The Transatlantic Economic Partnership: Current Trends & Prospects

Dario Zuddu

The economic relationship between the US and the EU has proven firm enough to overweigh transatlantic tensions over Iraq.

The EU and the US are one another's main trading partners and account for the largest bilateral trade relationship in the world. They are also the largest players in global trade.

The EU and the US both account for around one fifth of each other's bilateral trade, a matter of €1 billion ($1.2 bn - Ed.) a day. In 2003, exports of EU goods to the US amounted to € 226 billion (25.8% of total EU exports), while imports from the US amounted to € 157.2 billion (16.8 % of total EU im­ ports).

The investment links are even more substantial. The EU and the US are each other's largest trade and investment partner. The total amount of two-way investment amounts to over € 1.5 trillion ($1.8 tril­ lion - Ed), with each partner employing directly and indirectly about 6 million people in the other. Figure 1 shows how the stream of US investment inEurope by far and large outweighs American financial outflows to other trading areas.

The share of EU investment in the US amounted to more than 52% of EU Foreign Direct Investment over the period 1998-2001 (€ 162,663 million a year in average), while US investment in the EU amounted to more than 61% of EU FDI inflows over 1998-2001 (€72,041 million a year in average).

Our two economies are interdependent to a high degree. Close to a quarter of all US-EU trade con­sists of transactions within firms based on their in­vestments on either side of the Atlantic.

Potential and benefits of additional transatlantic integration

Nevertheless, as Daniel Hamilton and David Quinlan argue in Deep Integration: How Transatlantic Markets Are Leading Globalization, transatlantic economic inte­ gration still has enormous additional poten­tial. They point out that greater benefits could be achieved, reporting the OECD as saying that "further transatlantic liberalization could lead to permanent gains in GDP per capita on both sides of the Atlantic of 3 to V/t."

Trade in service is actually at its start. Liberalization of services is associated with a number of legal and political problems. Services are heavily regu­ lated, especially in the EU. Barriers to trade in serv­ ices remain high in the legal and accounting sector and include both foreign providers' discrimination and intra-union barriers. Important constitutional norms dealing with education and health care serv­ ices also tend to prevent a more accentuated integration.

By the same token, trade in services is the sleep­ ing giant of US-EU economic relations. The service sector accounts for the bulk of job creation in both sides of the Atlantic. A further liberalization of trade in services could result in a sharp increase of em­ ployment levels and economic growth. Hamilton and Quinlan remark the rise and the change of trans­atlantic trade in service: "Following in the footsteps of manufacturers, US and European service compa­ nies now deliver their services more through foreign affiliate sales than through trade. In the 1970s and 1980s, firms delivered services primarily via trade. In the 1990s, foreign affiliate sales became the chief mode of delivery. Sales of services by US foreign affiliates in Europe soared from $85 billion in 1994 to roughly $212 billion in 2002 - a 150% increase, well ahead of the roughly 65% rise in US service exports to Europe over the same period. US foreign affiliate sales of services in Europe - after being roughly equal to US service exports to Europe in 1992 - were nearly double the value of US service exports in 2002."

On March 2004 the European Commission elabo­ rated a Directive proposal, the so-called Services-directive. It is an ambitious project, as rather than providing for sector-by-sector liberalization, the Di­rective provides a legal framework for a general lib­eralization of services within the EU. According to a study of the Copenhagen Economics, the application of the Services Directive could result in up to new 600,000 jobs and in a rise of foreign direct investment up to 34%.

Undoubtedly, a pointed expansion of trade in services between the two sides of the Atlan­ tic, comparable to that of investment, will not take place anytime soon. Yet, not necessarily this process will meet the same problems af­ fecting the liberalization of services in the multilateral system. It is well known that within the WTO liberalization of services has faced a vehement opposition, resulting in a very cautious negotiation process. WTO member coun­ tries have so far submitted quite a limited list of services they "commit" to liberalize.

Still, in this as in many other fields, the situation of the US-EU enjoys the advantage of a consoli­ dated integration and a closer cultural understand­ ing. The schedule system, by which parties carefully select the service sectors they are willing to trade freely, is much more likely to succeed in the transat­ lantic partnership than it did in the world-trading arena.

A most immediate achievement: the coordination of technical standard in a neo-functionalist perspective

In terms of what could be done in the very short term, the harmonization of technical and safety standards between the US and the EU could result in immediate, tangible benefits. For sure, it offers the best cost-benefit performance.

Among non-tariff barriers, differences in technical and food safety standards represent a stumble stone in a further integration of US-EU economies. This issue is partly covered by WTO agreements, such as the agreement on the technical barriers to trade ( TBT), but progress in the field has been insufficient.

