WASHINGTON – We may be on the cusp of an upheaval in global trade.
Since World War II, the international trading system has operated on the premise of “most favored nation (MFN),” meaning concessions granted to one country must be extended to all others in the system. The standoff between the U.S. and China suggests that this is giving way to the emergence of rival economic blocs that increasingly control international trade and investment.
In a new paper, economists David Jacks and Dennis Novy argue that today’s contentious trade disputes recall what happened during the Great Depression. Led by Great Britain and Germany, competing trading blocs governed large portions of global commerce. Something similar is happening now. Witness President Trump’s threat to impose a 5% tariff on Mexican imports as a way of reducing illegal immigration.“The trade wars of the present day [may lead] … to a reorientation of world trade around China – and U.S.-centric trade blocs,” they write.
To be sure, MFN was not always followed with religious fervor. Exceptions occurred. Practical politics often collided with economic principle. Still, the U.S. was the world’s major economic power and the main architect of the postwar trading system, and it supported MFN.
The traditional American view has been that trade liberalization (fewer tariffs and quotas) benefits all countries, importers and exporters alike. Trade is not a zero-sum game, where one party’s gain is inevitably the other’s loss. Now this crude consensus seems to be crumbling under China’s emergence as an economic superpower and Trump’s election as president.
The U.S. and China each believes it could do better in a system that gives more weight to its economic power. Instead of a multilateral trading system, where gains are negotiated and shared by all, the U.S. and China each prefers a system built on a series of bilateral or country-to-country negotiations.
The Trump administration has argued that it could do better under this sort of system because providing access to the massive U.S. marketplace would enhance its negotiating leverage. The point is simple: If you don’t give us what we want, you can’t play in our market.
China nominally supports a multilateral trading system, regulated by the World Trade Organization while it does what it pleases – subsidizes critical industries, discriminates against foreign firms and forces disclosure of technical secrets as the price for staying in China. Like Americans, the Chinese believe they have superior bargaining power, based on the draw of their huge market.
Until World War I, free trade flourished in Europe. From 1815 to 1913, “world exports increased roughly by a factor of 50 in real terms,” note Jacks and Novy. But the Depression changed the context. Wages and prices fell sharply; unemployment rose dramatically. Desperate for relief, governments resorted to tariffs as a way to reduce imports and halt the downward spiral.
In 1932, Great Britain ditched its historic defense of free trade and negotiated bilateral agreements with Australia, Canada, India, Newfoundland, New Zealand, South Africa and Southern Rhodesia: Commonwealth countries.
Later in the decade, Germany formed a the Reichsmark bloc, whose members included Austria, Brazil, Bulgaria, Czechoslovakia, Germany, Greece, Hungary and Romania. The U.S. part in this surging protectionism was the well-known Smoot-Hawley tariff legislation signed by President Hoover in 1930.
“At the moment, we have not witnessed a wholesale collapse of the modern trading system,” say Jacks and Novy, but we seem to be headed that way. It’s not an ideal destination, notes economist Douglas Irwin of Dartmouth College. Trading blocs suffer from two significant drawbacks, he says.
First, they sacrifice some economic benefits; decisions of where to buy and sell are determined by political considerations, not economic efficiency. This is a serious, but manageable, flaw.
The larger defect is that trade blocs become a source of international conflict. Rather than trading for mutual benefit, countries increasingly view trade as a way to punish their adversaries and reward their friends. That seems to be Trump’s belief, reflected in his threat to impose a 5% tariff on Mexican imports.
We should be questioning whether this is where we want to go, and if not, how do we stop the drift?
Robert Samuelson is a columnist for The Washington Post.