Overcoming the poisonous politics of protectionism

LONDON – According to conventional economic wisdom, free trade is good – so the freer the better. After all, steady trade liberalization in recent decades has clearly boosted economic growth in developed and developing countries alike. But, as Barry Eichengreen of the University of California at Berkeley notes, “just because economists agree doesn’t mean they’re right.” And even when economists are right about trade, that doesn’t stop vote-chasing politicians from ignoring their advice.

That is certainly true today. “One thing is now certain about the upcoming presidential election in the United States: the next president will not be a committed free trader,” Eichengreen writes. Hillary Clinton, the Democratic nominee, “is at best a lukewarm supporter of freer trade, and of the Trans-Pacific Partnership [TPP] in particular. Her Republican counterpart, Donald Trump, is downright hostile to trade deals that would throw open US markets,” promising to impose high import tariffs, particularly on Chinese goods.

Now add Britain’s referendum vote to leave the European Union (the world’s biggest trade bloc), the demise of the World Trade Organization’s Doha Development Round, and growing opposition to regional deals, and the increasingly fraught politics of trade becomes even more apparent. Clearly, if countries are to benefit from economic openness and avoid its pitfalls, several questions must be addressed.

For starters, what remains of the argument – a staple of economic theory – that unrestricted trade benefits all? What should be included in trade agreements? And, perhaps most important, in view of surging electoral support for populist candidates favoring protectionism, what steps can political leaders take to encourage domestic support for trade liberalization?

Trade Optimists

Many believe that the fundamental benefit of international trade is undeniable. As UC Berkeley’s Laura Tyson and Sarah Lund of the McKinsey Global Institute observe, interconnectedness fosters growth via the productivity gains from specialization, competition, and innovation. Andrés Velasco, a former finance minister of Chile, notes that trade liberalization helps developing countries boost productivity by integrating them into global supply chains.

Similarly, the Hoover Institution’s Michael J. Boskin cites David Ricardo’s two-century-old theory of comparative advantage to defend the TPP. Harvard’s Jeffrey Frankel observes an 18% productivity gap between US manufacturers that export and those that do not. He, too, invokes Ricardo in promoting the TPP: “Countries benefit most from producing and exporting what they are relatively best at producing and exporting, and from importing what other countries are relatively better at producing.”

Likewise, Yale’s Koichi Hamada, a special economic adviser to Japan’s prime minister, argues that “the increased trade and investment flows brought about by the TPP’s ratification and implementation will benefit even the countries that must make larger sacrifices.” For her part, Yuriko Koike, a member of Japan’s National Diet, acknowledges the risks of the TPP for Japan’s agriculture, but says the agreement is “vital” for the country.

Advocates of the TPP describe it as an enormous growth engine for the global economy. Former Swedish Prime Minister Carl Bildt and Javier Solana, the former Spanish foreign minister, highlight the comparable benefits of the TTIP, calling objections to it “trivial.” And Ana Palacio, another former Spanish foreign minister, urges an EU-Japan trade deal as a more easily achieved complement to the TPP.

The Peterson Institute for International Economics has estimated that the TPP would boost the economies of the participating countries by 1.1% by 2030, and the US economy by 0.5%. Anders Fogh Rasmussen, the former secretary general of NATO, is similarly upbeat about the TTIP, arguing that it would add $125 billion to US GDP and a similar amount (proportionally) to the EU economy.

Trade Skeptics

Trump and other protectionists often argue that the flaw in unrestricted trade is that some countries, particularly China, keep their currencies artificially low. Simon Johnson, former chief economist at the International Monetary Fund and a senior fellow at the Peterson Institute cites the damage to US manufacturing employment from undervalued Chinese and Japanese currencies, arguing that TPP members “must commit not to run large current-account surpluses and accumulate excess foreign-exchange reserves.”

