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A Primer on U.S. Trade Policy

September 15, 2009

With the flurry of interest generated by President Obama’s recent “tire tariff” decision, and China’s response, I’m fielding a lot of questions about a specialized and rather dusty subject, U.S. trade law.  What is Section 421?  What is dumping?  What role does the President play in deciding whether to impose trade sanctions?  And what is the role of the WTO in all of this?  So I figured I’d whip up a little primer on U.S. trade law to help answer these questions and provide a little context for what you are reading in today’s headlines.

THE FOUNDATIONS OF U.S. TRADE LAW

The foundation of U.S. trade policy is the Tariff Act of 1930 – yes, you guessed it, the infamous Smoot-Hawley Tariff, often credited with deepening the Great Depression.  Many of the mechanisms it established — in particular, the processes it laid out for imposing trade sanctions on other countries — remain in effect, although the law has been updated numerous times, most notably in 1974.  For the most part, any new trade-related laws passed by Congress merely make amendments to this underlying statute.

But the rules and procedures laid out in the Tariff Act hardly exist in a vacuum.  Since 1930, the U.S. has entered a wide variety of multilateral and bilateral trade agreements with other countries.  The most important multilateral agreement is the General Agreement on Tariffs and Trade (GATT) which lasted from 1947 to 1994, when it evolved into the World Trade Organization (WTO).  But it has also included more specialized agreements like the Multi Fiber Arrangement (MFA) that governed trade in textiles and apparel until it was phased out in 2005.  The U.S. also has bilateral Free Trade Agreements (FTAs) with several countries, including Israel, Jordan, Australia, New Zealand, Singapore, Chile, Peru, Morocco, Oman, and Bahrain.  Many of these were signed in the past few years.  Of course, the U.S. also has the multilateral North American Free Trade Agreement (NAFTA) with Canada and Mexico and Central America Free Trade Agreement (CAFTA).

U.S. trade rules towards China are mainly defined by its own accession agreement to the WTO, as well as terms negotiated in China’s own accession agreement in 2001.  Those terms absolve China from full compliance with its WTO member obligations for a transition period, as it gradually opens it markets according to a defined schedule.  The terms also allow the U.S. to impose “special safeguard” tariffs to help it cope with rapid and disruptive surges in Chinese imports.

Although these trade agreements, from WTO to NAFTA, are often described as “treaties,” they are in fact “congressional-executive agreements” (CEA).  Treaties require ratification by 2/3 of the Senate only.  CEAs require “implementation” by a majority vote only of both the House and the Senate.  By passing such “implementing legislation,” Congress incorporates the provisions of these international agreements into U.S. trade law.

THE TOOLS OF U.S. TRADE POLICY

Within the context of these international agreements, U.S. trade law allows the United States to take various actions to protect its interests.  These actions fall into three main categories:

  1. Title VII Actions — Antidumping or Countervailing Duties 
  2. Section 201 and Related Actions – Global and Special Safeguards
  3. Section 301 Actions — Retaliation Against Trade Barriers

All three types of actions lie at the center of the present trade disputes between the U.S. and China.  So it is well worth taking some effort to understand what they are and the key differences between them.

1) Title VII of the 1930 Tariff Act created an administrative process for responding to two types of practices that give foreign competitors an unfair advantage and threaten to harm domestic industries.  The first practice involves foreign governments granting subsidies to their own producers.  The second involves “dumping,” which is defined in economic terms as selling products below cost (in order to drive competitors out of business, after which one would presumably raise prices in order to reap monopoly profits).  The procedure in both cases is nearly identical, as is the solution: imposing tariffs that counteract or negate the unfair advantage foreign producers might otherwise enjoy.

I say it’s an “administrative process” because it does not, at least on the surface, require any political decision by the President.  Petitions are usually filed by the affected domestic industry, or by unions representing a substantial number of workers employed in that industry.  The U.S. International Trade Commission (USITC), an independent federal agency whose six members are appointed by the President and are split evenly between Democrats and Republicans, determines whether harm has been caused to domestic producers.  The U.S. Department of Commerce (DOC), through its International Trade Administration (ITA, not to be confused with the USITC) determines whether a subsidy exists or whether dumping has actually taken place.  The process goes as follows:  petition is filed, USITC makes preliminary ruling on harm, DOC makes preliminary ruling on fairness, DOC makes final ruling on fairness, USITC makes final ruling on harm.  If, in the end, both tests are met, the DOC imposes a suitable tariff.  Of course, the Secretary of Commerce is appointed by the President and serves at his pleasure, so he will tend to reflect the President’s viewpoint on the matter.  But the President is never called upon to make a decision directly.

