Only a few years ago, mainstream economists and political leaders would have agreed: open trade policies are better than trade protectionism. No longer. Major economies are drawing back from regional and international economic integration, claiming that it has lowered people’s living standards or diminished sovereign political control.
The United States has moved from protectionist rhetoric to unilateral action, slapping tariffs on China and other leading trading partners, prompting retaliation in kind. The United Kingdom’s exit from the European Union would represent a departure from the world’s most deeply integrated transnational market.
The World Trade Organization’s dispute resolution mechanism – a pillar of the multilateral rules-based system of trade governance – faces paralysis amidst differences among governments over how itsappeals body makes decisions. In international fora from the Group of 20 leading economies to the Asia-Pacific Economic Cooperation bloc, meaningful consensus on trade issues has been elusive.
On the face of it, the controversy over trade is ironic. One, it is raging most strongly within some advanced economies, notably the United States, which until recently had been the principal drivers of the post-1945 liberal trade order. Two, trade has become a hotly contested issue at a moment that should have been its greatest triumph: open trade has been a key factor in the rapid growth and development that over the past 40 years has lifted more than a billion people around the world out of extreme poverty.
If we delve deeper, however, the backlash against trade seems less surprising. For all of the important gains of economic globalization – which has seen the fastest poverty reduction in history – many people, including in the world’s richest countries, have reasonable cause to feel that they have been left out.
Yet closing markets to trade and investment is not the solution: it would leave us collectively poorer, stoking political anger instead of soothing it. The goal must be to harness the prosperity that trade can foster to create societies that benefit everyone.
To understand how we got here, and where we need to go, we must examine what has gone right in the global economy, and how we have fallen short.
How open trade has made the world more prosperous
The open exchange of goods, services, and data has made countries more interconnected than ever before and fuelled transformational shifts in the world economy.
At the most fundamental level, trade enables greater specialization and scale, both of which lead to higher productivity. In 18th century Scotland, Adam Smith noted that one man working to make a simple pin from start to finish - cutting and sharpening wire, making and attaching pinheads, and so on - would struggle to make even one pin a day, let alone twenty. But as he wrote in The Wealth of Nations, ten workers each doing one step of the process, working in what we would now call an assembly line, could make 48,000 pins a day. His near-contemporary David Ricardo famously observed that trading with each other, by allowing countries to specialize in what they did best – or more precisely, what they did least badly relative to others – would make them better off than they otherwise would have been.
For the next century and a half, increasingly sophisticated factories and industrial clusters brought together raw materials, investment, workers, and know-how to manufacture goods, with steady growth in productivity. Such agglomerations mostly occurred in places like Western Europe, the United States, Canada, and later, Japan – a big part of the reason these countries dominated the global economy and were so much richer than the rest of the world by the 1970s. Growing cross-border trade contributed to rising incomes in these countries. Trade was mostly in final products – clothes, toys, cars, and so on.
The rapid expansion of global trade that started in the 1980s was driven by market-oriented reforms in China, India, and the former Soviet bloc, combined with falling trade costs. These falling trade costs were the result of policy changes – reductions in tariffs and non-tariff obstacles to trade – as well as advances in transport and communication technology. Progressively, more open trade policy was anchored in multilateral trade rules, under the General Agreement on Tariffs and Trade, and from 1995, the World Trade Organization.
Predictably open markets, along with the ability to cheaply coordinate production processes across long distances, made possible the fragmentation of production along multi-country value chains. Companies could disaggregate the production process into individual steps, and deploy capital and know-how to wherever an individual component could be made or processed most cost-effectively. This lowered the bar for entry into world markets: to profitably participate in international trade, countries and businesses no longer needed the economic sophistication to produce sophisticated products like cars; it sufficed to produce an auto part, or to carve out a market niche in a particular stage of car manufacturing. The result was a sharp increase in trade in intermediate goods, as labour-intensive manufacturing processes were offshored to lower-cost countries. In the 1990s, global trade grew three times as fast as overall economic output. Trade accelerated competition, the diffusion of technology across borders and further incentivized innovation.
Easier entry into world markets was particularly valuable for developing countries, where tradable sectors tend to be more productive than non-tradable activities. Open global markets allow countries with small home markets to use external demand to shift people and resources out of subsistence activities, and into more productive tradable goods and services. The result is to make the overall economy more productive.
