Introduction
This chapter provides the background for the dissertation. The research problem section links the ideas outlined in the background with trends that have been observed in the trade relations between the US and the European Union. This outlines the need to carry out the study, followed by the objectives. The final section describes the structure of the dissertation.
Background and Context
Trade both at local and international levels is important for the economic development of nations across the world. The success of economies around the world heavily anchors on trading activities by respective governments (Bhagwati, 1994, p.281). The importance of trade to the economic development of nations hinges on the premise that it presents an avenue through which governments can create new job opportunities without seeking funds from the treasury (European Commission, 2013, p.22). It instead provides additional funds to finance other government activities. This benefit makes it a desirable option for both developing and developed economies (Hasan, Quibria, and Kim, 2003, p.26). Governments have thus chosen to devise mechanisms, which can safeguard their trade interests on one hand and propagate their trade endeavors within their borders and beyond on the other hand.
Trends in global trade indicate that countries highly esteem international trade because it earns a country foreign exchange, which in addition to funding some government activities, assists in the payment of foreign debts. The idea of specialization and division of labor led to the growth of interdependence among countries such that no nation is capable of self-sustenance. This phenomenon has over the years led to the need for every government to have external sources for servicing foreign debts (Krugman, and Obstfeld, 2009, p.75). Even if the domestic earnings of a country were sufficient to finance government activities and service foreign debts, choosing to do so would mean that the country transfers its created wealth to other countries at the expense of using it to improve the living standards of its citizens (Dollar, and Kraay, 2004, p.36). Foreign exchange, therefore, helps countries to avoid this kind of scenario and augment the domestic earnings in funding government activities.
The need to strengthen international trade has compelled governments to devise mechanisms that make it easier to conduct international trade. These mechanisms come in the form of trade ties and treaties, which can involve two or more countries. Policies formulated to facilitate trade relations among countries may take on different forms but the underlying principles are often the same, that is, reduction of cross border tariffs and other impediments to trade and curbing discrimination among countries in international trade (Quick, 2008, p.391). Countries traditionally took defensive stances when it came to international trade issues. Governments levied high tariffs on international goods and services and imposed complicated non-tariff measures, which were aimed at protecting local industries from external competition. The rationale behind such measures was that some international companies were capable of producing goods cheaply and could present local industries with unfavorable competition if allowed to trade freely. Tariffs were thus aimed at ensuring that such goods ended up more expensive than or of equal price to locally produced goods. Time, experience, and research have taught governments that free trade promises far more benefits than the traditional restrictive approach to international trade (Krugman, and Obstfeld, 2009; Baier, and Bergstrand, 2004, p.49).
The realization led to the development of pro-free trade organizations such as the General Agreement on Tariffs and Trade (GATT), in 1947 to encourage countries to reduce their tariffs and other trade barriers to fast-track economic recovery among countries after World War II (Quick, 2008, p.394). Over the years, the body initiated many discussions aimed at liberalizing international trade with notable achievements before being transformed into the World Trade Organisation (WTO) in 1995 (Brummer, 2007, p.1359). The formation of such bodies served as revelations for many governments, which have since then engaged in the formation of regional and bilateral trade organizations (Quick, 2008, p.399). The principal focus of the trade organizations remains the same, that is, to liberalize international trade as much as possible. Complete liberalization is difficult to achieve as it denies governments a lucrative source of revenues from tariffs (Devereux, 1997, p.570).
The US, which is the world’s largest economy, has been aware of the importance of international trade for many years as evidenced by its endeavors to establish trade relations with almost all countries and regional trade blocs around the world. The most important among its bilateral trade relations is that between it and the European Union (EU), which is a political and economic union comprising 27 European countries (Matsushita, 2010, p.8). The bilateral tie between the US and EU is the largest in the world and is still growing (Cooper, 2011, p.1). In 2012, a total of 1,500.5 billion dollars moved between the US and EU (Cooper, 2011, p.1). This makes the EU the largest consumer of the US merchandise and services as well as the largest source of imports in terms of merchandise and services (Cooper, 2011, p.3). The EU is also the largest destination for US direct foreign investment. Based on these statistics, the trade relationship between the US and the EU is important not only to the trade partners but to the global economy.
Role of International Trade Organisations in Facilitating Trade
The formation of GATT and consequently the WTO has greatly changed the international trade landscape (Irwin, and Tervio, 2002, p.17). GATT successfully helped to bring down cross-border tariffs in its efforts to liberalize trade. However, in response to the reduction cross border tariffs, the international trade arena witnessed a proliferation of non-tariff barriers that were erected by countries to compensate for the ground they had ceded in reducing tariffs (Brummer, 2007, p.1378). Immediately after World War II, GATT started advocating multilateral trade relations among nations. This appears to have been the best approach at the time because the War had polarised the world’s nations into opposing camps and many diplomatic associations were severed. There was a need for rebuilding relations among nations across the world to put the global economy back on a growth path. McMillan (1993, p.83) observes that encouraging bilateral trade relations at the time would have raised suspicion among the major rivals in the War. GATT’s move was aimed at fast-tracking economic recovery as well as establishing deep-rooted world peace (Zeiler, 1997, p.710).
GATT’s successor, the WTO has since its inception in January 1995 pursued similar policies for liberalization of trade. WTO still advocates multilateral trade relations instead of bilateral relations (Brummer, 2007, p.1383). The WTO’s position seems to conflict with the arrangement in which nations are increasingly pursuing bilateral trade relations. For example, Matsushita (2010, p.4) notes that as of 1990, only 27 Preferential Trade Agreements PTAs had been notified to the GATT but by the close of 2008, the number of PTAs notified to the WTO stood at 421. Regional economic blocs have become commonplace and in 2010, every member of the WTO was party to an average of six different PTAs (Matsushita, 2010, p.6).
The regional economic blocks in turn form bilateral relations with other regional blocks from other parts of the world. The result is not far from the initial multilateral trade relations advocated by WTO but with some variations. Though it does not fully espouse PTAs due to the effect they have on the multilateral trading system, the WTO provides a functional framework for the EU – US trade relations, as is the case with all other existing PTAs (Bagwell, and Staiger, 2001, p.296). The two partners also have their bilateral trade policies, economic policies, and foreign policies, which guide their integration efforts, but all this has to be done within the guidelines of the statutes that govern international trade as outlined by the WTO. The WTO thus plays an important role in enhancing international trade by providing the auspices within which it can be conducted.
The Research Problem
The bilateral relations between the US and the EU are important to both partners due to the economic benefits that accrue on both ends. The importance of this relationship extends beyond the economic, social, and political benefits that the two partners enjoy.
The US economy plays an important role in global economic matters and any major economic shock that hits it is often felt in economies across the globe. Dees and Saint-Guilhem (2009, p.9) posit that emerging global players such as China have substantially reduced the influence of the US economy in the global economic arena; the US economy still influences its bilateral partners’ economies to magnitudes that extend beyond what the direct trade relations suggest. For most countries, the US is the first trading partner and this has been the case for over the last two decades (Dees, and Saint-Guilhem, 2009, p.16). Even countries that do not heavily trade with the US are still influenced by the US economy via other trading partners that have strong relations with the US.
The EU on the other hand, from the perspective of a single block, is the largest economic entity in the world with a gross domestic product (GDP) that is slightly greater than that of the US (Sapir, 2007, p.76). This position pitches the EU as an economic entity with enormous global influence on economic matters because like the US, its import and export statistics show that it has trade relations with most countries and regional trade organizations around the world. As the largest exporter in the world (European Commission, 2013, p.23), an economic shock that hits it would quickly be felt by countries that serve as markets for its products as well as those that depend on it as a market for their products.
These two trade partners hold the global economy in place, that is, their combined economies account for about 50% of world GDP, and trade between them accounts for over 40% of the world trade flows (Bagwell, and Staiger, 2005, p.500). Any occurrence that adversely affects the economies of both translates to a global economic issue. A prime example of such an occurrence is the global recession that was witnessed between 2007 and 2010. Both the US and the EU were negatively affected economically and the crisis turned into a global problem with smaller economies almost collapsing. Based on the importance of their trade relationship to the world economy, trade-related friction between the US and the EU is not good.
