The Trade Strategy We Need

The Trade Strategy We Need

Trump isn’t wrong to criticize the trading system. But his policies won’t fix it.

October 24, 2018

This article appears in the Fall 2018 issue of The American Prospect magazine. Subscribe here

Hardly a week goes by without another U.S. tariff hike on China, Mexico, Canada, or one of our European allies. Different justifications are given each time: to stop Mexicans from immigrating to the United States, to shrink the trade deficit, to make China and Germany play by the rules, and of course, to “make America great again.”

But Trump’s tariff tantrum is doomed to fail because it isn’t driven by a clear idea of what is wrong with the system. His policies will inflict pain on the United States and across the global economy, and crack the foundations of the international system. Worse, they are not part of an underlying economic strategy to restore balanced and equitable growth in the U.S. and world economy.

The one real bright spot is that Trump’s actions have revived an overdue debate about reform of the global trading system. Argument has been going on for decades, while trade policy was made by a bipartisan establishment cheered on by mainstream media—with critics banging on the door. Trump’s tirades have made trade reform prime-time.

 

From Global Prosperity to Global Deregulation

The WTO’s predecessor, the post–World War II General Agreement on Tariffs and Trade (GATT) was highly influenced and shaped by President Franklin D. Roosevelt’s New Deal policies. The GATT established treaty-based rules, principles, and governance that sought to increase global trade in a manner that allowed plenty of room for national policy, calibrated toward the pursuit of financial stability, full employment, and long-run prosperity. A golden age of capitalism ensued. Between 1950 and 1973, average incomes in the United States and the rest of the world grew at a faster rate than they had for the prior century—and haven’t been beaten since.

Not only did the United States prosper, but so did countries like Japan, South Korea, and to some extent Brazil and Mexico (but still leaving behind the least-industrialized countries), by fostering national policies for innovation and industrial development that enabled these nations to become global traders themselves. GATT, unlike the successor World Trade Organization created in 1994, left plenty of room for national development policies and a managed form of capitalism.

Beginning in the 1980s, however, the Reagan and Bush administrations and their counterparts overseas transformed the GATT from a treaty-based multilateral regime aimed at balancing global commerce and national economic goals into what would become the WTO. The new trade organization was created to facilitate deregulation of global finance, health policy, the environment, labor laws, and more. Developing countries were jarred by such proposals, but agreed to them on condition of stable and open access to the U.S. and Western markets.

The GATT system was very, very good to the United States and the world economy, but the more recent trade regime is yielding diminishing returns. Economists estimate that trade liberalization injected $1 trillion into the U.S. economy between 1947 and 2002, yet more than 90 percent of those gains had already occurred by 1982. The benefits of trade deals since that time have been marginal, and are shrinking. They may even be negative when one offsets the gains against the massive losses of the 2008 collapse and the recession that followed, which resulted from financial deregulation facilitated by the new global rules.

Efforts by the second Bush administration to further liberalize the global economy under WTO auspices were stymied in 2003 when many WTO members pushed back against a further deregulatory agenda. In response, the United States created a policy of “competitive liberalization” that leveraged its market power to promote numerous bilateral and regional deals that went far beyond the WTO’s terms. Since the establishment of the WTO, more than 2,000 regional and bilateral trade deals, such as the North American Free Trade Agreement, proliferated.

Rather than tightly regulating the financial sector so that finance, trade, and investment flow toward productive investment and good jobs, as was permitted under the more multilateral GATT regime, the more recent deals like NAFTA and the Trans-Pacific Partnership seek to deregulate finance and investment. They also make it illegal for participating countries to enforce regulations meant to ensure productive investment, meaningful employment, and social welfare. What is more, many of these treaties allow corporations to sue governments under the investor-state dispute settlement (ISDS), a system of private tribunals that usually side with foreign firms over host-country regulations on finance, public welfare, and the environment.

Indeed, the definitive study of NAFTA by members of the Federal Reserve, the National Bureau of Economic Research, and Yale University found that the pact only led to a marginal U.S. economic boost equal to a one-time 0.08 percent increase in GDP. Even though the TPP would have involved many more and larger economies, the economic benefits were predicted to be 0.38 percent for the United States. Indeed, if all the tariffs in the world were completely eliminated, there would only be a one-time bump in the world economy of just 0.7 percent.

As the gains from trade shrank, its costs grew. Financial crises became more frequent. Indeed, the International Monetary Fund found that the countries that liberalized their financial services industry, as many trade and investment pacts required them to do, were among the worst hit by the Great Recession.

(U.S. Government/White House)

President Bill Clinton signs the North American Free Trade Agreement into law in November 1993.

Rather than investing the profits from globalization into productive and employment-generating activity, global corporations have been choosing to speculate with their profits and buy back their own stock. The U.S. government isn’t redistributing the gains from trade either. Research from the Brookings Institution shows that the people who lose their jobs because of free trade are not compensated enough to make up for their losses through Trade Adjustment Assistance, a program that pays for people who wind up unemployed due to overseas outsourcing to get professional training and income support.

