The Tokyo Round and the Third World Jude Wanniski April 27, 1979

Executive Summary: The successful conclusion of the Tokyo Round of Multilateral Trade Negotiations is one of the better achievements to date of President Carter, attributable to the determination of Special Trade Representative Robert Strauss and his deputy, Alonzo McDonald. Chances are good that the package can be guided through Congress this fall, unless a recession sharpens protectionist opposition. This would enhance Carter's re-election chances. By reducing the international wedge against commerce, the accords have been already reflected in world stock markets. Final legislative passage would tend to lift markets further, along with the level of global wealth.

The developing nations of the Third World are disappointed in the agreements, which have not satisfied their demands for preferential treatment. This failure, though, may hasten Third World movement to more correct development stategies built on internal, incentive-led growth rather than subsidized export-led growth. A Tory victory in the May 3 British elections would bring experiment with this shift in stategy inside the U.K. and have positive spillover effects on Third World policies.

The Tokyo Round and the Third World

Eighteen months ago, the Tokyo Round of Multilateral Trade Negotiations was barely treading water. The talks had begun five years ago, but for trade liberalization to proceed requires the conscious commitment of the American President. The United States, after all, is the world's biggest trader, currently buying and selling about $376 billion in exports and imports annually against a gross world trade of $1.3 trillion. But what with Watergate, the brief presidency of Gerald Ford, and the early shakedown of the Carter Administration, it was likely that American Presidents for 3 ½ years were scarcely aware of the Tokyo Round, although each was surely aware of the incessant demand for trade protection from American business and industry.

Democrats, though, have a tradition of trade liberalization, born of the Southern agrarian interests of the pre-Civil War period. The one thing the country might count upon from a Southern Democrat as President that it actually got was trade liberalization. In one of the best moves of his Administration to date, President Carter eighteen months ago appointed the best man of his team, Robert Strauss, as Special Trade Representative.

Strauss, in turn, made an incredibly fine choice for his deputy, the man who would actually move the talks: Alonzo L. McDonald, chief of the Paris office of McKinsey & Co., the management consulting firm. First, though, McDonald went to Geneva where the formal talks had been moved from the initial meeting in Tokyo. McDonald polled 26 professionals on the U.S. negotiating team, asking a show of hands on how many believed the talks could advance and bear fruitful results. Only one hand went up. McDonald reported to Strauss that the atmosphere in Geneva was one of demoralization, that the professionals believed the only way they could save their careers was to find a way to "declare victory" and come home.

For his part, McDonald did not want to be part of such a mop-up and begged off the assignment. Strauss said fine, that his conscience was clear, having tried to get the best man for the job, but that he, McDonald, would have to live out his life with the thought that he could have made the difference. McDonald smiled as he told me the story, at a lunch in Manhattan earlier this month.

Strauss got his man, and McDonald went to work with the only attitude that could succeed. "There are thousands of ways for trade negotiations to go wrong, and only five or six ways for them to go right. We concentrated all our attention on the five or six and began to push."

Instead of negotiating with 120 participants in one big room, which had been the process, McDonald went to the "rock-in-the-pond" technique, hitting one key spot and then drawing in more participants in widening concentric circles. First, he achieved rough consensus with West Germany, the No. 2 world trader, then together they moved on to France and Britain, the rest of industrial Europe, Japan, and the advanced developing counties. Japan was the most difficult of the industrial powers, responding only to day-by-day salami-slicing tactics. On April 12, twenty industrial nations that do 80 percent of world trade initialed the agreement. McDonald reckons perhaps half of the rest of the countries will soon accept the terms of the pact. The "Group of 77" developing countries did not respond to the rock-in-the-pond technique. It will meet in May in Manila under the auspices of UNCTAD (United Nations Conference on Trade and Development) to denounce the accords. The developing nations had sought deep preferences in the Tokyo Rounds and did not get them.

The terms of the pact have been exhaustively reported in the financial press. The chief provisions, as reported briefly by U.S. News & World Report of April 23 in a special world trade edition, are these:

• Worldwide tariff cuts averaging 33 percent on industrial goods within eight to ten years.
• An end to tariffs on civil aircraft and a ban on unreasonable government pressure to promote sales of domestically produced planes.
• For U.S. farmers, foreign tariff cuts opening new markets for beef, poultry, tobacco, fruits, vegetables, wine, nuts and oilseed.
• Lower foreign tariffs that promise to boost U.S. exports to Japan of paper, computers, color film and semi-conductors, and to Canada of paper, computers, photographic and aerospace equipment.
• Restraints on subsidies giving exporters unfair advantage.
• New rules opening up more governmental purchases to foreign bidders, a market worth an estimated $20 billion.
• A call for uniformity in the way nations set values on imports when levying duties—aimed at ending arbitrary practices.
• An end to the so-called American selling-price system of valuing chemical imports by their U.S. prices, rather than by their world prices.
• A reduction in use of health inspections and safety standards as hidden barriers to imports.

