The primary causes of economic disruption

It is beyond argument that the widespread complacency over the existence of the liberal world trading system as we have known it has been disrupted.  The U.S. Administration might be all too willing to accept all the credit for doing so.  For it, all existing trading arrangements were stated to be badly flawed and perhaps unacceptable.  It is obvious that the change in announced U.S. trade policies is one cause of discontinuity and turmoil in the existing world economic order.   However, to attribute everything unsettling in the world of trade to Washington is to grossly oversimplify.  It is a mistake to view the current state of international trade through a single lens.  The current challenges to the world trading system have more than one source. 

To focus solely on Washington’s pronouncements and measures would be to ignore, for example, the rise of a major new economic power.  A major new entry into the world economy particularly through trade is always disruptive.  This was true of the rise of the United States in the mid 19th century with serious consequences for British agriculture.  It was especially true of the rise of Japan with the differences between the organization of its economy and those of the West, at least initially, in the last third of the 20th century.  The impact on manufacturing in the U.S. and elsewhere, particularly in consumer electronics and automobiles, was pronounced.  Disruption during the last two decades of this century has also accompanied the rise of China, whose economy has characteristics that differ from those of its major trading partners.  Differences in economic organization exacerbate friction among countries.  Economists assign a major cause of dislocations of labor markets, particularly in the United States, to competition from China’s becoming the factory of the world.

At the same time, technological change has had a major impact on employment, particularly in manufacturing.  Add to the list of causes of current disruption, wage stagnation, rising income inequality, the effects of automation, issues arising from immigration, and consequent rise of populism and nativism, combined with the failure in most national governments to provide adequate adjustment policies – all contribute to stress on the multilateral economic order. 

The disruption might have had far less impact if the trading system had kept pace with this list of challenges in the world economy.  However, there has been persistent underinvestment in the multilateral system from many quarters — from governments, from the private sector and from civil society.  The WTO needed reform before the confluence of major challenges struck.  It needed flexibility and a greater ability to improve its effectiveness.  To the extent that any institution fails to evolve, it would be likely to increasingly be less fit for purpose.  Adverse effects of this inability to adapt are not confined to the impact on the largest and most developed countries. 

To maintain a system based on consensus, of necessity its Members must view it as having a balance of benefits and a sense of shared responsibility.  It must also be based on an understanding that where flexibility is required to accommodate the needs of its members, especially as they are sovereign countries and where national objectives must to some extent give way to international disciplines.  Enormous sensitivity to this balance is needed for an international organization like the WTO to succeed. 

The WTO has in very many areas functioned very well in this respect.  Where it appears to have functioned less well, at least in the view of one major member, is in the area of dealing with what many call “protectionist” measures (antidumping, countervailing duties and safeguards).  It is imperative for any system comprised of sovereign entities to have safety valves, in this case, to allow trade remedies to function effectively to reduce pressure on the system.  Had there been a functioning political process as was intended in creating the WTO dispute settlement process, perhaps the current breakdown of the system might have been avoided.  The tools to mitigate the rate of change in competition from global competition, when harm occurred to domestic interests, were often not usable at all or taken away prematurely.  This alternative outcome, like all counterfactuals, is speculative. 

Dispute settlement has no political accountability to the membership through the Dispute Settlement Body, nor any political (policy) corrective possible through rule-making by the Members.  In national governments, this function is supplied by the legislature and in some cases the ballot box.  As noted by many commentators, seeking to perfect a “quasi-judicial” function without the existence of checks and balances, a system comprised solely of juridical governance poses systemic risks, undermining the legitimacy of the dispute settlement function at least for important participants in the system.  The purity, independent of a political system, of a single aspect of the international trading system – dispute settlement – is not, as it turns out, equally appreciated by all,

The new trade-restrictive measures

The reporting in the press has given understandable prominence to the series of trade threats made and measures taken by the U.S. — consisting of increased tariffs on imports of steel, aluminum, and more generally on goods from China, as well as the Newtonian (for every action there is an equal and opposite reaction) retaliatory measures imposed by America’s principal trading partners, the EU, Canada, Mexico, and China. 

There is a range of estimates of the current impact of these recent trade restrictive measures on world economic growth.  While trade patterns do not change overnight, and currency movements can offset some of the tariff increase, over time trade restrictions impair global economic growth.  The broader and more onerous the measures, the more negative the impact.  Ultimately, it is the effects on and of business and consumer confidence that will weigh most heavily on trade and investment. The impact of these broader effects is at present speculative but of likely greater magnitude.