Nor have the losses for American workers translated into widespread gains overseas. Indeed, NAFTA boosted Mexico’s trade and investment, yet its per capita growth has hardly budged. Environmental damage, however, has followed since NAFTA shifted pollution-intensive manufacturing south of the Rio Grande. Rural communities have suffered since more than two million Mexican farmers and farmworkers lost their livelihoods to cheap imported corn and other agricultural products exported from the United States.

 

China’s Challenge

For all the WTO’s faults, the global trade body actually remains fairer than regional deals like NAFTA. Under the WTO’s one-country, one-vote negotiation structure, our trading partners were able to push back on the most egregious proposals and thus leave considerably more room to maneuver than under U.S.-led bilateral and regional megadeals. What is more, rather than having corporations govern the rules under ISDS, the WTO allows governments to settle disputes among themselves.

While the United States has been using such trade deals to lock in draconian deregulation at home and with weaker trading partners, China has pursued its own course under the relative flexibilities of the WTO. The U.S. never had a prayer of pushing China into “competitive liberalization” deals like NAFTA.

Like the United States in an earlier era, China sought to further integrate its economy with the world’s in the early 1980s. China’s strategy was to invest heavily in infrastructure, industry, and innovation in the country, more than 40 percent of annual GDP for decades. China also kept tight rein on financial markets to ensure it was steering credit and investment into strategic industries that would someday become globally competitive, rather than investing abroad in firms that were more competitive at the time.

Until the turn of the century, China refrained from joining the WTO and regional and bilateral trade and investment treaties such as NAFTA. Regardless, U.S. and multinational companies flocked at the chance to invest in China. Despite strong conditions on the Chinese side (of the kind that the United States does not permit under deals like NAFTA), most global corporations were more than willing to trade technology and knowledge for access to the fastest-growing market in world history. Indeed, many U.S. firms also pushed China to maintain a “competitive” wage and currency environment so they could reap the benefits of being global exporters. Alongside the many joint ventures and other sharing arrangements that China required, China invested heavily in associated technology parks, research and development, and education through the public purse and a series of national development banks.

We know the story from there. The former World Bank economist Branko Milanovic has shown that the winners from these paired globalization strategies were China and the richest in the United States and the industrialized world. The losers were the middle classes in the U.S. and across the industrialized world.

(AP Photo/Andy Wong, File)

President Trump and Chinese President Xi Jinping in Beijin on November 9, 2017

China’s GDP per capita has jumped by a factor of ten in the past three decades and Chinese wages are higher now than in parts of Europe. According to the World Bank, in 1990, more than 750 million people in China lived in extreme poverty (less than $1.90 per day), representing almost 70 percent of the entire population. Despite some lingering rural poverty, just 1 percent of China today is extremely poor—though inequality is on the rise and (as was the case in the United States) China’s industrial boom has come at heavy environmental cost.

The United States pursued an opposite course. The U.S. strategy was to largely de-invest in infrastructure and industrial innovation, and to deregulate financial, labor, social welfare, and environmental protections, supposedly to reduce the cost of doing business and to make incumbent U.S. firms more globally competitive. Some firms thrived, but the broader U.S. economy did not. According to the World Bank, investment in the United States has fallen from nearly 25 percent of GDP in 1979 to 19 percent now. According to the Hamilton Project, wages for all but the top quintiles of wage earners have remained stagnant or declined in the United States since the early 1980s as the country lost competitiveness in key well-paying industries. Economists have found that China’s 2001 entry into the WTO likely cost the U.S. as many as 2.4 million jobs.

It’s no surprise that China maximizes the policy space that the WTO allows. Meanwhile, the United States disdains development policy and promotes deals that further deregulate large corporations and weaken protections for working people. Looking at the record of disputes, there is no question that China pushes the limits of WTO rules in an effort to globalize and develop their economy. So is China the villain? Or is it the U.S. and other industrialized nations that, under the GATT regime, used similar strategies to build global market share only to “kick away the ladder” by pushing through the more restrictive WTO rules once they thought Western corporations would forever have the upper hand?

As the United States resists a serious development policy, China is doubling down on a new round of investment and innovation. As Trump denies the science of climate change and Western companies use ISDS to stamp down attempts to reduce the use of climate-harming fossil fuels, China accepts the inconvenient truth of climate change, caps the use of fossil fuels, and invests in renewable technologies that have become the envy of the world.

 

No New Deal: Why Trump’s Tariff Policy Will Fail

Trump’s tariff war has been popular in some quarters, but a closer look suggests that Trump’s policies are unlikely to achieve the goals of reviving a balanced and more equal U.S. economy or of spurring development across the world.

First, the tariffs that do improve conditions for a small number of workers are producing retaliation that squeezes workers in other businesses. For example, higher tariffs on imported steel and aluminum are already raising costs in the automotive industry and construction, which are big employers. That was a lesson the White House should have learned from reviewing what happened when President George W. Bush experimented with similar across-the-board tariff hikes in 2002.

