Coalition or Collision?

The Past and Future of Transatlantic Trade Relations

By
10,000 Shipping Containers Lost At Sea Each Year
Coalition or Collision? : The Past and Future of Transatlantic Trade Relations - Claudia Decker and Stormy Mildner

Abstract

This article deals with transatlantic trade relations and analyses the question of whether or not the US-EU economic partnership has become substantially damaged in recent years. First, the authors differentiate between traditional trade disputes (Airbus/Boeing and the Byrd Amendment) and systemic trade disputes (GMOs and FSCs), before identifying the main political and economic causes for conflicts. Based on the analysis of four major trade disputes, the authors then come to the conclusion that the transatlantic economic partnership is still strong, while it currently also faces serious challenges which should not be underestimated. Therefore, they demand that the EU and the US intensify their efforts for conflict prevention and resolution and strengthening of the transatlantic institutional framework.

Introduction

Steel, Genetically Modified Organisms (GMOs), Foreign Sales Corporations (FSCs), Airbus/Boeing - the list of recent and historic transatlantic trade conflicts is long. In 2004, the European Union (EU) listed twenty-seven transatlantic trade disputes which were registered at the World Trade Organization (WTO): nineteen cases were launched by the EU against the United States (US), while in eight cases the US filed complaint against the EU.' Does this mean, however, that US-EU trade relations have become substantially damaged and that we are heading towards a dark age of transatlantic trade friction? This is hardly the case, since only two percent of bilateral trade flows are affected by conflicts. Despite many doomsayers, the transatlantic partnership still rests on a solid foundation, including common interests and ideologies in the economic and political spheres as well as a general overarching consensus about the structure of the international economic architecture such as the WTO.

As the past fifty years of transatlantic trade relations have shown, trade conflicts are nothing new and, therefore, not a sure sign of deeply-disrupted economic relations. Thus, there have always been ups and downs in transatlantic trade relations - some periods being more conflictual than others. For example, trade frictions grew noticeably in the 1960s with increasing trading ties as well is the rise of the EU as economic power and competitor. Another sharp increase in the number of trade conflicts and the volume of General Agreement on Tariffs and Trade (GATT) litigation took place in the early 1980s, caused mainly by the economic downturn in Europe and the US recession together with a strong appreciation of the dollar and an increasing current account deficit.2 Contrary to today, however, most of these disputes were handled without excessive political rancor. Thus, being aware that trade conflicts could easily spill into other policy areas and jeopardize the stable political partnership which was so essential during the Cold War era, both sides restrained from "tit-for-tat" retaliation.

But this has changed substantially with the end of the old bipolar order and the emergence of an increasingly multipolar economic world and growing global competition. Thus, the last decade has witnessed some worrisome developments which make the transatlantic partnership less clear and predictable than in the past: the number of trade disputes has risen, several conflicts are insoluble or at least difficult to overcome, and the political impact of big ticket trade conflicts such as the Airbus-Boeing case has increased. In addition, retaliatory "tit-for-tat" tactics are given more room within trade negotiations. In recent years, bilateral economic relations are further stressed by growing mutual disrespect and disagreement in foreign and security policy. Particularly before the Iraq War, the EU and US seemed to have fallen into hostile camps, reinforced by a growing resentment of Europe in the US and an upsurge of anti-Americanism (or rather anti-Bushism) in Europe.3

Consequently, while the transatlantic partnership is still strong, it currently faces some serious challenges which should not be underestimated. What's more, an escalation of economically explosive trade conflicts does not ·only disrupt bilateral economic but also political relations. Therefore, each individual trade conflict has to be taken very seriously.

Causes for Conflict

Trade conflicts can be divided into three categories: market access, industrial policy, and ideology-based disputes. The first category includes US complaints about EU labeling requirements for wine as well as EU complaints about US safeguard duties for steel or the Byrd Amendment. Industrial policy cases evolve around government support of national industries; prominent examples include agricultural support, aircraft subsidies, and US FSCs. Lastly, the ideology-based category is comprised of US complaints about EU hormone or GMOs regimes and EU complaints regarding US sanctions on Cuba or Iran.4 Another way to categorize trade disputes is by differentiating between so-called traditional and systemic conflicts: traditional conflicts evolve around the protection or unfair support of national industries through "at-the-border" protection, such as tariffs, quotas, or subsidies in sectors like steel or agriculture; systemic disputes result from different national regulatory systems and preferences, such as those regarding GMOs or FSCs. While traditional conflicts are relatively easy to solve, ideologically ­based systemic disputes are more difficult to address.