There have been efforts to quantify the economic impact of the new trade restrictions.  Direct tariff effects in analyses carried out by multiple organizations have found results ranging from 0.1% to over 2.2% in losses to global GDP compared to a baseline growth.  This is not trivial.  It means that if global growth is 3.9%, these policies would have the near-term effect of reducing that level to a range of from 3.8% to 1.7%, all other factors being equal.  But, of course, other factors are never equal.   The picture is far more complicated.   The trade effects are generally swamped by macroeconomic forces — the strength of the U.S. dollar, U.S. and China's saving and investment rates.  And as noted, the potential effect on the confidence of investors and consumers is a very large factor.

Neither is the picture perfectly clear in terms of the impact on particular sectors.  With higher tariffs on specific products, even if the effects on growth are small, a significant number of firms and workers will need to find new markets and jobs, incurring substantial transition costs in the short to medium-term. Nevertheless, some firms and workers will do well. 

As for the countries involved, there may be little if any effect on a country's overall imports and exports.  Analysis suggests as a general proposition that China's direct exports to the U.S. will decline while China's exports to other countries will rise, and that other countries exports to the U.S. will rise while US direct exports to China will fall and U.S. exports to other countries will rise.

The vast majority of economists would argue that the long run growth potential of all affected economies will be reduced — because more of their economic activity will not be based on comparative advantage, but on protection.  For the current US-China scenarios the estimated loss to global GDP is less than 0.2% in most models.  Again, not the end of the story, as models currently cannot account very well for potential interaction between real and financial sectors.   If tariff policies reinforce potential adverse effects from existing financial sector risks the effects could be bigger. 

The above estimates are based on what is known at present of the tariffs.  We do not know what the future holds for these tariffs, in either direction (an increase or a decrease).  With respect to the measures related to steel and aluminum, it is clear that the countries with which the United States is negotiating trade agreements have an expectation that it is possible for them to obtain an exemption from these tariffs.  So, the end result, even for these products, is far from certain.

A wild card is the extent to which new measures will affect trade and investment in automobiles.  Then there is a question of the extent of knock-on effects from the first wave of restrictions and retaliatory restrictions, and perhaps emulation. 

U.S. Trade policies are not uni-directional

Before writing a eulogy for the post-war liberal world economic order, there are other factors to be taken into account that are more positive.  Economic isolationism is not rampant.  NAFTA was renegotiated as USMCA, and while it contains elements of greater government intervention, particularly with respect to the automobile sector, economic integration of North America promises to continue.  Many of the new provisions in the USMCA agreement consist of modernizations of NAFTA and are consistent with the earlier work done on these subjects in the Trans Pacific Partnership.  The United States has also reached a revised trade agreement with Korea (KORUS).  In each case, USMCA and KORUS, the parties have expressed satisfaction with the result.  The United States has also agreed with Japan, the U.K. and the European Union to engage in negotiations of free trade agreements.  Moreover, the United States is highly active in the daily work of the various committees of the WTO and is sometimes second to none in its contributions to the work.  It is also active in the Joint Initiatives announced in Buenos Aires. 

The reformation

There are numerous efforts underway on the part of a number of countries to work toward reforms in the world trading system at Buenos Aires last December, U.S. Trade Representative Lighthizer called for a number of specific WTO reforms, and at that time joined the trade ministers of the European Union and Japan in a declaration to work together on several reform issues.  President Macron picked up this theme in March at the OECD.  The EU recently tabled a paper containing many detailed suggestions for reform, Canada convened a two-day meeting of trade ministers last week in Ottawa to discuss WTO reform, and a paper on transparency obligations in the WTO is being tabled by the U.S., Japan and the EU next month in Geneva.  China has now said that it will entertain reform and the EU and China formed a bilateral forum to discuss WTO reform.  The trading system is far from moribund.  Changes are being considered in many quarters.

The primary areas of focus of Members' discussions of reform are improved implementation of existing rules and structures, how to make the WTO more proactive, how to update the substantive rules of the WTO to address current problems and opportunities, and how to restore an appellate function to WTO dispute settlement before it disappears, which is in the offing.  To have an appellate function is extremely important.  The U.S. complaints are not an invention of the current U.S. Administration.  They have existed through several prior Administrations, regardless of the party in power, and are unlikely to be very different in any future Administration.  Absent an agreed solution, every dispute risks becoming an exchange of retaliation and counter-retaliation – movement further away from a rules-based system and a return to a state of nature.    

In short, due in large part to disruptions, WTO reform is in the air.  This is in marked contrast to just a year ago when it was not a current topic.  While some reform elements could be organic, coming through joint initiatives of interested members to address new topics such as e- commerce, and perhaps investment, domestic regulation of services, questions of gender in trade, and participation in trade of micro, small and medium sized enterprises, the broader questions of reform were unlikely to be taken up but for the onset of disruptions by the United States.  The result cannot be foretold.  There is a chance that major improvements in the working of the organization will be made for the benefit of all its members. 