Yet as Cooper (2011, p.4) notes, policy disputes often arise between the US and the EU causing friction and sometimes bilateral disputes between the partners. A prime example of potentially dangerous policies is the US’ Surveillance Policy, which allows the US government to secretly spy on foreign governments’ activities (Cooper, 2011, p.4). A leakage of US’ secret surveillance activities on Europe has threatened to jeopardize free-trade talks that were aimed at moving US and EU trade relations a step further by eliminating all tariff and non-tariff trade barriers (Cooper, 2011, p.5). This analyzes the trade relations between the US and the EU imperative as it can illuminate the motives behind either partner’s pursuit of potentially disastrous policies.
Purpose of the Study
In light of the outlined significance of the bilateral trade ties between the US and the EU to the global economy, influential governments and global organizations such as the United Nations (UN) and the WTO need to arbitrate between the partners to ensure that the relationship remains steadfast to maintain global economic stability. Some countries engage in activities, which go against the provisions outlined in the treaties, which underpin their trade relationships, such as the US-EU relationship, yet they are allowed to continue enjoying the benefits of such arrangements just like the countries, which remain committed to the provisions. The need therefore to understand this kind of relationship and all the principles which are essential for their formation and sustained maintenance is the reason behind this study. By analyzing the world’s most intriguing bilateral trade arrangement, the researcher hopes to develop a clear understanding of the dynamics that underlie bilateral trade agreements.
Objectives of the study
The study is guided by the following objectives.
- To explore the policy framework that underpins the bilateral trade ties between the US and the EU.
- To examine the challenges encountered in the bilateral trade relationship between the US and the EU.
Research Methodology
The scope of the trade relations between the US and the EU is beyond the researcher’s ability to access primary data. The study thus hinges exclusively on the analysis of documented information on the subject. The study draws all its findings from secondary data sources in the form of books, journals, reviews, and analyses by experts, government reports, and organizational reports from bodies such as the WTO. Online databases such as Academic Search Elite (EBSCO), Gale Virtual Reference Library, Oxford Reference Online Premium, and ABI/Inform Complete (ProQuest) also provided materials that gave insights into the dynamics of the US-EU trade relationship.
In establishing a theoretical framework for the study, theories on international trade and PTAs are analyzed to find how they link with the trade US-EU case. The researcher endeavors to find out if models that are relevant to the US-EU trade relationship can be used to analyze it.
The existing policy framework that underpins the trade relations between the US and the EU is examined to help in understanding the terms of their engagement. This serves as a basis for understanding the challenges that are inherent in the US-EU trade relationship, why they arise and continue to affect trade relations.
Dissertation Chapter Outline
This dissertation comprises five chapters. The second chapter provides a theoretical framework for the study and examines previous studies on the trade relationship between the US and the EU. Previous studies on similar trade arrangements in other parts of the world are interwoven into the theoretical framework in a bid to comprehend the dynamics of preferential trade arrangements. The third chapter articulates the trade relationship between the US and the EU; this includes each partner’s approach to foreign trade in terms of foreign policy and international trade policy.
This chapter also identifies key agreements that have been signed between the contracting partners from the inception of the relationship to its status. The chapter further outlines the WTO statutes that are relevant to the US-EU trade relationship. The fourth chapter analyses the trade relationship between the US and the EU against the statutes and agreements that underpin the relationship. The chapter uses the theories outlined in the theoretical framework to analyze the trade relationship between the US and the EU in a bid to establish its compliance to the different models of international trade that have been developed. The fifth chapter concludes the dissertation in a brief discussion, which is followed by the recommendations of the study.
Theoretical Framework and Literature Review
The development of international trade over the years prompted scholars to conduct investigations into the nature of international trade in a bid to understand its dynamics. This led to the development of numerous theories of international trade such as the Ricardian Comparative Advantage Theory, the Paul Samuelson – Ronald Jones Model of Specific Factors and Income Distribution, and the Standard Model of Trade or Paul Krugman – Maurice Obstfeld Model among many others that exist today. These theoretical models are developed by scholars for purposes of analyzing trade in a bid to explain prevailing trends and possibly predict the future of trade. The need to understand the dynamics of trade is necessitated by stakeholders’ need to prepare for any eventualities that they may encounter in the trade as time goes by.
Two theoretical models are explored in this literature review for purposes of analyzing the trade relationship between the US and the EU. These are the Standard Model of Trade/ Krugman – Obstfeld Model and the Comparative Advantage Theory. These two models are anticipated to provide ample room for the assessment of the trade relations between the EU and the US because they extensively explore the nature of bilateral trade arrangements. Their exploration of bilateral trade arrangements is suitable for this study because the trade arrangement between the EU and the US falls in the category of bilateral trade arrangements.
The comparative advantage theory
The comparative advantage theory is the most widely used and most reliable mechanism of explaining the dynamics of international trade (Archick, 2013, p.8). The theory is attributed to the efforts of David Ricardo in the book, On the Principles of Political Economy and Taxation. The theory postulates that a country is considered to have “a comparative advantage over its trade partners in the production of a certain good if it can produce the good at a relatively lower cost than its trade partners can” (Ricardo, 1908, p.75).
Ricardo uses the production of clothes and wine in two countries (denoted in this study as X and Y) to elaborate on this theory. Ricardo assumes that X has an advantage over Y in the production of both commodities. He further assumes that it is more difficult for Y to produce wine than clothes. Thus, X produces both wine and clothes while Y focuses on cloth production and imports wine from X at low costs. In the context of the model, this arrangement increases the overall world production of both commodities. The theory thus encourages countries to specialize in the production of commodities they can produce efficiently. Sen (2010, p.14) notes that a country just needs to have a lower relative cost of production to have a comparative advantage. The relative cost of production is obtained by comparing the cost of foregoing the production of a higher cost commodity between countries (Sen, 2010, p.16). If for example, the cost of foregoing the production of clothes is higher in country A than in Country B, even if the cost of producing clothes in Country A is lower, Country B still has a comparative advantage over Country A.
Like all other theoretical models, this theory makes several assumptions in its attempt to explain international trade. In a comparison of production costs between the two countries, the model assumes that the two countries use labor as the sole factor of production (Suranovic, 2010, p.87). A further assumption is that the goods under production are homogenous and although labor is the only factor of production, it is homogenous within one country but heterogeneous among the different countries (Suranovic, 2010, p.88). Additionally, the model assumes that goods can move across the two countries without any transportation costs and labor can move across industries within one country but not across borders (Morgan, and Katsikeas, 1997, p.85). It also assumes that there are technological differences within industries of the individual countries and among the comparing countries (Pollack, 2010, p.26).
These assumptions have drawn sharp criticisms for the theory on the premise that it heavily leans on them to draw conclusions and arrive at predictions yet the assumptions are not realistic. For instance, Bouare (2009, p.111) argues that the model is built on two countries that focus on the production of only two commodities using a single factor of production. This assumption is a total departure from the real world situation of international trade where numerous countries strive to trade with each other and produce numerous commodities via the interaction of several factors of production all at once. Further assumptions of the model are that the market of each country is perfectly competitive. This assumption is considered unrealistic because market dynamics cannot allow all markets to be perfectly competitive. Another assumption is that labor productivity is fixed yet in a real sense, it changes with time. Additionally, full employment cannot be guaranteed at all times because employees cannot instantly move across industries without any cost implications (Dong, and Yan, 2009, p18).
Dong and Yan (2009) and Bouare (2009) note that it is difficult to easily accept or understand the conclusions and the predictions of the Ricardian Model concerning international trade. It ignores critical aspects of international trade and focuses on production and supply only (Bouare, 2009, p.112). This aspect limits it in terms of its ability to explain the role played by the market forces, which dictate the patterns of trade in a free trade setting. Besides, no supreme authority defines the commodities that each country chooses to produce based on comparative advantage. Even though countries may specialize in the production of certain commodities, total specialization has been rare in practice (Dong, and Yan, 2009, p.22). Countries do not eliminate the comparatively disadvantaged industries from their economies.