What are the causes for these transatlantic trade conflicts? The high degree of economic interdependence is the most important factor in all trade disputes. Thus, conflict comes with closeness: the EU and the US are each other's most important economic partners. In 2003, around twenty-six percent of total EU exports went to the US while seventeen percent of total EU imports came from the US. The bilateral investment relationship is even more significant: both are by far each other's most significant source and destination for foreign direct investment (FDI). From 1998 to 2001, about fifty-two percent of EU FDI outflows went to the US, while more than sixty-one percent of all EU FDI inflows originated in the US.

In 2003, almost sixty-five percent of total US FDI went to the EU. Given this close economic integration, frequent trade tensions are not very surprising. Additionally, dispute resolution has become increasingly difficult in recent years since the US and EU are of roughly the same economic strength, so neither side can force the other to make concessions.5

The second cause of conflict results from increased trade liberalization, which leads to growing competition, especially in labor-intensive sectors (e.g., steel and textiles), so that countries continuously resort to the use of escape clauses and antidumping duties. Thus, the US is one of the world's leading users of "old-style" safeguard or escape clause measures, the steel safeguard duties in 2001 being one example. The antidumping instrument has been used frequently as a means of hidden protectionism by both trading partners.

Third, trade liberalization - especially the reduction of non-tariff barriers (NTBs) - has increasingly touched upon national regulatory issues, such as tax systems, health considerations, and animal/plant welfare, which are all politically sensitive issues because they affect consumer attitudes. Since different national preferences, values, and judicial systems collide with each other, the potential for conflict is particularly high. Above all, differing approaches to new technologies and industries are at the heart of a growing number of disputes: while the US trusts the self-regulatory power of the market, introducing new rules only when conflicts arise, the EU proactively tries to prevent potential problems before they arise. The lack of trust in each other's intentions and preferences further increases the potential for conflicts between the US and the EU: while the EU justifies the import restrictions on GMOs or hormone-treated beef with health considerations, the US suspects hidden protectionism of the EU agricultural sector.

Fourth, the politicization of trade since the early 1990s - particularly the conclusion of the North American Free Trade Agreement (NAFTA) - has increased the potential for conflict considerably. Thus, the public has become more aware of trade issues, and an ever-increasing number of interest groups such as environmental non-governmental organizations (NGOs) or trade unions try to influence national policy making. Since domestic policy calculus is gaining importance and trade negotiators can hardly depart from their original positions under the close scrutiny of civil society, there is little room for trade-offs and compromises, and trade conflicts can escalate more easily.

Fifth, the WTO dispute settlement body (DSB) has also contributed to the mounting number of unresolved trade conflicts. The DSB constitutes a substantial improvement in comparison to the former GAIT mechanism by treating cases on a more legalistic basis. However, it has its flaws: WTO investigations and dispute settlement procedures are requested more quickly than ever before, leading to a sharp rise in the total number of proceedings. Additionally, the rigid dispute settlement process often does not lead to a faster or more efficient resolution of problems - in particular when there are no WTO rules or precedents in some areas.

The danger of these insoluble and long-lasting trade disputes lies in a spiraling "tit-for-tat" dynamic: in order to increase its leverage in an existing trade conflict, a country initiates a new trade complaint in an unrelated area as a bargaining chip. This can tum a rather-marginal trade dispute into a serious "trade war": after the US brought a WTO case against the European banana regime and the import ban on hormone treated beef, the EU filed suit against US FSCs and the use of the escape clause on steel imports; the US retaliated by taking legal action against the restrictive European approval system of GM Os. Thus, while there has been an increasing judicial activism of both trading partners, their willingness to comply with the panel rulings has decreased.

