[Economic Report of the President (2006)]
[Administration of George W. Bush]
[Online through the Government Printing Office, www.gpo.gov]

 
CHAPTER 7

The History and Future of
International Trade

For many decades, the United States has worked to break down trade
barriers across the globe through a wide range of institutions and
agreements. Both the United States and our trading partners have
derived substantial benefits from greater global economic integration.
Many American consumers, firms, and workers are better off because of
these efforts.
While the economic research and performance of this time period
show the benefits of trade outweigh the costs, trade liberalization
has always brought anxieties. This has been the case both here in the
United States and throughout the world. Temptations to retreat to
economic isolationism often occur when trade agreements are
negotiated and current negotiations are little different in this
regard. Therefore, this chapter provides a retrospective on U.S.
trade policy and an evaluation of the payoff from greater trade and
investment liberalization that has been at the forefront of this
country,s international economic policy for the last 70 years.
The key points in this chapter are:
Over the past 70 years, policymakers across political
parties have consistently recognized the importance of unfettered
international commerce to America's standard of living and economic
growth, and have achieved major trade liberalization both here and
abroad.
The net payoff to America from these achievements has been
substantial. Many American consumers, firms, and workers have
benefited from increased trade.
A number of barriers to trade, especially in services,
remain, and the potential gains to the United States and other
countries from further liberalization are still significant. To move
beyond trade liberalization in goods, the United States is pursuing
greater economic cooperation and more-open markets with our trading
partners in order to stimulate economic growth.

A Retrospective on Trade
The country's historical influence in promoting global trade
liberalization can be traced back to the early part of the
twentieth century, and it spans both political parties. The early
1930s proved to be a critical turning point in the evolution of
modern American trade policy and heralded the first major American
trade liberalization effort. In the decades following, the United
States has spearheaded multinational, regional, and bilateral
negotiations in the interest of advancing trade liberalization. This
retrospective illustrates the undeniable progress toward trade
liberalization in the United States. Revenues from tariffs
(a tariff is a tax levied on imports coming into the United States)
in the early 1900s accounted for about half of Federal revenues
compared to less than 2 percent today. From the inception of this
country until the Civil War, tariff revenues were a major source of
government revenue. The addition of the sixteenth amendment to the
U.S. Constitution in 1913 broadened the tax base by introducing the
personal and corporate income tax. This change began the shift away
from indirect taxation (import duties and excise taxes) toward
direct taxation on personal and corporate incomes, thereby reducing
this country's dependence on import duties as a form of revenue.
Before the 1930s, U.S. trade practices fluctuated between
trade-promoting and trade-restricting policies. Prior to
World War I, President Woodrow Wilson pursued an internationalist
foreign policy that resulted in import tariff reductions through the
Underwood Tariff Act of 1913. The economic depression and subsequent
reversion to isolationism that followed the 1929 stock market crash
led to a rejection of Wilsonian policies in favor of greater
protectionism. The Tariff Act of 1930 (otherwise known as the
Smoot-Hawley Tariff) significantly raised average duties on selected
imports to an all-time high of 59 percent. Such protectionism was
designed to reduce unemployment and increase domestic output. By
reducing export markets, however, the heightened tariff and
nontariff trade barriers (such as quotas or quantitative import
restrictions) exacerbated the Great Depression. The collapse of
world trade from 1929 to 1933--a decline of more than two-thirds in
just four years--followed in the wake of protectionist policies
as countries depreciated their currencies, raised tariffs, and
imposed quotas. These isolationist policies contributed to a
spiraling contraction of world trade and a collapse of domestic
demand.
The historic Reciprocal Trade Agreements Act of 1934 marked a
turning point in modern trade legislation. The 1934 Act departed
significantly from previous protectionist policies, and it began the
historic shift toward lower U.S. and foreign trade barriers and
greater global economic engagement. Signed into law by President
Franklin D. Roosevelt, the Act passed Congress with overwhelming
support. The 1934 Act was the first of many steps over the twentieth
century leading to Americaï¿½s relatively liberal trade stance today.
Table 7-1 shows that key milestones in American trade history have
been consistently achieved by a number of administrations.
The Trade Act of 1934 changed U.S. trade policy. The 1934 Act made
trade a shared Congressional and Executive Branch responsibility,
and instituted a so-called bargaining tariff. Up to that point,
trade policy had been primarily

[[Graphic(s) NOT AVAILABLE IN TIFF FORMAT]]

