Is protectionism a threat to globalisation?

Analysis - 3/14/2017

The new Trump administration has clearly decided to move towards protectionism. After backing out of the Trans Pacific Partnership (TPP), Washington is casting a critical eye on the 1994 North American Free Trade Agreement (NAFTA) between the US, Canada and Mexico and is also threatening to leave the WTO.

Does this mean that the trading regimes established by major post-war multilateral treaties are about to break down?

And do recent dips in international trade suggest that globalisation will be replaced by deglobalisation?

1. International trading momentum has eased off

Between 1985 and 2014, international trade expansion outpaced economic growth. Emerging countries and China in particular, largely benefited from bigger global markets as did some developed countries like Germany. Rising imports caused major reshuffling of market share, a development which played a major role in the sharp drop in inflation over the period.

Competitive pricing from exporting countries was the crucial factor but direct investment by companies in developed countries also made a big contribution. Companies significantly increased their presence in countries where demand for goods and services was growing rapidly but where domestic purchasing power was too low to afford imported goods from developed countries. Capturing this demand meant setting up production facilities in emerging countries, driving growth, fuelling job creation and raising revenues. The same approach allowed companies to re-export to other emerging countries and, for some product types, to some developed markets.

But trade momentum has slackened over the last 2 years. International trade volume only increased by 2% a year, or less than the 3.5% achieved by global growth. This was in part due to the slowdown in China’s economy which hit its suppliers but it was also, more structurally, due to some stabilisation in global market shares. After the enormous changes following China’s accession to the WTO 15 years ago, market share gains have now started to fade, putting a brake on trade expansion. Trade has also been reduced by local production by foreign companies which has replaced some of their exports. And the percentage of services in GDP has been growing steadily, a sector where market share gains are not as high. Services now represent 25% of global trade but most of the sector, for example hotels and distribution, relies on domestic sites which are unconcerned by foreign trade.

  

 

Direct company investment is also an essential factor in globalisation. Developed country companies were the first in set up production units abroad but emerging country companies have now followed suit. Production relocation has contributed but only represents part of the development.

As their intra-zone trade expanded, southern countries increased direct investments, setting up production units or making acquisitions for example, in both emerging country and developed economies. In 2016, global direct investment returned to its 5-year mean of USD 1.5 trillion but this was 13% less than the exceptional USD 1.7 trillion registered in 2015.

If domestic demand is strong enough, direct investment is one way of managing or reducing exchange rate risk. Currency hedging tools provide only short term protection. Producing locally entails exposure to operating and asset value risk but debt financing, which is subject to currency moves, provides a sort of long-term hedging tool. And a local presence also offers protection against customs levies.

2. Globalisation has changed shape

The opening up of national frontiers, along with lower transport costs and customs duties, has encouraged large groups and their suppliers to change strategy. The traditional national production model has been replaced by a system of international industrial sectors organised around sharing of responsibilities in the value chain. According to the OECD, globally traded
goods include more than 50% of imported parts, a ratio which rises to 70% for services. This so-called vertical specialisation also largely explains why global trade has expanded faster than global GDP over the last 30 years.

However, not all sectors are concerned and areas like steel, cement and glass manufacturing have stuck with their traditional model. On the other hand, sectors where assembly is a key part of the production process have been influenced by, or have adopted, this new scheme. Components and sub-assemblies are produced in specialised, highly-competitive national platforms before being shipped to a unit which assembles the final
product.

The model has been adopted in European auto production but also plane manufacturing and in various electronic product sectors. In mobile phones, for example, screens, batteries and electronic circuits are made in different countries and assembled in a country like China which then exports the final product. As companies moved towards this model, cross-border trade accelerated for some time but recent stabilisation has slowed down the pace of growth.

The industrial sector has slowed down. As in China, services have replaced industry as growth drivers. As a result, trading in goods is no longer on the same trajectory. Container traffic, which represents 95% of manufacturing goods, is now only growing by 1-2% a year. But this in itself is not proof that deglobalisation is under way.

3. Establishing one set of rules

Due to rigidity, restrictions and sundry obstacles, the world is not entirely a free-trade zone. The WTO replaced the General Agreement on Tariffs and Trade (GATT) in 1995 and seeks to reduce obstacles to trade by introducing a common legal framework. It can also check that bilateral agreements comply with the WTO’s rules, by, for example, insisting that bilateral agreements do not discriminate against trading partners.

After ensuring free movement of products, the first goals of trade agreements were to reduce customs levies and other import taxes. Goods now circulate freely and levies have been seriously reduced. Since 1947, when GATT first came into force, customs duties in developed countries have on average fallen from 40% to 5%.

Since 1947, customs duties in developed countries have on average fallen from 40% to 5%



Despite unquestionable progress, there are still numerous hurdles due to local producer protections based on subsidies and barriers to entry. The protection of designations of origin, for example, was a big question during talks between the European Union and Canada before the Comprehensive Economic and Trade Agreement (CETA) was signed.

Negotiations over agricultural issues are the most sensitive area as the hold-ups to the Doha cycle talks show1. The WTO was undoubtedly being over-ambitious in trying to secure an overall agreement on freeing up trade but at least it managed to get the trade facilitation agreement ratified on February 22. The agreement is designed to simplify technical hurdles like customs clearance time for particular products. As such, it represents a victory for multilateralism and a big contrast with the prevailing mood.

