America's Two-Front Economic Conflict

DOUBLE TROUBLE

Since the end of the Cold War, the perceived threats to U.S. security have been mainly from "rogue states" such as Iraq and North Korea -- none of which are superpowers or likely allies of each other in confronting the United States. But the United States now faces the real possibility of economic conflict with both Europe and East Asia -- the commercial and financial equivalent of two-front combat. In this domain, both potential rivals are superpowers. Moreover, they have already demonstrated their ability to coalesce against the United States, as they did to help torpedo the Seattle ministerial meeting of the World Trade Organization (WTO) in December 1999.

Peaceful and effective resolution of these potential conflicts is one of the most important and difficult issues facing the new U.S. administration and the world. The American and global economies are slowing sharply, and their futures may be heavily affected by the outcomes. In a post-Cold War world in which economic issues are central to international relations, those outcomes will also be crucial for U.S. foreign policy and global stability. Compounding the complexity of the situation is the fact European and East Asian nations are not only the United States' economic competitors but also its economic partners -- and many of them are close security allies as well.

CONTINENTAL DIVIDE

The United States and the European Union (EU) are on the brink of a major trade and economic conflict. Washington has already retaliated against European import restrictions on American beef and bananas -- each retaliation accounting for a hundred million dollars or so of annual trade -- and has rejected all European efforts to resolve these disputes. Europe in turn threatens to retaliate against several billion dollars of U.S. export subsidies, as well as new U.S. trade laws that would channel the proceeds of antidumping penalties from the Treasury Department to the complaining industries and would force the president to continually change the products being retaliated against, thus intensifying the impact of U.S. punitive sanctions.

Still larger trade clashes loom. The troubled U.S. steel industry will likely file additional antidumping cases against European firms or even an industry-wide safeguard action that would restrict all European imports. In addition, a major dispute over commercial aircraft is brewing as the two sides quarrel over whether direct European governmental subsidies for Airbus or indirect Pentagon subsidies for Boeing are more egregious. Europe's outcry over U.S. sanctions against European firms that deal with American adversaries such as Cuba and Iran has only been swept under the rug. And just over the horizon lies the biggest battle of all: the debates over farm subsidies, genetically modified products, and overall agricultural trade that will explode in 2003, when the U.S.-EU "peace clause" (a moratorium on new complaints in the agricultural sector) expires.

The United States and Europe also differ on global trade issues for which they share leadership responsibility. They remain divided, for example, on whether to include competition policy and investment issues in new WTO negotiations. It was their opposing views on issues such as these that scuttled any prospect of launching a new round of trade talks at Seattle.

Furthermore, the United States and Europe are divided on energy and environmental issues. As energy prices soared and riots erupted on European roadways last fall, European resentment flared anew over Americans' penchant for cheap fuel and their profligate energy consumption. The recent Hague conference that sought to devise operational plans to check global warming broke up over fundamental disagreements about who bears responsibility for greenhouse gas emissions, how they should be cut back, and who should pay for doing so.

Financial relations are another potential land mine. When the European Central Bank intervened to halt the slide of the EURO last September, the United States provided only grudging support. But now that the EURO has rebounded, the shoe may soon be on the other foot as the dollar risks a sharp decline in the wake of a domestic economic slowdown and an annual trade deficit approaching $500 billion. Europe should be willing to help in such a circumstance, since it would not want to see the EURO soar to levels that would jeopardize the price competitiveness of its exports. But it might be less enthusiastic to bolster the dollar if the net effect were to finance massive tax cuts ˆ la President George W. Bush that would further reduce U.S. national savings and hence increase America's draw on foreign capital.

The accumulation of such potential conflicts poses high risks for both American and European economies. Moreover, the global impact of a commercial clash between these two titans could be severe -- including systemic damage to the WTO, especially its crucial but fragile dispute settlement mechanism. A transatlantic economic conflict may also exacerbate potential security tensions over issues such as a future policy toward the Balkans, American concern over European plans for an autonomous military force, and European anxieties that American proposals for a missile defense system will renew tensions with Russia and trigger another global arms race. All this calls for new basic strategies for managing globalization, especially in light of the developments simultaneously arising on the other side of the world.

