The EU system shoots itself in the foot when it levels trade defence measures against low-cost competitors, warns Henrik Isakson of the Swedish National Board of Trade. He argues that European companies lose more than they gain from protectionism
Defending the European economy against unfair international trade practices has long been a key element of EU external policies. It is almost an instinct among some politicians and business leaders that if competition is deemed unfair the European Commission should be asked to marshal new trade defences. Yet, the concept of trade defences is problematic in today’s globalised economy. What are we defending ourselves against, and more fundamentally, what are “unfair” trade practices?
Let’s start with trade defences. In the unfortunate absence of international competition regulations to prevent abuse of dominant market positions like predatory pricing and other anti-competitive activities, trade defences are a second-best option. Defence measures usually take the form of a temporary tariff and are normally supposed to correct a distorted import price and raise it so that the European producers do not have to compete against under-priced (dumped or subsidised) products. By far the most widely used instrument is an anti-dumping duty to impose some restraint on companies behaving in an anti-competitive way. Unfortunately, this comes at a price. By increasing tariffs, it is a measure that also raises prices for consumer durables and other input goods imported for European industry, which often means a welfare loss for society as a whole. This has long been known, but of course is ignored by those interests in Europe seeking trade defence.
Today, though, there is a new reality that increases the economic risk of opting for trade defences. The very word “defence” creates an image of a nation state, that is commercially connected to the rest of the world only via traditional trade. For such a state, all imports would truly be foreign goods, so that its trade defences would consequently be directed only against foreign interests. In today’s globalised world that can hardly be the case. Although we still have traditional trade, we also have foreign direct investments, off-shoring and outsourcing. We have global supply lines in which goods are developed in one country, manufactured in another and assembled in a third. Capital and know-how flows across borders, so traditional bi-lateral trade patterns have been replaced by a complex new web of international commercial relations.
This clearly has major implications for the whole concept of trade defence. If one wants to defend oneself, then one must have a clearly defined adversary to defend oneself against. This is generally no longer the case. If you have a mobile phone, assembled in India, but developed and designed in Finland, is it an Indian or a Finnish product? When European corporations outsource manufacturing that is labour-intensive to low-cost countries but keep the rest of the production process in Europe, they are greatly complicating matters for anyone trying to evaluate the economics of trade defence.
Using trade defence in a globalised world is risky; the sheer complexity of the globalised economy makes it uncertain who a measure will actually hit. To aim an anti-dumping measure against an Asian manufacturer may instead inflict most of the damage on a European producer. That to some extent happened in the October 2006 anti-dumping action against leather shoes, when the EU decided to impose anti-dumping tariffs against China and Vietnam. Sweden’s National Board of Trade conducted a case study of five European shoe producers in different countries and market segments to establish where the value added in their production processes is created. Examples from high quality fashion shoe producers in Italy and Spain, showed that things are not always what they seem, and are seldom as simple as they used to be. Although manufactured in China and Vietnam, the shoes were designed, developed and marketed in Europe and these largely intangible production processes before and after the physical manufacturing constituted 80% of the value added. In other words, shoes from China were 80% European! For less expensive shoes, with lower sums invested in the intangible parts of the production process, this figure was not as high, but is still more than 50%. The anti-dumping measures imposed by the EU therefore hit European companies hard.
One might perhaps argue that this was only one case study involving a few companies in one particular sector. Yet there is every reason to believe that these figures apply equally to other companies in other sectors, because the main reason that manufacturing is relocated to low-cost countries is precisely because costs are low, so the part of production that is physical manufacturing is often only a small part of the total value added.
If we turn to sectors with a higher human capital content, electronic consumer goods, for instance, they have much higher R&D costs than the shoe sector, so manufacturing these goods on an assembly line in a low-cost country is probably not very costly in comparison to R&D and other intangible costs. For more advanced goods, the EU value added (if the intangible part of the whole process of production is in Europe) is quite high. Imposing trade defence against such goods, even if legally warranted, is clearly likely to create problems for the globalised European industry.
Many would say that these problems are the price to pay for ensuring that companies do not engage in anti-competitive behaviour, or receive trade distorting subsidies. But the majority of trade defence measures are probably not directed against anti-competitive business practices, at least not in the sense of EU competition law. More often it is the politics of protectionism that are the crucial factor behind trade defences. Anti-dumping measures are frequently used against products that are simply so cheap that they pose a threat to European producers, even though that is no more than fair competition.
This raises another, more fundamental criticism of the way Europe’s trade defence mechanisms are misused. That is when they are resorted to even out natural comparative advantages, that a competitor may enjoy. International trade is by definition a competition between companies on an uneven playing field. Some companies, for example, have easier access to capital, whereas their competitors cannot get access to finance at reasonable rates of interest. Some have excellent infrastructure at their disposal, while their international competitors may have to contend with constant power cuts. Some companies have to pay excessive taxes, others operate out of tax havens. Some find it easy to recruit top notch engineers, whereas for others the abundance is cheap labour.
These problems and opportunities have much to do with where in the world companies operate. Are they based in Europe, in a developed country or in an emerging market in Asia, or perhaps one of the least developed countries in Africa? The legal and economic framework a company operates within sets the conditions for which it is able to compete in the world market, and is an essential part of the comparative advantages all trade is based on.
To create a completely level playing field is impossible and nobody advocates it. Many politicians and business leaders are nevertheless keen to focus on some of the differences they don’t like, from their particular point of view, that they would like to see levelled out. They therefore focus on the differences that they find most troublesome, and nowadays they often find that the playing field is tilted in favour of China. They complain the Chinese have all the “unfair” advantages. Yet from a developing country’s perspective European companies have so many other advantages, notably superior technology.
The bottom line is that the EU really should not, under the guise of countering unfair trading practices, restrict competitors from exploiting natural comparative advantages just because we cannot compete with them. When we do so we have to accept increased prices and thus lower welfare. And what will happen when our trade partners seek to even out our own comparative advantages? More and more countries around the world are already equipping themselves with anti-dumping laws, and that is an ominous sign. European companies could yet find it harder to get market access overseas, and then a vicious circle of protectionism would develop.