Posted on 23-6-2003

When two tribes go to war
by Faisal Islam, Sunday June 22, 2003, The Observer

As is the fashion with real wars these days, there was no formal declaration of this 'economic war'. But in the eyes of a senior member of the French cabinet, it came in an unprecedented American snub to last week's Paris Air Show. It was just the latest front of a transatlantic trade battle. Top executives from Boeing and Lockheed Martin boycotted the prestigious show after the US military greatly scaled down its presence at the biennial event. Just another move in this intricate game of snub, spin and sideline.

'The American defence secretary believes the US is the only military, economic and financial power in the world. We do not share this vision,' defence minister Michele Alliot-Marie told Le Monde, calling on European defence firms to combat 'American industrialists pursuing a logic of economic war'.

She will soon issue a report questioning the influence of US shareholders over European defence companies. In a mirror image of these moves, US legislators are attempting to put a de facto bar on the award of military contracts to foreign transport firms.

But the skirmish over defence is only the latest development of a bad month for US-European trade relations. First, the EU acquired the right to issue $4 billion of trade sanctions by the World Trade Organisation in response to a long-running dispute over US tax subsidies to exporters through Foreign Sales Corporation (FSC) measures.

A week later, the US took its dispute over an EU ban on imports of genetically modified foods to the WTO.

American aviation companies were left smarting after suggestions that Airbus blackballed a $2.8bn US bid to supply engines for the Europrop plane, thereby allowing the European consortium to re-tender with a lower bid. President Bush is being lobbied to issue retaliatory sanctions if international trade laws have been broken.

Last week, the EU referred the US back to the WTO over measures that stop products being sold below cost price, known as antidumping duties. And then there are large-scale disputes looming over US steel tariffs and Europe's agricultural subsidies.

Throw in the fact that many in Europe believe that the US has unleashed the weapon of mass devaluation - a falling dollar - on the world economy and there's a whiff of the 1930s. Of beggar-thy-neighbour devaluations. Of disastrous Smoot-Hawley tariffs. Of the globalisation process tripping up and the dreaded deflationary spiral.

'We haven't been here before; the probability of a catastrophe has increased markedly,' says Alan Winters, a leading trade economist from Sussex University. 'When the sympathy disappears from international trade talks then out come these weapons. I'd have no doubt that if the Americans push hard on GM, the EU will push right back over FSC. It's close to that really nasty scenario.'

Both parties can resort to a 'nuclear' option. The EU's weapon - its $4bn list of WTO-approved sanctions to compensate for the FSC - is loaded and ready to fire at will. The US arsenal - similar 'counter-measures' to compensate for Europe's GM ban - is being prepared.

Fear of mutually assured destruction will prevent either side firing, it is said. But there are signs that the nuclear analogy is not quite on the money. The truth is that both sides are developing their alternatives to genuine multilateralism. If the impasse continues, both have fallback options based on regionalist free trade areas.

Jagdish Bhagwati, the Columbia University economist considered high priest of free trade, has long argued that soundbite-loving politicians attach too much weight to the first two words of the phrase 'free trade area'. He says: 'These blocs do not mean free trade.'

But the US has, in the words of Robert Zoellick, the US trade representative, been pursuing a policy of 'competition in liberalisation' of trade. It has been striking deals bilaterally and regionally as well as through the multilateral WTO framework. Recently, special free trade deals have been signed with Singapore and Chile. This weekend, the US is pushing proposals for a free trade area, linked to the US, in the Middle East. These sweetheart agreements with favoured nations are a threat to more generalised free trade.

'It could end up with little happening in Geneva and the world carved up into regional blocs and overlapping agreements that encourage firms to invest for legalistic reasons rather than specialising based on comparative advantage,' says Philippe Legrain, a former special adviser at the WTO.

A much bigger game is being played out by the US negotiators. The menu of different side deals offers the US enhanced leverage over Europe. Zoellick believes that it was the establishment of North American and Asia-Pacific free trade areas in 1994 that forced Europe to close the Uruguay Round of trade talks, although that is disputed in Europe.

Europe, too, has been puffing up its regional base, either through expansion to eastern Europe, or through preferential trade treatment around the Mediterranean rim.

'Each of the two sides is now building up its own bloc with regional client states. Regionalism could undermine the multilateral system,' says Winters.

The military analogy stretches to the manner in which the US has attempted to 'internationalise' its dispute over GM. Australia and Argentina were brought on board for its attack on Europe's attitude to GM.

Legrain believes that the US attitude to the GM dispute is merely a warning shot to other would-be biotechphobes. Even if Europe opened the gates to GM foods, our consumers would not buy them. In turn, Europe's attitude to the FSC, a complaint that was hardly a cause célèbre of Europe's hard-pressed businessmen, is commonly assumed to be no more than a negotiating position.

But the disputes have come much further than many expected. There are moves in the US Congress to redraft the US tax code to make it compliant with the WTO. And the EU is in the throes of reviewing its moratorium on GM food. But goodwill is in short supply. And the EU-US spat promises to scupper September's crucial trade talks in Cancun, Mexico - which were tricky enough even before the trade difficulties.

