North America

The cracks in liberal orthodoxy are showing

‘America First’ rally cry exposes cracks in free trade facade, argues Clyde Prestowitz

A Trump fan on the trading floor of the New York Stock Exchange

The Trump administration’s withdrawal from the Trans-Pacific Partnership free trade agreement negotiations, together with its proposals to revise international trade agreements and an expressed preference for new bilateral deals over multilateral ones, has shaken the bastions of free trade orthodoxy.

So shaken indeed, that the Chinese President Xi Jinping, even as he prepared to unleash a boycott of South Korean imports in response to the country’s installation of a missile defence system aimed at North Korea, was grotesquely hailed as the new champion of globalization by the international elite gathered at the World Economic Forum, in Davos, Switzerland.

Far from confirming the error of the Trump administration’s thinking, however, the furore of the response may only be revealing fear and doubts about the efficacy of the underlying doctrine and arrangements to which the apostles of orthodoxy pay homage. One needn’t agree with everything the Trump team says to see cracks in the walls.

Fundamental to globalization doctrine is the notion that free trade is always and everywhere a win-win proposition. Sometimes the concession is made that everyone involved is not necessarily a winner. But it is claimed that the winners always out-number any possible losers and that the winners will compensate the losers so that everyone wins in the end. It is now generally agreed, however, that globalization has been an important element driving increasing income and wealth inequality. So either the winners don’t always outnumber the losers or they don’t always compensate them or both.

In fact, the economist Paul Krugman won his Nobel Prize by noting that most assumptions underlying the win-win doctrine − full employment, absence of economies of scale, zero costs of entering or exiting business, fixed exchange rates and zero cross-border flows of finance and technology − are nonsense in the real world.

Later, William Baumol, the former president of the American Economics Association, and Ralph Gomory, IBM’s former chief scientist, demonstrated in their book, Global Trade and Conflicting National Interests, that whether a trade arrangement is win-win, zero sum, or neutral in its impact on participants depends greatly upon the circumstances of the countries, industries and technologies involved.

Furthermore, there is no history of countries becoming rich by dint of free trade. The UK, the US, Germany, Japan, South Korea and now China have all become rich as mercantilists and protectionists. Only after becoming rich did they become, in some cases, free traders.

This evolution has now resulted in a polite but increasingly dysfunctional fiction − that as members of the World Trade Organization and the International Monetary Fund all the major trading nations are playing the same free trade/globalization game. In fact, they are not.

After the Second World War, Britain and the US adopted and applied the thinking of free market, free trade thinkers such as Adam Smith and David Ricardo. But others did not. As I wrote in Trading Places, Japanese officials openly told me that they did ‘the opposite of what the Americans told us to do’.

Japan was brought into the General Agreement on Tariffs and Trade, the predecessor of the WTO, by the US over

European objections for geopolitical reasons, not for its faithful adherence to free trade doctrine. Similar reasoning applied to South Korea’s and China’s admission.

The difference in philosophy and practice is evident in the global trade numbers. What might be called the Anglosphere countries – the UK, US, Canada, Australia, India, and those such as Mexico that imitate their policies − have all been accumulating large current account deficits for a long time. Conversely, those countries taking a more nationalist or mercantilist approach − Germany, the Netherlands, Switzerland, Russia, Sweden, Japan, South Korea, Taiwan, China, Singapore and followers − all have been running chronic current account surpluses.

Despite the uproar and fear directed towards the Trump administration, the truth of the polite fiction and of the arguments of Baumol and Gomory is reflected in the statements and actions of many of those voicing dismay about Trump.

‘While it may be that Trump does not have all the right answers, he is certainly not alone in having questions’

The Australians are voicing concern about Chinese investors and even limiting sales of certain assets to them. In Germany, the country with the biggest current account surplus by percentage of GDP, one hears rumblings about too much Chinese buying of advanced German manufacturers. Indeed, even Britain, the ultimate refuge of free traders and global investors, hesitated to allow Chinese investment in its latest nuclear power stations.

The European and American Chambers of Commerce in China have recently published papers saying that their member corporations are increasingly feeling unwelcome in China. Thus, while it may be that Trump does not have all the right answers, he is certainly not alone in having questions. Further, it is obvious that the WTO, IMF and other international institutions do not have good answers.

One of Trump’s concerns for which he is criticized is the chronic US current account deficit of about $600 billion a year. A recent spate of articles in leading media has archly noted that this deficit is matched by an inflow of the same amount on the capital account.

But the commentary made it sound as if the capital inflow is free, a kind of gift from the world for all that America does. Of course, it is nothing of the kind. It is an investment that expects a return, and that return represents a claim on American earnings for a long time to come. The only reason we Americans can get away with this is because we print the world’s main reserve currency. Even so, that doesn’t mean there is no cost.

One who understood the costs very well was the great British economist John Maynard Keynes. At the Bretton Woods conference, the IMF was established to make loans to countries in trade deficit and to develop plans for them to achieve balance.

Keynes argued vigorously that chronic surplus was as costly and dangerous as chronic deficit, and called for the imposition by the IMF of tariffs on the exports of countries in chronic surplus. Then a surplus country, the US objected and the Keynes proposal was not adopted, but that didn’t mean he was wrong.

How the US should deal with its current account deficits and with further trade negotiations is, of course, up for debate.

Some argue for tax initiatives and financial reforms that would raise the US rate of savings and make America a more attractive location for foreign direct investment and for the production of exports.

These suggestions are in the right direction and more than worthy of consideration. But there is no good reason automatically to exclude adjustments to trade agreements and trade measures as well. It is well known that some countries provide incentives that result in the creation of massive excess capacity in targeted industries. No changes in taxes or savings rates are going to change this reality.

Current trade rules were not created with the expectation in mind that state-supported or controlled enterprises would be dominant players in some areas of global trade. Should this new reality of the international market place be ignored for fear of altering rules made under very different circumstances? Of course, changes in any of the rules must be negotiated equitably by all players, but there is no good reason to ignore the need for change.