Free Trade Is Dead. Long Live Managed Trade

By Peter Coy

(Bloomberg Businessweek) -- At age 85, Jagdish Bhagwati has defended free trade for decades. The professor of economics and law at Columbia University even wrote a 2004 book called In Defense of Globalization. He doesn’t like the way things have gone lately. “My worry is basically that around the world, there are very different reasons why people are beginning to despair about free trade,” he says.

As economists such as Bhagwati never tire of saying, international trade lowers prices and increases variety by allowing producers in different nations to specialize in what they do best. It promotes productivity and innovation. The entry of China and India into the world trading system has lifted hundreds of millions of people from destitution.

But free trade has always faced a chorus of critics ranging from labor unions to environmentalists to national security types, from powerful corporations to those suspicious of powerful corporations. And now some of the players that worked hardest to counter those forces and make trade freer—such as the U.S. government—are themselves turning cool to it.

Trade in goods and services as a share of world gross domestic product has flattened out in the past several years after decades of increasing, according to data collected by the World Trade Organization. Trade in goods alone has been falling since around 2010 as a share of world GDP, perhaps because of a partial unraveling of global supply chains, according to an analysis by Hyun Song Shin, economic adviser and head of research at the Bank for International Settlements. Trade policy is a factor: “I wouldn’t say multilateralism is on life support, but it’s time for the major partners to reinvest energy in the global trading system, rather than build up walls, before it’s too late,” says Myron Brilliant, executive vice president and head of international affairs for the U.S. Chamber of Commerce.

Ever since President Franklin Roosevelt signed the Reciprocal Trade Agreements Act in 1934, American presidents have, with only a few exceptions, led the world in trying to make trade between countries freer and more rules-based. They helped launch the General Agreement on Tariffs and Trade in 1947 and its successor, the WTO, in 1995.

President Trump is approaching things differently. He views trade through the lens of national security. He’s an avowed nationalist, not a globalist. He feels he has more leverage pursuing bilateral trade deals than multilateral ones. He’s unhappy when the U.S. runs a trade deficit with a trading partner. And he loves tariffs—because “otherwise we have no cards to negotiate with,” as he said on Jan. 15.

Mexico, Canada, Japan, and China have had a taste of Trump’s approach. Now, Trump is focusing on Europe. Ireland’s Phil Hogan, the European Union’s new trade commissioner, complained on a visit to Washington on Jan. 13-16 that Trump is “obsessed” with the U.S. deficit in goods trade with the EU. He said Trump’s agenda has helped bring about “a high-pressure crisis moment for the international trading system.” (Perhaps realizing he wasn’t getting off to a good start with the readily angered U.S. president, Hogan later praised the “cooperative spirit” of the American side.)

Where Trump gets his way, trade is gradually becoming more managed than free. Free trade is about tearing down barriers, then letting private parties decide what and how much to buy from each other. Managed trade is about government negotiators setting goals or even quotas for purchases of specific products. It’s about cutting mercantilist deals rather than following rules.

The “phase one” deal with China that Trump signed this month, with its commitment by China to buy $200 billion worth of U.S. products, is managed trade, says Gary Clyde Hufbauer, a nonresident senior fellow of the Peterson Institute for International Economics. It even has a classified list specifying what products China must buy and in what volumes.

“The Chinese commitment represents a worrisome and radical change in US policy and conveys a troubling message to the rest of the world,” Hufbauer wrote in a Jan. 16 article on the Peterson Institute’s website. “The US Trade Representative dipped its toe into managed trade with the US-Mexico-Canada Agreement, by setting complicated ‘rules of origin’ and quotas governing the content of imported automobiles getting trade preferences,” Hufbauer added. “But the new US-China agreement is complete immersion. Price signals are out, quantitative commitments are in.”

It’s not happening everywhere. The EU entered an “economic partnership agreement” with Japan a year ago. China cut tariffs on more than 800 products on Jan. 1. But because Trump is president of the most powerful country, with the biggest domestic market, his approach is reshaping the world trading system. The effects may endure even after he leaves office.

The ebbing of America’s free-trade tide shouldn’t come as a surprise: The broad-based liberalization of trade that FDR helped kick off in 1934 is an outlier in world history, and incomplete at that. High tariffs were once a key source of government revenue around the world. Even today, tariffs are frequently justified as a way to protect infant industries or militarily sensitive sectors. Businesses favor high tariffs, “voluntary” restraints on imports, and hard-to-detect nontariff barriers because they can earn higher profits when protected from foreign competition. “Free trade turns out to be something that helps a rising great power, until it doesn’t, and which most countries claim to practice while trying to subvert its principles as much as possible,” Bloomberg Opinion columnist Pankaj Mishra wrote in December.