But Yale’s Stephen Roach counters that China long ago ceased buying dollar assets to hold down its currency, and that its current-account surplus has shrunk steadily. The US trade deficit, he argues, reflects inadequate savings, not Chinese currency manipulation, as illustrated by the fact that the US runs bilateral deficits with most of its trading partners.

Kemal Derviş of the Brookings Institution acknowledges that currency manipulation can be a problem; but he argues that trade agreements are not the right forum to solve it, owing to the difficulty of determining what actually constitutes manipulation. Do central-bank purchases of government bonds (so-called quantitative easing) qualify? What about the eurozone’s neglect of domestic demand, which contributes to its trade surplus? For Derviş, the best venues for addressing these issues are the G20 and the IMF, with the latter being given greater powers of multilateral surveillance.

And yet not all of the growing opposition to trade is groundless. For starters, Ricardo’s argument fails to account for structural change in economies as trade liberalization proceeds. As Adair Turner, the chairman of the Institute for New Economic Thinking, points out, further trade liberalization will not bring the benefits it brought in the past: non-tradables comprise a growing share of employment and economic activity, especially in developed economies; as global incomes converge, comparative advantage on the basis of low labor costs will become less important; and new manufacturing technologies will encourage on-shoring. In Turner’s view, “trade liberalization is decreasingly important.”

Indeed, the economic benefits projected by the Peterson Institute and others are relatively small – and may not actually materialize. The United Nations’ Jomo Kwame Sundaram points to a study by the US International Trade Commission calculating that the TPP would add just 0.15% to US GDP by 2032, and increase incomes by a mere 0.23%. Moreover, these modest economic benefits will accrue to firms rather than ordinary citizens, all participating countries will suffer higher unemployment, and incomes in the US and Japan will fall.

Johnson is skeptical of many of the TPP’s alleged benefits and notes that displaced American workers stand to receive only limited compensation.

This underscores the extent to which the benefits of trade liberalization are unevenly distributed both within and across countries. As Harvard’s Dani Rodrik puts it, “the real world has not lined up so neatly with trade economists’ assumptions.” Countries might have benefited in aggregate from more trade, but particular communities have been hit hard. Some developed-country workers who have been displaced by trade with developing countries have moved into better skilled (and better paid) jobs, but many are suffering permanent income losses.

The University of Oregon’s Gordon Lafer, a former senior policy adviser to the US House of Representatives’ Committee on Education and Labor, criticizes the TPP’s tolerance of inadequate workers’ rights in undemocratic countries such as Vietnam. The TPP is “not really a ‘trade’ treaty at all,” he argues. “Rather, it is a vehicle for corporate lobbyists to achieve what they have been unable to persuade legislators to support through normal means.”

Global or Regional?

Even many advocates of trade liberalization are highly skeptical of arrangements such as the TPP and the TTIP. Pascal Lamy, a former director-general of the WTO, laments the trend toward regional agreements. Multilateral trade liberalization, he explains, has helped narrow the global gap in living standards, “with per capita incomes in developing countries rising almost three times faster than those in advanced countries.”

And yet, even as multilateral trade liberalization has ground to a halt, the push for regional agreements continues. Columbia University’s Jagdish Bhagwati and Oxford University’s Emily Jones both worry that the rise of preferential bilateral and plurilateral agreements risks undermining the WTO’s credibility as the guarantor of rules-based trade – to the detriment of developing countries, many of which lack the market size to be invited to join these smaller clubs. Likewise, Lamy fears that the proliferation of regional deals, with regulatory demands that developing countries are unable to accept, is threatening decades of real-income convergence between developed and developing countries.

For Nobel laureate Joseph Stiglitz, however, that is precisely the point. The purpose of the TPP and the TTIP, Stiglitz argues, is to institute “a managed trade regime – managed, that is, to serve the special interests that have long dominated trade policy in the West.” But not everyone in the West agrees. Sciences Po’s Zaki Laidi, currently chief foreign policy adviser to French Prime Minister Manuel Valls, believes that Europe “has a greater stake in revitalizing multilateral trade” than the US. Unlike America, Laidi argues, Europe lacks the leverage to extract advantageous regional trade deals.