Unlike previous trade negotiations, these talks now include environmental protection measures, social rights and intellectual property, areas where it is harder to find some consensus view compared to a straightforward topic like customs duties.

Looking beyond customs levies, countries have a number of ways to protect themselves against imports. As well as quotas and labelling rules, technical and administrative standards are frequently used. Technical standards may cover food and vehicle security, for example. But the establishment of these standards is increasingly done by international, multi-state or professional organisations. Administrative standards, however, only concern national governments. And government contracts are the best example of a country’s opposition to free trade rules. The US and China have both signed up to WTO rules but have, unlike the EU, limited or refused access to tenders for foreign companies. Infrastructure projects are often restricted to national companies.

Another administrative standard like work permits for foreigners can also be used for protectionist motivations. Many US companies have protested against restrictions on hiring skilled foreigners as they are struggling to find US employees with the right qualifications. 

4. Are we moving towards increased protectionism?

The WTO regularly sounds warnings on threats to free trade. In spite of measures adopted during the financial crisis, expanding trade was for a long time seen as the best proof that the system was working in spite of its defects. 

Globalisation has gradually become a major political and social debate



Globalisation has gradually become a major political and social debate in many developed countries. For a long time it was the target of anti-capitalist forces but is now a core feature of all sorts of sovereignist platforms which accuse it of (i) creating wealth inequality among the middle classes in the West, (ii) sustaining high unemployment levels and (iii) slowing wage increases. Growing discontent among Americans in the Midwest2, where most of the swing states are, largely explains why Donald Trump was elected President and why a majority in the UK voted for Brexit. 

Just as with Brexit, the new mood in the Trump administration’s statements and its initial measures mark a break with the past. Surpluses run up by trading partners are seen as an attack on US interests with China (USD 367bn), Mexico (USD 61bn) and Germany (USD 60bn) as the main culprits.

The new administration’s measures are supposed to protect US consumers and workers but they could backfire. In one way or another, consumers will have to face more expensive products due to higher US production costs or levies on imports. And reinstating previous organisational procedures is bound to be costly for many sectors like autos. 

5. New defenders of free trade?

Shifts in US policy, paradoxically, are opening up the field to Chinese initiatives and President Xi Jinping has jumped on the chance: at his Davos speech in January, he defended a multilateral approach to free trade. This was surprising for a country which generally prefers bilateral agreements and trade practices but Beijing has for 2 years been working on a regional trade agreement, the Regional Comprehensive Economic Partnership (RCEP), which will include all those countries excluded from the TPP (which was clearly anti-Chinese in its ambitions).

The decision by the TPP’s previously biggest supporter, the US, to withdraw from it does not automatically mean the end of the project for the other 11 countries who signed up but it should make it easier for China’s regional project to work. 

Last year for example, the US decision not to join the Asian Infrastructure Investment Bank (AIIB), a Chinese idea, actually helped the project by encouraging Australia and Japan to participate. 

 

6. Illusory protection

Donald Trump has promised a lot to those who elected him and he intends to press on with protectionism. This will probably mean unilateral measures - import levies have been aired - but the goal is to renegotiate arrangements. Rather than installing traditional protectionism, Donald Trump wants to replace multilateralism with a bilateral system that gives the US the upper hand.

The North American Free Trade Agreement (NAFTA) - with Canada and Mexico, the biggest trading partners of the US after China, will be the first target. NAFTA is not a model trade agreement - the Obama administration was already keen to make some changes - but it has certainly helped to free up trade in many sectors, including agriculture, and created mutually beneficial industrial complementarity.

Given this interdependence, a trade war would make no sense. The car industry has buckled under government pressure and made some concessions but repatriating assembly lines for lowmargin vehicles would only accelerate the move towards more automation in the US. And the efficiency of customs duties is limited by shifting exchange rates. Import taxes do not provide absolute protection against monetary depreciation. The plunge in the Mexican peso shows how quickly currency traders react. 

 

 

 

 

Conclusion

Free trade is never perfect and can be reversed. The Brexit vote and Donald Trump’s initiatives have created uncertainty over trade rules. But attempts by countries to batten down the hatches have always in the past had negative results. Interdependence and business integration between countries have never been as high and protectionist measure from governments will very likely prove counterproductive.

Because Donald Trump places such great emphasis on symbols, there is a chance that realism and rational thinking will lose out and we cannot rule out a blunder in US economic policy. And yet the costs would quickly appear - after so many promises, being realistic is important. That is why an ultimate compromise is the most likely prospect. It would be risky to bet on America’s partners not reacting or not seeking to organise some joint opposition.

Ironically, resurging protectionism could even trigger opposition. Countries like Mexico which have been singled out have already contacted the European Union. As the world’s biggest market and exporter, the EU is obviously interested. And the reaction could also be underpinned by countries like China which are looking for some legitimacy and greater influence. In the recent words of Xi Jinping, “nobody wins in a trade war”. China has a lot to lose but so does the US.

Free trade has helped economic and business integration accelerate so that it is now an integral part of the global economic system. And circulation of data is rapidly consolidating the process. Governments are responsible for people who lose out and the most fragile sections of society but protectionism is not the best solution for the victims of globalisation. 

 

 


  1. The Doha cycle is seeking a root-and-branch reform of international trade by reducing trade barriers.
  2. The Midwest comprises states next to the Great Lakes and most of the Corn Belt which, to the west, gives onto the Great Plains.

Elément complémentaire