A free trader - to be or not to be....

Following Gideon Rose's editorial on Trump's next steps in Foreign Affairs Magazine, here are my thoughts on the future of globalisation.

As the US administration contemplates building a physical wall along the Mexican border and a metaphorical wall with the rest of the world it will in reality, and in perception, be seen to be moving against globalisation and losing interest in the global order and architecture of multi-lateral institutions that it played a lead role in setting up and nurturing from the time of Bretton Woods. As Wikipedia puts it "The Bretton Woods Conference, formally known as the United Nations Monetary and Financial Conference, was the gathering of 730 delegates from all 44 Allied nations at the Mount Washington Hotel, situated in Bretton Woods, New Hampshire, United States, to regulate the international monetary and financial order after the conclusion of World War II."

To be clear the underpinnings of these founding arrangements agreed to at the Bretton Woods Conference was, again from Wikipedia, "the notion of open markets. In his closing remarks at the conference, its president, U.S. Treasury Secretary Henry Morgenthau the establishment of the IMF and the IBRD marked the end of economic nationalism. This meant countries would maintain their national interest, but trade blocs and economic spheres of influence would no longer be their means. The second idea behind the Bretton Woods Conference was joint management of the Western political-economic order, meaning that the foremost industrial democratic nations must lower barriers to trade and the movement of capital in addition to their responsibility to govern the system."

By most measures (mass prosperity, global peace and economic growth) this international order led by the USA has delivered remarkable results over the last 70 plus years. But it always meant that firms operating in a world without economic borders would through the process of competition seek to exploit comparative advantages in productive labour, access to capital and investment terms wherever they may exist geographically. In succession this has meant that labour intensive manufacturing jobs have progressively moved from developed countries to one emerging economy after another (i.e. from Japan, to Korea, to China and so on). The paradox of this economically driven phenomenon has meant that whilst the average global per capita income has increased for the better (and literally hundreds of millions have been lifted from poverty across the developing world) the inequality in per capita incomes within developed and developing countries alike has also increased for the worse. Simply put, globalisation has lifted the average per capita incomes in developing economies and depressed the growth of average per capita incomes in developed countries. And if nothing changes these trends will continue forcing convergence of the two in the long run. Globalisation has also concentrated wealth in the hands of the enterprising capitalists (agents and owners of the firms) in both developed and developing economies alike. The displaced workers and disenfranchised people in the developed world are recognisable as Trump, Le Pen, Brexit voters. Whilst in the developing world the remaining poor have the full focus of their respective Governments who are absolutely fixated on maintaining a minimum level of economic growth to maintain political legitimacy, alleviate poverty and stave of civil unrest. 

Countries have sought to manage dislocation & inequality brought about by increasing automation, digitisation and globalisation in different ways. Many Scandinavian countries and Germany re-allocate fiscal proceeds to provide safety nets, training and education in keeping with their egalitarian values and have successfully contained inequality to below the average of OECD countries. In the UK and USA on the other hand there has been a much weaker policy response in keeping with their neo-liberal market philosophies. As a result inequality is running much higher in these countries. And the anger amongst the displaced has manifested itself in extraordinary outcomes at the voting polls. The disaffected have turned against the established political order, corporate elites and liberal immigration to preserve job security and reassert national sovereignty. 

So as the USA, the original architect of the current world economic order, turns inwards and talks of protectionism and America first (we win with the unfortunate interpretation abroad being put by Richard Haas in Foreign Affairs as "friends and allies come second, at best") we have witnessed the most amazing reversal of roles between the USA and China. The current role of China, which we need to remind ourselves was a very closed economy at the time of Bretton Woods, was nowhere better on display than at the World Economic Forum earlier this year at which China's leader Xi Jinping spoke strongly in favour of free trade, economic globalisation and win-win economic outcomes. Here is an extract of the words that he spoke, 

"Whether you like it or not, the global economy is the big ocean that you cannot escape from. Any attempt to cut off the flow of capital, technologies, products, industries and people between economies, and channel the waters in the ocean back into isolated lakes and creeks is simply not possible. Indeed, it runs counter to the historical trend.

The history of mankind tells us that problems are not to be feared. What should concern us is refusing to face up to problems and not knowing what to do about them. In the face of both opportunities and challenges of economic globalization, the right thing to do is to seize every opportunity, jointly meet challenges and chart the right course for economic globalization.

Free trade which is the driver behind economic globalisation as talked about by Xi Jinping has long been a central tenet of economic theory. But clearly, as the experience of different countries has highlighted there are real world practical issues which serve to undermine the simple economic assumptions and text book application on which the theory is based. 

The theory argues that economic efficiently outcomes are best achieved by pooling and optimising as many resources, capital and labour (to build scale & diversity on the production side) and market (to aggregate the consumption preferences of all consumers) as possible to maximise production, best meet people's consumption preferences and optimally adjust for innovation over time. And free trade which enables global pooling and then optimisation (by accounting for comparative advantage through regional specialisation) becomes necessary where the factors of production, potential markets and technological breakthroughs straddle national borders. 

The theory also predicts that there will be winners and losers but that the winners will always be able to compensate the losers so as to leave everyone better off. Without appropriate government policies, however, this does not happen as predicted. Within countries there is evidence that displaced workers cannot, as assumed, seamlessly move from low productivity sectors to high productivity sectors. This mobility is further inhibited in cases of, for example, high employment, older workers and the tyranny of distance with a consequence that workers may not be re-employed or compensated as the theory predicts but will end up in the ranks of the long term unemployed and an unproductive drag on the economy. 

