World politicians, business leaders, charities and pressure groups are meeting in Davos at the 2022 World Economic Forum. Normally this event takes place in January each year, but it was postponed to this May because of Covid-19 and is the first face-to-face meeting since January 2020.
The meeting takes place amid a series of crises facing the world economy. The IMF’s Managing Director, Kristalina Georgieva, described the current situation as a ‘confluence of calamities’. Problems include:
Continuing hangovers from Covid have caused economic difficulties in many countries.
The bounceback from Covid has led to demand outpacing supply. The world is suffering from a range of supply-chain problems and shortages of key materials and components, such as computer chips.
The war in Ukraine has not only caused suffering in Ukraine itself, but has led to huge energy and food price increases as a result of sanctions and the difficulties in exporting wheat, sunflower oil and other foodstuffs.
Supply shocks have led to rising global inflation. This will feed into higher inflationary expectations, which will compound the problem if they result in higher prices and wages in response to higher costs.
Central banks have responded by raising interest rates. These dampen an already weakened global economy and could push the world into recession.
Global inequality is rising rapidly, both within countries and between countries, as Covid disruptions and higher food and energy prices hit the poor disproportionately. Poor people and countries also have a higher proportion of debt and are thus hit especially hard by higher interest rates.
Global warming is having increasing effects, with a growing incidence of floods, droughts and hurricanes. These lead to crop failures and the displacement of people.
Countries are increasingly resorting to trade restrictions as they seek to protect their own economies. These slow economic growth.
World leaders at Davos will be debating what can be done. One approach is to use fiscal policy. Indeed, Kristalina Georgieva said that her ‘main message is to recognise that the world must spend the billions necessary to contain Covid in order to gain trillions in output as a result’. But unless the increased expenditure is aimed specifically at tackling supply shortages and bottlenecks, it could simply add to rising inflation. Increasing aggregate demand in the context of supply shortages is not the solution.
In the long run, supply bottlenecks can be overcome with appropriate investment. This may require both greater globalisation and greater localisation, with investment in supply chains that use both local and international sources.
International sources can be widened with greater investment in manufacturing in some of the poorer developing countries. This would also help to tackle global inequality. Greater localisation for some inputs, especially heavier or more bulky ones, would help to reduce transport costs and the consumption of fuel.
With severe supply shocks, there are no simple solutions. With less supply, the world produces less and becomes poorer – at least temporarily until supply can increase again.
Donald Trump has threatened to pull out of the World Trade Organization. ‘If they don’t shape up, I would withdraw from the WTO,’ he said. He argues that the USA is being treated very badly by the WTO and that the organisation needs to ‘change its ways’.
Historically, the USA has done relatively well compared with other countries in trade disputes brought to the WTO. However, President Trump does not like being bound by an international organisation which prohibits the unilateral imposition of tariffs that are not in direct retaliation against a trade violation by other countries. Such tariffs have been imposed by the Trump administration on steel and aluminium imports. This has led to retaliatory tariffs on US imports by the EU, China and Canada – something that is permitted under WTO rules.
Whether or not the USA does withdraw from the WTO, Trump’s threats bring into question the power of the WTO and other countries’ compliance with WTO rules. With the rise in protectionist sentiments around the world, the power of the WTO would seem to be on the wane.
Even if the USA does not withdraw from the WTO, it is succeeding in weakening the organisation. Appeals cases have to be heard by an ‘appellate body’, consisting of at least three judges drawn from a list of seven, each elected for four years. But the USA has the power to block new appointees – and has done so. As Larry Elliott states in the first article below:
The list of judges is already down to four and will be down to the minimum of three when the Mauritian member, Shree Baboo Chekitan Servansing, retires at the end of September. Two more members will go by the end of next year, at which point the appeals process will come to a halt.
This raises the question of the implication of a ‘no-deal’ Brexit – something that seems more likely as the UK struggles to reach a trade agreement with the EU. Leaving without a deal would mean ‘reverting to WTO rules’. But if these rules are being ignored by powerful countries such as the USA and possibly China, and if the appeals procedure has ground to a halt, this could leave the UK without the safety net of international trade rules. Outside the EU – the world’s most powerful trade bloc – the UK could find itself having to accept poor trade terms with the USA and other large countries.
The President of the United States, Donald Trump, announced recently that he will be pushing ahead with plans to impose a 25% tariff on imports of steel and a 10% tariff on aluminium. This announcement has raised concerns among the USA’s largest trading partners – including the EU, Canada and Mexico, which, according to recent calculations, expect to lose more than $5 billion in steel exports and over $1 billion in aluminium exports.
A number of economists and policymakers are worried that such policies restrict trade and are likely to provoke retaliation by the affected trade partners. In recent statements, the EU has pledged to take counter-measures if the bloc is affected by these policies. In a recent press conference, the Commissioner for Trade, Cecilia Malmstrom, stated that:
We have made it clear that a move that hurts the EU and puts thousands of European jobs in jeopardy will be met with a firm and proportionate response.