Despite the criticism, the assumptions lead to understanding the principles underlying the theory of comparative advantage. The “primary concern of this theory is to show what happens when two countries decide to move from a state of autarky to a state of free trade between them” (Winters, 1992, p.107). In the absence of trade, each country strives to produce at least a bit of every commodity it needs. Technological variations across countries will lead to each of them having slightly different prices for their goods. Under such circumstances, the country that has a comparative advantage over the other will present lower-priced goods to its people. If one country has an “absolute advantage over the other in the production of all goods, the standards of living in that country will be higher” (Dollar, and Kraay, 2004, p.39). This means that according to this model, standards of living are better in more technologically advanced countries than lower technology countries. The Ricardian model states that wages, which determine the standard of living, are dictated by the level of productivity; as such, in technologically advanced countries productivity is higher (Bagwell, and Staiger, 2010, p.236). This translates to higher wages and consequently higher living standards for the workers or higher returns for firm owners and still low income for workers.
The insight provided by the criticism of this model agrees with the assertion made by Suranovic (2010) that the theory only outlines what is likely to happen when two countries choose to engage in free trade and do not give the exact course of events to be witnessed. This is because countries cannot be compelled to specialize in what they can produce best, each country chooses to either fully embrace a model and witness the patterns outlined in the model or sparingly engage other countries in international trade and witness varying patterns. This makes the comparative advantage theory applicable in the analysis and predictions of international trade phenomena despite the criticisms leveled against it.
The Standard Model of Trade/Paul Krugman – Maurice Obstfeld Model
Paul Krugman and Maurice Obstfeld put forth this model in their book International Economics Theory and Policy. This model principally elaborates how the dynamics of one country’s economy can affect/be affected by the global economy (Krugman, and Obstfeld, 2009, p.75). To achieve this, it identifies the key relationships that vary to bring about economic growth or decline.
The first of these relationships is that between production possibility and relative supply. To understand it, an assumption is made of two countries which produce clothes, C and food, F. A further assumption is that of the countries in question, each has a smooth production possibility frontier (PPF) curve which implies that they are capable of producing at the highest possible level (Krugman, and Obstfeld, 2002, p.57). This means that each country compares its economy with the global economy and settles for the production of more of the commodity that gives maximum return on the resources invested. The production possibility frontier defines the scope within which a country can produce goods (Baldwin, 2006, p.1487); for instance, country A has a given amount of resources at its disposal for the production of food and clothes. Based on the assessment of the ease of production and the demand for each of the two commodities domestically, it will choose the production level for each of the commodities as dictated by the available resources. Thus, an economy can operate below the PPF curve but cannot exceed it (Edwards, and Lawrence, 2010, p.94).
This relationship’s relevance to international trade arises from the idea that countries are endowed with varying levels of both similar and different resources. A country, therefore, assesses its production capabilities against the demand for a given commodity both domestically and internationally and chooses the optimal level at which it can produce. Any deficits are compensated via trade with other countries. The rise and fall in the production levels of either clothes or food are dictated by the relative price of the two commodities. If the relative price of one of the two rises, the relative supply of that commodity rises as well and since there is a fixed amount of resources, the production of one commodity has to reduce proportionately to allow the rise in production of the other.
The second relationship involves prices and demand. It is based on the assumption that an economy’s consumption decisions can be likened to a single individual’s tastes and preferences so that this individual can be used to represent all the other consumers’ (in the economy) consumption patterns (Edwards, and Lawrence, 2010, p.96). The relationship further assumes that in an economy, the value of produced goods must be equal to the value of those consumed. If the production and consumption of food and clothes vary from time to time, the result is a variety of welfare levels for the consumer. Trying to reduce the supply of clothes to the consumer while at the same time trying to keep the welfare level of the consumer constant, implies that more food has to be supplied. Naturally, an economy chooses to produce at a point, which delivers the highest possible welfare level for its people, and all the adjustments witnessed in trade are always directed at ensuring that the welfare of the people remains at the highest possible level (Ornelas, 2005, p.1475).
At the optimum production point, the production of one of the two commodities exceeds the consumption capability of the economy thus giving room for exportation of excess commodity and import of the needed commodity. If an economy operates at such a level, the welfare of its consumers surpasses the highest level that could initially be achieved (Krugman, and Obstfeld, 2009, p.80). In this manner, trade between the two countries increases the welfare of consumers in both countries. Every country strives to make this pattern recursive so that the improvement in the economic welfare of a country becomes a continuum of small advances from one level of consumer welfare to a higher level.
The third relationship is that between terms of trade and a country’s welfare. It is pivotal in explaining the dynamics of the standard trade model. Terms of trade is a ratio obtained by dividing the cost of a country’s exports by the cost of its imports (Edwards, and Lawrence, 2010, p.99). According to Krugman and Obstfeld (2009, p.58), if for example there are two commodities food and clothes, and that a country exports clothes and imports food, this ratio is obtained by dividing the price of clothes by the price of food. This means that if the ratio rises, the welfare of the exporting country will rise, and if it reduces, the welfare of that country reduces. This ratio is known as the terms of trade; a rise in the ratio means that the terms of trade have improved and lead to an increase in welfare. Similarly, a reduction in the ratio is a reduction in terms of trade and consequently the welfare of the country in consideration.
Krugman and Obstfeld (2009, p.274) in explaining the effect of terms of trade on the welfare of a country, use the example of a world economy comprising of two countries only and one country exports clothes while the other exports food. Each of the two countries produces both commodities but exports one. For the country that exports clothes, the terms of trade are determined by dividing the price of the total clothes by the price of the total food supply by both countries. Similarly, for the country that exports food, the terms of trade are arrived at by dividing the price of the world food supply by the price of the world clothes supply. In this manner, a rise in terms of trade for the country that exports clothes lead to more production of clothes by both countries but the clothes exporter benefits more from such a shift in the global market. This assertion is also true if the terms of trade for the food exporter rise.
This example is unrealistic and it has attracted criticism to that effect from scholars such as Dong and Yan (2009) and Bouare (2009). The critics argue that like the comparative advantage theory, this model also gives an example of only two countries dealing in two commodities. This limits its applicability to real-life because although the bilateral trading system has notably developed in the past decade, the international trading system is interlinked and interconnected to an extent that no single bilateral relationship can be isolated from the rest and given credit for some economic phenomenon. Based on this assertion, it is not logical to use only to talk of two countries, which are completely isolated from the rest of the world.
The idea of trading in only two commodities does not apply to the real-world situation. Countries produce a variety of goods and each of these goods whether consumed domestically or exported to the international market contribute to the economic growth of a country. This means that isolating all other goods from the economy and trying to predict the economic effect of just one on the economy is a farfetched idea. In a real sense, economic growth results from the synergistic effect of all the commodities produced and consumed both domestically and internationally. The assumptions made by the standard trade model thus make its conclusions and predictions unreliable.
Another concern that emerges from the model is whether a rise in the welfare of another country or the rest of the world, economic growth, is beneficial to another country for instance or it affects the other country negatively (Klaus, 2003, p.121). Klaus (2003, p.123) further questions whether the growth in the economy of a country is more valuable when the country is closely knitted with other economies of the larger world market or such a relationship reduces the value of economic growth for a country (Klaus, 2003, p.123).
In an attempt to address these concerns, Grossman and Helpman (1995, p.670) argue that the growth effect of international trade results from a bias towards the production and sale of a particular commodity or the expansion of a given industry. According to Krugman and Obstfeld (2009, p.46), if technological advancement occurs in a particular industry in an economy, what follows is an expansion in the ability of that industry to produce more goods compared to other industries within the same economy. This means that the overall economic growth exhibits a bias towards the industry that has undergone technological advancement. The same case is also applicable to the example of food and clothes. Advancement in the clothes production technology leads to overall growth in the economy but the production and sale of clothes will claim a bigger share of the growth. The same case applies if technological advancement is realized in food production.
Secondly, Krugman and Obstfeld (2009, p.67), note that both the specific factors model and the factor proportions model, which argues that trade between countries is influenced by the relative abundance of production factors between the trading countries show that if the capital stock increases due to saving and investments, the result is the biased expansion in the ability to produce. This bias, like in the Ricardian model, is towards the commodity whose production depends on the factor of production, which has increased. This means that if a country engages in international trade, the very factors that motivate it to do so are the same factors that will cause biased growth in the industries or sectors of that country’s economy (Ferreira, and Rossi, 2003, p.1395).
With the background knowledge that according to this model, economic growth occurs in a biased manner, if country A, which is a clothes exporter in the two-country world economy setting, experiences strong clothes biased growth causing an increase in its production of clothes regardless of their relative price, a decline in its food production will be realized. From a world perspective, the production of clothes will rise compared to the production of food thus the relative price of clothes will decline. This means that the terms of trade of country A will reduce leading to an improvement in terms of trade of the food exporter, country B.