a product of the legislative exercise of its Constitutional
authority over foreign commerce. This Constitutional authority left
Congress open to the protectionist demands of specific industries
and special interests. President Roosevelt and Secretary of State
Cordell Hull recognized this vulnerability and worked with Congress
to enact this reciprocal trade program to make lower tariffs more
politically durable. With the enactment of the Trade Act of 1934,
Congress suspended passage of product-specific trade laws and
delegated specific tariff-setting to the Executive Branch. Doing so
formally changed the way Congress handled trade issues by insulating
elected representatives from the pressures that had led to
protectionism in the past.
The 1934 law also instituted the so-called bargaining tariff. This
concept linked tariff setting to international negotiations, whereby
U.S. tariff cuts were extended in bilateral negotiations to
countries that offered reciprocal tariff reductions benefiting U.S.
exporters. In this way, the bargaining tariff helped to shift the
balance of trade politics by engaging the interests of U.S.
exporters. The system effectively allowed the United States to
reduce its own trade barriers and to persuade the rest of the world
to reciprocate. In the aftermath of World War II, policymakers
correctly predicted that postwar trade expansion would help to usher
in a remarkable era of world prosperity and contribute to conditions
for a stable peace.
A commitment to the Wilsonian notion that prosperity and peace go
hand in hand is at the core of postwar trade liberalization for both
political parties in the United States. An extension of the
reciprocal trade agreement, which Presidents Roosevelt and Truman
both had recommended as a keystone of the country's postwar
international economic policy, passed Congress with strong support
in 1945. The enabling legislation put the Administration in a
position to begin in earnest the process of dismantling global trade
barriers. President Harry S. Truman signed the General Agreement on
Tariffs and Trade (GATT) in 1947, bringing the United States into
the multilateral trade regime by executive agreement. The GATT took
effect in 1948 and served as a forum for trade negotiations whereby
every signatory country could enjoy the concessions of every other
signatory (otherwise known as most-favored-nation status).
Membership in the GATT not only brought the United States into the
multilateral trade regime but also provided a vehicle to rebuild the
postwar economies of Europe and Japan. The lessons of Smoot-Hawley
contributed to broad support for freer trade that was to become a
critical component of U.S. international economic policy. This
political consensus marked a shift toward a broadly accepted liberal
market and free-trade philosophy that set the stage for the various
multilateral negotiating rounds that were to follow.
The next major acknowledgment of the necessity of liberalizing
trade came in the 1960s. President John F. Kennedy led the Trade
Expansion Act of 1962, which was approved with substantial support
in Congress. The Act authorized the U.S. government to negotiate
tariff cuts of up to 50 percent, which persuaded other countries to
actively participate in the Kennedy Round (1962-1967) of
multilateral trade negotiations. Congressional support was partly
due to the inclusion of legislation to assist workers affected by
trade, also known as Trade Adjustment Assistance. At the time, the
Kennedy Round signified the most ambitious series of trade
negotiations ever attempted under the auspices of the GATT. The
Round included negotiations on agriculture for the first time, and
reduced barriers to exporters for developing countries.
The Tokyo Round (1973-1979) led to further tariff reductions and
provided new disciplines on nontariff barriers. The Tokyo Round
included ``codes of conduct'' that were designed to curtail the use
of such barriers as instruments of protection. Launched under
President Richard M. Nixon, continued by President Gerald R. Ford,
and signed into law by President Jimmy Carter with the Trade
Agreements Act of 1979, the Round demonstrated a strong, consistent
bipartisan commitment toward freer trade.
As trade liberalization negotiations moved increasingly beyond
tariff reductions in nonagricultural products, progress toward
greater liberalization became more difficult for many countries. The
Uruguay Round (1986-1994) launched under President Ronald Reagan
nearly collapsed in 1990 over disagreements about lowering barriers
on agricultural products. Following a redrafting of the agreement by
GATT Director-General Arthur Dunkel, President George H.W. Bush
spearheaded efforts to complete negotiations of the Uruguay Round,
and in 1994 President Bill Clinton signed legislation implementing
the final agreement. The Uruguay Round achieved the most fundamental
reform of global trade rules since the creation of the GATT.
The Round established the World Trade Organization (WTO), extended
international trade rules beyond goods to include intellectual
property rights and trade in services, and greatly improved
procedures for countries to resolve disputes over international
trade.
At present, the United States is actively engaged in the current
Doha Development Round of multilateral trade negotiations that began
in 2001. This round aims to liberalize agricultural trade, lower
remaining barriers in nonagricultural goods trade, and reduce trade
barriers in services. The Round focuses on increasing market access
for developing countries as a means to encourage economic
development. Progress has been slower than anticipated, but the
eventual success of the previous Uruguay Round suggests that a
favorable outcome from Doha will emerge.
In addition to multilateral trade liberalization, over the past
two decades the United States has signed a number of bilateral and
regional trade agreements. The protracted nature of multilateral
negotiations has been one factor that has led the United States to
aggressively pursue other avenues toward free trade outside of the
major negotiating rounds. Under President Reagan, the United States
signed its first bilateral free trade agreement (FTA) with Israel in
1985. The United States and Canada signed a bilateral FTA in 1988
after three years of negotiations. The Bush Administration initiated
negotiations for the North American Free Trade Agreement (NAFTA)
in 1991, which President Clinton signed into law in 1993 and went
into effect the following year. In addition to trade, NAFTA
explicitly recognized the benefits of investment liberalization and
included provisions designed to extend national
(i.e., nondiscriminatory) treatment, among other protections to
investors.
The United States has recently embarked on a renewed series of
bilateral and regional free trade agreements. The ability of the
United States to negotiate trade-liberalizing agreements was
strengthened significantly when the President signed the Trade Act
of 2002 into law. That legislation provides the Executive Branch
with the ability to negotiate international agreements that are
subject to an up or down vote, but not amendment, by Congress.
The President's leadership was vital in securing this important
authority to pursue a full trade agenda including multilateral,
regional, and bilateral trade agreements. The President has
implemented bilateral FTAs with Jordan, Chile, Singapore, and
Australia. The Administration also has concluded FTAs with an
additional ten countries: Costa Rica, El Salvador, Guatemala,
Honduras, Nicaragua, the Dominican Republic
(the Central American-Dominican Republic FTA, or CAFTA-DR), Morocco,
Bahrain, Oman, and Peru. The United States is currently engaged in
negotiations with the United Arab Emirates, the five nations of the
Southern African Customs Union (Botswana, Lesotho, Namibia,
South Africa, and Swaziland), Thailand, Panama, Colombia, and
Ecuador. The adoption of CAFTA-DR is the latest chapter in
America's trade book, which demonstrates the country's ongoing
commitment toward trade liberalization and economic development.
Decades of U.S. trade liberalization achieved on a number of
fronts have had a dramatic impact on U.S. openness to trade.
Chart 7-1 shows how average U.S. tariffs have fallen since 1930. The
average tariff on dutiable goods approached 60 percent at the height
of the Great Depression and has dropped to 4.6 percent. The current
average U.S. tariff on all goods (both dutiable and nondutiable)
is just 1.4 percent.
Trade expansion has reached an important juncture, and resistance
both here and abroad to further trade and investment expansion could
jeopardize increased domestic and international economic growth. The
retrospective presented above illustrates America's historic
achievements in trade liberalization, and, as the next section
demonstrates, Americans, on average, have accrued immense gains
along with our trading partners from this liberalization.
The United States has a large stake in the current multilateral
negotiations of the Doha Round. The gains from prior trade
agreements provide grounds to stay the course on trade liberalization.