Countries from post-war Germany and Japan to Korea, Thailand, China, India, and modern-day Ethiopia have been able to ramp up growth by importing what the world knows - ideas, technology and knowhow - and exporting what the world wants to buy. Exporting is about more than increased specialization and scale; it works as a constant accountability mechanism: if your products are expensive or low-quality, you might get away with selling them in a protected domestic market, but foreigners won’t bother buying them. Imported goods and foreign direct investment help disseminate cutting-edge technology from advanced economies to emerging markets, bolstering productivity and sparking innovation.
Trade – and trade agreements, which make it harder for governments to slam their doors shut in the face of serious import competition - have been a big part of the remarkable poverty reduction of the past 40 years. The developing countries that tapped into international value chains registered rapid growth, transforming the balance of global economic power. In 1980, in purchasing power terms, the US and Western Europe accounted for about half of global economic output, ten times more than China and India combined. By next year, the US and Western Europe will account for 28% of the global economic pie – about the same as China and India combined. At market exchange rates, the US and Western Europe remain well ahead, but the gap is narrowing.
Dramatic growth in some developing countries has given rise to perhaps understandable questions about whether their meteoric rise has come at the expense of rich countries. The one-word answer is ‘no’. In advanced economies, international trade in goods and services has had less dramatic effects, but it has continued to enhance purchasing power while driving competition, innovation, and productivity.
Export market demand has played an important role in Spain’s recovery from the economic crisis of the past decade, enabling high-skilled manufacturing and services to expand as the construction sector shrank. In Canada, exporters reported almost twice as many research and development activities as non-exporters.
Taken as a bloc, advanced economies have grown, just at slower rates than developing countries. As we will see below, closing markets is no solution to the economic problems they face.
The case for a cooperative approach to trade, embedded in multilateral rules and institutions, goes well beyond short-term bread-and-butter issues. Climate change, migration, cyber-security, terrorism and pandemic disease all have cross-border implications that demand cooperative responses from countries; governments pursuing a negative-sum approach to trade and investment will struggle to achieve positive-sum outcomes on these other challenges.
Greater interdependence and cooperation among countries contributes to peace and stability: it is no coincidence that the rules-based trading system was set up in the wake of the Second World War. Having witnessed the breakdown in international trade and cooperation of the 1930s, the system’s founders were convinced that if goods did not cross borders, soldiers would. The European Union itself is a prime example of how economic integration and interdependence contributes to peace: there has been no conflict within the EU zone of integration since 1945 - the longest period of peace in mainland Western Europe since the early Roman Empire.
Despite all these advantages, open trade and the international policy architecture that underpins it are under threat today.
How too many people were left behind
For all of the prosperity open trade has enabled, many have not shared in the gains from the exchange of goods, services, and ideas.
This has been true in the developing world, where many countries and communities have remained on the margins of the global marketplace, suppliers at most of raw materials rather than value-added goods and services. More than 700 million people, close to 10% of the world’s population, still live in extreme poverty. Even within faster-growing emerging markets, where poverty rates have declined substantially, the biggest income gains have gone to the better off, potentially sowing the seeds of a future backlash against the economic order.
But the current political threat to the open global economy comes not from the countries that have languished on its fringes, but from the countries that have been at its very core. Within some advanced economies, substantial numbers of people, businesses, and regions have had difficulties adjusting to economic change. Opposition to open markets, which in the past attracted small if non-trivial constituencies in most advanced economies, now appeals to groups sufficiently powerful to deadlock political debate and even swing election results.
That the effects of trade have been uneven should not have come as a surprise. Economic theory plainly states that trade creates winners and losers, and that it can harm some people even while making societies as a whole better off. Trade makes countries richer precisely because it encourages resources to flow out of some activities, and into others. Importing furniture from China or Vietnam leaves more money in the pockets of Europeans decorating their homes. But some furniture makers in Portugal probably lose out. Trade can also contribute to increased inequality: Creating a global marketplace allows superstar companies to thrive on a global playing field, translating to higher profits and executive salaries. Trade might expand work opportunities and pay for the highly-skilled, while putting further pressure on the livelihoods of less-skilled workers.
The fact remains that for much of the modern era of globalization, economists assumed that political and business elites would redistribute some of the winners’ gains to compensate the losers and equip them to benefit from new economic opportunities. All too often, however, this never happened, certainly not on the scale necessary.