Traditional Trade Conflicts

AIRBUS/BOEING

One of the most prominent US-EU disputes in the category of traditional, industrial policy conflicts is the Airbus/Boeing case. As with many other conflicts, this dispute is not a new one but originated in the 1970s when both trading partners were involved in several rounds of negotiations to reduce subsidies for large civil aircrafts. In the late 1980s, with Airbus becoming a serious competitor for Boeing, the US and EU started to view a bilateral agreement as indispensable. As a consequence, they decided to reduce and eventually eliminate aircraft subsidies within the "US-EU Agreement on Large Civil Aircraft" (1992). This agreement banned future production support; as a trade-off, the EU received an exception for already-disbursed subsidies, as well as for previously granted support for future programs (dubbed a "grandfathering right"). Furthermore, the share of government support for the development of new aircraft programs was limited to thirty-three percent of the program's total development costs. These credits, which were granted below the market rate, had to be paid back within seventeen years. Additionally, the ceiling for indirect subsidies was set at a maximum of three percent of the annual total revenue of the industry. Thus, both sides were allowed to subsidize their aviation industry within certain limits. At the same time, they abstained from filing disputes concerning aircrafts at the GATI/WTO.

In late 2000, Airbus announced that it had formally launched a program to construct the new Airbus A380, the world's largest commercial passenger aircraft, reinvigorating the aviation conflict. In the following years - in particular as Airbus reached competitive parity with Boeing in the global market place - the bilateral agreement was regarded with growing concern. Talks for revising the agreement started to intensify in early 2004 at the same time as speculations surfaced on subsidies for a new Airbus plane, the A350, which would compete with the planned Boeing 7E7. In May, United States Trade Representative (USTR) Robert Zoellick met with the European Commissioner for Trade Pascal Lamy, proposing a new bilateral accord to eliminate and eventually phase out total subsidies for aircraft producers. The EU, however, stayed uncommitted. In August 2004, the conflict gained momentum when President Bush openly declared Airbus subsidies as unfair, asking Zoellick to take all measures to put an end to them - even if this included a WTO complaint.

While both sides attempted to find a compromise, the talks failed, leading the US to terminate the 1992 Agreement in September 2004. Since the dispute quickly hit the front pages of newspapers worldwide - also becoming a campaign ­issue that was named often in the same context as the labor market question - the US filed a WTO complaint against the EU in October 2004. According to Boeing, Airbus had received subsidies in the form of grants, debt forgiveness, and infrastructure support, seriously distorting the large civil aircraft market. In particular, the US criticized the fifteen billion dollar launch aid that the EU provided, since it shifted the commercial risk of airplane development from Airbus to EU governments. Zoellick further argued that Airbus subsidies were not justified as support to an "infant industry" anymore: Airbus had gained a market share of over fifty percent oflarge commercial aircraft sales and a sixty percent share of the global order book.

Contrary to this, the EU does not view Airbus support as subsidies but rather as loans, claiming that Boeing had received significantly more support than Airbus through indirect subsidies, amounting to twenty-three billion dollars since 1992; financial support for research and development had also been channeled to Boeing through NASA as well as the Departments of Defense and Commerce. Lamy especially criticized subsidies for the Boeing-project 7E7: for example, the state of Washington had offered a tax cut of approximately 3.2 billion dollars to Boeing to ensure that the final assembly of the company's airplanes would take place there. These state tax reductions could be viewed as equivalent to Airbus' launch aid. Therefore, the EU filed its own complaint with the WTO.6

With the reciprocal complaint at the WTO, the US-EU aviation trade dispute threatened to escalate. Particularly due to the economic importance of the aviation industry, its political and strategic nature, as well as conceptual differences on how to compare aircraft subsidies, the Airbus/Boeing conflict posed the danger of seriously burdening the WTO and straining transatlantic relations. Recognizing this, the EU and the US reached an agreement on the terms for negotiations to solve the dispute in January 2005. The goal of these negotiations is to phase out all types of aircraft subsidies. In return, the parties have agreed not to request a WTO panel.

BYRD AMENDMENT

The "Continued Dumping and Subsidy Offset Act of 2000," informally known as the Byrd Amendment, constitutes a relatively new trade conflict in the area of industrial policy. It provides that antidumping duties collected by the US government must be passed on to the companies that successfully petition for relief from dumped foreign imports. These offset-payments are to cover certain expenses incurred after the imposition of antidumping and countervailing duties. In the years 2001 and 2002, duties, amounting to 230 million dollars and over 300 million dollars respectively, where channeled to US companies. In most cases, the recipients were steel and other metal producers.7

Consequently, the EU filed complaint, together with eight WTO-Members - including Brazil, India, and Japan - against the Byrd Amendment in December 2000; six other states joined the complaint as third country-complainants, including Argentina and China. After unsuccessful consultations, a dispute settlement panel was established in mid-2001. In September 2002, the WTO panel ruled that the Byrd Amendment is incompatible with WTO rules, since it constitutes an illegal response to dumping and subsidization, providing an additional remedy to US companies and giving them an unfair competitive advantage. The WTO also criticized the fact that the payments created an incentive for companies to file and support petitions for off-set payments.

