marketplace where they have never paid tariffs on the final products.

For more than 30 years, the U.S. auto industry has been uncomfortable with Japan’s access to the American market.  Maintaining a minor tariff for a substantial length of time is one way to help encourage wavering members of Congress to avoid blocking the TPP agreement on behalf of the domestic auto industry. 

Why can’t Canada change the supply management system for dairy and poultry?  The TPP is supposed to be a high quality, 21st century trade agreement that includes all products with no exceptions and a goal of lowering tariffs to zero.  In this context, the myriad system of supports that Canada uses to protect domestic dairy and poultry farmers from competition (primarily from the Americans) ought to be phased out over time.

But Canada faces the same sort of collective action problems on agricultural reform that Japan confronts.  Although Canada’s consumers would clearly benefit from lower prices on a wider range of dairy and egg products, the industry is much better organized and can mobilize significant resources to fight change.  So far, the industry has been impressively successful in keeping supply management off the negotiating table, including (so far) in the TPP talks.

Why won’t the Americans open up the domestic sugar market to Australian sugar?  This question stems from an odd quirk in the current negotiating environment in the TPP.  Although officials are aiming for a high quality result, negotiators have to operate in a world of existing, overlapping trade agreements from the past.  These previous deals will not go away once the TPP is signed.

In an existing bilateral trade agreement between the United States and Australia, sugar was carved out or excluded from the deal.  At the time, it was part of a “grand bargain” of sorts that let Australia carve out investor-state dispute settlement while the Americans protected their sugar industry.  If Australia gets better access to the American sugar market in the TPP, it will undermine the provisions of the past deal.

The sugar industry in the United States has been amazingly well protected since WWII.  Production of sugar cane is highly concentrated in a handful of farmers.  But production of sugar beets is spread much more widely.  Large numbers of members of the U.S. Congress represent states or districts that grow sugar across diverse and politically important parts of the country.   These representatives have always responded to the money and influence of the domestic sugar lobby and the TPP is no exception.  Sugar changes in the TPP that would allow greater imports of Australian sugar have been vigorously fought off.

Why don’t American union groups support the TPP?  This question came to me with great puzzlement at a meeting of ASEAN trade union leaders this week in Kuala Lumpur.  From their perspective, any agreement that raises economic growth is likely to result in additional jobs.  With new markets opening up that were previously closed or difficult and expensive to penetrate, firms have new opportunities for expansion and job creation.

Yet American labor leaders have come out loudly and vocally against the TPP.  Union membership in the United States has been falling for some time.   Labor leaders fear that TPP changes will exacerbate the loss of union jobs in the United States, since many union members are blue-collar workers. 

What is especially strange about the objection to the TPP by labor leaders is that most union members are actually government employees of all stripes, including teachers or public health care employees, who are unlikely to be affected by this trade agreement.  The fastest growing segment of unionization is taking place among services employees.  If the TPP leads to economic growth, the service sector is also likely to expand.  Many of these jobs, like hotel and restaurant workers, are not going to be outsourced.  In fact, it could certainly be argued that easier movement of people across the TPP for business travel and tourism should bring additional jobs to American services union workers. 

We can argue about the quality of such jobs and the appropriate pay scales for workers, but the TPP should not affect either of these elements of service sector union jobs.

Why are some TPP members fighting over specific rules changes for one class of medicines?  One of the most hotly contested arguments in the entire TPP agreement has been about appropriate patent length protections for a class of pharmaceutical medicines.  Should biologic drugs receive 5, 8 or 12 years of coverage before going off patent and becoming available to generic drug manufacturers? 

What is strange about this fight is that biologic drugs like the flu vaccines are extremely hard to manufacture.  They cannot be easily reverse engineered.  Each dose can be unique, as biologic drugs are not simple copies of one another. 

Most TPP members do not have (and may never have) the capabilities to manufacturing pharmaceutical products.  Even fewer will be able to create biologic medicines.  Thus, the fight over patent length protection does not make sense for most members.  However, many countries appear to have seized on this issue as a tool for achieving their negotiating objectives elsewhere in the agreement.  It is more of a bargaining chip than a serious point of disagreement.

Closing a deal is hard.  Given the nature of trade negotiations, the most difficult, politically sensitive issues are left to the very end of discussions.  It is only after the broadest balance of interests is largely hammered out that leaders can make a clear-eyed assessment of their total gains and losses throughout a complex negotiation.  Given the determination of benefits and challenges, countries will decide whether they will continue to defend largely economically indefensible policies or whether such programs will be adjusted in the wake of the TPP.  The time for sorting out such decisions and making appropriate calculations is now.

***Talking Trade is a blog post written by Dr. Deborah Elms, Executive Director, Asian Trade Centre, Singapore***