If country B experiences strong clothes biased growth, the described scenario will be replicated because the world’s relative supply of clothes remains high thus lowering their relative price and country A’s terms of trade. Conversely, if either country A or B experiences a food biased growth, the relative food supply will raise and lower the relative food prices. This translates to a decrease in Country B’s terms of trade and an increase in country A’s terms of trade.
This explanation gives a principle that the standard trade model employs to address the two concerns that emerged over how the growth of the rest of the world economy affects the economic growth of a home country and whether being part of the global economy adds or reduces the value of economic growth for a home country. Krugman and Obstfeld (2009, p.93) argue that for both concerns, the response is influenced by the direction of the bias. If the rest of the world realizes export-biased growth, the home country benefits from better terms of trade. Import-biased growth in the rest of the world negatively affects the home country by lowering its terms of trade and thus welfare. Domestically, if the home country realizes export-biased growth, its terms of trade become worse and if it realizes import-biased growth, its terms of trade improve.
Case Study
This chapter delineates the development of the US-EU trade relationship to its contemporary status. It also includes the legal framework that governs the existence of the trade relationship between these two partners.
The United States
The US started emerging as a force to reckon with in international politics in the 25 years preceding the First World War (Fordham, 2011, p.63). During this era, the scope of its foreign policy ambitions heightened enabling it to colonize the Philippines, Puerto-Rico, and Guam (Fordham, 2011, p.64). The expansion in the US’ perspective of the world did not only stop at politics but incorporated trade as well. The prompt to seek overseas markets came from the periodic economic crises witnessed in the US in the late 19th century. It became explicit to the economists of the time that the rapid economic growth that followed the end of the American civil war led to heightened production, which surpassed the consumption capability of the local consumers. Foreign markets thus had to be sought to act as a sink for surplus production (Shafaeddin, 1998, p.16).
The idea then was to find markets to which the US could export its surplus products without having to import anything (Birdsall, 2008, p.28). To achieve this, the US decided to employ every available tactic including the use of coercion to abate the resistance that they often encountered from economic nationalists or rivals (Fordham, 2011, p.66). The pattern of the US’s approach to international trade began to change in 1934 after Congress enacted the landmark legislation known as the Reciprocal Trade Agreements Act 1934 (RTAA) (Canto, 1984, p.691). Alongside this legislation, the Foreign-Trade Zones Act 1934 was also enacted in the same year (Bilzi et al., 2011, p.6).
The RTAA bestowed upon the president of the US the mandate to negotiate trade agreements and take part in negotiations aimed at lowering tariffs (Canto, 1984, p.694). Under the auspices of RTAA, the US successfully signed 20 bilateral trade agreements with a variety of countries across the globe (Canto, 1984, p.699). Tariffs also dramatically reduced from about 60% in 1934 to about half the figure in 1947 (Gawande, Krishna, and Robbins, 2006, p.566). The trade agreements signed by the US then were bilateral arrangements because there was no framework within which a multilateral trading system could be operated (Limao, 2006, p.901).
To better the free trade environment, the Trade Agreements Expansion Act 1951 was enacted (Charnovitz, 1995, p.36). This Act preceded the Trade Expansion Act 1962 whose prime focus was to grant the then-president the mandate to lower tariffs at a GATT summit that was due. Most importantly, it led to the establishment of the office of the special trade representative, currently referred to as the U.S. Trade Representative (Canto, 1984, p.695). Just before the Second World War, many countries had resorted to neo-mercantilism as the best approach to trade (Freund, 2010, p.126). This approach has been hailed as one of the key causes of the Second World War (Canto, 1984, p.699). After the Second World War, the war-ravaged economies badly needed a means of getting back to the track of quick economic recovery. The US took advantage of the economic and political influence it had gained to herald the formation of international organizations such the United Nations (UN) and the GATT, which were aimed at fostering peaceful coexistence among the countries across the world and provide an enabling environment for the multilateral international trading system (Grossman, and Helpman, 1995, p.676). This means that the legislation that was adopted by the US in 1951 and 1962 was aimed at enhancing trade in the new trading arena that was provided by the GATT.
The GATT after its establishment required all member countries to cease any protectionist practices in international trade. Although many countries, including the US, were still under pressure from interest groups within their economies to restrict imports to some extent to protect local industries, such actions were contrary to the spirit of the GATT and had to be avoided. Thus, the Trade Act of 1974 was enacted to provide room for further reduction of tariff and non-tariff barriers to enhance international trade (Schott, 1998, p.56).
The need to move towards a freer international trading environment was however not approached without caution, the US established a commission, the International Trade Commission (ITC) to watch over and control the flow of international trade whenever necessary (Brett, Gilliatt, and Pople, 1982, p.136). For instance, in 1980, the Ford Motor Company allied with United Auto Workers to seek protection against auto imports from Japan via the ITC. Though the ITC did not find the imports from Japan to be substantial contributors to the woes of the US’s automakers, pressures from other quarters compelled the concerned authorities to seek and establish voluntary restraints on Japanese auto-imports with the Japanese government (Frieden, 2008, p.940). In another example, the ITC banned the US exporters from selling corn, wheat, and fertilizer products to the Soviet Union when it invaded Afghanistan (Gilbert, 1995, p199). Similar restrictions were also imposed on the export of high technology products to the Soviet Union.
The US continues to advocate for free trade through the formation of a plethora of bilateral trade partnerships in the past decade and the enactment of legislation that continue to ease the trade environment. NAFTA, which incorporates the US, Canada, and Mexico, is a prime example of the US’s commitment to free trade (Frieden, 2008, p.941). This partnership has grown from a preferential trade arrangement to a free trade area for the contracting partners in which all tariff and non-tariff barriers have been eliminated. The US continues to pursue similar agreements with its other trade partners for instance the EU, which is its largest trading partner in the world. This shows that even though the US takes protectionist stands over some issues, it readily pursues free trade agenda with trade partners who are ready for the same.
The European Union
The EU is a grouping of 27 sovereign countries, which have consented to surrender their sovereignty in certain predefined areas including monetary policy, environmental concerns, and employment issues (Borchardt, 2010, p.43). The EU as it is today is a result of a gradual integration process, which started in 1951 with only six founding members and is still ongoing with 27 member states (Borchardt, 2010, p.43).
At its inception, it was referred to as the European Coal and Steel Community (ECSC) and it included the Netherlands, Belgium, West Germany, France, Italy, and Luxembourg as its founder members (Borchardt, 2010, p.46). The idea of such an arrangement was conceived by the then French Foreign Affairs Minister Robert Schuman on the premise that close cooperation among the European countries on economic matters would dramatically reduce the likelihood of these countries going to war against each other (Meunier, and Kalypso, 2006, p.911). The need to reduce the chances of European countries ever going to war was necessitated by the effects of the Second World War. Schuman’s idea was thus well-timed as it came at a time when the US was championing the formation of global institutions to oversee world peace and free trade (Acemoglu, Johnson, and Robinson, 2005, p.553).
In 1957 the Rome Treaty, which gave rise to the European Economic Community (EEC) was signed (Acemoglu, Johnson, and Robinson, 2005, p.556). The EEC created a common market among the contracting members such that goods and services could freely move across their borders (Schwarze, 2003, p.96). Alongside the EEC, the European Atomic Community was also established in 1957 to enhance cooperation in the development of atomic (Swedberg, 1994, p.378). In 1967, the three institutions were fused to form the European Community (EC) (Bartels, 2007, p.736).
The expansion of the European organization was gradual with Greece joining in 1981 and Portugal and Spain joining in 1986 (Acemoglu, Johnson, and Robinson, 2005, p.554). Finland, Austria, and Sweden joined in 1995 but the largest expansion was witnessed in 2004 when ten countries joined the organization all at once. In 2007, two more countries joined the organization bringing its membership to 27 countries with a populace of close to 500 million. The integration process is ongoing and more countries still seek accession to the membership of the organization.
Over the years, the organization has amassed massive political and economic influence globally. It is currently the largest single economic entity in the world as its overall GDP surpasses that of the US (Archick, 2013, p.14). This gives the EU an upper hand in its negotiations with other regional economic organizations or large countries such as the US, China, and Canada because it engages them as equals (Balfour, and Raik, 2013, p.53).