Many important trade disputes under the WTO settlement system, such as that about genetically modified organisms ( GMOs), concerned non tariff-barriers. Harmonization or at least coordination of technical and safety standards could not only im­ prove transatlantic trade, but also bring about addi­tional institutional integration.

Hamilton and Quinlan do not call for specific in­ stitutional changes in order to enhance US-EU eco­ nomic cooperation. They basically argue that transat­lantic trade is a firm-to-firm relationship. Foreign in­vestment accounts for the bulk of transatlantic com­ merce, rather than trade in goods, which represents less than 20% of US-EU commerce. Institutional changes, especially the expansion of the institutional framework, would be not only unnecessary, but also potentially harmful.

This doesn't mean their case may not fit a federal­ ist or functionalist goal. In particular, the harmoniza­tion of technical and safety standards would require a sort of institution, such as the Codex Alimentarius Commission for the WTO, overseeing the implemen­tation of the standard setting agreement.

This institution could assess whether a Member's measure is against the common standards or, in a fur­ ther step, formulating new technical standards by thus getting closer to an actual intergovernmental en­ tity. A step toward standards-setting could thus sig­nify a first move toward a more permanent transat­lantic forum dealing with economic integration.

The impact of the exchange rate: a G-2?

Progress in transatlantic integration requires a solid monetary foundation. The exchange rate, by affecting the relative price of goods and services, powerfully influences international trade; excessive changes in it can be disruptive to efficiency and con­ tinuity of work. As a matter of fact, the need for se­ curing the effectiveness of the EU's internal market trade was one of the driving factors behind the insti­tution of the euro. The instability of the euro-dollar exchange rates depresses the progress of the common US-EU economy; an excessive instability might ad­ versely affect the existing level of common econ­ omy.

Figure 2 displays the fluctuation of the euro against the dollar in the past year. The volatility of the exchange rate was even sharper in precedent years.

With this in mind, the Institute for International Economics (HE), in its study The Euro at Five: Ready for a Global Role, makes a case for the forma­ tion of a G-2 monetary regime, with an informal steering committee, which should manage transatlan­ tic monetary cooperation. The authors point out that the current set of G-7 meetings is inadequate to serve the above purpose and that a deeper and more stable cooperation is required.

Figure 2. December 2004-2205 €/$ exchange rate fluctuation. The graph shows the sharp instability of the dollar against the single currency.

Min=1.1667(15 Nov2005). Max= 1.3633 (2 8 Dec2004)

Source: European Central Bank

The G-7 always had this purpose, to be sure, in the very different conditions under which it was formed in the 1970s. However, the last time it was seriously refurbished by James Baker in the mid- 1980s. Monetary cooperation helped at that time in heading off trade wars between Europe, America, and Japan, but was not formalized and dropped off as the sense receded of a Japanese threat and a crisis of "America in decline". Gaps in cooperation ree- merged. The advent of the euro gives the gaps in G-7 cooperation a new and sharper poignancy; the tradi­ tional purpose of the G-7 regime requires another in­ stitutional adaptation.

The authors suggest the G-2 might set a wide range within which the euro/dollar exchange rate might fluctuate. They mention previous US-Japan understanding as an example of bilateral coopera­ tion in monetary policy. The authors go on to consider how    such     an     agreement     may prompt    further    transatlantic cooperation and stabilize the relationship between the Fed and the ECB. Central banks would be charged with man­ aging the exchange rate agree­ ment   with   proper    sterilized intervention and also jawbon­ ing   arrangements.    However, the authors remark that a closer US-EU cooperation in monetary policy would require a consolidation of the decision making process in Euroland, in particular in the field of fiscal policy, which is still subject to the unanimity rule.

The authors here seem to follow the logic of spillover, by which the institutionalization of an agreement, here on fixed euro dollar exchange rate, would boost further political cooperation. In particu­ lar, they point to a possible acceleration of the turn to majority rule within the EU, in sensitive areas such as fiscal and labor polices. In fact, the adoption of a controlled exchange rate regime, even with a very broad fluctuation range, implies a need for significant macroeconomic coordination on both sides of the Atlantic.

This proposal is particularly important as it falls within a wider debate. 1990s financial crises in South East Asia and the recent instability of a dollar unveiled the shortcomings of the current interna­tional monetary system. Authoritative economists have urged the reintroduction of a managed mone­tary system, something like a Bretton Woods II, as did the Financial Times' Martin Wolf in his piece "A Global Market Economy Needs a Global Currency."

