What could go right?

The US and China were locked in trade talks again this week. The chances of a grand bargain that would see China rewrite its Intellectual Property (IP) laws, among other things, remain extremely remote. However, the mix of a swoon in the global economy, a thickening domestic scandal, and the approach of the 2020 campaign trail may burnish the appeal of a smaller deal or conflict freeze for the White House. This week we again look to the past for any clues on what we can expect next.

Cheap grain

Of course, this isn’t the first time that protectionism has reared its ugly head. One such time came in the late 19th century when tariffs and other barriers to international trade were used to answer a superficially similar set of problems. Many historians see this lurch towards protecting domestic industries and activities as a key spur in the long build up to World War 1. Interestingly, it is precisely this part of history, strung together with a few other comparable episodes, that is apparently creating so much existential unease about China’s rise amongst US policymakers. However, another curious, and potentially influential, aspect of this period that tends to get less attention is the quite sudden fall in the global price of grain (Figure 1)[i].

The US was actually the primary driver of this price plunge. The end of the US Civil War in 1865 roughly coincided with newly abundant steel, which in turn brought more and better railroads, and faster ships. However, it was the wider availability of products such as mechanical reapers and chemical fertilizers that provided a huge boost to farm productivity. This was more the case in the labour-scarce US than for traditional European grain providers, where people were more abundant[ii].

The effect was dramatic. In Italy and much of central and eastern Europe, newly unprofitable farms were abandoned, with many emigrating to the New World. Denmark, for its part, used this event to move into higher value farm products – exporting cheese, eggs and bacon. Britain and Germany were among those who opted for the use of tariffs to protect their domestic farming[iii].

The story gets significantly more complicated from here, as agricultural tariffs leaked into other areas of the economy. Stormier economic times inevitably provided more fertile ground for nativist geopolitics, exacerbated by a busier global top table, and so on. So goes the story, anyway.

What relevance for today

Misusing history is easy. Those who warn that China’s rise would inevitably lead to conflict with the US – the so-called ‘Thucydides Trap’ – are likely guilty of a couple of mistakes. First, there is nothing inevitable about China’s continued rise. No doubt, their policymakers have achieved something miraculous over the last half century – the reduction in absolute poverty is nothing short of astonishing (Figure 2). However, China itself is not of one mind as to what that recipe for their incredible success actually is. The suspicion is that with continued implicit and explicit support for lumbering state-owned enterprises over the nimbler private sector, they are getting further away from that recipe.

Second, we may all be guilty of exaggerating the link between IP and trends in domestic productivity. IP, in spite of much improved protection over the centuries, has long been stolen by all and sundry. The biggest, most closely guarded secret of all – the recipe for the atom bomb – was stolen by a low tech Russian agent in the immediate aftermath of World War 2.

However, Western powers, in particular the US, should be able to take a little reassurance from the fact that economic and technological development is not just about inventing stuff. It is perhaps more about how much and how quickly that innovation is diffused and used throughout the economy[iv].

In the historical example above, it was US labour scarcity that facilitated the faster take up of productivity-enhancing machines. But to modern ears, the story is told through cultural (the US) or institutional (Germany or Korea) superiority. This diffusion of technology and best practice is something that many UK companies currently struggle with relative to much of the competition at the moment as it happens[v].

More broadly though, the lesson from all of this is that productivity and globalisation can be extremely disruptive for societies. The bald statistics on the growth and inflation benefits of these two forces tend to materially understate this fact. Wealth, income, wellbeing and jobs can be redistributed widely and profoundly.

Protection is surely not the answer, though it is perhaps a more understandable response than many concede. If we are, as many suggest, in the foothills of a fourth industrial revolution, a redesign of the world’s social safety nets surely has to be high on the priority list for policymakers. How effectively the social contract between government and the governed holds will obviously be important in deciding the winners and losers from this period.

However, perhaps the most important factor will be when the new technological breakthroughs roll in, and how quickly and efficiently the domestic corporate sector is able to adopt and adapt.

Lessons for investors

Right now it is more important than ever to remember why we invest. Deafening noise around chaotic political developments and a sagging global economy are dragging us all to think only about surviving to tomorrow or the next week.

But it’s impossible to invest over such a short time frame. Investing in a multi-asset-class fund or portfolio is really about the idea of fuelling and benefiting from those long-established productive forces. Neither you nor I can possibly know when the next game-changing invention will arrive (it may have already arrived unheralded – few were blown away by the Excel spreadsheet’s birth) (Figure 3).

We need to invest, and stay invested, for this very reason. Innovation does not happen at times convenient to us, and neither does it have particularly predictable consequences… other than allowing the corporate sector to do more with less and, in turn, reward those who own these firms – you (Figure 4).   

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[i] Guy, Frederick. 2009. The Global Environment for business

[ii] Krasner, Stephen D. 1976. State power and the Structure of international trade

[iii] Gourevitch, Peter A. 1977. International Trade, Domestic Coalitions and Liberty: Comparative responses to the Crisis of 1873 - 1896

[iv] The Peterson Institute for International Economics and the Mckinsey Global Institute. 2019. China and the World: Inside the Dynamics of a Changing Relationship

[v] Haldane, A. 2018. The UK’s Productivity problem: Hub No Spokes – Academy of social sciences annual lecture, London