Numerous additional treaties have been signed since its inception to expand and deepen the mandate of the organization. The European Union (EU), as it is known today, was birthed after the Maastricht Treaty of 1992 (Global Europe, 2006, p.7). The EU is thus an organization, which is different from the federation type US arrangement and different from the UN where member states do not surrender any element of their sovereignty. It is an organization of its right, capable of making decisions that are binding on all member states.
In its trading relationships, the EU is an umbrella body, which is charged with the responsibility of negotiating trade agreements and defining the terms of engagement between its member countries with each other and with external trading partners to each other (Maur, 2005, p.1565). This means that the EU member countries each conduct international trade individually under the auspices of the EU statutes. As a joint entity, it draws its political and economic might from the synergistic effect of the cooperation of its members. The founding premise ‘a whole is better than the sum of many’ thus works to the advantage of the EU and its member states. The US-EU trade relationship is a typical example of how important the EU is to its member states as well as its trading partners.
The US-EU Trade Relationship
The trade relationship between the US and the EU dates back to the period immediately after the Second World War (Hamilton, and Quinlan, 2004, p.34). At the same time, the US was strongly lobbying for international cooperation through international organizations such as the UN and GATT whose formation it had facilitated (Frieden, 2008, p.941). The desire to assist Europe in its economic recovery activities led to the establishment of diplomatic ties between the then ECSC and the US in 1953 (Woolcock, 2007, p.10). With the establishment of the diplomatic ties, there came a slow but steady progression towards cooperation as time went by.
The US sent a delegation of observers to the ECSC to commence the talks towards a possible future economic and political cooperation. This led to the formal opening of the US Mission to the ECSC in Luxembourg in the year 1956 (Devuyst, 1992, p.26). Similarly, a group known as the Delegation of the European Commission to the US was also established by Europe (EU Committee, 2008, p.33). With the establishment of the diplomatic ties, there came a slow but steady progression towards cooperation as time went by. The established ties were formalized in 1990 via the adoption of the Transatlantic Declaration, which was the first cooperation agreement signed between the two sides (Hamilton, and Quinlan, 2013, p.16).
The Transatlantic Declaration focused on cooperation between the US and the then EC on economic, educational, scientific, and cultural matters (Ahearn, 2006, p.42). Specifically, the partners agreed to jointly combat and prevent terrorism, fight against the trafficking of narcotics and money laundering, address environmental concerns both locally and globally, and curb the proliferation of military weapons (Ahearn, 2006, p.93). The partners were looking to deliver a stable, secure, and peaceful world through their cooperation. This included the promotion of social justice and democratic governance across the globe (Bagwell, and Staiger, 1999, p.230). All these were to be achieved via a foundation of strong economic relations between the two partners.
The relationship strengthened further in 1995 with the adoption of the New Transatlantic Agenda (NTA) (Balfour, and Raik, 2013, p.56). The treaty was more comprehensive compared to its predecessor. This gave it the ability to strengthen US-EU relations. The year 1998 saw a new development occur in the US-EU relationship. The Transatlantic Economic Partnership (TEP) was established. The main purpose behind the establishment of TEP was to seek how to enhance both bilateral and multilateral cooperation between the two partners (Freund, and Ornelas, 2010, p.144). Bilaterally, TEP was concerned with strengthening the relations between the two partners through the elimination of remaining trade barriers thus creating a more enabling trade environment (Acemoglu, Johnson, and Robinson, 2005, p.557). In a multilateral sense, TEP aimed at strengthening international trade further through the WTO to deliver a better trading environment for the rest of the world. In its effort to link the US and Europe, it shifted focus from the government to the people (Balfour, and Raik, 2013, p.64). Several dialogue groups such as the “Transatlantic Business Dialogue (TABD), the Transatlantic Consumer Dialogue (TACD), and the Transatlantic Policy Network (TPN) among others have been established to enhance a people-to-people link between the partners” (Balfour, and Raik, 2013, p.65).
Contemporarily, it stands as the world’s largest economic partnership and it is still growing. The US and the EU combined accounted for up to 50% of the world GDP in 2012 (Cooper, 2011, p.4). The EU is the US’s largest trade partner in both merchandise and services as of 2012. Similarly, the US is the EU’s largest trading partner in both goods and services. Trade between the two partners accounted for about 40% of world trade in 2012 (Cooper, 2011, p.4). This shows how important this relationship is not only to the trading partners but to the global economy as well.
The trade between the US and the EU can be termed as intra-industry trade since they trade in similar goods and services (Balfour, and Raik, 2013, p.57). It is motivated by the tastes and preferences of their population. This makes the relationship a complex one that refutes most of the trade theories and models that have been advanced to explain factors that cause and sustain international trade. Despite this, the relationship is on a positive development track and is most likely to be strengthened further.
Emerging Issues in the US-EU Trade Ties
Despite the figures and the apparent success associated with the trade relationship between the US and the EU, the possibilities of moving it from a preferential trade agreement to a free trade area have been in consideration for a long time. The trade relationship has been under consideration since the 1990s, and specifically 1995 (Archick, 2013, p.15). The idea of a free trade area between the US and the EU was revisited in 2007 under the watch of the EU commissioner for trade, Peter Mandelson (McIver, 2011, p.43). Since then, there have been strong indicators of renewed interest in the idea. Have been operating can be termed as a preferential trade area because it involved reduction and elimination of tariffs on certain goods, which the partners trade between themselves. The desire to move it from that level to a free trade area is a move that will take the trade relationship a notch higher because a preferential trade area is the lowest level of economic integration (Mitra, 2002, p.479). A free trade area thus comes with more reduction in tariff and non-tariff barriers. A free trade area will see the relationship advance to a level where all tariffs are eliminated or reduced to minimal levels. Such a move will thus strengthen the relationship further because trade between the partners is likely to thrive and draw more returns compared to its current state.
In February 2013, the US president reaffirmed their commitment to ensuring that a more comprehensive trade agreement is achieved between the EU and the US (Archick, 2013, p.14). There is renewed vigor in the endeavors to establish this comprehensive trade and investment partnership than ever before. Currently, negotiations are in progress and according to Cooper (2011, p.6), they are likely to be concluded by the end of 2014. This means that the economic relations between the EU and the US will support additional jobs on top of the 12 million jobs it currently supports (Archick, 2013, p.8). The trade relationship between the US and the EU is anticipated to be the most illustrious of all trade agreements in the history of world trade.
Challenges Encountered by the EU-US Trade Relationship
Trade Disputes
The trade disputes that have been witnessed between the EU and the US are numerous and diverse. They can however be classified into broad categories under which they generally fall as outlined below. Trade disputes arising from direct protectionism where an export destination country decides to impose GATT-illegal tariffs have been reported between the EU and the US (Abbott, 2003, p.250). The tariffs are termed ‘GATT-illegal’ because these disputes manifest only either between countries, which are bound by GATT statutes within the auspices of the multilateral trading system, or between countries, which are party to a regional trade bloc or any other form of the preferential trade agreement, and all preferential trade agreements are formed under and are guided by GATT statutes. Direct protectionism thus contravenes the GATT statutes, which espouse a free trade environment, which is devoid of all tariff and non-tariff barriers.
The second category of trade disputes that have been witnessed between the EU and the US originated from indirect protectionism where one country chooses to impose taxes discriminatorily on another country’s products so that at the market level, the imported goods become more expensive than locally produced goods (Ahearn, 2006, p.104). Another cause of trade disputes has been reported as a distortion of trade through the provision of unfair subsidies in the production of products for export. This eventually leads to the production of goods, which are artificially low priced hence presenting unfavorable competition to the goods, which have been produced at normal production costs. The other form the trade disputes between the EU and the US have taken in the past is the abuse of WTO anti-dumping provisions, which are aimed at curbing the dumping of unrealistically low priced goods into another country’s market (Ahearn, 2006, p.112).
In the history of the EU-US trade relationship, one of the contentious issues that have caused trade disputes between the EU and the US to include the EU ban on the US produced beef on grounds that the beef has been produced with the aid of hormone growth promoters (Josling and Tangermann, 2003, p.63). The EU ban was motivated by the agitation among its populace over the use of hormones to enhance beef production. The EU ban is in contravention of WTO statutes but it is not likely to be removed easily due to the complex nature of the EU formation. It would require consent from the EU member countries to lift the ban and this has so far presented a huge challenge for the EU leadership. The ban has almost eliminated the US beef from the EU market yet apart from WTO statutes; the additional treaties between the two are not contravened in any way by the US’s beef production mechanisms (Josling, and Tangermann, 2003, p.66).