The Payoff to America from Global
Economic Integration
Trade liberalization remains a controversial subject because
competition invariably raises both anxieties and opportunities.
Reducing obstacles to trade can help economies grow more rapidly and
efficiently in the long run and create better, higher-paying jobs,
while global competition can lead to hardships for others in the
short run. (Impacts of international trade on labor markets are
discussed in Box 7-2 later in the chapter.) The appropriate social
and political response to these hardships is a critical issue. For
instance, at the macro level, pro-growth government policies can help
set the environment for economic growth and job creation.
Constructive policies that help displaced workers train for and find
new work and increase the portability of pension and health benefits
can also ease adjustment.
The gains from trade liberalization are more widely dispersed than
the losses and often not readily apparent. These gains are evident in
lower consumer prices and the greater variety of products available
to consumers. International commerce helps countries focus resources
on strengths and forces firms to innovate and to set prices more
competitively. Studies show that firms that are engaged in the
international marketplace tend to exhibit higher rates of
productivity growth and pay higher wages and benefits to their
workers. An economy with higher overall productivity growth can
support faster GDP growth without generating inflation. And higher
productivity growth means higher sustainable living standards. Taken
together, the net benefits from increased economic integration
(greater trade and investment liberalization) historically have been
positive for the United States. Benefits to Consumers Lower Prices
International trade fosters competition, which in turn restrains
cost. There is now ample evidence across many countries that greater
trade openness and the resulting exposure to foreign competition
reduces the ability of a country's firms to charge high markups
above production costs. Pressures for lower prices arise from the
direct impact of cuts in trade barriers being passed through to cuts
in prices. They also arise from the broader impact of raising market
contestability. At the detailed product level, many studies have linked lower
prices and/or price-cost markups to measures of trade openness such
as tariff rates. Chart 7-2 presents broader evidence of how trade
helps lower prices. It presents indices of U.S. consumer prices and
U.S. import prices since 1990. There is a clear difference between
the two indices: Overall consumer prices, which include not just
imported goods and services but largely nontraded goods and services,
have risen much more than have import prices. The average annual
growth in U.S. import prices for the period 1990-2004 was just 0.6
percent, compared to a 2.2-percent rise in overall consumer prices.
In real terms, total U.S. imports grew threefold during this same
period, from $553 billion to $1.5 trillion (in 2004 dollars).
In addition to the pro-competitive effects of trade, other important
contributors to price restraint are technology advances and
innovation. This has been especially true for consumer electronics
and information technology (IT) products. For instance, in just the
past eight years, consumer prices of color televisions are down 50
percent, and Americans today pay 60 percent less for camcorders and
mobile phones. It can be difficult to empirically separate observed
price declines into the relative contributions of trade, technological
change, and other forces. But a simple approach to assessing the
role of international trade in price changes is to compare price
changes between more- and less-traded products. Consistent with the
aggregate evidence in Chart 7-2, a clear divergence in price trends
emerges when products are split in this way. Internationally traded
products tend to experience lower inflation rates--even real price
declines--while nontraded goods tend to exhibit price increases.
Between 1997 and 2004, real prices fell for an array of highly traded
goods, such as audio equipment (-26%), TV sets (-51%), toys (-34%),
and clothing (-9%). In contrast, real prices rose for



largely nontraded products, such as whole milk (+28%), butter (+23%),
ice cream (+18%), peanut butter (+9%), and sugar and sweeteners
(+9%). Exactly which Americans most enjoy the benefits of lower prices
depends on which products enjoy the largest cuts in trade barriers.
Box 7-1 discusses the regressive nature of the current U.S. tariff
schedule.