ASIAN FUSION

The potential economic confrontation between the United States and East Asia is quite different from the transatlantic one. The sector-specific conflicts that have traditionally burdened U.S.-Asian trade relations (and that now burden U.S.-European ones) have diminished sharply. The problem now is that East Asia, for the first time in history, is creating its own economic bloc, which could include preferential trade arrangements and an Asian Monetary Fund (AMF).

Asian countries will shortly complete a Network of Bilateral Swap Arrangements, which will provide initially up to $50 billion and eventually as much as $100 billion in mutual currency supports among the "ASEAN + 3": the ten members of the Association of Southeast Asian Nations (ASEAN), plus Japan, China, and South Korea. In addition, they are contemplating cooperative exchange-rate systems to shield themselves from the huge fluctuations in the currencies of the major industrial countries -- similar to Europe's moves toward monetary integration in the 1970s to defend itself against wide fluctuations of the dollar. These countries are also devising new "early warning systems" to help prevent future regional economic crises. Building on the 1998 Miyazawa Plan, under which Japan offered $30 billion to support the recovery of the nations hit hardest by the 1997-98 financial crisis, these countries are clearly headed toward creating their own monetary arrangements.

On the trade side, fundamental changes in the trade policies of the three main East Asian powers -- Japan, South Korea, and China -- have initiated a spate of subregional and bilateral free trade negotiations. Japan, which has traditionally relied on the multilateral frameworks of the General Agreement on Trade and Tariffs (GATT) and now the WTO, has begun to pursue bilateral trade agreements with Singapore, Mexico, and South Korea over the past two years. South Korea has made a similar policy shift and is now actively negotiating with Chile, as well. China, which had also previously eschewed regional approaches, stunned everyone at the fourth annual ASEAN + 3 summit in late 2000 by proposing a China-ASEAN free trade area -- which the Southeast Asians, fearing Chinese domination, immediately broadened to include Japan and South Korea.

Thus a study of a possible East Asian free trade area, which would be a world-shaking development, was launched at the summit. The new study will build on the one already underway for the creation of a Northeast Asia free trade area comprising China, Japan, and South Korea, which itself is of major significance. In short, the East Asia Economic Group proposed a decade ago by Malaysian Prime Minister Mahathir bin Mohammed is beginning to take shape, albeit slowly and in subregional stages. ASEAN, for example, has already developed detailed plans to complete its own free trade area and currency network. No overarching political strategy drives Asian integration, as it did for the EU, and little coordination exists between the current financial and trade initiatives. But there can be little doubt that these new movements will result in the evolution of an East Asian economic bloc.

East Asian integration is not necessarily a bad thing and could in fact prompt new trade liberalization on the multilateral level. But an East Asian free trade area could also erect new discrimination against U.S. exports of at least $20 billion per year. And a unified East Asia could be an even more formidable competitor than Japan was in the past or China is today, though it should also be a more attractive market for both exports and investment from the United States.

On the financial side, the members of the AMF would hold monetary reserves of almost $1 trillion -- the largest in the world and far larger than those of the United States or the countries of the eurozone. Japan and China would support each other's currencies with the two largest dollar hoards in the world, totaling more than $500 billion. The AMF could clearly rival the International Monetary Fund (IMF) and raise potential conflicts, including disputes over the conditions of country rescue packages.

As with Europe, the new economic developments in Asia carry foreign policy and security implications as well. A truly united East Asia could sharply reduce the risk of conflict in the region and hence be very much in the U.S. interest. On the other hand, a sense that America was being shunted aside by both Asia and Europe could reinforce isolationist tendencies within the United States.

A CHANGING GLOBAL SCENE

The main historical underpinning of America's potential two-front economic conflict is the increasing multipolarization of the world economy. Despite America's prodigious economic performance in the 1990s, the EU is now the largest economic entity on the globe, and its lead will grow further as it expands its membership over the next few years. The EURO, although still suffering numerous growing pains, has completed the region's economic integration.