After the WTO Appellate Body had declared the Byrd Amendment once again as WTO-inconsistent in January 2003, a deadline was set for December 2003 by which the US was to bring the Amendment into WTO conformity. When this deadline expired without serious attempts in Congress to adjust the Amendment, the WTO gave a green light to the EU and other arbitrators to impose punitive duties on US products in August 2004. The level of these additional duties varies each year in accordance with the amount of disbursement made to US producers under the Byrd Amendment during the previous year.

Despite calls by the US administration to repeal the law as well as several proposals in the Senate, the US Congress has not yet implemented the WTO ruling. Thus, a majority in Congress - Representatives and Senators from both parties - expressed its continuous support for the Byrd Amendment. Consequently, the EU filed a list of seventy-eight potential product groups with the WTO, asking for authorization to implement punitive duties on them. Since chances that Congress will abolishment the Byrd Amendment or pass significant changes soon are relatively low, a solution to this dispute is not yet in sight.

Systemic Trade Conflicts

GMOs

Worldwide, trade conflicts over food security are increasing due to differing national preferences for and regulations concerning consumer and health protection. Ideological differences also l(e at the heart of the GMO dispute.

Simultaneously, substantial economic interests are at stake: the US is, by far, the main global producer of genetically modified crops; today around seventy-five percent of soybeans and cotton as well as thirty-five percent of corn contain GMOs. Through the European import ban, the US loses access to a large and important export market. In addition, the US fears that other countries will follow the European example, establishing restrictive rules and import bans for, GMOs. Zambia, for example, refused 26,000 tons of US food aid in October 2002 because it contained genetically modified corn.

Since April 1990, the EU approval process for biologically modified agricultural products has been regulated by Directive 90/220/EC. On this basis, the EU authorized the import of nine products/plants in the following years. However; Austria prohibited an already-approved corn variety in February 1997 due to health and environmental concerns, leading to a series of import bans by other EU members on approved products. In the same year (1997), the EU adopted the "Novel Food Regulation" (EC) 258/9 7, which set out rules for the authorization and labeling of genetically engineered foods. The conflict intensified when the European Commission stopped approving any kind of bio-engineered agricultural crops in 1998, constituting a de facto moratorium.

In October 2002, Directive 2001/18/EC came into force, establishing a new legal framework for labeling genetically modified products. Nevertheless, the EU decided not to approve any new GMO varieties until detailed regulations for labeling and traceability were in place. In July 2003, the European Parliament tightened the threshold for labeling food or animal feed, containing more than 0.9 percent GMO s, even further. Additionally, the new rules required that GMOs had to be traced "from the farm to the fork." The US severely criticized these new rules as an unfair NTB since they discouraged consumers by implying non-existing health risks.

Finally, the US filed complaint with the WTO against the EU's de facto moratorium and requested consultations in May 2003. In response, the European Commission started negotiations on the import of a variety of genetically modified sweet corn in November 2003. When the vote in the European Council led to a stalemate, the decision was passed on to the European Commission, which approved the sweet corn in May 2004. This corn variety has to be commercialized in accordance with the new rules on labeling and traceability. However, the final WTO ruling on the European approval and labeling system is still pending. A possible solution to the conflict lies in the non-discriminatory labeling of genetically modified products. As such, the import ban could be lifted and European consumers would be free to decide for or against genetically modified foods.8

FSCs

Another systemic conflict which has put a severe strain on the transatlantic relationship for years, is the industrial policy dispute about export-related tax benefits for US companies. These tax reductions were initially designed to countervail the basic differences between US and European tax systems: most European states follow a territorial system, where only the income earned at home is taxed. Additionally, exports are exempted from value-added tax, which is imposed on domestic sales. In contrast, the US uses a worldwide system of taxation, under which income is taxed regardless of where it was earned.