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Box 7-1:  The Regressive Nature of U.S. Tariffs
While the average tariff applied to U.S. imports is relatively low at
1.4 percent, there are peaks within the U.S. tariff schedule that fall
most heavily on lower-income consumers. Studies have shown that, on
balance, U.S. trade barriers are regressive because they
disproportionately raise the relative price of goods consumed by
lower-income Americans. Some of the most restrictive trade barriers
persist on everyday consumer products such as textiles, apparel
items, and footwear.
Tariffs disproportionately affect the poor in two ways. First, many
tariffs are highest on products that represent higher shares of
income expenditures for lower-income households. Staple consumer
products such as shoes and clothing face import taxes over 30 percent,
some of the highest tariffs in the U.S. tariff schedule. Footwear
represents 1.3 percent of income expenditures for lower-income
households (1.5 percent for single- parent households) compared to
just 0.5 percent for higher-income households. Similarly,
lower-income households (and single-parent households) spend roughly
6 percent of their disposable income on apparel, while upper-income
households spend just 4 percent.Second, within these high-tariff
product categories, tariffs are often most pronounced on the
cheapest products. That is, products that are more commonly purchased
by lower-income consumers are subject to higher import taxes than
are those commonly purchased by upper-income consumers. For example,
lower-priced sneakers ($3-$6 per pair) are marked up with a
32-percent tariff, while higher-priced sneakers, such as $100 track
shoes, are subject to a 20-percent tariff.
How did the structure of the U.S. tariff schedule become so
regressive? The cause was not a concerted effort to maintain
relatively high import taxes on cheaper products. Movement toward
increased trade liberalization tends to occur more slowly in
labor-intensive industries where greater liberalization may be
viewed negatively. The situation may reflect a classic
political-economy challenge to liberalizing trade.  The beneficiaries
of trade protection are often a much more concentrated,
well-organized group of individuals or firms than the millions of
households across the country that bear the costs. However, the
current Doha Round of multilateral trade negotiations offers an
opportunity to eliminate these tariffs and other trade barriers,
provided other WTO members reciprocate.

