Five Quick Thoughts about Global Trade

The Aspen Institute Italia held its first-ever US-Italy dialog in Rome on 3 December 2018.  As part of that conversation, the director of Aspenia, Marta Dassù, asked me to make a few remarks on global trade.  Here are five quick thoughts.

First, trade policy is moving away from multilateralism and toward something that more closely resembles a web of bilateral relationships.  This is true for two very different reasons.  The most obvious is that United States (U.S.) President Donald Trump and his trade team have a clear preference for bilateral trade negotiations over multilateral forums.  This preference was clear from the outset; it has only become more prominent over time.  The other reason, however, is more long-standing. In other words, while Trump may have encouraged this movement, he did not invent it (and it would likely be taking place even if he had not arrived on the scene). The reason is that multilateral trade forums have not worked as effectively as they were supposed to work.  This is true both in terms of the big omnibus trade negotiations like the Doha Development Round but it is also true in terms of the dispute resolution mechanism at the World Trade Organization.  Clearly there are advantages to using multilateral forums and fixed institutions.  Equally clearly, however, those forums and institutions can use some improvement.  The more they fail to live up to expectations, the more likely trade policymakers at the national governments or in the European Commission will resort to bilateral negotiations.

Both of these dynamics – the preference for bilateralism in the Trump administration and the critique of multilateralism across the globe – can be found in the G-20 leaders’ declaration made in Buenos Aires.  The preference for bilateralism shows up in paragraph four, where the usual declaration about the need to organize a fight against protectionism is absent and instead the language talks about using all available policy instruments to promote ‘balanced and inclusive growth’.  The critique of multilateralism shows up in paragraph 27.  That is where the G-20 leaders make it clear that the current multilateral system ‘is currently falling short of its objectives’ and so ‘support the necessary reform of the WTO to improve its functioning.’  They promise to come back to that issue next year.  In the meantime, however, trade negotiations are continuing – many if not most of them on a bilateral basis.

The second observation is that the practice of global trade is essentially multilateral rather than bilateral in nature.  This is obviously true when you think about complex value chains and distributed manufacturing.  Just look at any complicated manufactured product closely, and you will find bits and pieces that are put together in different parts of the world, composed of raw materials extracted, refined and processed somewhere else, using energy resources that come from still further afield.  The global economy is no longer about the trade of wine and wool in that classical Ricardian sense.  But the implications are even more important when we think about complex services and the role of information and communications technology.  Sure, there was a time when it made sense for financial services provides to cluster in the same location.  There are still advantages to be had from such clustering in terms of the sharing of human capital across industries and in terms of the development of a supportive local infrastructure.  The point is that these advantages are unlikely to overcome the competing tendency of financial services providers (and services providers more generally) to respond to a host of other incentives.  To see how this works, it is only necessary to look at what is happening to the City of London in the context of Britain’s exit (Brexit) from the European Union.  No other financial capital is emerging to strip London of its pride-of-place as the centre for European finance; instead, financial services are leaking out of the City and migrating to different parts of Europe in a more diffuse pattern.

This combination of bilateral trade policy and multilateral trade practice points to a third consideration which is that the two tendencies are in obvious contradiction.  Bilateral trade policy focuses too much attention on issues at the border.  It is about tariffs and quotas, or their ‘behind the border’ equivalents in terms of purchasing commitments or voluntary export restraints.  Meanwhile, multilateral trade practice focuses attention on the problem of regulatory compatibility and regulatory convergence.  It also focuses attention on the challenges associated with supervision on the part of governments and demonstration of compliance on the part of firms.  These are all the issues that lay at the heart of the completion of Europe’s internal market in the late 1980s and early 1990s; they are also the issues that made the Doha Round of multilateral trade talks so fiendishly complicated; and they are what lay at the heart of the Transatlantic Trade and Investment Partnership and the Transpacific Partnership that the Trump administration inherited (and rejected).  The problem for the Trump administration is that these notions of regulatory convergence, cooperation, and compliance can only be tackled meaningfully in multilateral forums – which the Trump administration prefers to avoid.  Meanwhile, tariffs, quotas, and their equivalents tend to undermine the practice of trading multilaterally in goods and services.  Here again it is only necessary to look at the implications of Brexit.