Hence, in more recent times the theory and consequences of free trade has been much debated by economists (and politicians), and suffice to say it no longer enjoys the unconditional support of all economists. It is situationally specific to a country's circumstances as the Nobel Prize winning American economist Joseph Stiglitz puts it - in other words it may not always be beneficial. In picking up on the discord The Economist magazine (30 June 2016) ran the headlines "free exchange - the consensus collapses". And the following is a quote from the accompanying article in The Economist which elaborates on the views of various economists 

"And then there is the question of how the benefits of globalisation are shared out. Joseph Stiglitz, a Nobel , has warned that rent-seeking companies’ influence over trade rules harms workers and erodes support for trade liberalisation. Raghuram Rajan, the head of India’s central bank, has argued that clumsy government efforts to compensate workers hurt by globalisation contributed to the global financial crisis, by facilitating excessive household borrowing, among other things. David Autor, David Dorn and Gordon Hanson have documented how the costs of America’s growing trade with China has fallen disproportionately on certain cities. And so on." 

And the article goes further to quote economists and geopolitical commentators who take a temporal perspective and observe that in reality we are caught in a continuous cycle of globalisation, protectionism, globalisation and so on. This may not help explain the reasons for cycling but certainly fits with the age old adage that history has a tendency of repeating itself - and that negative consequences unmitigated by effective policies build over time and eventually cause the losers to revolt. Here again is a quote from The Economist which talks to the cycle of globalisation.

"Branko Milanovic of the City University of New York believes such costs perpetuate a cycle of globalisation. He argues that periods of global integration and technological progress generate rising inequality, which inevitably triggers two countervailing forces, one beneficial and one harmful. On the one hand, governments tend to respond to rising inequality by increasing redistribution and investing in education; on the other, inequality leads to political upheaval and war. The first great era of globalisation, which ended in 1914, gave way to a long period of declining inequality, in which harmful countervailing forces played a bigger role than beneficial ones. History might repeat itself, he warns.

So what are we to make of the confused global economic picture painted here, and the question that the Foreign Affairs magazine posed, “What now?" for USA trade policy? And whilst we may not care we should because it will affect us all. 

Whilst there is a sense of inevitability around the redirection away from globalisation (as policies shift in tune with popular sentiment and inertia) we should hope that the mast is not tilted too far to the aft so as to precipitate a tic for tac race to impose trade barriers and tariffs. 

Most still believe that trade protection is rarely the answer, and that the advantages of free trade still far outweigh the disadvantages which should be the subject of active management by Governments. Trade protectionism is after all a populist quick and temporary fix which may support domestic industries in the short term but in the long term will present problems for closed countries as other more liberal countries and global corporations work around them and seek to maximise profit and source labour wherever it is cheapest. 

I do believe that a free open market can deliver benefits but that there is a responsibility on Governments to set strategic direction, encourage and actively manage economic diversity to build resilience, manage the domestic out workings of free trade and stress test a local economy against protectionism as the world economy cycles through globalisation to protectionism. 

To guard against the downsides of free trade countries can do a myriad of things e.g., regulate in trade agreements against disadvantages, redistribute fiscal proceeds, put in place environmental safeguards, legislate for labour laws which prevent poor working conditions, encourage local content and factory developments, create special development zones, support the development of ecosystems (nurturing links between likeminded organisations focussed on innovating to push the production technology frontier) etc.

The latter point related to innovation is in fact absolutely critical to ensure that the process of global convergence between countries does not simply become a zero-sum game - i.e. whereby in order for some to win some must loose in a slowly growing world economy. Innovation in all of its guises is critical to improving productivity and creating new products/services and ensuring that the global economy has a healthy grow outlook so that growth in developing countries can be accommodated whilst minimising the impact on developed country growth. In effect using innovation to create a bigger economic prize for the benefit of all. 

And on a final note let us not forget the WTO which as of 2017 is still universally supported, and has as its mission an open global economy. The WTO is there to ratify and encourage development towards this goal through the build out of a continuous suite of multilateral and bilateral free trade agreements which collectively give effect to its goal. It also not only helps vet and regulate this building network of free trade agreements but also helps countries ensure that agreement regulations are enforced. 

Hence, in coming back to President Trump the question facing the USA in respect to free trade is "to be or not to be". Much as Shakespeare's Hamlet did on the question of life or death - America's Trump now contemplates building a physical and symbolic wall to protect US interests, bemoaning the pain and unfairness that the US has endured in its role of global leadership in an open global economic system whilst one would hope unconsciously acknowledging that the alternative of withdrawal might be worse. But is it really so? Unlike for Hamlet, President Trump’s choices need not be so stark. Let us not forget that if the rudder is tilted gently enough there is a whole spectrum of options that exist between the black and white of "to trade or not to trade" which may in turn may overtime temper the arc of the global swing between globalisation and protectionism. 

And on a final note let me quote from Fred Hu and Michael Spence (another US Nobel Prize winning economists) where they say "Waving the banner of protectionism and nationalism may attract popular support, at least temporarily. But history has shown that, ultimately, it may well threaten global peace and prosperity. The United States, China, and the world at large would be far better off if they could find a path to a more sustainable globalisation, reforming the existing global order rather than tearing it down completely."