For the 7,000 items covered on the U.S. dutiable list, the average ad valorem rate drops to 4 1/2 percent from the current 8 percent. There will be 4,500 items on the nondutiable list.

To get this far has been an enormous achievement, and if McDonald and Strauss can get those non-tariff provisions requiring legislative approval through Congress this fall, it will definitely increase the President's chances of being re-elected in 1980. Not that individual voters will be directly aware of the existence of the trade pact. They won't. But the success of the Tokyo Round would mean not only a significant reduction in the international wedge affecting commerce. The global community will also have avoided the opposite path of increased protectionism, which would have meant further contraction. To the degree the pact contributes to the buoyancy of the U.S. economy, voters will feel the effects and tend to reward the President, everything else being equal.

Because the negotiating process is an elongated one, it is almost impossible on a daily basis to measure the impact progress or lack of progress has on financial markets. The markets, though, do this precise factoring, and I believe some significant, unquantifiable portion of the rise in global share prices in the last year can be attributed to glacially rising expectations of Tokyo Round success. (As compiled by the Economist, here are the percentage changes in stock price indices of world stock markets, year over year, as of April 9: London +13.0; New York +13.4; Canada +35.8; Australia +26.6; Japan +7.9; Hong Kong + 8.9; Belgium +8.1; France +25.2; Germany -2.1; Holland -0.5; Italy +20.0; Singapore +30.8; South Africa +55.9; Sweden -0.1; Switzerland +9.5.)

It is for this reason that McDonald's progress with Congress is also of importance to the path of the stock market in 1979. He himself puts chances of congressional acceptance at 2-to-l, an assessment that seems overly optimistic, except that McDonald himself has the assignment of getting it through Congress and that he clearly understands the dynamics of leadership. From the beginning of his consensus strategy, he has engaged the attention of key constituents at home. Staff members of the House Ways and Means Committee and Senate Finance Committee have either been in residence in Geneva or shuttled back and forth from Washington. Some 5,000 contacts in American business, industry and labor have been kept up to speed with privileged information on details of the negotiations. The Congress will have 90 working days to give its blessing or not, which, given time off for summer holidays, could mean a September or October vote. Because the greatest danger to congressional approval is a recession, which would sharpen protectionist interests, there is some hope of getting a pre-recess vote, but not much. A defeat of the package in Congress, by this analysis, would mean a marked, negative impact on world stock markets.

In the wedge model, one of the reasons for the doubling of world trade since 1970 has been a narrowing of the wedge on international transactions relative to the wedge on domestic transactions. Global inflation causes rates of taxation to increase inside domestic economies with systems of progressive taxation. But inflation's impact on tariff systems—which in many cases are specific—results in a net real decline in the tax rates on transactions across national borders. That is, if the tariff is specific—say 10$ a pound on a given commodity, and the commodity's value is $1 a pound, the wedge is 10 percent. If inflation carries the value of that commodity to $2 a pound, the wedge going to the government falls to 5 percent of the transaction. Thus, trading across borders becomes more attractive than previously.

One of the greatest difficulties in trade negotiations is that few people understand the enormous benefits that flow to the world population via liberalization. Individual transactors in the world economy view trade as a zero-sum game, in which one industry's gain is another's loss, or one country's gain is another's loss. Trade liberalization, though, elevates the wealth of the world economy, especially the wealth of those who participate directly. While there are indeed relative gains and losses among industries and nations, in absolute terms there are rarely any real losers; and this fact becomes reflected in financial markets. This is how U.S. Chamber of Commerce economist Jack Carlson can arrive at his exceedingly optimistic estimates showing that when the accords take full effect they will create a total of a "half million more jobs" in the United States. The important effect, though, is not on the number of "jobs," but on the increased standard of living for the nation as a whole.

Unfortunately, the agreed-to reductions in the tariff wedge would take place at a snail's pace over the next decade, which is one of the prices McDonald had to pay to achieve consensus. Financial markets would certainly discount the certainty of such reductions, except that the experience of the Kennedy Round tariff reductions a decade ago was that they spawned the global defensive tactic of non-tariff barriers, which became the focus of the Tokyo Round. Alonzo McDonald already perceives that these will "grow like weeds" again in the wake of the Tokyo Round; and unless oversight mechanisms are established to do the constant weeding job required, the gradual benefits of tariff cuts will be offset once again. Some oversight mechanisms have been built into the agreement; government procurement barriers will be reviewed in three years, for example. But only fairly relentless, focused effort at weeding will produce maximum gains to global wealth in the 1980s from the accords.

