Risk Management in Transatlantic Trade: A U.S. Perspective
“Risk” and “risk management” are not normally words applied to transatlantic trade. In general, observers assume trade is mutually beneficial, and that the benefits outweigh any costs.
Of course, life is not so simple: even in mutually beneficial interactions, there are possible downside effects, or “risks,” where the amount of risk faced is a product of the hazard (downside effect) and the probability of that effect occurring.
In that sense, however, “risk” is again an inappropriate term: although trade is always beneficial in the aggregate, some individuals are certain to be at least relatively worse off. This is not a “risk,” but an inevitability that comes with any economic growth, including that generated through trade.
The analysis that follows will therefore focus on two more narrowly defined areas of a government’s role in managing risk within transatlantic trade policy:
- the risks posed to the consumer, environment, and investors in products or services supplied from the transatlantic trading partner; and
- those posed to politicians and governments in considering embarking on an ambitious but realistic comprehensive program to liberalize transatlantic trade and investment
Managing Product and Service Risks in Transatlantic Trade
The Theoretical Level
The primary role of governments in modern societies is to protect their citizens—from foreign aggression, of course, but also from abusive labor practices, unhealthy environments, and unsafe products and services.
This last is the only relevant aspect when it comes to trade, that is, the export and import of goods and services across borders. And here, the focus is specifically on the level of safety demanded of goods and services on the market to reduce the likelihood of harm from hazards to consumer safety, to investors (in the case of financial services), or to the environment, whether the goods and services are locally produced (domestic trade) or imported from a foreign jurisdiction (international trade).
A government strives for a certain level of safety through legislation/regulation of goods and services available to its consumers and the implementation/enforcement of these measures by regulatory bodies. The level of regulation of goods and services chosen in a country reflects the risk preferences of the government of that country. In countries with little or no input from civil society, the preference level will reflect that of government officials; in an autocratic dictatorship, the preference of the ruler. In democratic societies, however, with a transparent and rules-based approach to governance, the risk preferences of the government will in general reflect the risk preferences of the voters as expressed in elections.
Reducing risk, or the likelihood of a negative effect, costs money. Ideally, the cost of reducing risk will be less than the benefits of so doing. In a democratic society, the level of risk accepted by the polity at large will therefore tend to be a function of income—the lower the level of income and wealth in a country, the more risk citizens will accept in exchange for less regulation and more growth. Alternatively, the higher the level of income and wealth, the less important the additional costs of risk mitigation and the greater the level of protection demanded. This is a wholly domestic affair—governments will regulate to the risk preference demanded even in the absence of imports from another jurisdiction.
Indeed, in many ways, the role of governmental regulatory bodies is to stop trade; their job is to prevent unsafe products and services, whether produced at home or abroad, from being placed on the market. They are almost by definition in apposition to the producers, and inward looking.
The Transatlantic Context
The United States and the European Union are the world’s largest economies, each producing about $15 trillion in goods and services each year. They are also one another’s largest trading partners, with two-way trade of goods and services approaching $1 trillion annually.
Despite the depth and breadth of this commercial relationship, differences in regulation are overwhelmingly cited as the primary obstacle to trade between them. The most exhaustive study of this problem, of non-tariff barriers to trade between the United States and the EU in twenty-three different sectors, by the Dutch economic think tank ECORYS for the EU Commission, estimates that removing half of the divergences between the two economies would lead to GDP increases between them of over $200 billion per year, with exports increasing substantially in both.
This is interesting because, as democratic societies with comparable levels of income and wealth and transparent regulatory systems, the United States and the European Union in general have identified the same sorts of goods and services as posing risks to their populace, and strive for the same level of safety in those areas—that is, their regulatory objectives and outcomes are generally similar.
This general observation is based on both impressions and empirical studies. Impressionistically, over 25 million people travel each way between the United States and Europe each year, staying in hotels, eagerly eating local foods, renting cars, buying products and otherwise engaging in daily activities; they do not seem to perceive any difference in the level of safety provided. More academically, a 2010 study published by Resources for the Future, based on 20 case studies and 3,000 observations of risk-reducing regulatory decisions in the U.S. and EU, found that overall risk stringency is about the same, with the differences largely due to non-safety related issues.
Assessing and Managing Transatlantic Trade Risks
Largely unnecessary regulatory divergences thus inhibit closer U.S.-EU trade relations. As noted, the main reason for these unnecessary divergences is that U.S. and EU regulators, like all regulators, are largely inward-looking and have little desire, time, or need to be aware of what their international counterparts do.