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Greater Product Variety
International trade also allows consumers to choose from a broader
variety of goods and services. One study shows that that the number
of imported product varieties has increased by a factor of four over
the last three decades, reflecting an important source of gains from
trade. Welfare gains from variety growth alone have been estimated to
be a remarkable 2.8 percent of GDP, which translates into gains of
over $4,000 for the average American family of four.International
trade allows year-round availability of seasonal and perishable food
items such as fruits and vegetables. For example, U.S. consumers
today enjoy grapes and peaches from Chile, limes and avocados from
Mexico, mandarin oranges from China, and cashews from India, many
during the off-season for U.S. production. Trade also provides U.S.
consumers with greater variety and choice for agricultural products
that the U.S. does not produce in large quantity. For example,
Americans enjoy coffees from all over the world, including from
Colombia, Costa Rica, Indonesia, Ethiopia, and Kenya.
Benefits to Firms and Their WorkersFirms can be linked to the
global marketplace through many channels:
exporting, importing, investing abroad, or receiving investment from
foreign firms (foreign direct investment, or FDI). Stronger linkages
to the global economy provide export opportunities for U.S. firms,
allow firms to realize economies of scale, and provide the ability to
establish and expand global production networks to lower prices and
boost productivity. These opportunities can raise U.S. living
standards by allocating national resources toward areas in which we
have a comparative advantage and by raising firm productivity.
Firms exposed to global competition are exposed to the world's best
practices in areas such as supply management, production processes,
technology, and finance. Studies show that firms exposed to the
world's best practices demonstrate higher productivity through many
channels, such as learning from these best practices, and also
creating new products and processes in response to this exposure. A
number of U.S. industries have been compelled to adjust and innovate
as a result of foreign competition via trade and FDI in the
United States. For instance, by the late 1970s, many Japanese
carmakers were outperforming U.S. companies in overall assembly
productivity, and U.S. imports of Japanese cars were rising sharply.
America's leading automakers initially focused their response on
trade protection. But competitive pressures from Japanese
firms continued, in particular through foreign investment
in the United States in the 1980s. This
foreign investment established and expanded ``transplant''production
facilities in the United States that soon achieved productivity
levels on par with Japanese plants. These transplants proved to be a
major spur to stepped-up innovation and performance among American
firms. In the steel industry, a combination of foreign competition
and the growth of the highly productive mini-mill sector has compelled
U.S. integrated-steel producers to improve their performance.
Various studies show that globally engaged firms have higher
productivity growth and tend to innovate more than their purely
domestic counterparts. For instance, evidence from the United Kingdom
shows that from 1998 to 2000, just 18 percent of domestic firms
reported either product or process innovations compared to 45 percent
of globally engaged firms. In recent years in the United States,
over 80 percent of total private-sector R&D spending has been
accounted for by multinational companies (i.e., by the combination of
U.S. parents of U.S.-headquartered multinationals and U.S. affiliates
of foreign-headquartered multinationals). Sales per employee, one
simple measure of productivity, is up to one-and-a-half times larger
in exporting plants than in others. Value-added per employee, another
measure of productivity, is up to one-and-a-third times larger in
exporting plants than in others. Exporting plants adopt new
technologies more frequently and intensively than nonexporting
plants; they also report more significant benefits from doing so.
The different channels through which international trade and
investment contribute to productivity growth are very important for
long-run U.S. living standards. Since 1995, the United States has
enjoyed an acceleration in labor-productivity growth. From 1973 to
1995, output per worker hour in the nonfarm business sector grew
at 1.4 percent per year. From 1995 to 2004, this rate accelerated to
2.9 percent per year--with rates averaging over 3 percent since 2000.
Productivity growth of just 1.4 percent per year means average living
standards take 50 years to double. At the faster rate of 2.9 percent
per year, living standards take just 24 years to double.
Many researchers have concluded that IT hardware has been at the
core of this productivity acceleration, citing both faster
productivity growth among IT-hardware firms and greater investment
in IT hardware throughout the economy. It is important to note that
these highly successful IT-producing U.S. firms are among the most
globally engaged firms in the U.S. economy. Exports and imports in the
IT sector represent over 70 percent of sector output, compared to an
economy-wide average of 10 percent. In recent years, IT firms have
grown stronger by expanding their global production networks through
increased international investment and trade, with output that entails
multiple production stages across multiple countries. Indeed, today
the United States runs large trade deficits in core IT sectors such
as computers and office products (see Chapter 10).
American workers, like firms, also benefit from stronger linkages
to the global economy. Studies show that workers in U.S.
multinationals receive wages and benefits up to 18 percent higher on
average than their peers in purely domestic firms. International
investment plays an important role, too. Evidence suggests that wage
premiums are 19 percent and 13 percent for blue- and white-collar
manufacturing workers, respectively, in foreign-owned multinational
firms. For American workers in multinationals with foreign investment
backing the wage premiums are 7 percent and 2.5 percent,
respectively. The productivity advantages of globally engaged firms
benefit American workers, insofar as high and rising labor
productivity is the foundation for gains in real wages economy-wide.
Taking Stock of the Benefits of Trade to America
The decades of American efforts to advance trade liberalization
described above have generated substantial gains for the country
overall. On the consumption side, households have enjoyed lower
product prices and greater product variety. On the production side,
firms have more efficiently allocated resources by focusing on areas
in which they have a comparative advantage. Those firms directly
engaged in international commerce tend to be more innovative, more
productive, and pay higher wages and benefits to their workers.
Overall, there is substantial evidence that trade has contributed to
high and rising living standards for the average American.
Having discussed the different ways through which freer trade benefits
America, the bottom-line question is how much has America benefited
in total from decades of trade liberalization? Studies have estimated
that the annual payoff from U.S. trade and investment liberalization
to date, including from the Tokyo Round, Kennedy Round, and Uruguay
Round, NAFTA, and other FTAs, is over $5,000 per capita or $20,000
for an average American family of four. These gains arise through
many channels: higher long-term levels of trade exposure in goods and
services that come from trade and investment liberalization;
increased product variety; more efficient allocation of resources;
and better transportation and communication technology. Some
economists have conjectured that trade liberalization alone has
accounted for about half of these gains, which implies that the
annual income gain from trade liberalization to date is over $10,000
for an average American family of four.
Box 7-2 includes a discussion of the impacts of international trade
on labor markets. The effects of trade on the environment are
discussed in Box 7-3.
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Box 7-2: Trade and Labor
Job growth in America is driven largely by demographics-
population growth and choices about labor-force participation-
and by macroeconomic policies that affect, in particular, the
business cycle. As the chart below shows, total employment has
closely tracked the number of people in the labor force
(employable people) since 1960, which in turn has closely tracked
the overall U.S. population. Import competition has the potential to
generate job losses where firms fail to adjust their operations to
meet new competitors. International trade can also create better,
higher-paying jobs in other industries. As discussed in the chapter,
American jobs in globally-engaged firms (firms that are engaged in
international trade or investment) are on average better and
higher-paying than are jobs in purely domestic firms.
The dynamic U.S. economy creates and eliminates millions of jobs
each year.  The enormous turnover in the U.S. labor market is a
reflection of the continuous stream of entry, exit, and resizing of
firms in our ever-changing economy. On average over the past decade,
the economy has had a net creation of nearly 2 million jobs each year.
This net increase has been the result of approximately 17 million
jobs created and 15 million jobs eliminated each year. International
trade is one of the factors behind job turnover, along with changes
in consumer tastes, domestic competition, productivity growth, and
technological innovation. Survey data from the Bureau of Labor
Statistics show in layoffs of 50 or more people between 1996 and 2004
less than 3 percent were attributable to import competition or
overseas relocation. Moreover, studies have shown that the rate of
job creation in globally engaged companies is faster than the
overall private-sector rate, and that trade-related dislocations on
average do not involve longer unemployment duration or lower
re-employment earnings than do dislocations from other causes.
Any job loss involves hardship, and any job change can involve
challenge. The President has outlined ways to help people gain new
skills in fields where jobs are being created.
It is often asserted that international competition pressures
American earnings. In today's economy, education is valued more than
ever and is a key determinant of worker earnings. Since the late
1970s, the returns to education have been rising in the United
States, despite the fact that the supply of educated workers has
also grown rapidly,