East Asia has achieved an economic weight comparable to those of the United States and the EU, but it has learned that its disunity has precluded it from achieving equal status on the global scene. Its inferior position was made clear during the 1997-98 financial crisis, when the region became dependent on the international financial institutions directed by the Atlantic powers. The image of IMF Managing Director Michel Camdessus dictating terms to Indonesian President Suharto is bitterly seared into Asian memories, especially now that prominent Western economists argue that IMF programs actually made the crisis worse and point to how Malaysia has recovered effectively without IMF assistance. Under such circumstances, Asia's gross underrepresentation in the IMF and other key international institutions has suddenly attained great salience. The Asians have vowed to never again be in such thrall to the West.

In addition, the creation of the EURO has prompted Asian countries to consider moving toward their own currency unit, albeit over a long period of time. More broadly, the traditional Asian repugnance toward "the huge bureaucracy in Brussels" has turned into widespread contemplation of emulating the basic European strategy of economic cooperation, despite recognition of the differences between the two regions and thus doubts about deep integration. Through biannual Asia-Europe Meetings, Asia is in fact seeking and receiving extensive European advice for its own coordination efforts.

The end of the Cold War has also contributed to the potential for a two-front economic conflict. The disappearance of the Soviet threat has reduced the importance of the American military umbrella over Europe and Asia. The security glue that traditionally encouraged the postwar allies to resolve their economic differences no longer exists. The semiannual U.S.-EU summits have been pitiful failures, and the Asia-Pacific Economic Cooperation forum (APEC), which seeks to prevent U.S.-Asia conflict by providing an institutional link across the Pacific, has only begun to address the issues posed by East Asian regionalism.

These changes in the global scene -- Europe's and East Asia's achievement of rough economic parity with the United States, and the end of the Cold War -- require a restructuring of global economic arrangements. Further delays in such reform will only heighten the risk of costly conflicts.

FOLLOW THE LEADER

A more subtle cause of the present crisis is the decline of effective U.S. leadership in the global economic system. This in turn stems from a domestic popular backlash against globalization and the resulting political stalemate in Washington.

During the postwar period, the pervasive tension between regionalism and multilateralism (mainly as a result of increasing European integration) was generally resolved in favor of multilateralism due to steady American leadership in that direction. The United States insisted on a new round of global trade liberalization after each major step in the European integration process, which otherwise would have created additional trade discrimination and likely emulation around the world. Thus the primacy of GATT was maintained. Indeed, a positive dynamic between regional and global trade liberalization remained consistent for more than four decades. Even when the United States itself began to embrace regionalism -- from bilateral free trade with Canada to the North American Free Trade Agreement to the proposed Free Trade Area of the Americas (FTAA) -- it was careful to simultaneously pursue new multilateral initiatives to ensure an umbrella of global trade liberalization.

Washington's ability to maintain such leadership has been severely curtailed over the past five years, however. Despite the strength of America's economy and the reduction of its unemployment rate to a 30-year low, the popular backlash against globalization has produced a political stalemate on most international economic issues. As a result, the president has had no effective authority to negotiate new trade agreements since 1994. Legislation to replenish the IMF languished for a year in the midst of the Asian crisis, until it was rescued fortuitously by the farm community's interest in restoring its exports to Asia. Even relatively straightforward issues -- such as extending permanent normal trade relations to China or offering enhanced market access to Africa and the Caribbean -- required lengthy, all-out presidential and business campaigns to persuade Congress.

Largely as a result of this domestic standstill, America's international economic posture has been compromised. The United States' initial refusal in 1997 to contribute to the IMF support package for Thailand for fear of further riling Congress, for example, earned lasting enmity throughout Asia. The main reason for the debacle at Seattle was the United States' inability to propose a new round of trade negotiations that would meet the legitimate interests of other major players. Lacking the domestic authority to lower its own trade barriers, Washington was forced to offer an agenda that sought to reduce protection only in other countries -- a prospect that was understandably unappealing to the rest of the world. Similarly, in 1997-98 APEC negotiations, the United States unsuccessfully pushed a program of sector-specific liberalization that focused almost wholly on U.S. export interests. And six years after the idea of the FTAA was launched in Miami, little progress has been made toward hemispheric trade liberalization.