'It is possible that the EU and US will be so absorbed by their own fight that Cancun just withers amid deep running frictions,' says Winters. 'We've moved into much more dangerous waters. The Americans have to realise that backing the French right into a corner will not work, because they'll walk.'

Ultimately, trade talks have been an expression of politics. It has worked within Europe, because it was seen as a route to help prevent France and Germany warring with each other.

'In the current disputes, we appear to be heading in the other direction. The GM dispute threatens to reinforce and institutionalise where they are already going on the politics,' says Winters.

The key question is whether a Europe emboldened by its increasingly popular currency, and an imminent eastward expansion, feels it can credibly fall back on its regional strength. Or perhaps the US will call Europe's bluff, and bank on the likes of Britain and Spain creating enough internal discord for the Continent to back down. Chancellor Gordon Brown, for example, has been pushing for free trade between the US and the EU, claiming that they would gain by £46bn and £72bn a year, respectively.

That ideal has never seemed further away. Just stopping each continent adding to their existing tariffs seems challenging enough.

Currencies: spectre of devaluation

It has been called the weapon of mass deflation by European wags. However, the apparent ditching of the US 'strong dollar' policy has got the continent's exporters concerned about competitiveness.

A stronger euro is also pushing down inflation - ordinarily considered a good thing. In the German context, however, even lower inflation means a serious risk of a deflationary spiral. As Japan has intervened to keep the yen down, most of the upward pressure has been felt by the euro - up 20 per cent in less than a year.

There is a real risk that, in a time of sluggish growth, major trading nations all revert to the same tactic. Last year, Morgan Stanley's chief economist, Stephen Roach, predicted as much. 'It's times like this that bring out the worst in xenophobic policies. Just the mere suggestion of reflating through currency depreciation conjures up the perils of competitive currency devaluation,' he said.

And in the past, competitive devaluations have gone hand in hand with increased protectionism and then depression. The clear hope is that existing economic co-operation mechanisms, such as the G7 meetings, will be enough to avoid a beggar-thy-neighbour free-for-all.

So far, the danger has not materialised. The strong euro has given the ECB room to cut rates by 0.5 per cent, and it has stabilised at around $1.17. The danger will come if the dollar slump resumes.

Agriculture: GM deadlock

Pascal Lamy, Europe's top trade negotiator, dismissed the US move on genetically modified food as 'pointless' at Friday's World Trade Organisation ministerial meeting in Egypt.

Talks between the US and EU broke off on Thursday in Geneva, and US officials said that they would soon request the WTO to convene a panel to hear the case. The US says the WTO should order the EU to end the moratorium on the ground that it is an unfair trade barrier.

Europe imposed a moratorium on the farming and import of biotech foods and grains in 1998 because of a tide of public concern about 'Frankenfoods'. But EU officials recently have been working on a system that would allow them to label genetically engineered food so that European customers can choose whether or not to buy it. Britain is believed to be helping to dilute the provision to bridge the gap with the US.

Biotech crops have been widely grown in the United States for years, including corn and soybeans genetically modified to resist insects or disease. US exporters say the ban has stopped $300m in sales of corn alone. And US officials claim that the EU ban has led to copycat actions in the developing world, which help to 'starve' poor countries by limiting the use of high-yield seeds.

This claim has caused fury among European negotiators.

Defence: tough talkingFor Boeing, Lockheed Martin and Northrop Grumman, there were too few major customers attending the Paris Air Show to generate any benefit. Their message was clear: we're interested in making money.

Meanwhile, across the Atlantic some US politicians are doing their best to embarrass the US defence behemoths, the Pentagon, State Department and the White House.

There are two key examples, both relating to the opening up of the notoriously difficult US defence market to foreign companies.

The first is an amendment to the Defence Authorisation Bill, which is currently navigating Congress. Tabled in the house of Representatives by Californian Republican Duncan Hunter, it calls for a list of 'critical items' in military systems to be supplied only by US companies.

The proposal has been attacked by the White House, the US Aviation Industry Association and individual companies. It would jeopardise 'interoperability' between American forces and their allies and major projects such as the F-35 Joint Strike Fighter, which relies on collaboration with a host of non-US companies. A source at Lockheed Martin, the F-35 prime contractor, said: 'This is clearly not helpful for anybody.' LM executives in Paris repeated this to defence procurement Minister Lord Bach, who is campaigning for better access for the US's 'ally in chief', the UK, adding that 'there was no chance' of it going through.

However, the UK industry is very nervous. Defence expert Dr Alexandra Ashbourne says they have reason to be. 'You have the White House, Pentagon and State Department in agreement on liberalisation, which is unusual. But the damage is in obstruction, and Congress can continue to obstruct this process.'

This is true of the other area - arcane rules governing the transfer of technology across national borders in collaborative projects, known as Itar, which governs some 9,000 restricted items.

The UK in particular has been putting pressure on the US defence procurement head Peter Aldrich to lift Itar on non-classified aspects of projects. 'It is an irritant, and hampers our ability to operate effectively,' says Professor Keith Haywood of the Society of British Aerospace Companies.

But while the White House and the industry is lined up behind reform, Congressman Henry Hyde has organised the House International relations Committee (which he chairs) to reject proposals for Itar waivers for America's allies, writing to Colin Powell arguing that the US needed to maintain a 'stringent system of control'.