Another longstanding trade issue between the EU and the US is the EU’s preferential treatment of banana imports from some former colonies of its member states (Josling, and Tangermann, 2003, p.73). In this case, the EU limits importation of bananas from sources such as the US and gives priority to some fragile economies with which its member states still share ex-colonial links. The quota regime operated by the EU on bananas is in contravention of GATT and WTO provisions. The EU thus is gradually moving towards a WTO approved quota regime on bananas but this might severe some of the political ties it enjoys with the nations it had given preferential access to its banana market because in the face of world competition they might lose part or all their market shares in the EU.
The US income tax concession for foreign sales corporations has also been an issue of contention between the partners for a long time (Lamy, 2004, p.21). The EU perceives this tax regime as a subsidy that is aimed at artificially lowering the cost of the US exports in the affected areas and reported the issue to the GATT as early 1973 (Ahearn, 2006, p.73). Although the trade guiding body did its investigations and arrived at a conclusion, the US has always held that the tax regime did not constitute a subsidy. The WTO has taken time to carry out its investigation on the issue and came up with findings, which have compelled the US to agree to amend the tax regime. The EU still finds the proposed amendments unsatisfactory; this means that the contention is not likely to be concluded soon.
Another example of key disputes between the EU and the US is the Airbus subsidy dispute in which the US holds that the Airbus launch aid given by the EU amounts to an unfair subsidy which contravenes WTO Subsidies Agreement (Young, and Peterson, 2006, p.800). The EU for its part holds that the launch aid that was accorded to the Airbus aircraft was repayable and thus is not a subsidy. The EU also hits back at the US with a claim that it also subsidizes its aircraft production via cheap military contracts. This aspect is an implicit case of a clash of interests between the EU and the US since Boeing, an American aircraft almost enjoys a monopoly over the world market of large aircraft. The US seems determined to maintain this status quo when the EU on the other hand seeks to claim a share of this market through its Airbus craft. These are just a few of the cases of trade disputes that have been reported between the two partners but there are other issues.
Policy Related Conflicts
The EU and the US have endeavored to adopt policies in the past, which advance their relationship to higher levels. In most cases, the partners have struck a golden mean that enabled them to forge ahead harmoniously. However, in some instances, the partners have found themselves on a conflicting path as far as some policies are concerned. A prime example of the policies that have caused a lot of tension between the EU and the US is the Surveillance Policy adopted by the US in the wake of rising global insecurity caused by the ever-increasing terrorism threat, nuclear proliferation, and numerous security threats presented by the cyberspace (Pollack, 2010).
In the aftermath of the 9/11 terrorist attacks in the US, the US government started devising mechanisms of intercepting individual communication in the form of text messages, phone calls, and emails. This move was aimed at monitoring all forms of communication to unearth any terrorist schemes before any further terror attacks occurred. Initially, it was a welcome idea, and not long afterward, some of the EU member states such as the UK, Italy, and France followed suit in establishing similar mechanisms (Schimmelfenng, and Sedelmeier, 2004, p.670). In the recent past, the US has doubled its efforts insofar as surveillance is concerned and has been spying on practically the entire world. This was established when the US National Security Agency (NSA) data from its PRISM program was leaked to the public (Bowden, 2013, p.42). The PRISM program focuses on monitoring the activities of senior government officials across the world. The leakage of the information turned out to be a major scandal that threatened the diplomatic relations between the EU and the US.
EU officials perceive the US’s surveillance on their activities as a betrayal of trust between the partners. The EU Commissioner of Justice, Viviane Reding, asserted that if it is established beyond doubt that the US had been spying on EU member state government officials, then the ongoing negotiations on the establishment of the Transatlantic Free Trade Area (TAFTA) or Transatlantic Trade and Investment Partnership (TTIP) would be jeopardized (Bowden, 2013, p.45). At national levels, French and German officials were enraged at the claims and demanded an explanation from the US government. The conflict is in the process of resolution but the US’s image has been dented worldwide. The effect of this on world trade is that it could deny the world the EU-US free trade agreement, which has the potential of adding 119 billion Euros to the EU economy and 95 billion Euros to the US economy, which translates to over 200 billion Euros to the world economy (Cooper, 2011, p.5).
The relevance of this policy conflict to the trade models discussed in this dissertation stems from the idea that through surveillance, the US can access information about all activities of the EU and its member states. This means that information about the production of any goods of interest is accessible to the US. From this perspective, the US is capable of establishing if there is any scheme aimed at distorting the natural market dynamics through unfair subsidies, which would grant the EU states comparative advantage on some commodities.
Based on the provisions of international trade espoused by the WTO, trade between countries needs to be conducted transparently. This is often not the case since countries often approach trade agreements with hidden motives. The issue of privacy and confidentiality for sovereign states aggravates this because a trading partner can only disclose information concerning its internal affairs to a given extent. Logically, the surveillance policy would not be much of an issue if countries were not so much concerned with guarding their privacy. The reaction from the EU is natural and points to the idea that countries, even those in trade agreements, never disclose everything about their internal affairs during their trade negotiations. If the US were at the receiving end of this conflict, it would exhibit a similar reaction or even worse. The policy conflict thus reveals that the principles of trade models such as the standard trade model and the comparative advantage theory are not observed by many countries in bilateral trade arrangements. This partly explains why most trade agreements deviate from the predictions of trade and economic theorists.
A Highly Dynamic Economic Arena
The EU-US trade pact is currently the biggest across the world and by extension the most important because it accounts for about 50% of the world GDP. However, this scenario is rapidly changing with the emergence of fast-growing economies such as that of China, India, and Brazil among others. The influence of the EU-US relationship thus faces the threat of reduced global importance as evidenced by world trade statistics. About a decade ago, the EU and the US accounted for over 60% of world GDP (European Commission, 2013, p.18). China in particular is well on its path to be the world’s largest exporter and importer. Similarly, India is emerging as a world leader in technology and electronic services.
Coupled with these developments, the world’s demographic distribution is also shifting in favor of the Asian continent as projections indicate that by the year 2025, 50% of the world’s population will be of Asian origin (European Commission, 2013, p.19). Currently, China and India alone account for over a third of the world population, and the population growth rates in Asia are among the leading in the world. This means that within a short time the population of Asia could even surpass the projections of 50% by 2025. With the increase in competitiveness, productivity, and market size in Asia, the influence or further development of the EU-US relationship faces an uphill task.
Apart from the rapidly growing Asian economies, other countries such as Brazil, Argentina, and South Africa are striving to establish themselves as industrialized nations. This means that they are increasingly producing competitive products for the world market and are slowly claiming shares of the world market that were initially under the US or EU control. The deterioration of EU-US influence on global issues is seen in the fact that today the positions of Russia and China have to be sought on major global matters including trade (Balfour & Raik, 2013, p.59). This means that efforts to improve the trade relationship between the EU and the US need to be approached from a perspective, which will also consolidate their global economic importance.
Analysis
This chapter analyses the trade relationship between the EU and the US in the light of its development, current state, and possible future development. This goal is achieved by applying the theoretical trade models in Chapter two to the relationship to find out if the models can successfully predict its future development.
The EU-US trade relations in the light of the reviewed trade models
Trade, both in the domestic and international realms, is vital for the economic and social advancement of the world. All nations across the world appreciate this aspect and thus they have engaged in a plethora of activities to enhance their trading edge over other nations. The comparative advantage theory is a theoretical model advanced to explain specifically international trade.
The comparative advantage model holds that a country needs to have a comparative advantage over its trade partner in at least one commodity for the two to have a thriving trade relationship between them. This assertion is not entirely false for the EU-US trade relationship but it does not hold for all cases of trading activities between the two partners. The EU and the US are approximately at par in economic and social development thus their trade is conducted on an equal-partners basis. Both partners are industrialized and focus on technology-intensive production so that trade between them is subject to technology-intensive products such as computers, vehicles, and aircraft among others. Trade-in hi-tech services also thrive between the two especially because the two partners have elaborate financial policies and systems, which support their trading activities without any difficulty (Cooper, 2011, p.8).
