November, 2012

53rd ANNUAL TAX FORUM.

“No nation was ever been ruined by trade” Benjamin Franklin

“Free trade is not based on utility but on justice” Edmund Burke

Background.

1

Entrepreneur

Investor

Managing Partner

ARGENTO DIGITAL VENTURES

Partner / Vice-President

ADVENTIS MANAGEMENT

CONSULTING

Leader, Telecommunications &

Media Practice

ROLAND BERGER STRATEGY

CONSULTANTS

Principal (Twice Winner of

Professional Excellence Award)

BOOZ ALLEN HAMILTON

Managing Director

GOLDEN SEEDS - Angel &

Venture Capital Investment Group

Managing Partner

ARGENTO DIGITAL VENTURES

CEO / Founder

MON AMI PET WORLD

Member of Technical Staff

AT&T BELL LABORATORIES

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1. International Trade and the U.S. Trade Deficit.

Globalization and International Trade are related by a “virtuous” cycle.

3

Technology evolution. Rising incomes.

Reduced transportation and communication costs

Increased economic specialization

GLOBALIZATION

INTERNATIONAL TRADE

Increased interdependence (goods, financial) across nations

As a result, the growth in exports worldwide has largely outpaced GDP growth since 1950. Export increased 35X while GDP only 9X.

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Source: WTO

0

500

1000

1500

2000

2500

3000

3500

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50

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55

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60

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65

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70

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75

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80

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85

19

90

19

95

20

00

20

05

20

10

1950 = 100 Exports (volume) GDP (volume)

Exports multiplied by 35 times since 1950, while GDP only by less than 9 times

EXPORTS AND GDP GROWTH WORLDWIDE

The Great Recession of 2009, temporarily slowed down exports growth. In the last decade, exports grew 1.6X, while GDP grew 1.3X.

5

90

100

110

120

130

140

150

160

2000 = 100 Exports (volume) GDP (volume)

-15%

-10%

-5%

0%

5%

10%

15%

20%

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

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volume growth rates

average growth rate

of exports = 4.3%

average growth

rate of GDP= 2.4%

EXPORTS AND GDP GROWTH WORLDWIDE

Source: WTO

In the last two decades, U.S. imports grew 3.6X, exports 3.2X, while GDP 1.7X. As a result, trade deficit has increasingly become an issue.

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Source: IMF, World Economic Outlook

90

140

190

240

290

340

390

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90

19

91

19

92

19

93

19

94

19

95

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96

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97

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98

19

99

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20

01

20

02

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03

20

04

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06

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07

20

08

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09

20

10

20

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1990 = 100 GDP (volume) Exports (volume) Imports (volume)

U.S. IMPORTS & EXPORTS

In the last two decades , the U.S. trade deficit has increased from 2% of GDP to over 5% of GDP. China has been responsible for 40% of the U.S. trade deficit, in the last three years.

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Trade balance in $ billion (rhs)

-1000

-900

-800

-700

-600

-500

-400

-300

-200

-100

0

-8%

-7%

-6%

-5%

-4%

-3%

-2%

-1%

0%

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

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$ billion% of GDP -current prices

Source: IMF World Economic Outlook Database

U.S. TRADE DEFICIT

- Decrease in U.S. demand

- QE I, II – cheaper dollar.

- Sanctions.

The U.S. ranks third in exports and second in imports, worldwide.

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0

500

1000

1500

2000

0%

3%

6%

9%

12%

15%

$ billionShare of total exports

0

500

1000

1500

2000

2500

0%

4%

8%

12%

16%

20%

$ billionShare of total imports

The U.S. ranks 3rd in exports worldwide (share of 10.3%)

Source: WTO

The U.S. ranks 2nd in imports worldwide (share of 15.6%)

The U.S. share of WW

GDP is 22%

(China’s is 10.4%)

China is the world’s largest exporter, surpassing the UK (2002), Japan (2004), the U.S. (2007) and Germany (2009).

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16 32

128

0

25

50

75

100

125

150

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90

19

91

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92

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93

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94

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95

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96

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99

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20

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US exports = 100 China Germany Japan UK India Brazil

In 2007, China overtook the US

Source: WTO

TOP WORLD EXPORTERS

Is GERMANY an example

worth following?

U.S. imports are concentrated around 5 trading partners that represent 68% of total. China is our largest import partner.