Another assumption was that people would adjust quickly to trade displacement, finding new jobs in different sectors. But empirical research in the United States has revealed that adjustment has been slower, costlier and more geographically concentrated than expected. In a series of studies, David Autor of the Massachusetts Institute of Technology, together with his co-authors, found that in the parts of the US most exposed to a sharp increase in competition from Chinese imports in the early 2000s, wages and labour force participation remained depressed for at least a decade. Other scholars have found evidence indicating that the new export opportunities opened up by China’s entry into the global economy created about as many jobs in the US as were lost – but these new jobs were often in different locations.
The Organisation for Economic Co-operation and Development last year reported that across its member countries, income inequality had increased since the 1990s, while social mobility had stalled. At existing levels of inequality and intergenerational earnings mobility across the OECD, it would take an average of 150 years – five generations – for the child of a poor family to reach the average income. Children born between 1955 and 1975 to parents with low levels of education and income had reasonably good odds of moving up the income ladder, but for people born since 1975, this upward earnings mobility has stagnated: in recent years, 60% of people in the bottom income quintile have tended to remain stuck there, while 70% of people in the top quintile remained there.
The perception that the economy is not working for large numbers of people has fuelled understandable resentment. Trade becomes a convenient scapegoat for such anger. Foreigners - the goods and services they produce, the jobs they allegedly take - provide tangible objects to blame. Other factors affecting people’s job prospects fly under the radar screen: machines and software that get quietly better each year; domestic policy choices that do little to equip people to benefit from economic change.
Voters don’t normally get a say on slowing down technology, but they can vote against trade agreements. And yet it is those other culprits that matter far more. Closing markets in the face of economic anxiety will not succeed at creating the better jobs and greater security voters crave. Indeed it would almost certainly make things worse.
Why closing markets will not solve anything
If governments start to go it alone on trade, it will become harder, not easier, to generate the jobs and increase incomes that angry electorates want. One country’s unilateral measures will beget retaliation from its trading partners. Trade protection will hurt purchasing power in the short term, while undermining growth prospects in the long term.
And it will not achieve its principal stated aim: to protect the local economy from job losses.
Closing markets would raise prices, hurting people’s purchasing power. Poor households would be hit the hardest. One study estimated that shutting off trade would reduce the real purchasing power of the poorest tenth of the US population by 60 and 57% in Brazil. New academic work on the tariffs introduced in the US over the past year suggests that the costs have been entirely born by US consumers, though this could change as importers revisit supply relationships in the months ahead.
If trade protectionism prevails, it would stifle growth both in developing and advanced economies. For the poorest countries, a less open global economy would close off access to markets that have provided others a way out of poverty. This would almost certainly put out of reach the United Nations Sustainable Development Goal of eradicating extreme poverty by 2030.
In richer countries, less competition and specialization would translate into lower productivity, higher prices, more limited consumer choice, and diminished growth potential.
The effects on domestic jobs – the purported justification for raising trade barriers – would be similarly disappointing. Factory employment has been falling in all rich countries, and trade has often been blamed for the decline in well-paying jobs for low- and mid-skilled workers. But manufacturing output, even in the United States, remains near historic highs. The mismatch arises from the fact that it is machines, not people, doing the manufacturing.
It is hard to tell what percentage of job loss is caused by technology and what percentage can be attributed to trade, since they have similar effects, but one estimate is that technological change destroys four jobs for every job lost as a result of international competition.
Automation appears set to accelerate, with breakthroughs in areas such as artificial intelligence and robotics – good for aggregate productivity and growth, but with potential for job losses. Many repetitive work functions are being mechanized. A recent OECD (1) report finds an estimated 14% of jobs in advanced economies are at risk of being automated. A further 32% will be transformed, placing lower-skilled workers especially at risk of losing jobs. The World Bank estimates that 1.4 million new robots would be put into operation by 2019, bringing the worldwide total to 2.6 million. Equipping individual workers to thrive in a world of rapidly increasing automation will be every bit as important as enabling them to cope with trade-related job displacement.
Curbing access to imported components would hurt the competitiveness of manufacturing value chains. For instance, the global competitiveness of the European auto supply chain relies on continental economic integration. Jobs and investment in Slovakia support jobs and investment in Germany or Spain. Unwinding cross-country value chains through trade and investment restrictions would end up making cars and auto parts more expensive, hurting purchasing power at home and costing companies’ market share elsewhere in the world.