Although the determination process all sounds very scientific, there is actually plenty of wiggle room.  The fact that an industry has lost revenues and jobs may look like “harm,” but is it due to the imports in question or other economic circumstances?  Governments do many things that benefit industry, including tax breaks and providing supporting projects and services — which of these constitute subsidies?  There’s an additional — and very important — complication that arises in antidumping cases.  The economic definition of “dumping” may be selling below cost, but because that can be incredibly difficult to determine, the regulatory definition is selling below the price a foreign producer charges in its home market (i.e., price discrimination).  So in most cases, a manufacturer that charges at least as much for its products in the U.S. as it does at home is off the hook.  But that is only the case for countries recognized as having “market economy status.” 

Each country makes its own determination which of its trading partners enjoy “market economy status”.  Neither the EU nor the U.S. recognizes China as a market economy.  As a result, the prices charged in its home market do not qualify as a valid benchmark for comparison with prices charged abroad.  Regulators must choose an alternative benchmark: the price charged in an “analogue market” like Brazil, South Africa, or Germany.  Who chooses the “analogue market” and whether it offers any fair basis for comparison with the exporter’s actual home market is a matter of economic judgment and political influence.  The result is that a Chinese exporter may well be found guilty of “dumping” because its US prices are lower than analogue prices for the product in a comparable market economy market, like India, even if it actually charges less in China.  This is the reason why China has been so adamant in lobbying the U.S. and EU to grant it “market economy status.”

The Commerce Department’s announcement last Wednesday, September 9, in favor of imposing tariffs on Chinese-made steel pipes is a Title VII action.  The petition was filed by both U.S. domestic steelmakers and the AFL-CIO, and the DOC made a preliminary ruling that Chinese exporters had received subsidies ranging from 11% to 31%, and proposed countervailing tariffs of the same amount.  Since this was a preliminary ruling, the DOC will consult more extensively with the parties involved and produce a final ruling sometime in November.  In the meantime, the U.S. will begin collecting the additional duties and placing them in escrow.  The USITC will also have to follow up its preliminary harm ruling with a final ruling before the tariffs can fully go into effect.  But in actual practice, nearly all final rulings agree with preliminary rulings, so observers are right to see last Wednesday’s decision as a key turning point.

2) Section 201 of the Trade Act of 1974 offers what is called an “escape clause.”  It allows the U.S. to impose temporary tariff “safeguards” to protect any domestic industry seriously disrupted or injured by a sudden “surge” of imports.  Such actions offer an “escape” from normal WTO obligations, and are actually permitted by the WTO agreement on the rationale that rapid and disruptive shifts in trade can cause great hardship that might undermine overall support for free trade.  Like Title VII, petitions are initiated by the affected industry or its union employees.  Unlike Title VII, it does not require any finding of unfair trade practices by the DOC.  However, Section 201 requires a much higher level of harm (the injury or threatened injury be “serious” and rising imports must be a “substantial cause” (important and not less than any other cause) to be found by the USITC.  If the USITC finds that this is the case, it can recommend imposing a protective tariff, but this tariff must be “global” — i.e., it has to be imposed on all countries that contribute “non-negligible” amounts of imports, not just on one particular country.  Finally, the President of the United States must personally make the final decision on whether to impose a tariff and to what degree.  It therefore has far greater political implications and risks than a Title VII action, even though it may have similar effects.

The “global safeguards” provided by Section 201 derive from GATT.   There are other “special safeguard” provisions that derive from specific trade agreements and apply only to the trading partners involved.   Section 302 deals with “safeguards” specific to NAFTA, aimed at Canada and Mexico.  Section 421 was adopted in 2001 as part of the U.S. conditions for agreeing to China’s WTO accession.  The procedures under 201, 302, and 421 are essentially similar.  However, the standard of harm in Section 421 is the “material injury” standard used in Title VII cases, much lower than in Section 201.  Also, tariffs imposed under Section 421 are directed solely against imports from China.  

President Obama’s decision to impose tariffs against a “surge” of Chinese-made tire imports, which he made late Friday night, is a Section 421 action.  The petition was filed by the United Steelworkers and the USITC voted 4-2 that sufficient injury had either occurred or threatened to occur.  There was no need to find any unfair trade behavior on the part of the Chinese.  And ultimately, unlike a Title VII action, President Obama had to make the final decision himself.  President Bush, in contrast, was presented with seven Section 421 petitions approved by the USTIC, and rejected all of them — which is why Obama’s action represents such a significant shift in U.S. trade policy.   