The command-and-control nature of managed trade is a far cry from the free enterprise that Republican presidents have typically advocated. It can also be unfair to American allies, which could lose sales to China because of preferences given to the U.S. That’s why managed trade is frowned on by the WTO. During his visit to D.C., Hogan said the EU will file a complaint with the WTO if it concludes that the U.S.-China deal breaks the rules.

The WTO, though, has no enforcement powers of its own. The free-trade group “only works if people believe in it,” Robert Koopman, the body’s chief economist, said on a panel at the Jan. 3-5 annual meeting of the American Economic Association in San Diego. The organization has lost influence since the U.S. neutered its Appellate Body by blocking the appointment of new members. So Trump’s managed trade could eventually become the norm. Writes Hufbauer: “In the immediate aftermath, other countries may complain; over a longer period, they are likely to emulate.”

It would be unfair to portray Trump as the lone renegade in a world of dutiful free-traders. There are many that flout the rules, chief among them China, which continues to restrict access to its market despite its accession to the WTO in 2001. “China critics” tend to argue that managed trade “is the only way credibly to ensure improved access to the Chinese market,” Stanford Law School professor Alan Sykes said in a Q&A on the school’s website on Jan. 16.

It’s understandable why Trump got into a trade war with China. It’s harder to see why he would do the same with Europe, which is an ally of the U.S. and is far more open to trade than China. But Europe seems to exasperate the U.S. president, who broke off talks on a Transatlantic Trade and Investment Partnership soon after taking office and then put duties on European steel and aluminum on national security grounds. He’s threatened 25% tariffs on European cars and parts unless European automakers shift more production to the U.S. According to the Washington Post, he has made the same threat to get Britain, France, and Germany to formally accuse Iran of breaking the 2015 nuclear deal. France’s 3% digital services tax has inflamed the U.S. side because it would slam U.S. tech giants, though it applies to all countries. Under a truce reached on the sidelines of the World Economic Forum in Davos, Switzerland, on Jan. 22, the French will postpone collecting the tax until the end of 2020 and the U.S. will refrain from retaliatory tariffs.

Food trade has long been a bone in the throat of both the U.S. and the Europeans. France, for one, insists that its chefs shall never make coq au vin with chlorinated chickens from the U.S., nor mousse de saumon from America’s genetically modified salmon. To the American side, that smells like protectionism. But the U.S. has its own set of sheltered products, including peanuts, apricots, and Roquefort cheese. In Davos, Trump said he aims to strike a trade deal by November with the EU—but added that “they are frankly more difficult to do business with than China.”

One reason trade agreements are so fraught is that they’re asked to do too much. Conservatives seek deregulation through trade deals (unless they’re seeking to export American intellectual-property protections to benefit Big Pharma). Liberals insist that trade deals must fix inequality and include labor and environmental standards. The breadth of the agendas strikes some critics as mission creep, or meddling in trading partners’ domestic affairs. For his part, Trump wants trade agreements to shrink trade deficits, even though the main reason for the overall trade deficit is that the U.S. is consuming beyond its means.

Expecting one tool—a trade agreement—to achieve such varied objectives violates what’s known as the Tinbergen rule, named after Jan Tinbergen, the Dutch economist who shared the first Nobel Prize in economics in 1969. The rule of thumb holds that each economic target you’re trying to hit requires an instrument of its own. Which is kind of common sense.

While getting trade policy right matters, “what happens at home has and will have greater impact on workers than what happens abroad,” Harvard economist Dani Rodrik, a skeptic of free trade, said at the San Diego meeting. Kimberly Clausing, a Reed College economist who likes free trade more than Rodrik does, told the same conference that the ideal pairing for society is freer markets to benefit consumers along with a stronger social safety net to protect workers—“so, the opposite of the policy we’ve been following the last few years.” Trade adjustment assistance for workers who lose jobs because of trade isn’t enough, Clausing said.

A strong social safety net undoubtedly would increase the public’s and politicians’ support for free trade by relieving fears of job loss. James Green, a senior research fellow at Georgetown University’s Initiative for U.S.-China Dialogue on Global Issues, says, “This unrest about trade, in my view, is an overhang of the 2008 financial crisis” and the job loss it caused. Then again, insulating citizens from risk is hardly a simple chore. “None of this is easy,” says Massachusetts Institute of Technology economist Kristin Forbes. “If it was, we’d be doing it.”

In a world of sovereign nation-states, it’s unrealistic to believe that borders to trade will ever be thrown completely open, Peter Chase, a senior fellow at the German Marshall Fund, told the German broadcaster Deutsche Welle in 2018. He added: “Ask not if ‘free’ trade is dead; ask if it ever lived.”

To contact the author of this story: Peter Coy in New York at pcoy3@bloomberg.net

To contact the editor responsible for this story: Howard Chua-Eoan at hchuaeoan@bloomberg.net

©2020 Bloomberg L.P.


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