Europeans Undermining Trade Negotiations

Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz professor of entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

The Obama administration would like to negotiate separate free-trade agreements with some Pacific trading partners and with the European Union. The prospects of sufficient support on Capitol Hill for the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnership are being weakened by European demands to include financial regulation in its partnership. The Europeans should drop this demand for political reasons and because it makes no sense from the perspective of making the financial system safer. (For more on current sticking points for Trans-Pacific Partnership see my Dec. 5 post.)

Trade agreements of this kind need to pass both houses of Congress. The way this has been handled in the past is first to pass what is now called trade promotion authority - it used to be known as fast-track authority - which authorizes the administration to bring a trade agreement to Congress that would be voted up or down, without amendment.

While first adopting trade promotion authority does not assure passage of a subsequently completed agreement, chances of adoption are greatly increased because the details of that agreement do not get amended in the congressional process, which would make for cumbersome rounds at the negotiating table. But for trade promotion authority to pass, enough members of Congress, including key people in leadership positions, must be confident that they will like what will be in trade agreements that have not yet been fully negotiated.

Senator Harry Reid of Nevada, the Senate majority leader, said recently that he did not support trade promotion authority, so this looks like an uphill climb for the Obama administration.

The primary goal of negotiations with the European Union is to bring about convergence on the details of product safety and similar regulation. If a seat belt is good enough for the German authorities, it should be good enough for American regulators, and vice versa. Converging on such details is not without controversy - think of genetically modified food - but still a sensible goal. Countries in the European Union have relatively high income, and American trade with them is largely within industries, so further liberalization of this kind would not be disruptive to particular sectors. The proposed agreement could create modest but sensible gains from trade on both sides. (See this primer rom the ever-helpful Congressional Research Service.)

Many officials on the American side would prefer to leave financial regulation out of partnership with the European Union, and there is strong precedent for this approach, as Jeffrey J. Schott and I explained in a recent policy brief. Financial regulation is already covered in forums including the Basel Committee for Banking Supervision, the United States-European Union Financial Markets Regulatory Dialogue and the International Organization of Securities Commissions. From my ersonal experience, I would be surprised if any week went by without some sort of substantive exchange between regulators in the United States and their European counterparts.

Nevertheless, the European Commission is determined to include financial regulation in the new partnership, and various representatives were in Washington making this case recently. Their argument is that we need to have a legally binding treaty that will commit the United States and Europe to trust each other’s rules, including on bank capital (i.e., how much equity is used to fund banks, relative to their debts) and on all the details of derivatives (including how transactions are structured and reported).

To be clear, the European Union proposal is not to negotiate financial regulation within the new partnership - they acknowledge that it is better handled in other forums - but rather to use the trade agreement as a way to enforce compliance with agreed-upon principles of cooperation.

For example, if the Europeans felt one of their financial services companies was being treated unfairly by the United States, they could bring a case through the dispute resolution mechanism of the partnership, which could then rule against the action of the Federal Reserve or other regulator on the grounds that it violated American treaty obligations.

There are three problems with this approach.

The first is that the European vision of financial services companies is very different from what has been, and what should be, the view in the United States.

Continental Europe remains deeply committed to sprawling and rather coddled universal banks, which are allowed to engage in a very wide range of investment and operational activities.

From an American perspective, banks have a big advantage because they have access to funding from the Federal Reserve and other forms of explicit and implicit downside insurance from the government. Allowing big banks to expand the range of their activities puts all others in the private sector at great disadvantage. (I am aware that Goldman Sachs is adding Danish windmills to its broad portfolio of energy and industrial assets, but this only points to the unfortunate way in which America’s established policy has broken down.)

The second problem is that Europe can hardly be said to have its financial house in order. Yes, a process of financial reform is underway in Europe, as Mr. Schott and I discuss in our paper. But where will this end up, given the current economic difficulties in Europe and the power of their “national champion” banks? It is far from clear that the United States should tie itself, by treaty, to European details to be named later (as described in a recent “road map” and a guide to what has been done.)

Third, I am in favor of a treaty that would specify exactly how global megabanks and other cross-border financial companies would be handled in the context of impending failure. In fact, discussions of cross-border “resolution,” as the jargon puts it, are largely meaningless without some sort of legal commitment.

But this should be a separate agreement that is fully aired in public. This is not likely to happen; the interests opposing it are too strong. In any case, attaching it or pretending that down the road it could be attached to a trade agreement is not at all helpful.

If the Europeans want to keep the prospects for the Transatlantic Trade and Investment Partnership alive, they should drop their proposal to include financial regulation. Their current approach threatens to undermine further support not just for the proposals but also for any trade agreement that would be covered by a potential trade promotion authority.