The brave new world of trading blocs, Opinion

Tue, Jun 04, 2019 – 5:50 AM

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 favoured nation (MFN)”, meaning that concessions granted to one country must be extended to all countries in the system. The trade standoff between the United States and China suggests that this approach is giving way to the emergence of rival economic blocs that, increasingly, control international trade and investment.

In a fascinating new paper, economists David Jacks and Dennis Novy argue that today’s contentious trade disputes recall what happened during the Great Depression of the 1930s. Led by Britain and Germany, competing trading blocs governed large portions of global commerce. Something similar is happening now. Witness President Donald Trump’s threat to impose a 5 per cent 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 US-centric trade blocs,” they write. To be sure, MFN was not always followed with religious fervour. Exceptions occurred. Practical politics often collided with economic principle. Still, the US 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 liberalisation (fewer tariffs and quotas) benefits all countries – importers and exporters alike. Trade is not a zero-sum game. Now this crude consensus seems to be crumbling under the weight of two events: China’s emergence as an economic superpower and Mr Trump’s election as president.

For slightly different reasons, the US and China each believes that it could do better with a system that gives more weight to its disproportionate economic power. Instead of a multilateral trading system, where gains are negotiated and shared by all, the US 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 US marketplace would enhance its negotiating leverage. Meanwhile, China nominally supports a multilateral trading system, regulated by the World Trade Organization (WTO), while – in practice – it does exactly what it pleases. That is, it subsidises 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 (inflation-adjusted) terms”, note economists Jacks and Novy. (Their study was recently published as a working paper by the National Bureau of Economic Research. Mr Jacks teaches at the Simon Fraser University in Canada and Mr Novy at the University of Warwick in the UK.)

But the 1930s 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 of wages and prices.

In 1932, Great Britain ditched its historic defence of free trade at the Imperial Economic Conference in Ottawa. It negotiated bilateral agreements with Australia, Canada, India, Newfoundland, New Zealand, South Africa and Southern Rhodesia. Trade was deliberately diverted to Commonwealth countries.

Later in the decade, Germany formed a bloc (the Reichsmark bloc), whose members included Austria, Brazil, Bulgaria, Czechoslovakia, Germany, Greece, Hungary and Romania. The US part in this surging protectionism was the Smoot-Hawley tariff legislation signed by then president Herbert Hoover in 1930.

“At the moment, we have not witnessed a wholesale collapse of the modern trading system,” say the two economists. But we seem to be headed that way, they indicate. It’s certainly 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 Mr Trump’s belief, reflected in his threat to impose a 5 per cent 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? THE WASHINGTON POST WRITERS GROUP