Trade between the EU and the US is thus majorly driven by the desire to provide the consumers on both ends of the Atlantic with variety to cater to every individual’s tastes and preferences. With or without considerable comparative advantage, products from the EU find a market in the US not because there is a lack but because the American consumer is fully aware of everything that is available and makes an informed choice of what they want. Similarly, in the EU, consumers are not restricted to domestically produced or EU produced commodities but have the luxury of choosing what exactly meets their expectations. Every partner thus strives to ensure that its consumers maximize utility by placing a variety of goods at their disposal (Edwards, and Lawrence, 2010, p.13).
Superficially, this approach to trade is a total departure from the doctrine of the comparative advantage model because according to the model, international trade cannot occur without comparative advantage. The EU-US trade relationship has refuted this assertion because the two regions trade in similar goods and services yet business between them is thriving. However, careful consideration of the trade relationship reveals that elements of comparative advantage are still applicable to it. A consumer settles for a given product because of the conviction that the particular product will provide them with better utility in comparison to the numerous similar products they forego. Whether this kind of conviction is inspired by advertising, recommendations by other consumers or practical experience gained by testing several products before finally settling for one is not important, what is important is that eventually, a particular product has been purchased and another left. This, from the perspective of the consumer, amounts to the purchased product having a comparative advantage over the foregone product. Though they serve the same purpose, the consumer feels that their choice can serve the purpose better.
Trade between the EU and the US mainly involves technology-intensive products and services (Cooper, 2011, p.10). Examples of such goods include computers, motor vehicles, cell phones, aircraft, and military technology among many others. Cooper (2011, p.13) notes that the EU and the US are among the most socio-economically and technologically advanced regions in the world. Both partners produce all of these commodities. Despite this being the case, the commodities are exported and imported on both sides of the Atlantic. This state of affairs shows explicitly that this trade relationship is underpinned by the diverse and increasingly sophisticated nature of consumer demands. The quality is in some instances real and in others, only perceived but even so; trade between the two partners is thriving.
From this perspective, the comparative advantage model applies to the EU-US relationship. It can therefore explain why trade between the EU-US has been sustainable and has kept growing over the years and as can be seen from the current volumes of trade between the two, trade between them has led to a win-win situation. This element is in agreement with the conclusion of Ricardo that if countries follow the doctrine of comparative advantage then the result is a win-win situation for the trading partners.
Trade can successfully be conducted between two countries without necessarily following the doctrines of the trade and economy and still end up with the results that the theorists predicted. This aspect of trade concurs with the assertion made by Suranovic (2010) that trade does not always follow the patterns outlined by trade theories and models. The models only try to predict the possible patterns that trade would follow under certain conditions, which are often outlined in the theoretical models in form of assumptions. In most cases, however, the assumptions turn out to be realistic as was the case with both the comparative advantage theory and the standard trade model.
In light of the standard trade model, the EU-US relationship can be linked to the fundamental relationships that underpin the model. These include the production possibility-relative supply relationship, prices-demand relationship, and terms of a trade-welfare relationship. The relationship between production possibility and relative supply is one whose relevance to international trade stems from the idea that different countries are often endowed with varying levels of resource abundance. This means that although two entities such as the EU and the US may have different or similar resources, each of them will have them at differing levels. It then follows that a country tends to produce more of the commodity whose resource it has in abundance.
Since technology-intensive products dominate trade between the EU and the US, it follows that both partners are endowed with massive intellectual capital since their populations are among the most educated in the world and their levels of technological advancement are among the highest in the world (Cooper, 2011, p.14). This means that the two partners are more or less equally endowed in this area of production. Despite this state of affairs, the two continue to trade well. It can be tentatively assumed that the two are equally endowed in terms of technology and capital yet they trade and in incremental terms periodically. This pattern is not fully captured by this principle of the standard trade model.
The relationship between demand and supply as elaborated in the standard trade model cannot be used to explain any aspect of the trade relationship between the EU and the US adequately because the demand-supply relationship in the model assumes that there is a single individual whose tastes and preferences are used to represent tastes and preferences of a country’s consumers. This does not fit in with the trade relationship in question because the essence of the trade between the EU and the US is the diversity and sophistication of consumer tastes and preferences. This aspect means that taking all the tastes and preferences of the US and the EU consumers to be represented by a single individual’s tastes and preferences in each case could lead to no trade between the two partners. This makes the second principle of the standard trade theory also inapplicable to the EU-US relationship.
The standard trade model thus does not capture the spirit of the trade relationship between the EU and the US adequately and cannot be effectively used to analyze the trade relationship. This confirms the position of the critics of the standard trade model that its assumptions are unrealistic and cannot allow it to draw meaningful conclusions or make any reliable predictions. The idea of import and export biased growth is difficult to pinpoint in the trade relationship between the EU and the US because both partners have technology-intensive industries. They therefore import and export similar goods and services but they still benefit from thriving trade. Export or import biased trade would be possible if US exports to the EU were different from EU exports to the US. This way, one of the countries would benefit from better terms of trade if the flow of international trade favored its export commodity. Thus, the fundamental relationships that are termed as the underpinning principles of the standard trade model are all refuted by the EU-US trade relationship.
The trade relationship between the EU and the US is a complex one that does not follow the conventional patterns that have been outlined by existing trade models such as the comparative advantage model and the standard trade model. It calls for a model that focuses on consumer tastes and preferences to explain international trade due to the increasingly sophisticated nature of consumer tastes and preferences. In the face of globalization, consumer tastes and preferences are gradually taking center stage as a key driver of trade. This pattern of trade should be espoused because it enhances the welfare of consumers through the maximization of utility in the world market. The availability of numerous brands of a particular product allows a consumer to settle for the best quality. Producers are also encouraged to heighten the quality of their commodities for them to compete favorably on the global market. The EU-US trade relationship could be a trendsetter for the future of trade relationships and thus close attention should be paid to developments around it.
Pertinent Issues in the EU-US Relationship
The US moved from being an openly protectionist economy to become an ardent advocate for the liberalization of trade within the first half of the 20th century. This has been its position since then. In its endeavors to facilitate the liberalization of global trade, the path has been long and still leads on. It inspired the formation of the EU and supported its development amid threats from Eastern Europe. A close consideration of the development of the trade relationship between the EU and the US points to the idea that the US envisaged the potential benefits of the trade relationship before it even started.
In comparison to economic blocs such as the EU, NAFTA, and many others, the EU-US trade relationship is relatively new insofar as its formalization date is concerned. However, within the two decades of its existence, it has grown to be the world’s largest such arrangement. This aspect is partly attributable to the size of the economies of the two partners but credit must also be given to the two for the spirited efforts they have made to ensure that the relationship endures despite challenges in its development.
Challenges have been encountered in the trade relationship mostly because the EU member countries are wary of genetically enhanced products for instance the hormone-produced beef which has caused a longstanding contention between the two (Josling, and Tangermann, 2003, p.77). Several other conflicts have been witnessed between the EU and the US for instance the banana dispute, which has also protracted just like the beef issue (Ahearn, 2006, p.88). A relatively recent dispute was that of the Airbus subsidies which sparked a war of words between the two (Bhagwati, 2008, p.146). Despite these disputes, only between 1% and 2% of trade between the EU and the US is negatively affected (Ahearn, 2006, p.95). This aspect is an indicator that this trade relationship has grown to an advanced level of maturity.
Challenges such as policy disputes which come about when one partner chooses to pursue a policy path that is not in the interest of the other partner have also been witnessed between the EU and the US in their trading relationship. The most illustrious of these is the Security Surveillance policy, which was adopted in the aftermath of the 9/11/2001 terrorist attacks in the US (Cooper, 2011, p.6). Although some European countries such as Britain and Italy also enacted similar legislation not long afterward, the recent PRISM scandal has caused a lot of friction between the EU and the US (Cooper, 2011, p.5). This friction stems from the extent and focus of the US surveillance has gone overboard because initially, the surveillance initiative was aimed at screening international communication into or out of the US (Erwin, and Liu, 2013, p.7). However, as time has gone by, the US in its efforts to tighten its security even further enacted the Patriotic Act which gave the government to spy on every US citizen and even secretly spy on world leaders’ activities (Bowden, 2013, p.58). The move started as a well-intentioned initiative but getting to the extent of spying on world leaders, especially EU officials who were involved in the important negotiations to move the EU-US relationship further into a free trade area was rightly overboard as noted by the EU Commissioner of Justice (Bowden, 2013, p.52).