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14%

12%

19%

17%

6%

U.S. TOP IMPORT PARTNERS

Source: WTO

U.S. exports are concentrated around 5 trading partners representing 62% of total. China is our fourth largest export partner.

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19%

18%

13%

5%

7%

Source: WTO

U.S. TOP FIVE EXPORT PARTNERS

Germany and China rely on exports as their “economic growth engine”. The U.S. relies much less so, among industrialized nations.

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16% 21%

36%

26%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

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10

20

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US China Germany Japan UK India Brazil

Source: WTO, IMF World Economic Outlook Database

DEPENDANCE OF ECONOMY ON EXPORTS (EXPORTS/GDP)

The U.S. has

BARGAINING POWER in

TRADE NEGOTIATIONS

The U.S. dependence on trade for “economic growth” is relatively low when compared to major trading partners. The U.S. bargaining position in trade negotiations is STRONG.

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28%

48%

53%

30%

23%

30%

51%

61%

Source: WTO

DEPENDANCE OF ECONOMY ON TRADE (EXPORTS+IMPORTS/GDP)

The U.S. has

BARGAINING POWER in

TRADE NEGOTIATIONS

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2. Trade Practices the Role of Free Trade Organizations and Free Trade Agreements.

The U.S. has the lowest average import tariffs among large,

industrialized economies.

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3.5%

5.3%

9.4%

4.5%

13.7%

5.3% 9.6%

12.6%

Source: WTO

IMPORT TARIFF IMBALANCE – U.S. & ROW

The U.S. also has the lowest import tariffs as a percentage of total imports.

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2.1%

7.2%

10.2%

4.6%

3.1%

2.1%

9.5%

2.8%

Source: WTO

Import tariff imbalance across key goods is much more severe.

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Source: WTO – average tariffs by product

0

2

4

6

8

10% Chemicals

0

10

20

30

40% Clothing

0

5

10

15

20% Leather and Footwear

0

5

10

15% Non-electrical machinery

0

5

10

15% Electrical machinery

0

5

10

15

20

25% Transport equipment

Non-tariff barriers, a major obstacle to fair trade are applied routinely by some export-driven nations.

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NON-TARIFF MEASURES (NTMs)

First three measures are often necessary to achieve public policy goals (e.g., health

and safety of consumers).

A harmonization, rather than elimination of these practices is recommended.

Important NTMs (Non-Tariff Measures)

Technical barriers (e.g., labeling).

Sanitary measures (e.g., licenses, certifications).

Domestic regulation.

Quantity restrictions.

Export subsidies.

The impact of NTMs on total imports is estimated at 10%, higher than the impact

of tariffs. Quantification of their impact is challenging.

Other unfair practices are used to unbalance international trade.

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DUMPING

Pricing on imported products lower than in their domestic markets.

WTO’s “Anti-Dumping Agreement” aims at addressing this issue.

EXCHANGE RATE MANIPULATION

China’s currency is “purposely” under-valued distorting trade in their favor

(imports from China become cheaper and exports to China more expensive).

Trade deficit with China could be easily narrowed by a re-alignment of the

Dollar/Yuen exchange rate.

An agreement for global re-alignment of exchange rates is urgently needed.

The World Trade Organization (WTO) is the main body overseeing “trade practices”. Multilateral Trade Agreements go further in liberalizing trade.

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ORGANIZATIONS AND AGREEMENTS AIMED AT FOSTERING “FAIR TRADE”

GENERAL AGREEMENT ON TARIFFS AND TRADE (GATT) -- January, 1948.

Initially 23 member countries.

The first round of negotiations resulted in 45,000 tariff agreements affecting

$10 billion (around one-fifth of the world trade, at that time).

MULTILATERAL TRADE NEGOTIATIONS (Trade Rounds)

Aimed at tariff reduction and non-tariff barriers elimination.

Several rounds have taken place over last 50 years fostering international trade

by eliminating barriers to free trade (e.g., NAFTA).

URUGUAY ROUND (1986-1994). Birth of the World Trade Organization (WTO)

Formally replaced GATT.

Permanent International Institution -- GATT was a multilateral agreement.

Besides goods trading practices, WTO covers trade in services and

Intellectual Property (GATT focused exclusively on goods).

The US has been a member of the WTO since its birth, 1 January 1995;

The US was also one of the 23 first signatories of the GATT in 1948.