Second, unilateral and scattershot tariff hikes by the world’s largest economy will inflict real economic pain across the world. It would be one thing if Trump’s tariffs were carefully targeted in the service of renegotiating trade rules so as to achieve a more balanced trading system, but they are not. A new study by the World Bank estimates that the trade war could reduce global exports by up to $674 billion and global GDP by $1.4 trillion. If the trade war makes the investment community go into hysterics it could even be worse. Moreover, as Ken Shadlen from the London School of Economics has reminded us, developing countries went along with some of the draconian WTO proposals on condition that they would have stable and expanding access to the world economy. Trump is breaking that deal with tariff hikes that block developing countries’ access to Western markets, and in so doing may jeopardize the foundations of the entire system.

Third and most importantly, trade deals are not ends in themselves but tools to implement broader economic policy goals. Trump lacks any overarching economic plan that these tariffs would support. His trade measures are not connected to any set of innovation, industrial, or infrastructure policies of the kind that countries as diverse as China and Germany deploy to build strong industry. Rather than investing in America, we have a major tax cut that slashes investment and jeopardizes our ability to do so in the future, and at the same time assaults the investments in health care, financial stability, and environmental integrity that we have already made.

 

Five Principles for a Real Global Deal

Again, let’s credit Trump for one thing—globalizing the conversation across television screens, research papers, and Twitter feeds about the need for trade reform. In that spirit, here are five principles for global reform that are ready for prime time.

1. Restore multilateralism. A multilateral system with a one-country, one-vote system can lead to more balanced growth for the world economy. By contrast, regional and bilateral deals like NAFTA accentuate national power inequities and distort global trade. The bedrock of multilateral trade is non-discrimination. By resorting to bilateral deals, free-traders violate their own first principles. Trade and investment are not a zero-sum game; the more all nations and people prosper from trade and globalization, the stronger and more stable the world economy will be.

(Chinatopix via AP)

2. Make trade agreements about trade again. The case for liberalizing trade in goods like shoes and cars is fairly ironclad. The low-cost producer of comparable products should make the sale. Countries that already enjoy comparative advantages in such goods should have low tariffs, while countries still trying to become competitive should have the flexibility for more protection for a certain amount of time. The end result is more competition and more general economic well-being.

Trade deals used to be about liberalizing tariffs, quotas, subsidies, and preferential purchasing measures. That’s their proper domain. But there’s little justification for using trade deals to reduce regulations on foreign investment (especially financial flows) or on health, the environment, and worker protections. The economic costs of financial crises, climate change, and healthy societies far outweigh the “benefits” that otherwise flow to unregulated firms.

3. Preserve the right to regulate. Trade is not an end in itself. Tax, subsidy, and social investment policies are needed so that the world economy is less environmentally destructive and more socially inclusive. Private markets will not supply these public goods. Governments need the flexibility to design appropriate policy for social welfare. Too often, trade “liberalization” has been veiled deregulation. Economics has shown time and again that incorporating the costs of financial crises, climate change, health care, and worker protections make economies more efficient and better off, not worse. Powerful global firms have sought to deregulate global markets as a form of implicit subsidy in their pursuit to capture more and more profit while externalizing the costs of their actions on households and the environment. Nations, developed and developing alike, need the policy space to calibrate the globalization of their economies in terms of national economic priorities.

4. Re-balance trade and investment governance. The governance of trade needs to be inclusive and transparent. The privatization of dispute resolution to private firms through ISDS should be reversed. The WTO model of state-to-state dispute settlement, whereby nation-states can properly weigh the private costs versus the social benefits, should be the core of a multilateral trade system. What is more, trade negotiations and dispute resolution needs to be done in a more transparent and inclusive manner. The Washington Post, in an investigative report titled “Industry Voices Dominate the Trade Advisory System,” revealed that U.S. trade policymaking is run by the same corporate interests that get to govern the treaties through ISDS. Negotiations need to be transparent and inclusive, and dispute resolution needs to be settled between nations, not privatized to corporations.

5. Make use of parallel investments, standards, and adjustment assistance. When the European Union became more economically oriented, that region set a series of strong and uniform environmental, health, and worker standards so that nations would not compete based on low standards. What is more, recognizing that some countries would have a difficulty in meeting those standards, the EU set up adjustment funds for regions and individuals. Finally, the European Union’s mammoth European Investment Bank (as well as national development banks such as Germany’s KfW) was refueled to invest in the technologies and companies of the future to get them ready for the global marketplace. Such an approach, which the United Nations has elaborated on as part of a “global new deal,” not only better ensures that the benefits of trade and investment are shared, it also generates a stronger constituency for integration.

Trump’s tariff tantrum is far from a serious effort to correct the wrongs in the current system. Yet, for the moment, Trump has kept allies and adversaries off-balance, and has simulated an America First trade policy for his base. But as the effects of these policies sink in, he is managing to unite America’s trading partners, divide the Republican coalition, and produce no economic gains. The debacle of Trump’s trade policy creates real opportunity for a new approach to trade that actually delivers.

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