When trade officials from the governments of the United States and the Dominican Republic finalized a free trade agreement in March of this year and signed the agreement in August, few people would have guessed that it would begin to unravel by the end of September. In late September, the Congress of the Dominican Republic passed a 25 percent tax on soft drinks made with high-fructose corn syrup (HFCS). This was done to protect domestic sugar producers from lower-priced imports and to increase tax revenue to help convince the International Monetary Fund (IMF) to unfreeze a $600 million standby loan. There are several lessons to be learned from this debacle that will be useful as other trade agreements are negotiated in the years ahead.
The first lesson is that bad trade policy in one country can easily spread to other countries. The Dominican Republic was simply copying a Mexican 20 percent tax on soft drinks made with HFCS. The Mexican tax is part of a long simmering dispute between the United States and Mexico on restrictions on the movement of sugar from Mexico to the United States.
U.S. government trade officials often go to great lengths to avoid setting precedents in trade policy. In the world of modern communications, there are few trade policy secrets. Each trade agreement or other trade policy action taken by the U.S. government is thoroughly analyzed by third parties in search of tips on how to negotiate the next agreement or respond to the next crisis. While the U.S. government, sugar industry and HFCS industry have spent countless hours trying to hammer out an agreement with the Mexican government and industries, the Mexican HFCS tax remains as a beacon that attracts other followers.
The second lesson is that trade agreements seldom completely resolve deeply-rooted, contentious, product specific issues. Sugar is a vital part of the Dominican Republic’s economy, and that country is the largest holder of the U.S. tariff rate quota (TRQ) for sugar. They wanted a major increase in access for sugar to the U.S. market, but received an increase of only just over 5 percent. The agreement retains an existing 14-20 percent tariff on HFCS with a phase out over 15 years and a safeguard mechanism in place during the transition. No matter how this skirmish is settled, the battle will go on.
The third lesson is that trade policy in most countries, as in the United States, is simply an extension of domestic politics. In both Mexico and the Dominican Republic, the presidency is held by one party while the Congress is controlled by an opposition party. Dominican Republic President Fernandez opposed the HFCS tax, but signed the complete tax bill because he had no real alternative. Australia ran into the same problem when its Senate made a change in the pharmaceutical provisions of the Australian-U.S. free trade agreement. Trade Promotion Authority in the United States has been able to partially blunt political conflicts by allowing the President to negotiate agreements and then have an up or down vote on the package.
The fourth lesson is that trade policy cannot be separated from other economic policies. As noted earlier, the HFCS tax was added to a $500 million tax increase bill that was demanded by the IMF to balance the budget in return for unfreezing a $600 million loan that has been tied up since August of 2003. Economically poor countries like the Dominican Republic are often at the mercy of whatever demands the IMF chooses to make. The bad news is tax increases and trade restrictions have never been part of a recipe for improved economic growth.
The last, but certainly not the least, lesson is that a trade agreement cannot be allowed to be undone after the fact by conditions related to the first four lessons. The tax action by the Congress of the Dominican Republic significantly undoes a critical piece of the political and economic balancing act that led to the agreement. A trade agreement results in expectations by industries in both countries. When action by one country changes the underlying economic framework, the agreement has been fundamentally undone. The U.S. government has no choice but to reject the U.S.-Dominican Republic Free Trade Agreement until the issue is resolved.
Resolution of this type of a dispute is not easy. Keep in mind that the U.S. Congress just spent two years working out a deal to reconcile U.S. tax policy with our commitments to the WTO and only achieved a positive outcome by adding on dozens of unrelated tax and other policy measures. The disagreement with the European Union (EU) on tax policy has gone on for 30 years. And, the EU is reserving judgment on the U.S. actions until they have read all of the fine print.
Despite the complications in negotiating and implementing trade agreements, supporters of freer trade have only two options. One is to support efforts by governments officials like Trade Representative Robert Zoellick to hammer our trade agreements, warts and all. The other option is to push unilaterally toward free trade by supporting the removal of U.S. barriers without waiting for other countries to recognize the benefits of freer trade.