Higher costs resulting from trade restrictions would also have knock-on effects elsewhere in the economy. For instance, if every component and bit of software in an iPhone had to be sourced domestically, they would have cost substantially more. Even if they had been commercially viable back when first launched in 2007, Apple would have sold many fewer of them. This would have meant less business for Apple’s suppliers. But the extra hundreds of dollars every one of its customers spent on a phone would have been money they did not spend at neighbourhood restaurants or shops. Had smartphones remained a niche luxury product, instead of something most people in rich countries could afford, the app economy could never have taken off at the scale we now take for granted.
Finally, inward-looking trade policies would likely lead to greater mistrust and hostility among nations. The history of the 1930s stands as a stark reminder that isolationist approaches to international economic relations are bad for growth and worse for political comity. Today, zero-sum economic thinking – the idea that your country’s prosperity must be coming at my country’s expense, or vice versa – would leave us perilously exposed to climate change. A critical component of decarbonizing the world economy will be the innovation and rapid cross-border diffusion of new technology.
Better domestic policy would help address dissatisfaction
If closing markets cannot help address the anger driving today’s backlash against globalization, what can? Better domestic policy.
All rich countries have been more or less equally exposed to both technology and globalization. But their outcomes have been dramatically different. In 1980, the richest 1% in the US and Western Europe were each taking home about a tenth of national income. The share of income accruing to the bottom half of the income distribution was also about the same – a bit above 20%. Then things diverged. By 2016, the share of national income going to the top 1% in the US had nearly doubled, while the share going to the bottom 50% had fallen by nearly half. Meanwhile, in Western Europe, the top 1% share went up, but only by a bit. The bottom 50% share went down, but only a little.
The differences in terms of absolute real income gains is just as stark: the World Inequality Lab recently found that between 1980 and 2017, the average real income of the bottom 50% in Europe increased by 37% - not quite the average growth for the population as a whole, but close. But in the US, despite faster overall growth over the same period, the bottom 50% saw real incomes grow by a paltry 3%.
What happened? Countries made very different decisions about taxation, wage-setting, public spending, corporate governance, and education.
So-called active labour market policies are a particularly relevant example. Denmark spends over 2% of gross domestic product on helping workers retrain and find new work. Spain spends 0.6%, close the levels in Germany and Switzerland. In the United Kingdom, the equivalent is only 0.23%, and in the United States, 0.1%.
European countries, particularly the Nordics, have gone furthest towards developing a blend of social protection and active labour market support that enables societies to seize the productivity benefits of technological change and open trade while ensuring that most people are equipped to share in the gains.
That said, even in Western Europe, many voters, particularly working class and less-educated people, have been on the sharp end of a generation’s worth of changes in both trade and technology. Over the past decade, fiscal and monetary policy within the Eurozone often fell short of what they might have done to stimulate growth. Unemployment in many places remains stubbornly high – 14% in Spain.
Nevertheless, governments have used available policy tools to make a material difference to people’s wellbeing. The challenge for European governments and institutions in the years ahead is to use these tools to enhance opportunities for individuals and tackle growing disparities among regions.
Do not overstate opposition to trade
One fact that can get lost amid the headlines about trade wars is the fact that public support for trade is relatively strong.
A Pew survey last year found that across 27 advanced and emerging economies, the median percentage of respondents who agreed that growing trade and business ties with other nations was a good thing for their country was 85%. In the Netherlands, Spain, Sweden, South Korea and Kenya, over nine out of ten adults agreed with the proposition. A Gallup poll from March 2019 found that 74% of Americans believed trade was an opportunity for growth rather than a threat.
Many governments remain enthusiastic about trade’s potential to drive growth and development, nowhere with more significance than in Africa, where governments have agreed to establish an African Continental Free Trade Area (AfCFTA). Set to enter into force in July 2019, the bloc will boost intra-African trade by roughly 52% by 2022, according to estimates from the United Nations Economic Commission for Africa. This is particularly significant because the goods African countries trade with each other tend to be more sophisticated than those they export to the rest of the world. According to the United Nations Conference on Trade and Development, medium- and higher-technology products account for 25% of intra-African trade, compared to only 14% of the continent’s exports to developed countries. The African Export-Import Bank projects that the removal of trade barriers could boost gross domestic product by 3.15% while increasing household purchasing power by nearly 2 percent.
Elsewhere, when Washington withdrew from the Trans-Pacific Partnership (TPP), the remaining 11 parties signed up to a revised version of the deal, formally called the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which has now entered into force. The European Union’s bilateral agreement with Japan has also entered into force; a similar accord with Canada is being provisionally applied.