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Third World disappointment in the Tokyo Round is partly the result of zero-sum thinking. The Group of 77 would like trade structures arranged in a way that purposely benefits the poorest countries through preferential treatment. Specifically, they would like preferential access to developed markets for their labor intensive commodites and they dream of guaranteed high prices for raw materials delivered to the industrial nations. At least their complaints are justifiable to the degree that the developed sector goes the other way, establishing non-tariff barriers against imports of labor-intensive goods. The protectionist agricultural policies of the European Economic Community are constantly cited. And as long as the United States remains in a contraction mode, domestic pressure for retention of labor-intensive jobs is too powerful to resist politically. Indeed, the only reason the U.S. textile industry has not kicked over the Tokyo Round accords is that the Carter Administration agreed to sprinkle liberally its trade agenda with textile weeds. The National Journal of March 17 summarized the Administration's pledges to the textile industry:

• Institute a continuing global evaluation of textile and apparel imports under the supervision of a Cabinet member who would report to the President on a quarterly basis.
• Control current and projected import surges that disrupt the domestic market as a result of carry-overs of previously unfilled quotas and other factors.
• Limit import growth to growth in the domestic market in each of the three years following 1979 and restrict 1979 import to 1978 levels.
• Negotiate bilateral agreements with new suppliers—specifically, with China.
• Expand textile exports to Japan.
• Include a snapback clause in the trade agreement that would restore textile and apparel tariffs to their previous levels if the Multi-Fiber Arrangement or its replacement is unsatisfactory.
• Improve enforcement and remedies authorized under current U.S. trade laws.
• Initiate an export drive that would include a market development program and efforts to remove foreign trade barriers.
• Include the ladies' apparel industry in the current export pilot program.

Even so, McDonald believes such concessions to textiles would have been made anyway, but at least the Administration removed the greatest congressional threat to the overall package, which includes a 21 percent cut in textile tariff rates. Congress last year responded to the influence of the textile industry and its unions by passing legislation exempting them from the Tokyo Round tariff negotiations, a bill the President vetoed.

The U.S. negotiators did maintain exemptions on tariff cuts in rubber and non-rubber footwear and color TVs; and the phased cut in the steel tariff will likely be postponed to 1982, as a concession to this other primary source of opposition to the liberalization of trade. But these are the kind of product areas in which the developing world must hope to attain manufacturing capability and this is why the Third World sees the Tokyo Round as a deal among the developed nations that does nothing for them.

In response, the Third World will probably continue to pursue a counter stategy that has been fundamentally in error. Because of the postwar influence of Keynesian economic theory, the belief persists that development should be "export-led," an idea that in practice thwarts natural, internal development. The idea forces countries into "socialist" postures, for governments must force this unnatural strategy by subsidizing exports and throwing up internal barriers against imports. Extremely steep progressive tax rates on personal income exist throughout the Third World on the theory that rich people only spend their wealth on conspicuous foreign imports anyway, and this wealth can better be spent by the government to subsidize export industries.

This only removes the incentive to become wealthy, choking off the natural impulse toward internal growth. The talented leave for other countries where the accumulation of wealth is possible, or remain at home as tax evaders in the grossly inefficient barter economy. Rarely is the American model of development even considered. By concentrating on internal growth through individual incentives and very low tax rates, the United States from the beginning imported more than it exported, running a trade deficit nearly every year until 1896 by exporting financial assets.

Most of the Third World nations that have attempted export-led development have, in most cases, failed to produce an export surplus. Instead of the private sector importing capital goods and exporting financial assets, as in the early United States experience, governments have borrowed abroad, from banks and other governments, funneling resources into nationalized industries. Because personal tax rates are so high, they can not find the talent to run the industries. The goods produced cannot find the preferential openings in world markets, forcing each government to increase taxation on its population to finance the accumulated foreign debt.

In the 1980s, this vicious cycle may finally be broken. In a sense, the failure of the Tokyo Round to satisfy the Third World demands for preferential treatment will hasten this process, forcing the Third World toward the alternative of internal growth. China has now correctly delayed its initial lunge onto this obsolete development path, wary of borrowing billions in the West to finance export industries that can not be managed with the available talent pool, especially when it sees the Tokyo Round casting a cold eye on tariff preferences. Asia as a whole is enjoying success with experiments in internal incentive systems. Positive developments have recently occurred in the Middle East as well. A large part of the reason for An war Sadat's popularity in Egypt, which enabled him to sign a peace treaty with Israel, is his movement back toward capitalism in general and his recent tax reform in particular: the top rate on personal income was cut from 95 percent at $14,000 to 80 percent at $140,000, with equivalent reductions across the board.

The best thing that could happen to accelerate Third World movement in this direction would be a Tory victory in the British elections May 3. Much of the developing world continues to take its cues on internal economic policy from the U.K., and Conservative Party Leader Margaret Thatcher has explicitly pledged to restore incentives to internal growth through sharp personal tax-rate reductions. Success of such policies would spread rapidly through the Commonwealth and former colonies, perhaps even including this former colony.

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