14 May 2019

The trade war is bad. The trade truce could be much worse

By Craig VanGrasstek

The stock markets once more give us cause to question the wisdom of crowds. While China’s counter-retaliation against US tariffs was entirely predictable, it still precipitated a major drop in share prices. We may safely assume that when Washington and Beijing eventually call a truce in this trade war, the markets will claw back at least as much as they have lost. If the celebration extends into the more irrational precincts of exuberance, the traders will prove how short their time horizon really is.

Far more is at stake than what the United States demands of China, or the trade that is immediately at risk. This confrontation is part of the Trump administration’s plan to remake a trading system that rests on four foundations, all but one of which are now under attack.

The first of those foundations holds that the gains from trade are positive-sum, and that agreements should create opportunities rather than dictate outcomes. These are principles that trade negotiators sometimes honour in the breach, making whatever compromises they think necessary for the sake of “getting to yes”, but the trend over time had been for the principle to overcome the exceptions.

The second foundation is the premise that while trade serves economic and security interests, those two spheres are best kept apart. Thus while GATT and NATO were coeval institutions, everyone understood that the GATT had no more business taking up security issues than NATO did in resolving trade disputes. These principles were reflected in the loose rule by which countries could invoke the security exception of GATT Article XXI, and the stronger norm by which they would never do so frivolously.

The third foundation put multilateralism at the heart of the system. While countries are permitted to negotiate free trade agreements (FTAs) and customs unions, these were meant to complement rather than substitute for GATT and now the WTO. FTAs can serve the larger interest of the community by permitting the most ambitious countries to make deeper commitments on the established issues while setting precedents on new ones.

All three foundations rested atop the fourth, which was the trust that the community placed in a leader. The United Kingdom played that role in the 19th century, and — after a few tumultuous decades — the United States took it up in the middle of the 20th. This is unfortunately the only foundation in which the Trump administration believes, and for all the wrong reasons. Trump aims to remake the system along unapologetically mercantilist lines that challenge all of the other premises.

Trump’s mercantilism is rooted in an unshakable belief that all gains are zero-sum, that power and wealth are indivisible, and that only a fool puts the community ahead of his country. In place of supporting a liberal, multilateral system founded upon the rule of law, Trump wants to reinstate power as both the means and the end of the trading system. That larger objective has so far manifested itself in three major initiatives.

The first was the Trump administration’s deliberate gaming of the system in order to restrict imports of steel and aluminum, and possibly cars as well. It did so by invoking the most permissive of all US trade laws (the Section 232 national security statute), backed up by the most permissive of the exceptions clauses (GATT Article XXI). This undeniably brilliant manoeuvre not only achieved the immediate aim, but also forces the WTO into an impossible dilemma: Let Trump get away with this abuse, or provoke him by questioning his national-security rationale.

The administration’s second initiative was to advance a new template for FTAs, starting with its renegotiation of NAFTA. While there are many aspects of this revamped agreement that reflect established US positions, two others point to radical shifts. One sets trade management as the agreement’s principal objective, as reflected both in the administration’s express goals and in specific provisions (e.g., the rules of origin). The other is a provision by which Canada and Mexico gave the United States a veto over any future plans for FTAs with China.

That latter point helps to define the context in which the third initiative — the dispute with China — is being conducted. The administration clearly wants the trade-management provisions of this agreement to go far beyond those in the renegotiated NAFTA, including purchase commitments that could make this pact appear like a dressed-up barter arrangement. When combined with the other two initiatives, the administration’s true aim appears to be a complete sidelining of the WTO, and its replacement by a series of bilateral deals in which the state may matter as much as the market.

The Trumpian system contemplates agreements that are mercantilist in their objectives, bilateral in their structure, and exclusive in their benefits. If this sounds far-fetched, consider how far we have already gone towards a bloc system. We now have one group that consists of the United States, plus its existing FTA partners, plus its FTA negotiating partners (ie, the European Union, Japan, and the United Kingdom); they collectively account for three-fifths of global GDP. The corresponding bloc of China and its partners accounts for two-fifths of global GDP. What is most striking is how few countries have a foot in each camp. Apart from Japan and South Korea, the other five are all fairly small (e.g., Australia and Chile).

Will Trump replace the WTO zoo with a bilateral jungle? Much will depend on how long he remains in office, as a second term would create many more opportunities for mischief. The most immediate questions are, first, whether and on what terms Congress might approve the revised NAFTA, and second, how far China goes in yielding to US demands. The latest signs suggest that both Capitol Hill and Beijing are putting up more resistance than Trump expected. Things have admittedly come to a fine pass when the friends of open markets must pin their hopes on Congress and China, but at least both of them take a longer view than the day-traders who now occupy Wall Street.

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Craig VanGrasstek teaches the political economy of trade at the Harvard Kennedy School, and is the author of 'Trade and American Leadership: The Paradoxes of Power and Wealth from Alexander Hamilton to Donald Trump'.