3) Section 301 of the Trade Act of 1974 is a policy tool available to the President to threaten or impose sanctions in order to break down foreign trade barriers abroad.  Such barriers can be almost anything deemed to interfere with fair trade.  Any interested party can file a petition requesting the U.S. Trade Representative (USTR), the chief U.S. trade negotiator who reports directly to the President, to launch an investigation.  The USTR can also self-initiate an investigation.  Section 301 gives the President broad discretionary authority to threaten, impose, or defer a wide range of retaliatory actions based on the USTR’s findings and the country’s broader interests and obligations.  It also gives the USTR broad authority to negotiate with foreign governments to arrive at a compromise, such as adopting voluntary import restraints.

Over the years, Congress has added additional provisions such as “Super 301,” “Special 301,” and “Telecommunications 301″.  These are essentially reporting requirements that require the USTR to monitor specific areas of concern or conflict, such as intellectual property rights.  Once a problem is identified, however, the USTR relies on the “normal” Section 301 mechanism for enforcement.

In September 2004, the China Currency Coalition, including a number of U.S. metals-related industries and their unions, joined several Members of Congress in filing a Section 301 petition with the USTR arguing that China was enjoying an unfair trade advantage by “manipulating” its currency.  By keeping the Renminbi pegged to the U.S. dollar at an artificially low valuation, they argued, China helped its exporters undercut U.S. producers on price.  The Bush Administration rejected the petition, although it always reserved the right to change its mind, a stance that helped “persuade” China to loosen the peg and allow the RMB to gradually appreciate.  This is the reason why Chinese officials reacted so angrily when Treasurer Secretary Timothy Geithner hinted earlier this year, during his Senate confirmation hearing, that China was “manipulating” its currency.  They are concerned that the Obama Administration might revisit Bush’s view and pursue a Section 301 action that would likely involve very broad-ranging sanctions against China.

The provisions of Title VII, Section 201 (and related clauses), and Section 301 overlap in many ways.   Given the facts of their case, petitioners (or politicians) must choice which route offers the greatest chance of achieving a desirable outcome.  Title VII requires proof of both harm and unfair trade practices, but minimizes political exposure.  Section 201/302/421 need not demonstrate unfair behavior, but require the President to explicitly sign on.  Section 301 is the most flexible and has potentially the broadest impact, but requires the greatest level of commitment on the part of the President.  The question is, now that a new President from a new party is in office, do the latter two options offer a more viable path than before?  Many believe that President Obama’s tire decision is likely to invite a “surge” of new Section 421 petitions, giving rise to a series of new disputes with China.

THE ROLE OF WTO DISPUTE RESOLUTION

On Monday, China announced it would challenge President Obama’s tire decision before the WTO.  So what role, exactly, does the WTO play in all this?

In principle, the terms of the WTO explicitly allow member nations to take unilateral actions to protect themselves in the types of situations envisioned by Title VII and Section 201.  Even Section 301, which was challenged by the European Union, was upheld by a WTO ruling in 2000.  But the key phrase here is “in principle.”  The U.S. may impose tariffs on Chinese-made steel pipes in response to what it concludes is dumping, under Title VII.  But is it a fair response to dumping, or is that just a cover for protectionism?  The U.S. and China are not likely to see eye to eye on this question.

When a country wants to impose trade sanctions against what it sees as unfair or harmful trade practices by others, it has two choices.  It can hold off and take its case to the WTO, seeking a ruling that will allow it to impose sanctions.  So, for instance, in September 2006 the U.S., the EU, and Canada together filed a complaint with the WTO against what they claimed were discriminatory Chinese tariffs on imported auto parts.  After the WTO ruled in their favor in February 2008, China had until later this year to respond or face WTO-authorized sanctions from its trading partners.  Just a few weeks ago, China quietly announced it would begin to comply. 

Alternatively, an aggrieved country can go ahead and impose sanctions claiming WTO rules allow it to do so.  The target country, then, can challenge the sanctions and take its case to the WTO seeking to have them lifted.  That is what has happened in the tire case:  the U.S. imposed sanctions, claiming the right to “special safeguards” negotiated as part of China’s WTO accession.  China views the tariffs as an abuse of such provisions, and will challenge their propriety before the WTO.  The Chinese will likely argue that the increase in tire imports does not rise to the level of a “surge” and is not the primary reason why U.S. domestic tire manufacturing is declining, hence the U.S. does not qualify for safeguard relief.  We’ll have to see what the WTO says.

Of course a country has the “right” to disregard a WTO ruling and pursue its own course, but only at the cost of exposing itself to authorized trade actions not only from the opposing party to the dispute, but all other WTO members.  That is why China and the U.S. are both likely to defer to the WTO’s final judgment on these cases, at least to the degree necessary to avoid such exposure.

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