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Opinion: U.S. ‘Poison Pill’ Targeting China in North America Trade Deal Makes No Sense

(Straits Times) — “I agree to a trade arrangement with you. But if in the future you decide to trade freely with another country whose trade practices I do not approve of, I reserve the right to end my trade arrangement with you.”

This seems to be one of the conditions the United States has imposed upon Canada and Mexico in the U.S.-Mexico-Canada Agreement (USMCA) — the successor to the North American Free Trade Agreement — which was signed on Sept 30.

Buried almost at the end of the USMCA is Clause 32.10.4, which reads as follows:

“Entry by any Party into a free trade agreement with a non-market country, shall allow the other Parties to terminate this Agreement on six-month notice and replace this Agreement with an agreement as between them (bilateral agreement).”

In other words, if either the U.S., Canada or Mexico make a trade deal with a “non-market country,” either of the other two can nullify the USMCA and replace it with a bilateral agreement.

China becomes a target

No non-market country is named, but to all observers, it is obvious that the country being targeted is China. In December, the U.S. formally told the World Trade Organization (WTO) — the watchdog of world trade — that it remains opposed to granting China “market economy” status, a position it has held since China’s entry into the WTO in 2001. The European Union shares the same view because of the Chinese government’s pervasive control over the economy.

Even though it is not named, China has reacted with outrage, in a clear indication that it is not unaware that it was being targeted. A spokesman for the Chinese Embassy in Ottawa described the insertion of the clause as “dishonest behavior that blatantly interferes with the sovereignty of other countries.”

He also said: “We oppose fabricating the concepts of ‘market country’ and ‘non-market country’ outside the framework of the WTO, which in essence is the excuse made by some countries to shirk their obligations and refuse to meet their international commitments.”

China’s “non-market” status at the WTO was supposed to end in December 2016 under its terms of accession, but both the U.S. and the EU ignored that deadline, arguing that 16 years of China’s WTO membership has failed to end its trade malpractices.

Although theoretically either Canada, Mexico or the U.S. would be able to invoke Clause 32.10, it is highly unlikely that Canada or Mexico would use it against the U.S., which is their largest trading partner. It is only the U.S. that would possibly invoke it, in the event that Canada and Mexico try to forge a trade deal with China.

But the significance of Clause 32.10 could go far beyond just applying to Canada and Mexico.

U.S. Commerce Secretary Wilbur Ross described it as a “poison pill” that might be included in other trade deals involving the U.S. With the precedent now set, “people can come to understand that this is one of your prerequisites to make a deal,” he said ominously.

So the poison pill could be incorporated in future U.S. trade deals with, for example, the EU and Japan, among other parties. If that happens, they might find it more difficult to do free trade deals with China, which would then become increasingly isolated. Isolating China on trade appears to be one of the aims of the Trump administration, which seems willing to use its clout to get its trading partners to sign up as accomplices to this goal. The poison-pill clause — which is unprecedented in trade agreements — is one of the means by which it is trying to achieve this.

An infringement on sovereignty

It is a bad idea, both in terms of principle and tactics.

First of all, as China has pointed out and as many Canadian observers have also noted, it is an infringement on sovereignty. Trade agreements cover trade between parties to the agreement. They do not, and should not, cover the right of parties to negotiate with other parties.

In the context of the USMCA, the poison-pill clause could constrain the ability of Canada and Mexico to diversify their export markets.

Second, while it is possible that isolating China — if it succeeds — will hurt China’s economy, it is not clear how it will help the U.S. economy.

If the objective is to get China to open up and become more like a “market economy,” free-trade deals between China and other countries should be encouraged, not discouraged. For instance, if the EU — or, for that matter, Japan or Canada or Mexico — were to explore such a deal, they would demand and extract concessions from China such as better market access and stronger protection of intellectual property rights, which would benefit U.S. companies too.

Every trade deal that China makes would help it move closer to being a market economy.

Third, almost three-quarters of world trade today is supply-chain related and is in intermediates rather than finished goods. Trade is also between companies, not just countries, and trade relationships are specific to industries, not geographies.

For example, many U.S. companies operating in Mexico who sell to the U.S. market are part of supply chains that also include China-based suppliers. (China is the second-largest supplier of goods to Mexico.) The freer the trade between Mexico and China, the more efficiently and cost-effectively will such supply chains operate.

If restrictions are put on such trade — for example, by preventing free-trade arrangements between China and Mexico — they will distort firms’ choices and eventually raise the cost of production, some of which will ultimately have to be borne by U.S. consumers. Thus, in a world of supply chains, imposing trade barriers against third countries can be costly. This is effectively what the poison-pill clause threatens to do.

Indeed, to deal with supply-chain-based trade, the most efficient and far-reaching trade agreements are plurilateral (which involve several countries) or, better still, multilateral, which involve all countries.

A prime example is the Information Technology Agreement (ITA) which was concluded at the Singapore WTO Ministerial Conference in 1996. Initially, 29 countries signed up, but since then, the number of signatories has grown to 82 and the agreement was expanded to cover more items.

The ITA now covers about 97 per cent of world trade in IT products, where supply chains are ubiquitous. This has resulted in lower prices for IT products and the faster spread of IT, benefiting all countries. Trying to exclude countries from trade deals in a world of supply chains — especially countries as important as China — makes no sense.

WTO can tackle concerns

The U.S. — as well as the EU, Japan and other countries — has legitimate concerns about some of China’s trade practices such as forced transfers of technology, weak intellectual property protection, and the granting of subsidies and other forms of favoritism to local companies.

The Trump administration has suggested that the WTO lacks the capacity to deal with many of these problems — a storyline that is widely repeated. But this is a myth.

Although the WTO is far from perfect and needs reform, it can address many of China’s alleged trade malpractices, even in its present state — and so far, China has a good record of complying with the WTO rulings against it.

James Bacchus, former chairman of the Appellate Body of the WTO (the organization’s dispute settlement arm), has pointed out that WTO jurisprudence takes a broad view of trade violations and has successfully adjudicated in more than 500 cases. The U.S. has been the most frequent complainant and has won more than 90 per cent of the cases it has initiated.

Many of China’s trade transgressions that the Trump administration complains about, including forced technology transfers, the violation of intellectual property rights and the misuse of subsidies, can be addressed by the WTO, either through litigation or mediation, both of which options are available.

Moreover, if the U.S. wants to forge a coalition against China, it can do so by enlisting allies like the EU, Japan and Canada, which have similar reservations about China’s trade practices, to make a joint complaint in the WTO.

China says it supports the WTO. The U.S. and its like-minded allies can put this to the test.

This would be far better, fairer, and more effective than inserting discriminatory poison-pill clauses into trade agreements like the USMCA to try to isolate China.

This article originally appeared in The Straits Times.

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