Efforts to address these differences began with the Joint Statement on Regulatory Cooperation at the end of 1997, followed a year later by the “Agreement on Mutual Recognition Between the European Community and the United States of America.” These first agreements, however, were limited in scope, applying only to recognition of certain laboratories being able to test whether locally-produced products in six sectors met the regulatory requirements of the other party. More substantive cooperation began to take off with the first U.S.-EU “Regulatory Cooperation Roadmap” in 2002, which was successively expanded from six sectors to about sixteen over the next three years, when the U.S.-EU High Level Regulatory Cooperation Forum (HLRCF) was established to promote “best practices” in such cooperation. By 2007, when the Transatlantic Economic Council (TEC) was founded, transatlantic regulatory cooperation was booming. For example, at that time the Food and Drug Administration (FDA) informally estimated that its officers were having over 1,000 substantive contacts a year with their European counterparts in DG SANCO, the European Medicines Agency (EMEA) the European Food Safety Authority (EFSA).
This growing cooperation has had a number of significant results, both broadly, as with the 2008 report comparing U.S. and EU approaches to import safety, and in individual sectors, from the November 2007 FDA/EMEA decision to accept a single application for orphan drugs, to the 2008 U.S. Securities and Exchange Commission’s (SEC) decision to accept the EU’s International Accounting Standards as equivalent for U.S. capital markets purposes, to extensive work on regulation and standards related to electric vehicles. In 2012, the two governments began to undertake even more ambitious agreements, including mutual recognition of their respective approaches to organic produce and to container and air cargo supply chain security systems.
A New Approach to Transatlantic Regulatory Cooperation
These last agreements reflect a new method to manage risk in transatlantic trade—recognition that the overall approaches of the U.S. and EU counterpart regulators of a set of goods or services are functionally equivalent and thus compatible, in the sense that a product or service sold in one market can be made available for purchase in the other.
This approach was initially spelled out in a May 2011 study by John Morrall, a former ranking official in the U.S. Office of Management and Budget’s Office of Regulatory Information and Analysis (OIRA), for the U.S. Chamber of Commerce. In Annex 1, he describes how this process could take place, starting with a detailed study to compare the objectives and outcomes of regulatory decisions in a sector. Where it can be demonstrated those decisions are functionally equivalent, the regulators—in consultation with their political oversight bodies—would enter into an agreement to accept the other side’s product or service determinations, retaining, however, the right to reject a determination in individual instances. Where for some reason the trust and confidence on which such an agreement must be based were lost, one side would be able to immediately suspend the agreement, and terminate it within a short period of time, if necessary. The Morrall study identified the auto, pharmaceutical, chemical, and financial sectors as the best and most important candidates for initially trying to achieve such agreements.
Such an approach—long called for in more general terms by the Transatlantic Business Dialogue and the Transatlantic Policy Network—is now more possible for a number of reasons. The first is that the overall U.S. and EU approaches to regulation have evolved significantly and converged around best practices in the fifteen years since the initial Joint Statement. A second is the history of regulator to regulator cooperation accumulated since that time. The third, and potentially most important, is the absolute and relative increase in the imports U.S. and EU regulators now face, as well as the change in direction of trade, where goods and services increasingly come from third, less well-known, jurisdictions. And the final, and most urgent, concern is that regulators have come under increasing budgetary pressure. If they are to do their jobs, they cannot afford to devote increasingly scarce enforcement resources to low-risk jurisdictions. That is, the regulators themselves have reason to enter into such arrangements with their transatlantic counterparts to improve their efficiency, and thus their effectiveness in accomplishing the task set for them by their political overseers.
In recent submissions to the Office of the U.S. Trade Representative and to the EU Directorate-General for Trade, the U.S. Chamber and BusinessEurope jointly called for this approach to be explored more decisively as part of an ambitious trade and investment agreement between the two parties. They noted that establishing the trust and confidence between counterpart regulators would take time, and that this process could be facilitated and overseen by the High Level Regulatory Cooperation Forum and the Transatlantic Economic Council, with individual sectoral arrangements adopted even after the overall agreement was concluded. This “road map” approach harkens back to those concluded between the U.S. and EU between 2002 and 2007, and echoes those in the U.S. Regulatory Cooperation Councils with Canada and Mexico, although those agreements are not as ambitious as the “compatible regimes” approach described here.
Managing the “Risks” of a Broader Transatlantic Trade Agreement
Facing a possible double dip recession in late 2011, Presidents Barack Obama, José Manuel Barroso, and Hermann Van Rompuy at their November summit in Washington, D.C. called on the TEC to establish a High Level Working Group under U.S. Trade Representative Ron Kirk and EU Trade Commissioner Karel De Gucht to “explore all options” for using the transatlantic economic relationship to generate jobs and growth. This HLWG, welcomed by business and other stakeholders on both sides of the Atlantic, has been working hard to prepare an interim report by the end of June, with an eye to finalizing recommendations by December 2012.
The benefits of such an agreement are well-established: an October 2010 econometric analysis by the European Centre for International Political Economy estimates that eliminating tariffs alone would expand GDP in the two economies by some $160 billion, as trade levels leap 17% above what they otherwise would have been. Additional steps to liberalize trade in goods and services, investment, government procurement, and regulatory cooperation would expand those gains significantly.
The interesting question is why the two governments do not act more quickly if the gains are so clear; that is, what costs do they fear, what is the probability those hazards will obtain (the risk), and how can that risk be managed to improve transatlantic trade.