Bare

Minimum

“Free”

Trade

The U.S. has signed several Regional and Bilateral Trade Agreements but not with China, India, Russia, Japan or Brazil some of the most protectionist nations.

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TRADE AGREEMENTS – U.S.

BILATERAL TRADE AGREEMENTS

Australia, Chile, Morocco, Bahrain, Oman, Peru, Singapore.

Several other bilateral agreements are waiting for Congressional approval.

REGIONAL TRADE AGREEMENTS

North-America Free Trade Association (NAFTA).

Trans-Pacific Partnership Agreement (TPP).

Free Trade Area of the Americas (FTAA).

US-Southern African Customs Union Free Trade Agreement.

The Enterprise for ASEAN Initiative.

U.S.-Andean Free Trade Agreement.

Central American Free Trade Agreement—Dominican Republic.

In 2011, the WTO had 153 members accounting for 95% of the world’s

trade. Four new members entered in 2012, Russia among them.

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WTO FOOTPRINT

Doha Round, sponsored by the WTO, is a key effort to balance tariffs. It has been deadlocked for a number of years.

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• Doha Round – Has the current WTO trade round reached a deadlock?

Negotiations have extended over more than 10 years now ;

For the US, the chief goal of the negotiations is to improve market access in

agricultural trade, primarily by eliminating agricultural export subsidies; easing

tariffs and quotas; and reducing other forms of trade-distorting domestic support;

In return, the US hopes to expand negotiations on trade in services and to force

fast-growing emerging economies to reduce tariffs on industrial goods so to reach

a level playing field, at least for some manufacturing sectors;

Emerging markets insist that the Doha round was never intended to result in

such harmonization.

The root of the Doha impasse may be indeed its over-extension in time as goals

have shifted dramatically in the last decade, as so has the contribution of emerging

economies to the growth of world GDP (almost 75% of the addition to world GDP

between 2011 and 2014 will come from outside the rich world, against less than

50% between 1998 and 2001 ).

DOHA ROUND

Negotiations have extended for over 10 years.

The U.S. is offering to improve access to foreign agricultural

products into the U.S., eliminating agricultural export subsidies; easing tariffs

and quotas and reducing other forms of trade-distortions.

In return, the US aims to negotiate services trading and to reach a level

playing field with emerging economies by reducing tariffs on industrial

goods for some manufacturing sectors;

Emerging economies insist that the Doha round was never intended to

result in such balancing.

RATIONALE FOR NEGOCIATION FAILURE

Scope creep. Excessive delays.

Shifting economic power away from industrialized nations. (75% of world’s GDP

growth in 2011- 2014 will come from developing nations, compared to less than

50% in 1998 - 2001)

The WTO mandate does not go far enough to ensure “fair trade”.

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OBJECTIVE OF WTO AND MULTILATERAL TRADE AGREEMENTS

Reciprocal liberalization of trade-barriers applied in a

non-discriminatory fashion.

BARRIERS TO “FAIR” TRADE

Tariffs, import taxes across product categories.

Non-tariff barriers, such as quantitative restrictions (e.g., rare earth metals) or

export subsidies (e.g., solar panels).

Dumping (e.g., solar panels).

Currency manipulation/devaluation.

NATIONS FAVORED BY TRADE IMBALANCED HAVE “LITTLE” INCENTIVE TO

NEGOTIATE

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4. Impact of International Trade on the U.S. Economy.

Nations’ core capabilities determine their exports. International trade influences economic development and social welfare.

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IMPORTS IMPACT THE ECONOMY AND SOCIAL WELFARE

Economic structure, Welfare.

Inflation.

Unemployment.

Wage inequality..

NATIONS EXPORT PRODUCTS WITH COMPETITIVE ADVANTAGE

Economics Models (e.g., Heckscher - Ohlin) indicate that countries export

goods that use abundant resources and import goods that use scarce

resources.

Under this theory, the US and other developed economies would

export mostly capital-intensive and knowledge-intensive goods and

import from developing economies labor-intensive goods and natural

resources..

IMPACT OF INTERNATIONAL TRADE ON THE U.S. ECONOMY

EXPORTS bring innumerous benefits to a nation’s economy and it drives local businesses to become world-class players.

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• Increased revenues. Selling to new “foreign” customers. Foreign market may be growing faster than domestic market.

• Lower production costs due to economies of scale and “experience curve” effects.

• Utilization of idle capacity.

Access to New

Markets

• Focus on core capabilities.