Following this system, American subsidiaries are first taxed according to the laws of the country where the income is earned. When dividends from a foreign subsidiary are repatriated to the US, they are additionally taxed according to US laws. Thus, income earned from foreign sources is taxed twice. Although companies receive a foreign tax credit for taxes paid on foreign-source income and various international tax agreements have been signed to prevent this kind of double taxation, certain types of foreign-source income are still taxed under Subpart F rules (1962) of the US Internal Revenue Code - even if the US parent company does not repatriate those profits.

Subpart F rules, which initially were meant to eliminate the deferral for foreign-based company income earned in tax havens, put us exporters at a clear competitive disadvantage. Therefore, the US established so-called Domestic International Sales Corporations (DISCs) in the early 1970s, a tax break for US export earnings. After various countries had filed complaints with the GAIT -among them the EU -a GATT panel declared the DISCs illegal export subsidies in 1981. As a consequence, the US changed its tax law, creating the Foreign Sales Corporations (FSCs) in 1984, which also constitute an exemption from Subpart F rules. FSCs are US corporate entities in foreign jurisdictions, handling the foreign sales of their parent companies. On average, a company could exempt fifteen to thirty percent of its export earnings from taxation under this rule. Boeing alone received more than 1.6 billion dollars over the period 1992 to 2003.9

After the EU had again filed complaint with the WTO and consultations had failed, a WTO panel was established in July 1998; in 1999, the WTO ruled that FSCs also constituted an illegal export subsidy. When the WTO's Appellate Body upheld this initial finding, the US Congress passed the "FSC Repeal and Extraterritorial Income Exclusion Act" (ETI Act) in November 2000. While the legislation formally abolished FSCs, new regulations were implemented, which included similar tax privileges.

Once again, the EU asked for a WTO investigation, questioning the WTO compatibility of the ETI. In January 2002, the WTO declared the legislation WTO ­inconsistent. When the US made no serious attempts to change ETI until May 2003, the EU set an implementation deadline of fall 2003, which was later extended to March 2004. 10 Simultaneously, the WTO endorsed the EU request for punitive duties worth four billion dollars.

At this time, both Houses of Congress passed bills to repeal the FSC/ETI provisions. However, when Congress seemed unable to resolve existing differences, the EU imposed retaliatory tariffs on a range of US goods starting at a rate of five percent in March 2004, which was to rise by one percent every month, up to a seventeen percent level to be reached in March 2005. The situation improved when both bills were passed by the Senate and House of Representatives in May and June 2004 respectively. Finally, a joint bill was passed by both houses of Congress in mid-October, which President Bush signed shortly after; the changes became effective on January 1, 2005. The new bill repealed the export tax breaks of the FSC/ETI system and partially reformed the US corporate tax law by closing existing tax loopholes as well as granting tax reductions across the board to all US manufacturers.

In October 2004, the EU Commission correspondingly announced the suspension of its sanctions, effective January 1, 2005. However, the EU remained doubtful that all provisions fully complied With the WTO panel decision of 2002 and decided to file a new complaint with the WTO. In particular, the EU criticized the two-year transition period during which US exporters still receive FSC/ETI advantages. Lifting European sanctions clearly led to the mitigation of one of the most severe transatlantic trade conflicts. However, the final conclusion of this conflict depends on the WTO-compatibility of the new law developments in other conflicts such as the Airbus/Boeing case.11

Conclusion: Coalition of Collision in Future Transatlantic Relations?

Will the Atlantic widen? There is little evidence that current disputes will dramatically disrupt the transatlantic relationship or fundamentally hinder further economic and political cooperation. Both trading partners still support multilateral, as well as transatlantic, norms and institutions and have worked hard to overcome recent disagreements: examples for this are the removal of the steel duties by Bush in late 2003 as well as progress within the FSC and Airbus/Boeing disputes.

Furthermore, Bush will continue to foster multilateral and transatlantic trade liberalization. Here, his success clearly depends on the "Trade Promotion Authority," which will expire on June 30, 2005. However, his chances for an extension are considerably better than in 2002 since the Republicans gained seats in both houses of Congress. Furthermore, the present depreciation of the dollar against the euro, clearly favoring US exporters, might also dampen protectionist sentiments in the US Congress.