The sources of hazard to a bilateral trade agreement between the world’s two largest economies are basically three: fear of undermining the WTO or the WTO’s “Doha Round” of multilateral trade liberalization; economic dislocations in their own economies; and related political sensitivities.
The WTO: Previous recommendations for a bilateral U.S.-EU free trade agreement foundered primarily on considerations related to the WTO and on-going negotiations, whether the Uruguay or the Doha Round. There was long a sense that the two stalwarts of the multilateral rules-based trading system should not do something bilaterally. That sense has diminished, not least as the logic cannot hold up when the U.S. and EU are negotiating bilateral trade deals with almost all other prospective partners, and when the Doha negotiations have stalled, due largely to the fears of other developing countries about opening their markets further to China.
Economic Dislocations: All policy measures that affect growth in an economy entail some relative winners and losers. These considerations appear even more sensitive in the area of trade, where forces outside a country are perceived as the source of the dislocations. The trick in either case is to ensure the beneficiaries are more numerous, and that measures are in place to help the losers adapt to changed relative circumstances.
In the case of a U.S.-EU trade agreement, however, the feared dislocations are likely to be fewer for a number of reasons. The U.S. and EU are deeply integrated not just through trade, but through investment, where U.S. firms have invested more than $1.9 trillion into Europe and European firms have put over $1.5 trillion of direct investment in the United States. This has two major consequences: well over a third of total transatlantic trade is intra-corporate and intra-industry, and thus reducing barriers to trade between the two will significantly increase the overall global competitiveness of these firms, especially relative to those of third countries.
Interestingly, these gains are likely even in such “sensitive” sectors as shoes and apparel. In the United States, for instance, well over 95% of these products are imported, yet the sectors employ over four million people in occupations running from design to marketing to sales, with a median salary of approximately $70,000. With U.S. and EU brands both seen as providing top quality, synergies are likely.
Political Sensitivities: Perhaps because of this, many of the traditional domestic political sensitivities to trade agreements do not obtain with a U.S.-EU trade agreement. The AFL-CIO, for instance, has voiced support for an ambitious transatlantic trade initiative. And neither Americans nor Europeans can seriously complain about the absence of environmental regulation, or other forms of “social dumping,” in the other. This may be why almost all European leaders have called for an ambitious transatlantic trade agreement.
This sentiment does not appear to be shared by the Obama administration — at least not yet. The President and his advisors have shied away from endorsing a possible trade agreement, in particular pointing to their concern that the EU may not be ready to liberalize in some key agricultural products, primarily beef, pork, and poultry, where the EU has bans on the use of hormones and pathogen reduction treatments. (Top Administration officials say they have decided not to tackle the European “religion” on genetically-modified agricultural products.) The U.S. is a significant exporter of these products, but not to the EU, where importation is virtually prohibited by sanitary and phyto-sanitary (SPS) food safety requirements. On the other hand, agricultural trade is a tiny portion of U.S.-EU actual and potential trade, and the number of people involved in U.S. agricultural production is even smaller. The economic costs here cannot possibly outweigh the economic benefits of a comprehensive agreement to the broader economy. Politically, however, agricultural producers come from numerous states where Senate races in 2012 are important.
Managing the Risks: The approach to regulatory cooperation outlined in Part I above can be used to manage even this political risk emanating from a possible U.S.-EU trade agreement.
As conceived by the two major business proponents of an agreement, an ambitious yet realistic approach to comprehensive transatlantic trade and investment liberalization would have five parts: provisions governing the trade in goods (elimination of tariffs, rules of origin, customs facilitation), trade in services (movement of consumers and providers, internet provision of services), investment (removal of most barriers to establishment in all sectors, protections, dispute settlement), procurement, and regulatory cooperation. The last would establish as an objective that transatlantic regulatory counterparts in individual sectors should strive to build the trust and confidence necessary to agree—in consultation with their political oversight bodies— that their approaches are functionally equivalent and thus compatible, allowing each to accept the product or service safety determinations of the other such that products available in one market may be sold in the other. This would take time, depending on the extent of the relationship between those counterpart regulators, whether they’re responsible for food safety, product safety, or the qualification of service providers.
With such a framework, agricultural producers would be treated exactly like their manufactured goods counterparts—tariff barriers at the border would be removed (although probably over longer transition periods for many agricultural products), while non-tariff regulatory differences would take longer to eliminate. Ironically, this process could potentially be accelerated for food products, as the United States and European Union already have a Veterinary Equivalence Agreement. The TEC co-chairs could (and indeed should) ask the co-chairs of the VEA Joint Management Committee to begin working earnestly to resolve these issues now (and some key ones are under consideration now).
This approach to managing the political risks to the administration posed by the farm sector (as opposed to the virtually non-existent food safety risks) would not only spur transatlantic cooperation on regulatory issues, but would provide an opportunity to finally move toward an integrated transatlantic market, with all the benefits that would bring. Alas, there remains a risk that it will not be realized in 2012, although we can all continue pressing for it.