The EU is still in the process of determining the credibility of the claims that the US was spying on its officials but the damage is already done and the talks over the TTIP stand jeopardized if it is determined that the claims were true and the US lacks a proper explanation to give (Bowden, 2013, p.36). Such is the extent of damage that policy disputes between the two partners can cause. This means that despite the strength of the ties, it is also as fragile as many other such arrangements worldwide. The partners thus need to stay committed to the guiding principles and always make choices, which will ensure that the relationship is strengthened. This assertion holds, as the world is dynamic and is subject to numerous changes some of which cannot be envisaged by anyone beforehand. Such changes although they affect the world economy shifting economic influence from some nations to others can be considered external because they do not directly affect relationships such as the one between the EU and the US. Just as the two have struggled amid the changes all over the world, where China, India, and other emerging economies are taking over the global economy, but they keep on trying to make their relationship better by strengthening it. The relationship can weather numerous other challenges it faces or will face if the partners stay committed and good-willed.
Policy Implications for the EU-US Trade Relationship
Both trade and investment statistics indicate a strong bilateral economic partnership between the EU and the US, which is likely to grow in the future. The growth may stem from further technological advancement and enlargement of the EU. Some European countries are yet to become members of the EU. The implication this state of affairs has on the EU-US relationship is that it has the potential to grow bigger. Its further growth as already noted is beneficial to both sides and the rest of the world.
What needs to be clear to all parties involved is that as economic integration progresses, involved economies become interdependent, and apart from bringing numerous benefits, this interdependence comes with its share of challenges for the contracting partners. The aforementioned disputes between the EU and the US are examples of policy-related conflicts. The most outstanding, however, is.
The EU and the US have several outstanding trade disputes like the aforementioned Airbus dispute and the EU ban on hormone-enhanced beef products from the US and the EU’s banana policy are among the contentious disputes that have been witnessed between these two partners. This contention has lasted years yet the volume of trade that agricultural products account for in the trade between the EU and the US is small. In the year 2012, trade in agricultural products accounted for slightly above 3% of total trade between the two, for both partners (European Commission, 2013). This percentage makes it easily ignorable yet, on the contrary, agricultural products have caused a lot of friction between the two partners. This begins to point to the idea that the disputes were more politically motivated rather than economically motivated. If the economic weight of the disputes was anything to go by, they would not have received the attention they received at the official level and from the press (Brummer, 2007).
These disputes are good examples for policymakers on both sides to consider keenly when formulating policies. Any policy that touches the other partner in any way often leads to friction between partners even if it was not directly intended to affect the partner. For instance, the US economic sanctions against countries such as Cuba and Iran were not intended to affect the EU but the sanctions were a source of friction between the two partners because they indirectly affected some EU member states, which had economic interests in the said countries (Sapir, 2007). That the policymakers on both sides face an uphill task in formulating policies, which cause minimal friction, is obvious. Nonetheless, they still have to seek avenues of ensuring that their policies are friendly to each other even if it calls for cooperation between policymakers from both sides.
It is known to both partners that the conflicts over the banana and hormone enhanced beef products were inspired by inconsiderate policies but despite being aware of the same, the US went ahead and devised a surveillance policy, which allows it to spy on other countries’ top officials (Cooper, 2011). The leakage of information concerning this surveillance sparked tension between the partners and threatens to jeopardize the talks intended at strengthening the relationship between the two. This move by the US is to a given extent an indicator that the partners have remained adamant on their approaches to handling their national issues, which have the potential of affecting the trade ties between them. This begins to paint a picture of a lack of goodwill on pertinent issues, which would lead to a dispute-free trade relationship.
Conclusion and Recommendations
Conclusion
The study set out to analyze the trade relationship between the EU and the US. This was to be achieved through exploring the policy framework that gives life to the relationship and the challenges it faces as new developments such as globalization sweep across the world. The analysis was necessitated by the desire to understand the dynamics that underlie this relationship at this time when other similar arrangements face challenges, which threaten to bring them down.
The EU-US trade relationship is an intriguing one not only due to its enormity and importance to the global economy but also due to its resilient nature. While similar arrangements such as the bilateral ties between the EU and China do not show any indications of deeper integration shortly, the EU-US trade relationship is already in the process of advancing to deeper levels of integration in which it seeks to advance from a preferential trade arrangement to free trade arrangement. While this may cause one to think that the trade arrangement does not face any challenges, it faces challenges such as the protracted banana and beef import disputes in which the US faulted the EU over the handling of its banana and beef exports.
As revealed by trade statistics, the trade relationship between the US and the EU, though on a gradual decline in terms of its importance to the global economy, still stands out as the leading economic partnership in the world. This position is not likely to change soon because the contracting partners are on a mission to expand the relationship even further. The trade disputes that have been registered in this trade relationship are not of any substantial economic significance because, despite their publicity, the beef and banana disputes affected less than 2% of the total trade carried out between the partners.
Despite such disputes, the partners seem to understand their global economic standings and strive to act with modesty to ensure that their disputes do not escalate into global economic crises. In this respect, it becomes apparent that the trade relationship between the EU and the US is rightly positioned, considering the ongoing further integration talks, to continue providing the global economy with the tenacity it requires to accommodate the ever-rising pressure from population growth, needs for better infrastructure and improvement of socio-economic conditions of citizens of the developing world. The contracting partners’ determination to continue trading is encouraging. Challenges are inherent in every human endeavor and should be perceived as opportunities that provide room for improvement. The trading partners seem to be awake to this reality because as years go by they seek to establish a commensurate economic policy framework to govern international trade between them. The reported trade disputes between them, except the Airbus subsidy dispute, are relatively old and have been which the concerned partners have sought to address over the years and shall be brought to amicable conclusions.
The trade relationship still has the potential to expand because the EU is still growing and besides, with its transformation into a free trade arrangement, there are possibilities of incorporating other North American countries such as Canada and Mexico. As it is, the trade relationship between the US and the EU is a trade arrangement that is performing above average and has the potential to perform much better if nothing major changes its trends negatively because it is an engagement of peers. The obstacles it has encountered are not adequate to jeopardize its development. As it is, the trade partnership between the US and the EU is good but it will be better if strengthened further because this way, it will continue benefiting the contracting partners and the global economy beyond the current levels. Thus, such a move should be supported by every potential beneficiary, which includes the entire world because the global economy stands to continue benefiting from the improvement of the EU-US trade relationship as long as it continues to exist. It is a great asset rather than a liability first to the contracting partners and by extension to the global economy.
Recommendations
The EU-US trade relationship has emerged as unique among its peers. However, it is not isolated from the challenges they face thus it has faced numerous challenges. Despite all these challenges, the relationship remains as important as ever to the world economy and should be nurtured and strengthened further. The study thus makes the following recommendations, which have the potential of sustaining and strengthening the relationship for posterity.
- The trade relationship between the EU and the US is beneficial to the contracting partners and the global economy at large. Even so, going by the disputes that have transpired in the course of its existence, the success or failure of the trade relationship depends on the conduct of the contracting partners to each other. With the ever-increasing rate of globalization, the integration will be inevitable if the two nations want to remain relevant in today’s competitive global economy. Given that the EU and the United States are amongst the major world economies, if this integration is realized, the two partners’ economies and the global economy will receive a major boost. In this respect, the contracting partners need to expedite the talks. Both partners should desist from stalling the process under whatever excuses because this further integration will be an explicit indicator that the EU-US trade relationship has the potential to grow.
- About the hormone enhanced beef products dispute, the EU failed to emerge as the umbrella body that it purports to be. Despite it having nothing specific against the beef products from the US, the EU was not able to compel its member states to allow the US beef exports into their markets. This shows that although it acts as an umbrella body, there are issues over which it has no control over its members. In this respect, the EU member states need to reconsider their positions insofar as the surrender of aspects of their sovereignty to the EU is concerned. It is selfish for them to enjoy the benefits of the EU arrangement yet refuse to be bound by some of the decisions that the EU makes. For the future EU activities to run smoothly, its member states have to be prepared to abide by its decisions whether they are affected positively or negatively.
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