By Robert E. Scott for the Economics Policy Institute
President Obama has built his closing case for the Trans-Pacific Partnership on a political argument, saying “…we can’t let countries like China write the rules of the global economy. We should write those rules.” But it is both arrogant and wrong to think that the United States has the power to shape the rules governing China’s relationship to TPP signatories. As of today, China has already established deeper trade ties than the United States with the TPP nations. Further, congressional approval of the TPP would actually lock in those advantages for China. China has a large trade surplus with the TPP countries, and crucial terms of the agreement (specifically weak rules of origin (ROO) requirements, which we’ll talk about in detail below) would provide a back-door guarantee for China and other non-TPP members to duty-free access to U.S. and other TPP markets. This would be especially significant for autos and auto parts, as well as other key products. TPP exporters are not going to turn away from their suppliers in China just because they signed a trade deal with the United States.
The United States has a massive trade deficit with China that has taken on added significance in the light of the proposed TPP agreement between the United States and 11 other Pacific Rim countries. While China is not party to the TPP, it is a major force behind a larger East Asian co-production system that uses unfair trade (dumping, subsidies, excess capacity, export restrictions, and more), coupled with currency manipulation and misalignment, to make U.S. goods more costly and thus less competitive in China, the TPP and in other markets.
The United States also had a large trade deficit with the TPP countries in 2015 that cost 2 million U.S. jobs. Flawed trade and investment deals, such as the North American Free Trade Agreement (NAFTA), plus the currency manipulation and unfair trade by some TPP members account for many of those lost jobs (note that Mexico and Canada are TPP countries). In addition, analysis developed here demonstrates that a substantial share of these TPP job losses can be directly linked to trade between China and the other members of the TPP. Specifically, most of the TPP countries run large trade deficits with China while running large, offsetting trade surpluses with the United States. Thus, it appears that at least some TPP producers are buying parts and components from China and re-exporting them in the form of finished goods to the United States.
The links between China and TPP exporters would get a big boost from crucial accounting provisions of the TPP, specifically the rules of origin (ROO) requirements. ROO are used to determine the country of origin of a product for purposes of duties and restrictions imposed under the rules of the proposed TPP and other trade and investment deals, and they are critically important in the U.S. automotive and parts industries, which play a critical role in trade within NAFTA, and in trade with Japan and other TPP partners. Under the TPP, TPP partners can get preferential access to U.S. markets for goods with a lower share of domestic content than in prior agreements, especially the NAFTA. This opens a large back door for increased imports from China and other non-TPP exporters. In other words, China, which is already exporting a lot of artificially cheap and subsidized goods directly to the United States, could export even more by increasing what are essentially pass-through exports to the TPP countries, which would make nominal changes and then ship them on to the United States. This could lead to growing U.S. trade deficits with and job losses to the TPP countries if the agreement is approved and implemented without dramatic changes in the ROOs.
The TPP dramatically weakens ROO in the TPP, as compared with the NAFTA agreement. Under NAFTA, at least 62.5 percent of a finished car or truck had to originate in the region, and the rule applied only to imports from Mexico, Canada, and the United States. The ROO standard is reduced to 45 percent under the TPP “net cost rules,” and 55 percent under the “build down” option (producers may choose from one of two TPP accounting standards, or the original NAFTA rules, which will remain in effect). While the NAFTA and TPP ROO accounting rules are not directly comparable, at least 8 percent more non-TPP content can be included and still be treated as TPP-originating (House Ways and Means Minority Staff Report at 12).
The day TPP takes effect, those accounting standards will weaken dramatically. Unlimited imports of parts from all 11 TPP countries would count for duty-free treatment in finished vehicles imported from Mexico or Canada, and at least eight percent more could come from non-TPP members such as China, Germany, or Thailand. Note that this benefit would not apply to cars and trucks imported from Japan until U.S. tariffs begin to fall on those products, which could take place 15 and 30 years after the agreement takes effect, but it would apply to most Japanese auto parts, as noted below (House Ways and Means Minority Staff Report at 12).
And the rules for auto parts are even weaker. NAFTA required a regional value content (RVC) of 60 to 62.5 percent on auto parts (with an RVC as low as 50 percent for some products). Under the TPP, the RVC ranges from 35 percent to 45 percent using TPP ROOs. Tariffs would be eliminated for most auto parts immediately, and for 80 percent of auto parts from Japan, and the TPP ROO would apply to those products at that time (House Staff Report, note 6 at 3, and at 7). Tariffs on particularly sensitive products from Japan in the steel and auto industries would be phased out over 15 years, at which point the TPP ROO would apply to all U.S. auto parts and most other imports.
There are three additional ways in which the TPP would weaken NAFTA ROO on motor vehicles and parts. First, NAFTA included a “tracing list” of parts, such as engine parts, that could never be counted as originating within the agreement (House Staff Report at 17). The TPP does not contain a tracing list, so parts used in assembly can be treated as TPP content when the final product is shipped, sold or traded in the TPP. Thus, under the TPP, an engine can be assembled with up to 65 percent of its value composed of parts from China and other countries and still be considered originating in the TPP region. The full value of that engine will then count toward the 45 percent RVC standard for a vehicle finished in the TPP, thus significantly diluting the effective RVC of the finished vehicle (House Staff Report at 15).