suggesting that the demand for skills and
education has grown even faster than supply. There is now a large
body of empirical research exploring the causes of rising wage
inequality across skills. There is broad consensus that trade has
marginally contributed to rising wage inequality by placing a higher
premium on skills and education. This contribution has been small
compared to other factors such as the advent of new technologies
that demand higher levels of skill.
It is important that the United States help our workers thrive in a
competitive world. The President has said he will not be satisfied
until everyone who wants to work can find a job. At the macroeconomic
level, monetary policy can aim to achieve maximum sustainable
employment with low inflation-irrespective of the trade situation.
At the microeconomic level, constructive policies can help students
and workers, including displaced workers-regardless of the cause of
displacement-train for and find good work in the 21st century. The
President has proposed a number of measures to improve job training,
including Community-based Job Training Grants and
Career Advancement Accounts
(for further discussion, see Chapter 2).

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Box 7-3: Trade and the Environment
A nation's environmental policies are largely determined by domestic
factors. The most direct mechanism through which trade liberalization
could affect environmental quality is through changes in the
composition of industries or the scale of industrial or agricultural
output. Trade means greater specialization, potentially increasing
the concentration of polluting industries in some countries
(so-called pollution havens) and decreasing it in others. On the
other hand, multinational corporations from industrialized countries
that set up operations in lesser-developed countries often bring a
higher level of environmental performance with them. There is little
or no empirical evidence directly linking trade liberalization to
environmental changes.
Trade can affect the environment indirectly as well, both positively
and negatively. Increased trade can lead to higher incomes, and as
incomes rise, the demand for improved environmental quality rises.
Another indirect effect is the influence of trade on the rate of
economic growth, which could either decrease pollution
(due to the use of cleaner technologies through capital stock
turnover fueled by economic growth) or increase pollution
(due to increased consumption).
While it is widely recognized that international trade policy
measures are usually not the best method for achieving environmental
objectives, recognition of the importance of the issue has resulted
in a number of significant policy and institutional responses, both
nationally and multilaterally. For instance, the environmental side
agreements of NAFTA established the North American Commission for
Environmental Cooperation to undertake capacity-building projects
and to put procedures in place that help to monitor each country's
effective enforcement of environmental laws. Active participation by
governments and institutions is a necessary component of the success
of such efforts.
FTAs can provide a basis for enhanced bilateral cooperation on
environmental issues. Environmental provisions in NAFTA and U.S.
free trade agreements require each country to effectively enforce
its own environmental laws, and strive to ensure that failure to
enforce these laws does not affect trade or investment. These
agreements are accompanied by separate environmental cooperation
agreements or arrangements intended to take advantage of the closer
economic ties and broadened environmental cooperation that goes
beyond the trade sphere. Although some criticize trade agreements
for a failure to do even more to advance environmental policy
objectives, others acknowledge the significant benefits associated
with the core obligations and cooperation mechanisms.

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The Policy Scene Today:
Avenues to Further Liberalization
Trade liberalization to date has had substantial benefits. Still,
barriers to international trade and investment remain and limit growth
opportunities for many countries. With the United States accounting
for just 5 percent of the worldï¿½s population, 95 percent of the
potential consumers of U.S. goods and services live outside our
borders. The prospective gains from further liberalization,
particularly in services (e.g., finance, insurance, information
technology, and professional and business services), are substantial
for the United States and our trading partners through greater
efficiency of production and higher national incomes. The extent to
which different countries experience gains depends on both the range
of sectors that are liberalized
and the extent of liberalization within each sector. The United States is
pressing for freer trade, especially in services, through bilateral,
regional, and multilateral agreements.Prospective Gains from
Further Liberalization Prospective Gains for the United States
The prospective gains for the United States from further trade
reform are substantial. One study suggests that global free trade in
manufacturing and agriculture would generate annual economic gains
of over $16 billion for the United States, or roughly $220 for the
typical family of four. The gains from removing all remaining
barriers  to trade in services are substantially larger, amounting
to about an additional $520 billion for the United States, or over
$7,000 for the average American family of four. This is additional
income each year that will not be available in the absence of trade
reform. These income gains would be fully realized in about a decade
from the date of liberalization. These large gains reflect the United
States having a comparative advantage in services sectors and the
high barriers to services trade in other countries, which are often
investment restrictions that effectively block the main conduit for
trade in services. These restrictions include limits on the number
of service providers, minimum local-content requirements that limit
the participation of foreign firms, nontransparent and burdensome
standards and licensing procedures, and discriminatory access to
distribution networks. Prospective Gains for the Rest of the World
Further liberalization in trade would bring significant global
economic gains, particularly for developing countries. One study
reports that the reduction of all remaining barriers to trade in
services would generate over $1.5 trillion in income for the world.
For full trade liberalization in agriculture and manufactured goods,
the World Bank reports that reducing trade barriers would generate
about $290 billion of additional income to the world economy each
year once the full effects of liberalization are realized, about a
decade out. The income gains are even higher at $460 billion with
more generous assumptions of tradeï¿½s effect on economic growth.
Nearly half of those income gains would go to developing countries.
Various studies find that at least half of the developing-country
gains would be obtained from agriculture trade reform by
industrialized countries (including the United States), including
tariff reductions and the elimination of subsidies and domestic
support programs. (Agricultural trade reform is discussed in detail
in Chapter 8.)
Debt relief and foreign aid can help to reduce poverty, but trade is
a more powerful tool. For instance, in 2004, industrialized countries
spent over $78 billion on development assistance to poor countries
and industrialized countries are currently considering debt relief of
$56 billion. Even the conservative estimate of the $140 billion
effect of trade liberalization to developing countries exceeds both
assistance and debt relief combined. Studies show that reducing
barriers to global trade has the potential to lift hundreds of
millions out of poverty. Agriculture liberalization is particularly
important since roughly 75 percent of the worldï¿½s poor live in rural
areas and farmers constitute the majority of the poor in developing
countries. The gains from integrating developing countries into the
global economy are not one-sided.  As developing countries
increasingly participate in the global economy, industrialized
countries benefit from increased export and investment opportunities
in those markets. Over the past decade, U.S. export growth to
developing countries exceeded the rate to industrialized countries.
Yet tariffs and other trade barriers in developing countries remain
high (Chart 7-3). Realizing these market opportunities and
encouraging development in these countries requires further trade
liberalization efforts while promoting transparency, good governance,
and sound institutions, all necessary building blocks for economic
growth. Persuading developing countries to reduce trade barriers
continues to be an important objective for the United States. As
developing countries become more active participants in the global
economy, they experience higher rates of economic growth and are
better able to reduce poverty. Studies show that over the past two
decades, developing countries that have been more open to free trade
have experienced higher rates of economic growth. During the 1990s,
per capita GDP in developing countries that liberalized more increased
5 percent compared to 1.4 percent growth in other developing
countries. China's integration into the world economy is discussed in
Box 7-4.