Nevertheless, these positive developments are no reason for complacency. While some trade conflicts have been solved, there are many unresolved trade ­related issues, many of which have broader political implications. Furthermore, both trading partners continuously resort to protectionist measures, also forming more and more bilateral and regional trade agreements. Moreover, regarding the ever-growing US trade deficit, Bush will increasingly push for additional market access abroad for goods and services, which is likely to increase conflict potential even further.

Thus, several dangers reside in current trade disputes, touching all levels of cooperation:

NATIONAL CHALLENGES

On the national level, the growing number of unresolved trade conflicts can weaken the position of the pro-free trade forces among the population, industry, and policy makers. Thus, trade conflicts, like the FSC case, fostered the already ­growing general rejection of further trade liberalization in the US Congress. Furthermore, domestic economic policy challenges will continue to be serious in the coming years: the EU will need to manage the social and economic implications of EU enlargement, intensify structural reforms, tackle its demographic problems, and deal with growing fiscal pressure. All of these are politically difficult tasks, complemented by great pressures from civil society. If these challenges are accompanied be serious recessions, political backlash and protectionism will be likely to occur.

Bush's trade policy will also depend decisively on domestic economic conditions, i.e., economic growth and labor market developments. Thus, the economy will be strained by the burdens of past tax cuts as well as the increasing budget and current account deficits. The danger of protectionist measures, particularly in labor intensive sectors such as steel and textiles, will increase exponentially with a downturn of the US economy. The Farm Bill and safeguard measures against steel imports show that Bush does not hesitate to resort to protectionist measures.

BILATERAL CHALLENGES

Trade conflicts can spill over into political areas of cooperation, which are already under strain because of issues such as the Iraq War, the Kyoto protocol and the International Criminal Court.12 A second potential danger resides in the WTO code of practice to allow complainants to raise retaliatory tariffs when a panel decision is not implemented in a set time frame. This can lead to a growing level of protectionism in transatlantic trade, which would have negative economic implications for both sides.

MULTILATERAL CHALLENGES

On the multilateral level, unresolved trade conflicts, the increasing use of retaliatory methods, and the insufficient willingness of countries to comply with WTO's rulings seriously undermine the credibility of the WTO, weakening the multilateral legal order and its legitimacy. Lastly, conflictual transatlantic relations can also give negative impulses to global growth and prosperity due to the sheer size and economic importance of the two trading partners.

Implications

Because of these potentially negative consequences of trade conflicts, the EU and the US have to intensify their efforts for conflict prevention and solution. First, they have to solve long-standing, traditional disputes involving the protection and unfair support of national industries: here, chances look relatively good, considering progress in the FSCs and Airbus/Boeing case. In this context, it is indispensable that both trading partners cool their rhetoric: trade conflicts should not be used as domestic policy or even campaigning instruments, and threats of boycotts should be avoided. Second, the US and EU have to deal with different public preferences concerning new technologies (e.g., GMOs), improve the climate for mutual recognition of standards and come to an agreement on foreign policy sanctions. Solutions in these systemic conflicts look less likely in the close future.

Overall, the institutional framework has to be strengthened: while conflicts can never be fully avoided, there are several instruments to improve the transatlantic climate - through an enhanced early warning system as well as a more efficient solution mechanism. Central to this is a so called "top-down­ approach," e.g., by expanding the "New Transatlantic Agenda" (NTA), the "Transatlantic Economic Partnership" (TEP) or the "Positive Economic Agenda" (PEA), as well as a "bottom-up-approach," e.g., strengthening the existing transatlantic dialogues (Business, Consumer, Environment, Labor, and Legislators). Overall, mobilizing a stronger pro-free trade force in both the US and the EU to prevent future trade disputes is indispensable.

Notes

Dr. Claudia Decker is a resident fellow specializing in transatlantic trade relations and the WTO at the German Council on Foreign Relations (DGAP) in Berlin. She holds a Master's degree in North American studies economics, and political science and a PhD in economics from the Free University of Berlin. Stormy Mildner, former resident fellow at the German Council on Foreign Relations, is currently lecturer at the Free University (Berlin), finishing her PhD in international economics. She has earned a Master in international political economy at the London School of Economics (2000) and was an international Fox Fellow at Yale University 2002/2003.