Reflections on a Trade War

The current “trade war” that the U.S. appears to be launching is, fortunately, still at the level of frontier skirmishes. The theaters of war are being explored and the resolve of the enemy is being tested. With any luck, this will be mostly theater and little war. However, one cannot help but believe that a little bit of war could be a good thing, for a few very important reasons. It is these reasons that we shall explore over the next few weeks in this blog.

First, recognizing the wisdom in Colin Powell’s warning that no battle plan survives contact with the enemy, it is still wise to at least plan for battle. More specifically international trade is always a form of ongoing, simmering warfare. The economics of trade is an optimistic, entirely positive-sum story: cooperation, collaboration, expanding commerce, escalating opportunities, partnering for innovation, and creating mutual prospects for growth. The politics of trade, however, is always a form of warfare.

A bit of history will help set the stage. From the time of Marco Polo until World War II, trade was about importing, in which imports were considered a good thing. Trade brought exotic goods from far away to those few who could afford them. During the 19th century industrial revolution imports brought in the raw materials that fed the great machines of industry. Industrial economies thrived by supplying the growing demand for the fruits of modern technology. Of course, as mass production shifted trade from exotic goods on the fringes of consumer choices to a broad range of goods that people want and need, imports began to look like a threat to domestic producers and to the jobs their workers enjoyed. And they were.

It became clear that imports were a problem for some. It was equally clear that exports are an important wealth-generating opportunity for business, and in turn for nations. Exports became a public benefit, imports became— at least politically— a public problem. Since every export must also be an import, it is, politically, a zero-sum game.

After WWII, Japan, Germany, South Korea, Hong Kong, Taiwan, Singapore, all grew rich on their exports. Now China, with 1.4 billion highly motivated entrepreneurs and workers and an authoritarian government focused laser-like on becoming the world’s wealthiest nation (and regaining its historical role as the world’s preeminent culture) by, in turn, becoming the world’s factory, dominates that strategy.

National policy aimed at accumulating wealth through exports is called mercantilism. It emphasizes governmental regulation of a nation’s economy for the purpose of augmenting wealth and typically State power at the expense of rival national powers. Historically, such policies motivated colonial expansion and frequently led to war. It is the dominant economic policy of every nation, especially every nation anxious to reach rich-nation status. President Obama’s trade policy was officially to double American exports. He nearly did. Every nation’s trade policy is to expand exports. What could go wrong?

Plenty actually. A real war for one thing. History is replete with wars born from economic conflict. Graham Allison, in his brilliant book Destined for War, paints a scenario of a trade war becoming a live war. Distilling from his scenario, we can imagine a path:

A new U.S. President and his team identify China as the culprit in a massive and unending trade deficit. China argues that it is a decades long lack of U.S. savings and excessive government deficit problem. The problem gets worse from a massive tax cut that isn’t balanced with spending cuts; indeed, is topped off by a massive spending bill. The exploding deficit requires vast amounts of new U.S. debt. China and Japan are the largest foreign buyers of U.S. debt. The large surplus of inbound capital to finance the U.S. deficits in turn funds greater American consumption of imports—in fact the capital surplus is the flip side on the double entry balance sheet of our trade deficit. The deficit is only going to get worse.

The U.S. President, set on reducing the tariff by direct trade measures, learns he has tremendous authority over trade restrictions granted to him in a long string of Congressional Acts starting with the Trading with the Enemies Act of 1917. He can, in times of national emergency– which the President himself can declare– impose virtually any level of trade protection on any goods and services as well as freeze any and all assets—physical, financial and intellectual property—of a declared enemy.

To tackle the chronic trade deficit, the President begins by imposing select duties on steel and aluminum. He demands greater intellectual property protection to cover the hundreds of billions in annual losses that he lays at China’s door. If compliance is not forthcoming, he threatens to expropriate certain Chinese property in the United States of comparable value. Retaliation by China in agricultural products leads to further U.S retaliation in electronic goods and consumer products, which leads to further retaliation by China on autos and aircraft. Soon, health problems are found with a long list of U.S exports to China, blocking numerous high-value U.S. exports.

In response, the U.S. President invokes his emergency authority not only to prohibit Chinese investment in certain industries, but invokes by Executive Order a rule that puts a long list of industries off limits for any Chinese investment, especially mergers and acquisitions. Soon, inspections, work stoppages, and even increasingly violent protests arise at U.S factories in China. Production in many is stopped. U.S. executives are forced to leave for safety reasons.

Stock markets start to collapse. Intense volatility and ‘flash-crashes’ are believed to stem from malicious software, with a Chinese digital signature. Malware is found in a number of U.S. banks, exposing millions of U.S. citizens to drained or erased accounts. Havoc ensues in the financial sector. To prevent further decay, but avoid overt warfare, an attack on the Chinese cyber unit believe to be perpetrating this attack on the U.S. financial markets will be conducted using a top-secret drone capability, to be launched from a base in Japan. However, the Chinese have hacked the Japanese base and know not only of the weapon, but of the impending attack. They initiate a preemptive missile attack on the drone facility on the U.S. airbase, killing both U.S soldiers and Japanese personnel. Citizens in both countries are outraged and demand retaliation. War follows.

This is an unlikely scenario, but not am impossible one. The more optimistic scenario is a long, drawn out process tit-for-tat economic skirmishes resulting in substantial loss of wealth-creating opportunities. The pressing question for nations in 2018 is how to engage in strategic economic statecraft that allows the predominant and self-serving mercantilist interests to accommodate each other in order to take advantage of the economic opportunities that free markets and open trading relations can provide.

This overarching goal is the intellectual foundation of the rules-based trading system created under the rubric of Bretton Woods. Launched in 1947, the Bretton Woods system created over the past 70 years provides a reasonable infrastructure of institutions—like the World Trade Organization—and processes for negotiating rules for a free and fair trading regime. It offers a powerful dispute settlement system. The dispute settlement system is critical for two reasons. First it settles specific disputes. Second, in so doing, it interprets and refines the meaning of the rules negotiated and agreed to in the Uruguay Round in 1994. It is an international structure designed to regulate the self-interested impulses of powerful nations and corral their ambitions and energy into an orderly process that lets all participants engage peacefully under a predictable yet evolving set of rules.

These evolving set of rules is intended to let all players work productively in the rapidly growing and deeply interconnected global production networks that characterize the modern global economy. This is the rule-based system that America and its allies created. It is the system President Obama extolled in support of the Trans-Pacific Partnership. It is the system that President Trump has heavily criticized. It is the system that made China’s success possible and that China is now directly challenging. And it is the system that presents the most likely avenue to resolve the issues leading the current march to a trade war. Strong and determined economic statecraft—the little bit of trade war mentioned in the first paragraph– will be the focus of this series of posts.

Robert A. Rogowsky is Professor and Program Co-chair of the Masters in International Trade & Economic Diplomacy at the Middlebury Institute of International Studies in Monterey, CA and Adjunct Professor of Trade & Diplomacy at Georgetown University’s Masters School of Foreign Service.
These essays are the opinions strictly of the author. They do not necessarily reflect the views of the Institute or any officials of the Institute.


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