Easing the pain of trade liberalisation

This year’s textiles crisis shows what can happen if the EU and the US are ill-prepared for competition from emerging Asia. The integration of China and India into the world economy means that manufacturing and low-cost services in the West will have to adapt rapidly. Some companies will survive by cutting costs and improving their products. Many more will have to develop new forms of business, in particular the production of high-tech goods. Others will simply close down, as many textiles firms already have. Undoubtedly, these adjustments will have high social costs.

Governments on both sides of the Atlantic recognise the need to help their industries and workers cope with this transition. EU governments often give financial support to embattled companies to help pay for restructuring. The US, meanwhile, prefers to restrict imports to give industries time to adjust. These types of adjustment aid also serve a useful political purpose. They act as a safety valve for protectionist pressures and can thus help to maintain a country’s commitment to free trade. However, such measures must remain temporary: they can help to ease the pain but should not be used to shelter companies or industries that are no longer competitive.

Traditionally, WTO rules have allowed member-states to use a so-called safeguard device. This means WTO members can impose temporary global (not country-specific) quotas or tariffs to protect an industry that faces a surge in imports. The US has been the most frequent user of such safeguards, protecting industries ranging from steel to motorcycles to corn.

However, recent decisions by the WTO dispute settlement body – effectively the world’s trade court – have left governments with much less room for manoeuvre in providing adjustment aid. In its rulings on US safeguards for wheat, gluten and steel, the WTO insisted that an increase in imports must be “recent”, “sudden”, “substantial” and “unforeseen” for governments to take action. The WTO is seeking to limit the use of what is, after all, an overtly protectionist mechanism. But by doing so, it has undermined one key means of easing the pain of trade liberalisation. Equally, the WTO’s new interpretation of the safeguard clauses might cause serious transatlantic friction, in at least two ways.

First, in some cases the United States is likely to simply impose safeguards in violation of WTO rules. The Bush administration did just that in 2002, when it imposed tariffs of up to 40 per cent on steel imports. As a result, cheap foreign steel was diverted from the US market to European and other countries. Predictably, these countries took the US to the WTO court, and imposed their own safeguards against steel imports. The dispute threatened to blow both EU-US relations and multilateral co-operation off course. Such conflicts are likely to become more frequent now.

Second, the US could make greater use of anti-dumping measures, now that the rules for safeguards have become stricter. Anti-dumping measures are worse than safeguards: there are no limits on the amount of duty imposed and they can last for a decade or more. The more widespread use of anti-dumping would translate into substantially greater and longer-lasting import restrictions.

Existing WTO rules could also spark more transatlantic rows over the EU's preferred kind of adjustment aid, namely financial support. EU competition rules allow member-states to pay money to domestic industries, provided it helps to restore competitiveness or offsets redundancy and closure costs. However, US law treats any government financial support for a company as a subsidy, irrespective of what the money is spent on. The US Commerce Department argues that money is fungible: when a company receives support for closing a plant, this frees up corporate funds for other purposes. As a result, the US has imposed ‘countervailing duties’ on EU steel imports in retaliation against the payment of restructuring aid. These duties have cost EU steel producers millions of dollars since the 1980s.

WTO rules confirm the US view that any financial support is a subsidy, whatever its use. If a government gives money to an industry, the WTO allows other countries to impose countervailing duties or challenge the subsidy before a WTO panel. Of course, the challenging country has to prove that the subsidy has harmed its economy, but this is relatively easy in a context of increased global competition.

In short, present trade rules make it very difficult for governments to help their industries adjust. Growing global competition will bring to the fore existing differences between the US and the EU about what kind of adjustment aid is justified under which circumstances. Instead of risking more trade rows, the Europeans and Americans should aim to reach a common position along the following lines:

The EU and the US should seek to revise WTO rules limiting the use of safeguard mechanisms. Such a reform already has widespread support in the US. But the Bush administration will also need the backing of European and developing countries to proceed. To get this backing, the US should propose new limits on the amount and duration of safeguards, as well as requirements for protected industries to implement credible adjustment plans. The WTO should have oversight of the safeguard process to guarantee its fairness.

In exchange for its support, the EU should ask the US to agree on changing the WTO law on state aid for struggling industries, and it should suggest clear limits to avoid any protectionist bias. Any industry receiving support should be asked to provide a clear adjustment plan. An independent national commission should approve this plan and monitor the use of funds. Furthermore, the WTO should define a maximum limit for government aid.

The lesson to draw from this year’s textiles crisis is that adjustment aid will be very much in demand in today's fast changing global economy. The surge in Chinese textiles exports was entirely predictable. The decision to end textile quotas was taken in 1995, so the EU and the US had over a decade to encourage textiles firms to adjust – but they did not do so properly. If the textiles crisis is not to be replicated in industry after industry, the US and the EU need to agree on the ways that governments can help local companies adjust to the new economic realities. And the world trade rules must be changed to permit such an adjustment process.

Richard Cunningham is a partner at Steptoe & Johnson.