This international leadership vacuum has had two subtle but profound effects on the world economy. Like a bicycle on a hill, the global trading system tends to slip backwards in the absence of continual progress forward. Now, with no serious multilateral trade negotiations taking place anywhere in the world, the backsliding has come in the form of intensified regionalism (which is inherently discriminatory), as well as mercantilist and protectionist disputes across the Atlantic. An East Asian free trade area -- and along with it, a three-bloc world -- will likely emerge if the United States remains on the sidelines of international trade for another five years. Such U.S. impotence would also mean that the traditionally positive impact of regional liberalization on the multilateral process would give way to increasing antagonism and even hostility between the regional blocs.

The other chief effect of the leadership vacuum is increased international disregard of, or even hostility toward, the United States on the economic front. Because of its weight in the world economy, its dynamic growth, and its traditional leadership role, the United States remains the most important player in the global economic system. The other economic powers generally seek to avoid confronting it directly. The EU, for example, has tried to avoid overt battles, despite its escalating range of disputes with the United States. East Asian governments are careful to assure Washington that their new regional initiatives are fully consistent with existing global norms and institutions -- a conciliatory stance that is in sharp contrast to Mahathir's shrill rhetoric of a decade ago and Japanese Vice Minister of Finance Eisuke Sakakibara's aggressive 1997 promotion of the AMF.

In reality, however, the United States is perceived as wanting to call the shots without putting up much of its own money or making changes in its own laws and practices. These specific economic complaints fuse with and feed on more general anti-American sentiments throughout the world. Hence, the two other economic superpowers are proceeding on their own. The EU has launched the EURO, a new association agreement with Mexico, and negotiations with Mercosur (the trade bloc comprising Argentina, Brazil, Paraguay, and Uruguay); East Asia is pursuing the AMF and the East Asian free trade area. The result is a clear and steady erosion of both the United States' position on the global economic scene and the multilateral rules and institutions that it has traditionally championed. If not checked soon, this erosion could deteriorate into severe international conflicts and the disintegration of global economic links.

ALTERNATIVE MEDICINE

The remedies for this risky situation are intellectually straightforward but politically difficult. The cardinal requirement is to subsume the current bilateral disputes and evolving regional initiatives within a reinvigorated multilateral system that rests on an internationally shared vision of how to manage globalization. Such a system will have to restart the momentum of multilateral trade liberalization, provide a global umbrella that effectively reconciles the inevitable regional groupings, and negotiate rather than litigate the most politically sensitive disputes among the major powers. This remedy will require the restoration of a domestic consensus on globalization in the United States and considerable trade and financial reforms in Europe and East Asia.

The United States faces two tempting responses to the current tensions, each of which would be a mistake. One is to resurrect the mid-1990s proposal for a transatlantic free trade area (TAFTA) between the United States and the EU. TAFTA would erect new trade discrimination against East Asia and thus assure the acceleration of both its regional integration and its anti-Western orientation. In addition, TAFTA would discriminate against all developing countries -- "the richest ganging up on the poorest" -- and would end any prospect of their constructive participation in the WTO and other global institutions.

The second bad idea is for the United States to pursue the FTAA without simultaneously working toward a new round of multilateral negotiations at the WTO. The new Bush administration has indicated interest in the FTAA and will have an early opportunity to pursue it at the third Summit of the Americas in Quebec in late April. Absent a parallel multilateral effort, however, such an initiative would validate the regional emphases of both Europe and Asia and spark new trade discrimination.

Although President Bush will not have enough time to obtain fast-track negotiating authority before going to Quebec, he must work out enough congressional support to provide credibility for any pledges he makes at the hemispheric summit. While doing so, he could also seek congressional blessing for a broad-based initiative in the WTO to get the multilateral process back on track. Such an initiative would ideally move toward global free trade in which all regional trade preferences would be eliminated. The United States could then begin working with Europe and Asia to launch a new round at the WTO ministerial conference later this year, while still proceeding with inter-American integration at Quebec. To buy time for this strategy to be implemented, the United States and the EU should broaden their "peace clause" on agriculture by declaring a three-year freeze on all retaliatory actions and complaints in additional sectors.