The US and the EU may thus act as pioneers — as the "federalist nucleus" so to speak, borrowing from Streit's conceptual innovation - with the possibility of expanding a managed US-EU exchange rate mechanism to other countries.

The drawbacks of this proposal are related to the debate about fixed-flexible exchange rates. To be true , a fixed exchange rate has serious flaws as well as benefits. Past experiences like Bretton Woods it­ self showed how difficult is to coordinate a system of pegged currencies. However, the level of transat­lantic    economic    integration is far higher than in the past; so is the degree of integration of European economy, which now has, unlike in he Bretton Woods era, a common currency. The above-mentioned flexibility of a target zone is meant to avoid the difficulties of a fixed    exchange    rate.   A joint US-EU exchange rate system, flexibly harmonized rather than strictly pegged, is more needed, and more likely to be successful today, than in the past.

The sustainability of US foreign deficit: a gathering storm?

In this rosy picture, however, there are thorns. A large debate is going on about the sustainability of the US current account deficit. Americans them­ selves are as much worried about this as Europeans: Americans too have a nagging concern that their country has become too free from the traditional near-term disciplining factors. There is a community of worry; unfortunately it would not spare damage to the practical economic community if a crash land­ ing were to ensue. A community of policy disci­plines, on the other hand, could be reassuring to all parties.

Most economists agree upon that deficits are not necessarily harmful. A recent article in The Economist, not by chance, titled "In defense of defi­cits". Paradoxical as it may sound, trade deficits can be an indicator of the good shape of an economic system. That all very much depends on what the deficit is actually serving.

Developing countries such as Mexico used heav­ ily foreign borrowing to finance productive invest­ment. International capital markets provide an indis­ pensable source for countries with an insufficient banking and financial system.

Problems arise when, on the contrary, external deficits aim at financing domestic consumption, both private and from the government. In this case the external imbalance might turn unsustainable in the long term, as the economy is not producing the income which is necessary to pay off foreign bor­rowing. That actually seems to be exactly the case of the USA.

The agenda of the current US administration has resulted in a sharp increase in government expendi­ture and a significant tax cut. Beside the parenthesis of the 2001 recession, private borrowing, also nec­ essary to cover the huge US consumption, has boomed in the US. The resulting financial gap re­ quired the US heavily borrowing from abroad, espe­ cially from Japan and China. According to the Cen­ sus Bureau, "the Nation's international deficit in goods and services increased to $59.0 billion in August from $58.0 billion (revised) in July, as im­ ports increased more than exports."

Domestic industrial system does not actu­ ally help the situation, as the industrial base has faced erosion. From 2000 to 2003 jobs in the manufactu ring sector declined by almost 3 mil­ lions. The economic growth in the serv­ ice sector has thus not been followed by an adequate rise in the industrial sector. This would further deteriorate the US foreign debt, if US consumption kept running high.

All the above is the rationale of the current, end­ less debate about the US trade imbalance with China, accused of keeping the Yuan overvalued. Such a debate has received a strong political conno­ tation and has rapidly heated up. There is ground to sustain that similar disagreements might affect the transatlantic dialogue as to the US deficit with the EU.

Conclusions

Given the depth of Atlantic interdependence, it is unlikely that US deficit issues would result in a trade or currency war. Nevertheless history is not reassuring: the U.S. and Britain were always deeply interdependent, yet the dollar and sterling clashed sharply in the periods when they were comparable in power, doing tremendous damage to the world econ­ omy, particularly during the Great Depression.

The rise of the euro to a currency comparable in strength to the dollar could bring new clashes, at first almost accidental, later taking on a political coloration, with untold damage to the economies on both sides and around the world. If the euro com­peted with the dollar as a reserve currency or as the currency in use for oil transactions, serious tensions might arise.

Europe and America could head this off by or­ ganizing to coordinate their exchange rates and re­lated indicators and reserve systems more closely. European Federalists have long held that a common European currency, as an institution finally restoring European equality with America and producing a balance of power, even if in a limited sphere, should impel America to take cooperation more seri ously and enable the two continents to reach a new level of integration agree­ ments.

The advent of the euro puts this theory to the test; it becomes a matter of find­ing the political will to put theory into practice. As yet America has moved little from an undisciplined free float, Europe has prod­ ded it little, and America has been little receptive to diplomatic prodding. It is in the coming period when it will be determined whether the euro will lead to a new level of Atlantic economic integration with considerable benefits to all parties; an interme­diate mix of advances, crises, costs, conflicts, and restraints on conflict, with limited benefits and con­ strained advances; or in the worst case a reversion to what we had all thought were outlived levels of trans-Atlantic conflict, with costs to the world's economy and stability that could potentially exceed that of the Great Depression. □