The Terms of Trade Deals

Can a managed trade regime be fair, given differences among countries’ levels of development and the relative strength of those sectors in which they have a comparative advantage? As Sanjaya Baru, former national security adviser to India’s former prime minister, Manmohan Singh, points out, the TTP goes well beyond traditional free-trade agreements on goods and agriculture. In addition to intellectual-property protection and provisions to prevent “unfair” competition by state-owned enterprises, it includes labor rights, environmental protection, and investor protection from regulatory changes.

Boskin and Frankel reckon this is all to the good. Bhagwati and Stiglitz, however, argue that developing countries have been right to resist inclusion of many such provisions within WTO agreements. If trade agreements do not advance social objectives, they should not be permitted to impede them.

UN Special Rapporteur on the right to food Oliver De Schutter and Kaitlin Y. Cordes of Columbia University show what can happen otherwise. The US demand for patent protection for plants, they argue, threatens to restrict farmers’ access to productive resources, which could cause governments to violate their obligations under human-rights treaties.

Likewise, Stiglitz and Adam S. Hersh of the Roosevelt Institute contend that the investor-state dispute settlement (ISDS) provisions within the TPP could allow foreign investors to pursue binding private arbitration against a government if new regulations to protect citizens’ health and welfare reduce their expected profits. US tobacco companies, for example, could then demand compensation for regulations aimed at reducing tobacco consumption. Similarly, Sundaram stresses that the TPP will give pharmaceutical firms longer monopolies, hurting both consumers and governments. And Velasco contends that, more broadly, the rights of US firms to protect their intellectual property must be balanced against the need to spread the benefits of technology.

Trade Justice

Concerns about currency manipulation, workers’ rights, environmental standards, and much else highlight a widespread fear that Ricardian rhetoric may serve as a fig leaf for the pursuit of parochial interests, whether of nation-states or of multinational firms. Will regional deals like the TPP, rather than maximizing comparative advantage, trigger a race to the bottom, as Lafer, Stiglitz, and others fear?

Rodrik notes that workers in developed countries will accept losing their jobs because of technological change, but not when it results from competition with low-wage countries that forbid organized labor. He argues that the world needs trade agreements that allow developed countries to restrict trade when imports clearly conflict with domestic social norms – but which also allow developing countries to pursue economic diversification.

Perhaps more important, whereas advocates of free trade and globalization talk a good game about the need to compensate those who lose out or are left behind, most countries don’t put their money where their mouth is. But, as Bo Lidegaard, a former editor-in-chief of the Danish daily Politiken, observes, those that do reap enormous benefits. In terms of employment, the top seven countries worldwide have “welfare economies” that

provide free education for all and skills training for any age, so that workers can move up the labor-market value chain; social security for the unemployed, so that a temporary loss of work does not become a personally catastrophic event; and highly developed systems of care for children, the elderly, and vulnerable members of society, so that workers do not have to choose between employment and caring for loved ones.

Lidegaard acknowledges that welfare economies “are not immune to populism, nationalism, or nativism.” Nonetheless, “with higher employment and lower inequality” promoting a sense of fairness, and with strong social safety nets boosting, rather than impeding, labor-market flexibility, “challenges to the social contract itself are far more rare than they are elsewhere – particularly the US.”

The US may never be Denmark, as Clinton pointedly observed in an early debate with her Democratic rival Bernie Sanders. But now she faces an election that, as with the Brexit referendum, has come to revolve around the legitimacy of the “establishment” that she represents. And no issue has fueled that challenge more powerfully than trade. Unless Clinton – and political leaders elsewhere – embrace what has been shown to work, the challenge will grow stronger, and probably uglier as well.

Simon Tilford is deputy director at the Centre for European Reform.