• Improved efficiency.

• Improved product quality.

• Becoming more price competitive.

Enhances Competitiveness

• Balance domestic market fluctuations.

• Overcome saturation of domestic markets.

• Extent product-life cycle.

• Follow domestic customer while overseas.

Increased flexibility

IMPORTS also bring significant consumer and economic benefits.

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• Lower prices for certain products due to increased supply increased real disposable income.

• Increased variety of products to choose from.

• Hedge against temporary shortages (e.g., agricultural products and local weather effects).

Benefits to Consumers

• Fair trade fosters competitiveness and keeps suppliers efficient (e.g., making investments, reducing production costs).

• Trade barriers foster non-competitive industries, able to supply only protected domestic market (e.g., Brazil auto industry)

Enhanced Competitiveness

• Lower cost imported intermediate goods.

• Lower production costs for local producers.

• Reduced prices for consumers or increased profits for producers. Lower Inflation

IMPORTS are capable of creating or destroying jobs.

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IMPACT ON U.S. JOBS

Between 1983-2002, 6 million manufacturing jobs were lost mainly due to imports and offshoring.(source: 2011 World Bank).

Despite this loss of jobs the manufacturing sector maintained its share of real GDP (around 23% vs. 22% in the 1960s) and even increased its share in exports of goods (from 61% in 1963 to 71% in 2011).

Manufacturing in now more concentrated on capital goods (around 38% vs.

28% in the 1960s), which is in line with theoretical predictions.

IMPACT OF IMPORTS ON “U.S. JOBS”

Timely availability of “alternative” jobs for displaced manufacturing workers

and /or retraining mechanisms MUST BE ENSURED !!.

The trade deficit with China eliminated or displaced more than 2.7 million jobs (2.1 million in manufacturing), since entering the WTO.

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Source: Scott (2012)

The major NEGATIVE impact of IMPORTS appears to be on wages.

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FLEXIBILITY AND SIZE OF U.S. ECONOMY ALLOWS TRADE TO IMPACT WAGES

MORE THAN UNEMPLOYMENT LEVELS

65% of manufacturing workers who lost their job during the 1980s-90s due to

trade liberalization were employed two years later.

However, 25% accepted jobs with 30% lower wages.

(source: The Economist, 2007)

TECHNOLOGICAL CHANGE AND REQUIRED SKILLS-SETS >> WAGE EROSION.

OTHER POTENTIAL REASONS.

De-unionization.

Decrease in real minimum wage.

Immigration of unskilled workers.

The U.S. focus on EXPORT of knowledge and capital-intensive goods exacerbates demand for highly skilled labor.

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1

• The U.S. excels on knowledge and capital-intensive sectors.

2

• Demand for skilled workers increases.

• Demand for unskilled workers decreases.

3

• Skill premium increases.

• WAGE INEQUALITY INCREASES

REAL HOURLY WAGES ACROSS INCOME PERCENTILES

Wage inequality has been expanding since the 1980s. Individuals with

lower incomes and education levels are the losers.

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REAL HOURLY WAGES ACROSS INCOME

PERCENTILES

REAL HOURLY WAGES ACROSS EDUCATION LEVELS

Source: Yellen (2006)

While the real hourly wages of workers in the 90th percentile rose by 30%

from 1973 to 2005, those at the 50th percentile or below saw real hourly

wages increasing by only 5% to 10%.

Individuals in lower skilled jobs - lower education levels - are most affected

by international trade.

International trade must be carefully balanced. “Dogmatic” approaches could be disastrous.

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INTERNATIONAL TRADE IN THE BALANCE - U.S. ECONOMY

Benefits Costs

National Security

Potential loss of Industrial Base

Increased Wage Inequality

High Unemployment Levels

Controlled

Inflation

Improved Competitiveness

Improved Consumer Welfare

Economic Growth

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5. The U.S. Response to Trade Imbalance.

For the U.S., the promise of international trade is not being fully realized. However, the U.S. is in a strong bargaining position.

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THE PROMISE AND REALITY OF U.S. INTERNATIONAL TRADE

- Globalization >> Trade.

- Trade >> Economic Growth, Social Welfare, Competitiveness.

- U.S. Complacency >> Barriers

- Barriers >> Trade Deficit.

- Trade Deficit >> Unemployment, Wage Inequality, Industrial Base Erosion.

- Trade partners unwilling to negotiate.

