Pressures for change in the international trading system

There is much talk these days of trade wars. It may well turn out to be more than talk although it is still too early to say. Donald Trump is determined to change the situation which has led to massive American trade deficits. The flip side of such trade deficits are the trade surpluses of the European Union and China. Trump’s actions to curtail these threaten to disrupt the accepted “rules of the game” of the international trading system which has governed trade barriers and the settling of trade disputes among member nations.

In confronting China and the European Union, Trump believes he is dealing from a position of strength. The US is much less involved than with international trade. It has less at stake and, so the thinking goes, less to lose. This calculation may be misleading. Any raising of trade barriers to either China or the EU is likely to meet with a response. In the final analysis, the volume of exports vulnerable to trade barriers may not be as important as the sensitivity of governments to public pressure. Rising trade barriers will affect jobs and business firms will lose sales. The EU.has already prepared a list of tariff increases for products from the electoral districts of American congressmen who may be sensitive to pressure from their constituents.

China is doing the same. It has already given notice that any attempt to raise trade barriers to its exports will be reciprocated. This may go beyond trade barriers to include American investments in China. Moreover, with its quite different form of government, China’s susceptibility to public pressure is something of an unknown. Although they may not be entirely immune from such pressures, Chinese leaders are clearly not as concerned with forthcoming elections or indeed, any elections, in the same way as western leaders.

Whatever the outcome, the most significant impact of such frictions may be on the international trading system itself. The mission of the World Trade Organisation (WTO) is to provide a forum for the reduction of trade barriers. Member nations meet to negotiate reduction in trade barriers. These negotiations are based on the assumption that the price of the products being negotiated reflect market prices. Toward this end, WTO rules forbid state interference, particularly in the form of subsidies for exports.

Have the rules been strictly observed? Certainly not. Much of Chinese industry is state-controlled and state supported. Attention has also focused recently on China’s announcement of a new national strategy to back the development of high tech industries in areas such as information technology, aerospace, numerical control, robotics and biological medicine.

Both Europe and the USA have engaged in state initiatives involving some form of state subsidy. Europe has previously had a spate of national champions - industries considered of strategic importance to the national economy and supported by the state. The USA has provided state support for a whole range of companies producing defense related products which also increased the ability of those companies to export. Somehow, these exceptions were previously never so large that they could not be tolerated, eliminated or compensated.

With the rise of China, a major trading nation with a mixed economy of state and non-state industries, identifying subsidies and market prices where industry is managed by the state becomes much more difficult. So difficult that some would say it makes the rules of the present world trade system untenable. China’s recent announcement relating to the new national initiative to back the development of high tech industries only adds to such concerns.

Even prior to the rise of China, the current system was clearly in difficulty. The WTO has not had a successful round of multilateral trade reductions since the Doha round was initiated in 2001 and despite years of negotiations, never completed. Trump is not entirely alone in his tirade against the tendency of the current WTO system to generate long term trade surpluses (China and Germany) and long term deficits (USA and UK). Many economists agree that such trade imbalances, if they persist, are disruptive and counter to the smooth functioning of international trade.

The problem of trade imbalances is not new. The issue was addressed during the post WWII Bretton Woods conference which laid down the foundations of the present trading system. One of the principal architects of the system was the well known British economist John Maynard Keynes. During the discussion on the rules which would govern international trade, Keynes suggested a radically different alternative to the proposals which comprise the present trading system.

Anticipating the potential harm of major trade imbalances between nations, Keynes proposed a system which would penalise long term trade surpluses and include automatic measures incentivising countries to reduce and eliminate them. These proposals were vigorously opposed by the American representative (Harry Dexter White) who spoke in favour of the current WTO system.

Today, this system is in trouble. Formed in a different era, it has worked effectively for much of its life, but is clearly no longer functioning as intended. There have been calls for its revision, a “Bretton Woods II”. It would be ironic if the present difficulties with trade imbalances and state industries led to changes in the rules of international trade to a system more nearly in line with Keynes’ proposals.