A fourth thought is that this whole conversation about trade ignores the potentially more important influence of macroeconomic imbalances on the promotion of ‘balanced and inclusive growth’.  The G20 once fought hard to acknowledge the role of macroeconomic imbalances in the context of the global economic and financial crisis.  Now the summit declaration is noteworthy for the fact it makes no mention of the problem.  To see why that is a concern, it is necessary only to look at the distribution of current account positions.  For example, you can just offset the huge current account surpluses of China, Japan, and Germany, with the deficits of the United States and the United Kingdom.  That offset is something that the Trump Administration finds particularly alarming.  The question is why there is that kind of equivalence.  You could make an argument that US and UK workers are more expensive than those in China, but the reality is that China is the smallest contributor to the global imbalance: Japan’s current account surplus is roughly twice the size of China’s; Germany’s surplus is roughly twice the size of Japan’s.  Moreover, both Germany and Japan are high wage countries, not low wage countries.

Germany and Japan also have very low if not negative real rates of interest prevailing in their domestic economics; for its part, China has capital controls.  In other words, all three countries face strong incentives to maintain their export earning abroad and to export any surplus savings.  Meanwhile, the United States and the United Kingdom have open, deep, and highly liquid capital markets backed by a favourable legal environment.  These are good places to invest.  The problem is that when Germany, Japan, and China invest their export earnings in the United States and the United Kingdom, those receiving countries have to do something with all that capital they are importing.  Ultimately, their trade in goods and services with the outside world will have to accommodate the staggering inflow of capital.  The two countries will run massive current account deficits as a result.

This story about macroeconomic imbalances is important because most countries do not run current account deficits as a matter of policy; by contrast, most countries run current account surpluses as a policy choice for export-led growth.  When the do so, those export-led growth countries distort current account positions across the globe.  To absorb the combined current account surpluses of the eight countries (including the Germany, Japan, and China) that had a net balance greater than $70 billion in 2017, for example, you would have to combine the current account deficits of the twenty countries (including the United States and the United Kingdom) that had a net balance greater than $7 billion.  The club of export-led growth countries is correspondingly very small and the burdens they place on growth and development elsewhere are widely distributed.

This brings me to my fifth and final point.  Trade policy is increasingly becoming a matter of power politics more than rule of law.  Here the illustration is that ‘poison pill’ clause that was introduced as Article 32.10 of the United States, Canada, Mexico Agreement.  That clause states that any of the three signatories of the agreement must notify the other two participants if they decide to open ‘free trade’ negotiations with a non-market country.  The assumption is that the non-market country implied here is China.  The other two parties have the right to know about the negotiations and to review the final agreement.  If they do not like what the third country writes into its new ‘free trade’ agreement with the non-market country, then they can dissolve the triangular relationship created between the United States, Canada and Mexico and replace it with a bilateral relationship that cuts the third country (and its non-market ‘free trade’ agreement) out.

The language in Article 32.10 is meant to be symmetrical but the implications are not.  It is hard to imagine a situation where the United States does a deal with China and so Mexico and Canada choose to go off on their own.  It is easy to imagine how the United States would use this clause, however, to prevent either Canada or Mexico from free-lancing.  Although this is a legal arrangement, the article is really a matter of power politics.  It is also deeply ironic.  The Trump Administration steadfastly refuses to call this new agreement between the United States, Canada, and Mexico a ‘free trade’ agreement.  Doing so would make it sound too much like the NAFTA that the new ‘USCMA’ replaces.  The question is whether Canada and Mexico could use the same sort of naming convention.  By avoiding any reference to ‘free trade’ in a new agreement with China, perhaps they could escape Article 32.10 entirely.  Somehow, I doubt it.  Power politics does not work that way.

Many thanks for your attention.