Peering into the future

The international trading system performed remarkably well for over seven decades following the Second World War. The progress made through trade negotiations was cumulative.  Generations of trade negotiators did the best that they could, in their time — in the Kennedy, Tokyo and finally the Uruguay Rounds of multilateral trade negotiations, from the 1960s into the 1990s.  They made breakthroughs and substantial improvements in the world trading system.  They created new agreements and when they could, new institutions.  In fact, all countries now state that the WTO is indispensable.  This is a major point of agreement in what can be and often is a fractious world community.  By far most of world trade is in fact conducted within its terms, and all bilateral and regional agreements are based on its existence.  Whether or not the WTO could have been maintained longer as it was, largely unchanged from when it was created is unknowable but unlikely. 

For over seventy years the United States was the prime mover for the creation of the liberal economic order that brought a high degree of economic growth, stability and peace to the world.  The U.K. and the EU were its allies and partners, but without the United States, starting after the Second World War, the current world order would not exist.  According to Robert Kagan, author of the important new book The Jungle Grows Back, this period was an aberration, far from what is usual in the interaction of nations, both in terms of the absence of global conflict among the major countries, and bitter economic rivalries.

That Washington is causing disruption is beyond question: disruption in willingness to depart from trade agreements (the Trans Pacific Partnership for one), disruption in terms of extensive use of increased tariffs, disruption in terms of modes of an expressed willingness to engage in trade wars, disruption in articulating national objectives, disruption in willingness to employ disparities in power to rebalance trade relationships, disruption in an expressed preference for bilateral arrangements as compared to multilateral arrangements and, not least, disruption in its method of dealing with the major rising economy of the last two decades — China.  The effects of the manifold disruptions caused by U.S. trade policy vary.  Most important for the future of the world trading system is the fact that the United States has stepped back from its seven-decade long role of being the prime mover and the guarantor of the world economic order.  Atlas has shrugged.

It is worth noting that on more than one occasion, past trade conflicts have provided an opportunity to re-examine the rules or change conduct for the better or both. This was true of U.S. leadership following the Second World War, it was true of U.S. unilateralism in the form of the 1971 import surcharge which preceded the creation of the floating exchange rate system and the first nontariff barriers agreements in the Tokyo Round, and it was true in U.S. unilateralism paving the way for the creation of the WTO itself.  More often than not, the means have been found to use economic conflict as a stimulus to improve the international economic system.  This is not to argue for disruptions of trade, for departures from accepted trade norms.  It is a plea to work with the situation as we find it and make progress toward constructive solutions. The path forward should be looked for with pragmatism and with a minimum of unproductive emotion. 

As for the China-U.S. exchange, it is too early to judge where an equilibrium point will be reached in economic relations between the two countries. Will some issues be settled or does retaliation and counter-retaliation proceed to add layer upon layer of trade and investment restrictions?   Does either the U.S. or China know where the new equilibrium will be established or at what level?  I suspect that they do not.   We do not know what the End Game will be, but there is a possibility of a Middle Game.  (This was true even during the geopolitical Cold War between the West and the USSR).  If a settlement, formal or de facto is reached, it should include improved trading rules, so that the relationship is governed by agreed rules to a greater extent and occur less outside the system.  An interim result along those lines should be possible

Not the end of history

I believe that the WTO will endure and will be strengthened and improved.  This is because it is in the interests of its Members that this be so.  Good will and creativity can yield positives result.  To reach that point will require agility, creativity and pragmatism on the part of Members, and a willingness of each to make a net contribution for the sake of the system.  This would benefit all.   Events call for this.  A successful outcome demands it.

Change in the WTO tends to be glacial, and under current conditions some glaciers are retreating.   Extensive time is a luxury that the WTO reform process cannot afford.  Bilateral negotiations offer a way forward to create a template for what will become the multilaterally agreed rules.  The absence of change could easily result in a degeneration of the trading system.  Marching in place is not an option.  The multilateral trading system can be by-passed by an increasing use of measures outside the rules. The system can also be overtaken by the world economy evolving to the point where it makes the rules increasingly less relevant.  Both would do great damage to the world economy.

Disruption can easily be damaging; it can also be positive.  For the outcome to bring the WTO to a better place, a joint effort will be needed by its members.  A growing sense of urgency will be required, not least to create a dispute settlement system with more broadly acknowledged legitimacy before this one ceases to function.  Pragmatism and creativity resulted in the establishment of an agreed dispute settlement system in the first place, and there is no reason why it could not provide a basis for agreement once again.