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Wilbur Ross Is Wrong About the TPP’s Back Door for China

Thursday, December 1, 2016 13:48
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In a recent CNBC interview, Donald Trump’s pick for Commerce Secretary, Wilbur Ross, explained why he thought the Trans-Pacific Partnership was a “horrible deal.”  His main complaint was that the agreement has “terrible rules of origin.”  Specifically, he warned, “In automotive, a majority of a car could come from outside TPP, namely could come from China, and still get all the benefits of TPP.”  Presumably this is what Trump was talking about when he said China would “come in … through the back door.”

All trade agreements have rules of origin that specify how much of a product’s manufacturing has to occur within a member country for it to qualify for tariff preferences.  These rules differ from product to product and are the result of negotiation and industry pressure.  Under the TPP’s rules of origin for automobiles and most auto parts, at least 45% of an import’s value must have been created within one or more TPP members for the good to qualify.

So, technically, Ross is correct.  A hypothetical car could contain 55% Chinese content and still be eligible for TPP preferences as long as all the rest came from Japan, Mexico, the United States, or some combination of TPP members.  What Ross is missing, however, is why this is a good thing.  

For one thing, liberal rules of origin help alleviate the problem of trade diversion.  Reducing protectionist trade barriers removes artificial impediments to economic growth by enabling greater specialization that relies on a country’s comparative advantages.  But trade agreements only remove barriers between some countries, leaving others in place.  When all countries’ exports are burdened equally, investment still flows to where products can be made most efficiently.  Tariff preferences, while better than no liberalization at all, have the downside of incentivizing investment based on where there are preferences, creating their own sort of inefficiency.

Ross himself alludes to this problem in his CNBC interview when he notes that “Mexico has 44 treaties with other countries that make it very advantageous to do international shipping from Mexico rather than from the United States.”  But if the rules of origin in Mexico’s treaties allow for high levels of non-Mexican content, some of those goods shipping out of Mexico might be largely made in America.  Mexico’s treaties could benefit American companies that use Mexican parts just as the TPP could benefit Chinese companies that use American parts.

Strict rules of origin, on the other hand, threaten to interfere with cross-border supply chains.  With or without trade agreements, the fact is that many industries have expanded beyond national borders.  Any automobile purchased in the United States, regardless of brand, is going to have lots of foreign-made parts.  The manufacturing process from raw material to pickup truck involves the labor of people in countries all around the world.  The phenomenon of global supply chains unlocks new levels of comparative advantage—instead of car-making, the relevant activities are things like engine-making, glass blowing, software design, and assembly.  Each part of the process is more valuable if the other parts are done as efficiently as possible.  U.S. autoworkers are more productive (and therefore better compensated) when these supply chains are not hindered by tariffs.

Some industries, of course, would rather have protection than efficiency.  The reason that Ross is focusing on automobiles in his criticism of the TPP is that Detroit automakers are highly invested in North American supply chains.  They benefit from tariff-free trade under NAFTA, but NAFTA has very strict rules of origin for autos—requiring over 60% of content to be from the region. 

Replacing that arrangement with the TPP’s 45% rule would open up a lot of competition not only from Japan but from China and Thailand as well.  The TPP would eliminate some of the benefits Canadian and Mexican suppliers currently enjoy under NAFTA’s preferential access.  More competition among suppliers, however, will lower costs for U.S. operations and make the industry as a whole more competitive.

Like other Trump advisors, Ross has expressed a preference for bilateral trade agreements rather than regional ones.  Combined with strict rules of origin, this strategy (if pursued) would worsen the problem of trade diversion; promote inefficient, policy-driven supply chains; enrich rent-seeking cronies at the expense of economic growth; and generate the least possible benefit from trade liberalization.  That’s why previous administrations (Obama with the TPP; George W. Bush with the Free Trade Area of the Americas) have preferred a regional approach. 

Ultimately, Ross’s analysis of the impact of the TPP is fatally flawed due to his erroneous understanding of trade as a zero-sum game.  Trade is a cooperative endeavor in which people in different countries seek mutual advantage through exchange.  Allowing people in China to benefit from trade with Americans is not a failing of the TPP.  On the contrary, it’s one of the ways the TPP would help create value for U.S. companies and better jobs for American workers.  

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