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Box 7-4:  U.S.-Asia Trade Relationship
The robust postwar economic performance of many Asian countries
has driven the strong U.S.-Asia trade and economic relationship. In
recent years Asian economies have experienced some of the world's
highest growth rates and will continue to be key export markets for
U.S. firms. Outside of South Asia, trade with the Pacific Rim region
represents about 30 percent of U.S. trade with the world. The United
States imports different items from the Asian region than it exports.
The top imports from the Pacific Rim include electrical machinery,
automobiles, toys, furniture, clothing, and footwear. The top U.S.
exports to that region include aircraft, chemicals, plastics,
agricultural products, automobiles, and pharmaceutical products.
U.S.-China Trade
Since 1995, U.S. trade with China has represented an increasing
share of U.S. total trade, reflecting some substitution away from
other Pacific Rim trading partners toward China. The United States
imports different items from China than it exports to China. In 2004,
top import items from China included a wide range of consumer goods,
such as toys, sporting goods, apparel, and footwear. Top U.S. export
items to China included a number of intermediate components and
machinery, aircraft, soybeans, and cotton. Many imports from China
now take the place of goods previously imported from other countries.
China increasingly is a large and growing market for U.S. goods and
services.  As the chart below shows, since Chinaï¿½s accession to the
WTO, U.S. exports to China have risen faster than exports to the
rest of the world.
Engaging China
The U.S.-Asia trade and economic relationship offers vast
opportunities for citizens in all of these countries to prosper,
however, China's integration into the global economy will not come
without challenges.  For instance, WTO membership has offered China
new benefits, such as Permanent Normal Trade Relations with the
United States and access to the WTO's rules-based dispute-settlement
mechanism. Chinaï¿½s WTO membership also brings new responsibilities,
such as improving the protection of intellectual property, full
compliance with trade agreements, and continued progress toward a
flexible, market-based exchange-rate regime. China has made strides
toward economic reform at all levels of government, but there are
areas that require further progress. The United States will continue
to work with China to assist its integration as a responsible
stakeholder in the international economy and to ensure that
bilateral economic relations are mutually beneficial.