These agreements create meaningful new commercial opportunities and break new ground in defining rules for the digital economy. Just as importantly, they send a powerful signal about how cooperation on global trade contributes to growth, value addition and job creation.
Nevertheless, the opinion surveys also show that support for trade is shallow, and therefore could shift. For instance, 25 of the 27 countries Pew surveyed, more people believed trade increased prices, or left prices unaffected, rather than making goods more affordable. Only four out of ten Europeans believe that trade creates jobs, while 30% believe trade leads to job losses and lowers wages. Over 40% of Americans think trade has a negative effect on US workers.
As long as people feel vulnerable, rather than optimistic, about the modern economy, there will be space for political entrepreneurs to make hay by scapegoating trade.
Conclusion: where to go from here
The historian Eric Hobsbawm once wrote that the Soviet Union managed to build the best 1890s economy in the world, dwarfing everyone else in the production of steel, pig iron, and tractors. There was a problem, though: it was the 1980s, not the 1890s, and the Soviets were note very good at silicon and software.
Advanced economies could conceivably use trade barriers to alter market incentives and encourage businesses to shift capital and resources into building the best 1960s economy around. But in 2020, that might not do much to meet public aspirations. And as we have seen, such barriers would diminish development prospects for the rest of the world.
The challenge is to harness the benefits from trade and technological change while ensuring that people at different income and skill levels, businesses of all sizes, and regions at the periphery as well as the core are able to share in the gains.
This agenda of protection without protectionism requires action at both the domestic and international levels:
First, oppose trade protectionism and support rules-based trade. As we have seen, trade protectionism does not protect jobs; it hurts purchasing power in the short term while undermining growth prospects in the long term. Keeping global markets open and preserving rules-based order embodied in the World Trade Organization is in all countries’ interest. In an increasingly multipolar world economy, multilateral cooperation is the most efficient way to manage interconnectedness. A might-makes-right approach to trade would be messy and ineffective, ultimately leaving most people poorer than they would have been.
Second, instead of complaining that global trade rules are not up to the standards of 21st century business practices, governments should work together to find shared solutions to common grievances. Where possible, governments should work together to update the global trade rulebook, most of which dates back to the mid-1990s. WTO discussions on e-commerce offer an avenue for defining a level, predictable playing field in the digital economy that will shape the coming decades. An agreement on curbing fisheries subsidies could help ensure that there are still fish left in the ocean by the end of the century. Cutting trade barriers for renewable energy technologies would reduce the cost of reducing carbon emissions. Updating the rulebook on industrial subsidies would go some way towards reducing current trade tensions.
Third, act boldly at home to help those displaced by both imports and machines. New challenges are coming to people’s jobs: increasingly sophisticated machines are automating blue- and white-collar jobs and encouraging reshoring from developing countries. More services are becoming tradable. As with all trade, there are winners as well as losers. But it also means that better education and active labour market policies might need to be supplemented with new forms of social entitlements, such as capital grants or basic incomes, to provide individuals a sufficient measure of insurance against the downsides of economic dynamism.
Fourth, work to end economic exclusion everywhere. Trade cannot work for everyone so long as large sections of the global population are still shut out from the opportunities it presents. As manufacturing ceases to be the engine of job creation it used to be, the danger is that instead of moving from low-productivity agriculture to higher-productivity, higher-wage manufacturing jobs, people in developing countries will end up in low-productivity service work. The focus must be on encouraging value addition in agriculture and services as well as manufacturing, and connecting businesses in all sectors to regional and international value chains. Both in developed countries and in developing ones, empowering women as equal actors in the economy is both a moral imperative and an economic one: countries cannot reach their full economic potential if they fail to use the talents of half of their population.
And finally, address tax competition and tax avoidance. Cross-border capital mobility and tax competition have left governments increasingly reliant on taxing consumption and labour incomes. Average households feel squeezed, while multinational corporations declare a disproportionate share of profits in a handful of tax havens. The domestic social agenda to rebuild popular support for open markets is expensive. While there is no magic money tree, more international tax cooperation would help give national governments a bigger set of tools to fund social policies.
Ensuring that trade and economic growth contribute to building a better society for all is not just about social justice. It is a matter of practical politics. If the last few years have made anything clear, it is that neglecting the distributional consequences how the economy is functioning will open the door to political leaders who care about neither growth nor distribution.
(1) OECD Employment Outlook 2019: The future of Work.