She added that, ‘I truly hope that this will not happen. A trade war has no winners.’
Why is everyone so worried about trade wars then? Trade wars, by definition, result in trade diversion which can hurt employment, wealth creation and overall economic performance in the affected countries. As affected states are almost certain to retaliate, these losses are likely to be felt by all parties that are involved in a trade war – including the one that instigated it. This results in a net welfare loss, the size of which depends on a number of factors, including the relative size of the countries that take part in the trade war, the importance of the affected industries to the local economy and others.
A number of studies have attempted to estimate the effect of trade restrictions and tariff wars on welfare: see for instance Anderson and Wincoop (2001), Syropoulos (2002), Fellbermayr et al. (2013). The results vary widely, depending on the case. However, there seems to be consensus that the more similar (in terms of size and industry composition) the adversaries are, the more mutually damaging a trade war is likely to be (and, therefore, less likely to happen).
As Miyagiwa et al (2016, p43) explain:
A country initiates contingent protection policy against a trading partner only if the latter has a considerably smaller domestic market than its own, while avoiding confrontation with a country having a substantially larger domestic market than its own.
As both Canada and the EU are very large advanced market economies, it remains to be seen how much risk (and potential damage to the local and global economy) US trade policymakers are willing to take.
Since running for election, Donald Trump has vowed to ‘put America first’. One of the economic policies he has advocated for achieving this objective is the imposition of tariffs on imports which, according to him, unfairly threaten American jobs. On March 8 2018, he signed orders to impose new tariffs on metal imports. These would be 25% on steel and 10% on aluminium.
His hope is that, by cutting back on imports of steel and aluminium, the tariffs could protect the domestic industries which are facing stiff competition from the EU, South Korea, Brazil, Japan and China. They are also facing competition from Canada and Mexico, but these would probably be exempt provided negotiations on the revision of NAFTA rules goes favourably for the USA.
Assuming there were no retaliation from other countries, jobs would be gained in the steel and aluminium industries. According to a report by The Trade Partnership (see link below), the tariffs would increase employment in these industries by around 33 000. However, the higher price of these metals would cause job losses in the industries using them. In fact, according to the report, more than five jobs would be lost for every one gained. The CNN Money article linked below gives example of the US industries that will be hit.
But the costs are likely to be much greater than this. Accorinding to the law of comparative advantage, trade is a positive-sum game, with a net gain to all parties engaged in trade. Unless trade restrictions are used to address a specific market distortion in the trade process itself, restricting trade will lead to a net loss in overall benefit to the parties involved.
Clearly there will be loss to steel and aluminium exporters outside the USA. There will also be a net loss to their countries unless these metals had a higher cost of production than in the USA, but were subsidised by governments so that they could be exported profitably.
But perhaps the biggest cost will arise from possible retaliation by other countries. A trade war would compound the net losses as the world moves further from trade based on comparative advantage.
Already, many countries are talking about retaliation. For example, the EU is considering a ‘reciprocal’ tariff of 25% on cranberries, bourbon and Harley-Davidsons, all produced in politically sensitive US states (see the first The Economist article below). ‘As Jean-Claude Juncker, president of the European Commission, puts it, “We can also do stupid”.’ In fact, this is quite a politically astute move to put pressure on Mr Trump.
But cannot countries appeal to the WTO? Possibly, but this route might take some time. What is more, the USA has attempted to get around WTO rules by justifying the tariffs on ‘national security’ grounds – something allowed under Article XXI of WTO rules, provided it can be justified. This could possibly deter countries from retaliating, but it is probably unlikely. In the current climate, there seems to be a growing mood for flouting, or at least loosely interpreting, WTO rules.
President-elect Donald Trump has blamed free trade for much of America’s economic problems. He argues that cheap imports from China, partly from an undervalued yuan, have led to a loss of jobs and to large-scale income flows from the USA to China. “They have taken our jobs; they have taken our money; and on top of that they have loaned the money to us and we actually pay them interest now on money,” he claimed to The Economist.
And it’s not just trade with China that he criticises. He sees cheap imports from developing countries generally as undermining US jobs. The solution he advocates is the imposition of tariffs on imports that threaten US jobs and scrapping, or fundamentally renegotiating, trade deals.
He refers to NAFTA – the North American Free Trade Agreement with Canada and Mexico – as the worst trade deal in US history and blames it for the loss of thousands of US manufacturing jobs. He has said that he will demand better terms from Mexico and Canada. If they don’t agree to them, he’d pull the USA out of NAFTA altogether.
A more recent trade agreement is the Trans-Pacific Partnership (TPP) with 11 other Pacific rim countries (but not including China). The agreement was signed on 4 February 2016, but is awaiting ratification from member countries. Amongst other things, the agreement cuts over 18,000 tariffs. Donald Trump has said that he would block the deal, even though it would lead to the elimination of tariffs on most US manufactured and agricultural products exported to the other countries. He argues that it would lead to a large-scale loss of US jobs from cheap imports.
