Trump’s Demand for Trade Reciprocity

By Hans Mahncke

One effect of the election of Donald Trump as President has been a renewed interest in international trade rules. The current trade regime has been in place for around 70 years, first in the form of the General Agreement on Trade and Tariffs (GATT) and, since 1995, in the shape of the World Trade Organization (WTO). A little-known fact is that the GATT principles are found in United States law, specifically the Reciprocal Trade Agreements Act 1934.

The 1934 Act had three objectives: the elimination of trade barriers, non-discrimination between trading partners (also known as the Most-Favored-Nation principle (MFN)) and reciprocity in negotiations. While these objectives are found in the current world trading system, the current discussion is centered on the last of objective, that is, reciprocity in trade negotiations and agreements. The fact that reciprocity has been historically critical is evidenced in the name of the 1934 Act.

Reciprocity means that a trading partner is only committed to an elimination or reduction of trade barriers vis-à-vis those trading partners who reciprocate by offering corresponding concessions. Reciprocity is what the Trump administration laments as lacking, i.e. that the United States, the world’s largest importer of goods, has very low import tariffs, while many of its trading partners maintain high entry barriers.

How did we end up in this situation if the emphasis was on reciprocity? The reason is that reciprocity exists in tension with the MFN principle. MFN means that if, for example, the United States agrees with Canada that both countries lower tariffs on a particular good to an X-level – which would be an example of reciprocity – then all other trading partners of both the United States and Canada would get to benefit of the same X-level tariffs. Thus, while the deal between the United States and Canada would be reciprocal, the benefit derived by other countries would not be based on reciprocity – other countries could take advantage of the low United States tariffs, while not reducing their own tariffs.

While many believe such ‘freeloading’ by other countries to be inherently unfair, there is an economic argument that it does not matter to the importing country whether the exporting country has lowered its tariffs or not. That is due to the economic theory underpinning free trade, first expressed by David Ricardo more than 200 years ago, that a country that buys goods or services cheaply abroad raises its living standards. For example, if the United States imports steel cheaply without imposing tariffs, domestic users of steel, as well as consumers stand to profit. The downside is that domestic producers of steel stand to lose out if their steel is priced higher than imported steel.

The problem with the economic theory of free trade is that while the country as whole profits, some individuals, companies and even regions lose out. If we were to leave aside the difficulties certain domestic interests might encounter, there is still an inherent sense of unfairness associated with granting easy trade access to countries that have not reciprocated.

In this vein, the Trump administration is pushing trading partners to reciprocate by lowering their own trade barriers or face repercussions in the form of higher United States import tariffs. How does this fit with existing trade rules?

While the origins of the current system are based on reciprocity, the current system only foresees reciprocity at the negotiation stage. For instance, countries like The Bahamas, who are not WTO members, are expected to reciprocate if they want to become members. Lack of reciprocation may well be why they have not been able to gain access. But once a country is a member of the WTO, it is no longer required to reciprocate as it can rely on MFN and bound tariffs (WTO members may not raise tariff levels that they previously agreed to) to achieve low tariff access to foreign markets. This creates challenges for countries like the United States who want to force existing members to reciprocate post-WTO accession. To exert pressure, the United States has raised tariffs on non-reciprocating countries and, while there are tools available within the WTO framework that allow members to raise tariffs on other members, these are exceptional, for instance, to safeguard national security.

The WTO has a quasi-court system (the Dispute Settlement Body) and it remains to be seen whether the United States’ newly imposed tariffs pass muster. If it can be shown that the United States imposed these new tariffs in order to pressure other countries, rather than for one of the narrow exceptions allowed under WTO law, the United States will likely be found in breach of its obligations under international law.