Second, the United States and Japan negotiated a special appendix to the TPP on auto parts covering a list of parts including safety glass, bodies, body stampings, bumpers, and drive axels (House Staff Report at 12). If one of a list of operations is performed on these products, their full value then counts as original content for calculating the RVC of parts and vehicles. This appendix is available to all TPP members. The covered products included commodity products such as steel products, machinery, rubber and plastics and stone, cement, and glass, for which China possesses massive excess capacity and has been found guilty of dumping in 759 cases between 1995 and 2014.
Finally, there is the issue of duty drawback provisions, which encourage the use of imported components by allowing countries to refund duties paid on components imported for re-export. NAFTA prohibited duty drawback provisions, but the TPP does not mention this issue, suggesting that such measures are allowed. Under NAFTA, if a company in Canada imports an auto part from Korea and pays a duty on that import, the Canadian government may not refund that duty when the final product is exported to the United States. But under the TPP, it appears that such duty rebates are allowed (House Staff Report at 12). This creates additional incentives to use imported components under the TPP.
China, TPP Trade, and Job Loss
Most of the members (eight of the 11) of the proposed TPP had trade deficits with China in 2015, as shown in the Table below. Of these eight, five had relatively large goods trade deficits with China, including Canada ($35.6 billion), Japan ($51.3 billion),Malaysia ($7.2 billion), Mexico ($65.1 billion), and Vietnam ($28.7 billion). Each of these countries also had significant trade surpluses with the United States that—except for Canada—were nearly as large, or larger, than their trade deficits with China.
Overall, the 11 other members of the proposed TPP had a trade deficit of $168.4 billion with China in 2015, and a near-mirror image trade surplus of $163.6 billion with the United States in the same period as shown in the Figure below. The U.S. trade deficit with the TPP countries cost 2 million U.S. jobs in 2015, with job losses in every state.
The last column of Table 1 and Figure A shows that the TPP countries’ trade with the world was roughly balanced (an overall goods trade deficit of $28.8 billion). The TPP countries had a much larger trade surplus with the United States in 2015 than they did with the five biggest countries in the EU (not shown)—France, Germany, Italy, Spain, and the United Kingdom—which totaled only $66.2 billion (EPI analysis of UN Comtrade 2016, not shown). Together, these five EU countries had a combined GDP of $11.6 trillion, about two-thirds the size of the United States, yet the TPP countries’ trade surplus with the EU-5 was only one-third as large as that with the United States.
Taken together, it is clear that the TPP countries form part of a greater East Asian production system. That system is based on export-led growth. Furthermore, the United States absorbs the lion’s share of the trade surpluses, and job losses, exported by those countries. Two conclusions are immediately apparent from this analysis.
First, a substantial share (some, but not all) of the 2 million U.S. jobs lost due to TPP trade deficits can also be directly traced to China trade with the TPP countries. Some are due to failed trade deals like NAFTA, which did not do enough to stimulate growth in Mexico and demand for U.S. exports, and which encouraged outsourcing, trade deficits and job losses. But others appear to be associated with increased use of cheap components from China.
Second, approval of the proposed TPP agreement is a step in the wrong direction and would only increase U.S. exposure to unfairly traded imports. The TPP agreement would substantially weaken ROO expressed in preexisting trade and investment deals such as the North American Free Trade Agreement. This would provide a back door for increased imports of parts and components from China through increased imports of goods containing unfairly traded Chinese components under the TPP.
The Asian members of the TPP (Australia, Japan, Malaysia, New Zealand, Singapore, and Vietnam) imported more than twice as much from China as they did from the United States in 2014 (data for 2015 for Vietnam was unavailable), based on total goods trade. Their imports from China rose 11.9 percent between 2011 and 2014, while those from the United States declined 3.9 (EPI analysis of data from UN Comtrade). Thus, China is poised to use the TPP as a back door to increase duty-free exports to the United States through its trade partners in these countries, due to the weak rule of origin provisions in the agreement.
In addition, approval of the TPP will provide significant, immediate tax cuts to TPP exporters that use imported Chinese components in the covered sectors (especially motor vehicle parts), in the form of duty drawback credits. This will reduce the cost and increase the competitiveness of TPP exports to the United States overnight if the TPP is implemented. Such hidden benefits may help explain the sudden surge in U.S. imports from and trade deficits with Korea that followed implementation of the U.S. Korea Free Trade Agreement in 2012 (This agreement has cost 95,000 U.S. jobs).
The TPP is not an effective answer to China’s growing influence in the TPP region. Approval of the TPP would only make it easier for China to expand exports to the U.S., resulting in growing TPP trade deficits and job losses. The best alternatives for dealing with China are enhanced enforcement of U.S. unfair trade laws to put a stop to China’s illegal dumping and subsidies, and direct intervention in currency markets to end misalignment and manipulation of China’s heavily undervalued currency.