Avenues for Further Liberalization
Countries are increasingly employing negotiations at the bilateral,
regional, and multilateral levels to achieve further liberalization.
These avenues are not mutually exclusive. The United States employs a
multi-faceted approach, and in recent years has signed a number of
bilateral and regional free trade agreements. These agreements set
rules for trade, increase market access for firms, and strengthen the
effective enforcement of intellectual property rights and
environmental and labor laws. Other trading partners such as the
European Union (EU) have pursued an even greater number of bilateral
and regional agreements. The WTO nevertheless remains the most
important forum for trade liberalization due to its global reach and
the interdependence of the world economy.
The general consensus on the WTO among academics and practitioners
is that the organization has facilitated increased trade and
openness. By establishing a rules-based system, the organization
provides a forum for all members to resolve trade disputes and offers
a greater voice to developing countries in the establishment of
global trade rules. These rules help to foster better business
climates, particularly among developing countries, which can help to
reduce corruption and attract more foreign direct investment. The
United States fully supports the role of the WTO in promoting a
rules-based global trading system, opening markets, and encouraging
economic growth.
The 149 WTO members are currently engaged in the Doha Development
Round of negotiations, which recognizes that global trade expansion
can make a significant contribution to spurring economic growth and
reducing global poverty. The Doha Round focuses on better integrating
developing countries into the international trading system and
enabling them to benefit from increased trade.
Moving Beyond Goods Trade Liberalization
To date, most trade liberalization has been in the form of reduction
in barriers to goods trade. Using existing trade agreements and
partnerships, trade and investment ties can be strengthened to
include services and other nontariff measures that limit international
commerce. This section discusses how the United States is pursuing
deeper economic cooperation across North America and with the
European Union.
Services Liberalization
From telecommunications and finance to health and education,
services are the single largest sector in most industrialized and many
developing countries. Not only do services provide the bulk of
employment and income in many countries, but services provide
critical input for the production of other goods and services. An
in-depth look at financial services illustrates many of the key
issues involved in liberalizing trade in services.
The unprecedented growth of global financial markets in recent years
has given prominence to the issues associated with financial
services liberalization. Liberalizing international trade in
financial services can be a market-based means to strengthen
financial  systems. It is often an important catalyst in improving
the quality of capital flows through exposure to foreign competition
and in strengthening financial systems-particularly in developing and
transitioning economies. Enhanced financial services trade can improve
technology transfer and encourage better risk management across
borders. Foreign competition challenges domestic firms to improve the
quality of their financial services through broader opportunities for
trade and portfolio diversification. This results in more consumer
choice and competitive pricing.
Financial services liberalization for developing countries offers
many possibilities for strengthening weak domestic financial systems
through trade openness, competition, and sound regulation. Countries
with fully open financial service sectors grow on average one
percentage point faster than other countries. Foreign-backed
financial institutions in developing countries often possess a
greater ability to lend to those countries during economic downturns
and thereby stabilize capital flows in times of crisis. Foreign
banks that can extend credit to local businesses can be critical for
stabilizing developing-country economies in the absence of more
limited capacity of domestic financial intermediaries.
The General Agreement on Trade in Services (GATS) of the WTO is the
most comprehensive framework to date that supports national programs
of financial services liberalization within an international context.
Insurance, banking, and financial services trade exists primarily in
two forms: cross-border trade and commercial presence. In cross-border
trade, domestic consumers purchase services from a foreign supplier
abroad. In the case of commercial presence, a foreign supplier
establishes itself in a country through direct investment.
U.S.-EU Economic Initiative
Trade and investment ties between Europe and the United States have
been crucial in each region's economic growth for several decades.
Trans-Atlantic trade is mostly free in terms of border taxes, with
the exception of the agricultural sector. However, there remain a
host of nontariff measures and regulatory divergences that hinder
U.S.-EU trade and investment. In 2005, the United States and the
European Union launched a trans-Atlantic economic initiative, which
aims to promote regulatory cooperation and mutual recognition of
standards, enhance trade in services, stimulate open and competitive
capital markets, and promote innovation, among other
economic-cooperation goals.
In order to enhance trade in services, the initiative calls for U.S.
and European authorities to work with regulators and professional
associations to identify sectors where the potential exists to
achieve mutual recognition of professional qualifications. For
instance, an agreement in architectural services might allow American
architects to provide their services to European developers without
having to navigate a complex and often nontransparent regulatory and
licensing process. Underlying these goals to promote trans-Atlantic
commerce is a commitment to greater cooperation beyond the reduction
of traditional trade barriers.
Strengthening Economic Cooperation Across North America
NAFTA achieved important trade liberalization across the United
States, Canada, and Mexico, and has laid the foundation for further
economic cooperation in trade, investment, and other mutual interests
such as immigration and security. Through the North American Security
and Prosperity Partnership, the United States is working with the
governments of Canada and Mexico to promote such economic
cooperation. This ``NAFTA-plus'' initiative aims to eliminate
nontariff barriers, streamline regulatory processes, expand
duty-free treatment by liberalizing the rules of origin, and promote
free and secure electronic commerce. Heightened security concerns
since September 11, 2001, have resulted in greater port inspections,
longer shipment times, and more-frequent delays. The imposition of
security fees and increased inspections on NAFTA commerce can
increase trade costs, adversely affecting businesses that have
integrated their operations on a regional basis (such as the auto
industry). This initiative also aims to harmonize safety standards
for trade, streamline checkpoint operations, and make the movement
of legitimate and low-risk traffic across North American borders
more secure and efficient.
Conclusion
The expansion of international trade and investment over the past
two decades has created an increasingly interdependent global
economy. Achievements in trade liberalization have had substantial
payoffs for the United States and our trading partners. With just 23
members (or ``contracting parties'') in 1948, the purview and
membership of the GATT have grown dramatically. Today the WTO
(the formal international organization of the GATT) has 149 members
with many countries eager to join. While this increased engagement
by countries in international commerce presents immense opportunities
for U.S. consumers, workers, and firms, reaching consensus among all
these countries on further reductions in trade barriers can be
difficult. Like many other countries, the United States has pursued
multilateral, regional, and bilateral agreements to achieve its
goals. These avenues all lead to the same destination of more-open
markets and greater economic growth. Existing trade partnerships and
formal agreements can be platforms for further economic cooperation
in areas such as services and investment. Recognizing the payoff to
date and the prospective gains from further liberalization, the
United States is committed to working with all countries to open
markets and create favorable conditions for economic growth both
here and abroad.