Dispute Overload
I must have caught a wave this week. Not surfing or paddling, but anticipating trade policy proposals. I blogged a little over a week ago about how well the WTO’s dispute settlement mechanism works, and then Monday about the controversy over revaluing the yuan. On Tuesday, the South China Morning Post published an op-ed piece by Kevin Rafferty that proposed combining the two: taking exchange rate disputes away from the IMF’s rather ineffective system and putting the WTO in charge. Rafferty acknowledges that he got the idea from Simon Johnson, former chief economist of the IMF, who has pushed it on numerous occasions. Here’s one for the New York Times last fall. Johnson is pretty cautious, but makes a good case, while recognizing that such a shift would require long drawn-out negotiations. I worry, too, that it might overload the WTO’s dispute settlement system.
I am not alone in that worry, as I discovered yesterday morning when I read an opinion piece in the Asia edition of the Wall Street Journal. Titled “Don’t Push The WTO Beyond Its Limits,” it is an article by a fellow in a position to know how much political weight the WTO’s dispute structure can withstand: James Bacchus, a former U.S. congressman and trade negotiator, and – most importantly – a former member of the WTO’s Appelate Body. And that is exactly Bacchus’ point: the WTO process may crumble under an all-out fight between the United States and China over exchange rates. Bacchus outlines two scenarios, both dire.
Legislation has already been introduced in Congress that, if passed, would characterize China’s undervaluation of the yuan as an export subsidy and would require the Obama Administration to apply “countervailing duties” to all imports from China. Aside from the disaster this would create in all those American companies that use Chinese inputs and parts, this would massively increase U.S. unemployment as Walmart and other importers find their cost of doing business quickly rising. Interesting to see if a Democratic, pro-labor Congress will do this during Congressional election campaigns. (There I go again, just not able to resist the lure of rationality.) But, should the Congress be nuts enough to do this and Obama crazy enough to go along, the resulting “countervailing” duties against Chinese goods will be speedily taken to the WTO by the Chinese. And on excellent grounds. I helped negotiate the WTO’s rules on export subsidies and countervailing duties – and currency valuation is not covered by those rules. Regardless of what a member of Congress from East Podunk says, an undervalued currency is not prima facie evidence of an export subsidy. Therefore, duties to counter the undervaluation are not warranted. Should the WTO take the case, it will speedily decide for Beijing, leaving Washington to choose between backing down or ignoring the decision. If the latter, China will eventually be allowed to retaliate – and on a huge scale, further destroying American jobs. Is this really what the Congress wants?
The Big Mac Index - as good as any.
The second scenario that Bacchus lays out is more subtle, based in the original General Agreement on Tariffs and Trade (GATT), which has been subsumed by the WTO. Article XV:4 (which addresses the impact of exchange rates on trade) says that signatory governments “shall not, by exchange action, frustrate the intent of the provisions of” the GATT. The United States could, theoretically, bring a case in Geneva that relies on this provision, but that will open a political and diplomatic can of worms that could rebound for decades. Neither the GATT nor the WTO have ever had a dispute using this clause, so there is no case law to be consulted. A case would call into question how to measure over or under-valuation of a currency versus other currencies, should the WTO measure it or should the IMF, what sorts of currency controls need to be governed by either organization and how, and at what point, a currency is so out of line that further cases can be launched. This is a morass we really don’t want to get into, especially with the economic power of the United States and China pushing in different directions.
To get a feel for how far this could go, take a look at The Economist‘s Big Mac Index (which, frankly, is as good an index as anything published by the IMF or by government agencies). The March 16 edition of the BMI shows the Chinese renminbi (or yuan) nearly 49% undervalued when compared to the U.S. dollar. It also shows the Malaysian dollar as nearly 41% undervalued. Should the United States take action against China, but not Malaysia? The same index shows the U.S. dollar nearly 48% undervalued against the Norwegian kroner, so should Washington expect a suit filed by Oslo? See where this is going? Chaos.