Another major trade deal criticised by Trump is that being negotiated between the USA and the EU – the Transatlantic Trade and Investment Partnership (TTIP). It has already faced fierce opposition in Europe, with many fearing that it would give too much power to US corporations in their operations in Europe. With the opposition from Trump, it looks unlikely that the agreement will be signed, even in an amended form.
So is this more protectionist stance by Donald Trump in America’s interests? The main argument against restricting imports is that people generally in the USA would be poorer. This is the prediction from the law of comparative advantage. Trade allows a country to consume beyond its production possibility curve by specialising in the production of goods with relatively low opportunity costs and importing goods which would have had a higher opportunity cost if they were produced domestically (see, for example, Economics, 9th edition, pages 711–4). By imposing tariffs or other restrictions on cheap imports, consumers would end up paying more for such goods if they now have to be produced domestically. Cheap Chinese t-shirts would be replaced by expensive US ones. Real US incomes would be lower.
Another danger of pursuing protectionist policies is that other countries might retaliate. Trade wars might result, with the world ending up poorer.
Then there is a problem of locating products. It is not a simple question of saying a product is made in the USA or elsewhere. With complex modern supply chains, many products use components and services, such as design and logistics, from many different countries. Imposing restrictions on imports may lead to damage to products which are seen as US products.
An open trade policy, by contrast, not only leads to higher consumption, it stimulates economic growth and the extra competition it creates improves domestic productivity. As the pro-free trade article by Graeme Leach, linked below, argues:
There is overwhelming evidence that free trade improves economic performance by increasing competition in the domestic market. Trade disciplines domestic firms with market power, and simultaneously promotes productivity growth. Research also shows that a 10 per cent increase in trade leads to a 5 per cent increase in per capita income. More open trade policies are associated with higher per capita incomes.
And as the article by Clark Packard argues:
There is no question that America’s middle and lower classes have benefited from our trade liberalization. Through the widely accepted principle of comparative advantage in our trade policies, productivity has surged and prices have declined. Lower prices save the average American family thousands of dollars a year on goods they consume, raising the standard of living through enhanced purchasing power.
Despite these arguments, there is one crucial problem with free trade. Although overall levels of consumption may be higher, trade may make some people poorer. If workers in the US steel or garment industries lose their jobs because of cheap imports, they will certainly feel worse off, especially if there is no prospect of them getting another job elsewhere. They may lack transferable skills or have too many family or personal ties to move elsewhere in the country.
The government could help to ameliorate the problems of those made unemployed by providing retraining or resettlement grants or by investing in infrastructure projects that require relatively low skilled, but local, construction workers. But, as the Forbes article states:
It is in helping displaced workers of all types that US government, as well as the leaders of other rich countries, have largely failed. Little has been done to assist laid-off workers whose industries simply cannot compete in developed countries anymore.
What is more, inequality has been growing in the USA, and in most other developed countries too. International trade and investment and the growing concentration of power in large corporations has meant that most of the gains from trade have gone to the richest people. Many of the poor blame trade for their plight and the argument that they have still made some gains is either not believed or is not enough to appease them.
An interesting insight into why people may have voted for Trump and his policy of protectionism is provided by the Ultimatum Game (see also). As the final article below explains:
The game itself involves two players. The first player receives a sum of money, and gets to propose how to divide it between the two players. The second player can do only one thing: accept or reject the proposal. If the second player accepts, then the money is divided between the two players as proposed. But if the second player rejects the proposal, then neither player gets anything.
It might seem that the rational thing for the second person to do is to accept whatever the first person proposes, however little it gives to the second person providing it is something – after all, even a little is better than nothing. But experiments show that people playing the second person do not behave in that way. They seek a fair distribution. If the proposed distribution is perceived as unfair, they would prefer to reject the proposal, with both players getting nothing.
This may help to explain the psychology of poor blue-collar workers. They would rather punish the rich a lot, and possibly themselves a little, than let the rich continue getting richer while they are stuck on low wages with little prospect for improvement. But, of course, they may also believe Trump’s rhetoric that they will indeed be better off from protectionist policies that help save their jobs.
What precisely Donald Trump will do about trade agreements and protection, we will have to wait and see. Often what is pledged in an election campaign is not carried out in office or is substantially watered down.
Use a simple two-product production possibility diagram to demonstrate the possible consumption gains to a country from trading with another country and specialising in exporting the good in which it has a comparative advantage.
Search Donald Trump’s speeches to identify statements he has made about the trade policies he will pursue as president.
Explain why some people may gain more from free trade than others. Why do the people who have gained the most tend to be the richest people?
What are the arguments for and against the free movement of labour (a) within countries; (b) between countries?
Compare the relative benefits and costs of tariffs and various forms of administrative constraints on trade.
If the second player in the ultimatum game rejects an ‘unfair’ offer, should this behaviour be described as ‘irrational? Explain.
Find out the details of the Trans-Pacific Partnership agreement. In what ways, other than through increased trade, would the agreement benefit the residents of the member countries?
Does free trade threaten employment in the long term? Explain.