A useful adjunct to this strategy of renewed multilateralism would be cross-regional free trade agreements (CRFTAS) that cut across East Asia, Europe, and the Americas. Such pacts are already being pursued at the bilateral level, such as the U.S.-Singapore and Japan-Mexico initiatives, and at the super-regional level, as with APEC and the EU-Mercosur talks. Although these arrangements still create new discrimination and potential trade conflict and are thus decidedly inferior to multilateral liberalization, they could nevertheless dilute the regional groupings that may otherwise solidify into rigid blocs. Thus CRFTAS represent a useful addition to renewed multilateral efforts, or at least a second-best fallback if that preferred course turns out to be unobtainable in the near term.

A renewal of multilateral efforts is also required on the financial side. The IMF has already made significant policy changes but must now take additional steps to buttress its ability to prevent and quickly respond to crises. The main institutional change needed at the IMF is to accord East Asia more voting shares and leadership assignments to account for its greatly increased economic weight -- mostly at the expense of Europe, which is overrepresented. The IMF also needs to address the costly instability and prolonged misalignments among the dollar, the EURO, and the yen, which contribute to the need felt by the Asians to create their own monetary zone.

The success of these remedies rests on the ability of the United States to overcome its crippling domestic resistance to globalization. This will be a difficult task for the new administration, but the potential threats to U.S. economic prosperity, its international leadership, and global stability should be enough to convince both the White House and Congress to agree on a new approach to the international economy.

This agreement should rest on several key elements. It must start from a clear consensus that globalization brings substantial net benefits to the American economy, including intensified competition that holds down inflation and thus permits the creation of millions of additional jobs. At the same time, Washington must acknowledge that globalization causes job and income losses in certain sectors, which exact significant psychological tolls. The government, therefore, has a responsibility to channel help from the winners to the losers, for humanitarian and equity reasons as well as to maintain political support for continued globalization efforts.

To fulfill that obligation, the country must adopt stronger safety nets, including more generous unemployment insurance eligibility criteria and compensation levels, portable health insurance and pensions, and perhaps a new program of wage insurance. Even more important, government and business leaders need to work together to provide better education and training programs to enable all Americans to benefit from globalization rather than feel victimized by it.

At the international level, the White House and Congress need to reassert American leadership in negotiating new agreements on both trade and finance, as described above, that will place the current conflicts into a broader global and strategic context. These agreements should, among other things, promote international labor and environmental standards that will avoid distorting either global competition or normal trade flows.

If Washington does not adopt such a strategy early on, the current situation could become much worse. The U.S. economy has slowed sharply, the unemployment rate will soon rise, and the annual trade deficit is approaching $500 billion (about five percent of GDP). Blame for such economic troubles will inevitably focus on foreign competition -- especially if European and Asian countries raise new barriers against U.S. exports. Washington will feel intense pressure to retaliate against Europe and to thwart the rise of even tougher rivals in East Asia. It will also be tempted to adopt new unilateralist measures, such as withdrawal from international monetary cooperation and multilateral trade efforts.

Both the prospective global slowdown and any such U.S. reactions to it could accelerate the current trends in Europe and Asia. Tougher economic times will make it harder for Europe to resist its own protectionists, especially as French elections approach in 2002. Economic troubles will prod East Asians to speed their integration plans, as their financial crisis has already done. Any new protectionist or unilateralist steps taken by the United States would trigger parallel responses elsewhere. And any significant American slowdown would further embolden the Europeans and the Asians to overcome their humiliations over the initial fall of the EURO and the shattering of the "economic miracle," respectively, and go their own ways.

This potential two-front economic conflict could severely threaten international prosperity and even global security. Restoration of both an effective global economic order and renewed U.S. leadership should be a top priority for the new administration and Congress.