- Trade Agreements Insufficient.

PROMISE REALITY

U.S. BARGAINING POWER (TRADE / GDP)

U.S.= 28%.

China = 53%..

Russia = 48%.

India = 51%%.

In an environment where “lack of trust” prevails, how to play the game to balance our trade deficit ?

37

FAILURE OF TERMS-OF-TRADE APPROACH

FAIR TRADE SHOULD LEAD TO OPTIMAL OUTCOMES, BUT…

Consider two trading partners (e.g., U.S. and China) and two trade policy options:

i. Fair trade or

ii. Impose tariffs that raises own real income at the expense of trading

partner’s income

The Prisoners' Dilemma game illustrates that short-term mentality and lack of

trust, would drive both partners to protect themselves and get sub-optimal

payoffs (-5, -5) -- equilibrium position.

If both parties are not equally aggressive, the passive party pays dearly

(-10, 20).

China (aggressive)

Fair Trade Protection

U.S. (passive) Fair Trade (10, 10) (-10, 20)

Protection (20, -10) (-5, -5) NE

C

A “tit-for-tat” approach to trade would induce aggressive trade partners to cooperate – fair trade. (1/2)

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Source: The Evolution of Cooperation. D. Axeldrod.

CURRENT AGGRESSIVE PARTNER

SAYS ‘UNCLE”

“FAIR TRADE” (NASH EQUILIBRIUM)

The U.S. is in a

STRONG BARGAINING

position

A “tit-for-tat” approach to trade would induce aggressive trade partners to cooperate – fair trade. (2/2).

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In trade relations, short-run incentives for non-cooperation often dominate.

Countries boost domestic production by levying tariffs on imports or by resorting

to non-tariff barriers.

Disadvantaged trade partners may retaliate and initiate what is known as a

TIT-FOR-TAT strategy

The objective of this strategy is twofold:

(i) In the short-term it stops unfair trade.

(ii) in the longer-term, it enforces cooperative behavior.

The threat of future payoffs forgone in case of non-cooperation serves as a

disciplining device to foster cooperation.

A tit-for-tat strategy would foster trade liberalization and fairness..

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6. Conclusion.

Most agree with the end-goal of free trade and its benefits. The path for getting there is crucial and must be defended.

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International Trade driven by Globalization is here to stay.

Exports fuel GDP growth – the U.S, does not export enough – 10% of WW exports

and 22% of WW GDP.

Unfair trade practices by key U.S. trading partners have created a trade deficit that

contributes to job losses, wage inequality and erosion of our industrial base.

WTO is unable to guarantee “fair trade”. “Rogue” nations have no incentive to negotiate.

Multi-lateral Trade Agreements are effective but take long to negotiate.

Economic theory models free trade, “statically” (end goal only, not the path) and

assumes that nations will voluntarily adopt “fair trade” practices while getting there.

The dynamic nature of international trade and its consequences – unemployment,

wage inequality, potential loss of industrial base - demands a dynamic, proactive response.

The U.S. is in a strong bargaining position to negotiate balanced trade relative to

partners that drive our trade deficit – in a trade war, they have a lot more to loose.

The U.S. should proactively adopt a tit-for-tat approach to foster trade

liberalization and fairness or risk losing the “international trade war”.

Above ‘fair trade” enforcing mechanism would provide crucial time for retraining of

displaced labor and/or protecting sectors impacted by unfair practices.

CONCLUSION

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Appendix

REFERENCES

Ebenstein A., Ann Harrison, Margaret McMillan and Shannon Phillips, “Estimating the Impact of Trade and Offshoring on American Workers Using the Current Population Surveys”, World Bank, 2011.

Janet L. “Economic inequality in the United States.” FRBSF Economic Letter 33-34 (2006): 1-7.

Scott R., “The China toll - Growing U.S. trade deficit with China cost more than 2.7 million jobs between 2001 and 2011, with job losses in every state”, Economic Policy Institute, 2012.

Sitchinava N. “Trade, Technology, and Wage Inequality: Evidence from U.S. Manufacturing, 1989-2004” (working paper).

“Trade's victims - In the shadow of prosperity.” The Economist, January 18, 2007.

“The Doha round - Dead man talking.” The Economist, April 28, 2011.

World Trade Reports of 2007, 2008, 2011 and 2012, www.WTO.org.

Tariff Profiles, www.WTO.org.

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