By Eric Vandenbroeck and co-workers

The Trump Global Trading System

The sweeping tariffs announced by U.S. President Donald Trump on April 2, along with the subsequent postponements and retaliations, have unleashed an enormous amount of global uncertainty. Much of the world’s attention is on the chaotic, short-term consequences of these policies: wild stock market fluctuations, concerns about the U.S. bond market, fears of a recession, and speculation about how different countries will negotiate or react.

But whatever happens in the near term, this much is clear: Trump's policies reflect a transformation of the global trade and capital regime that had already started. One way or another, a dramatic change of some kind was necessary to address imbalances in the global economy that have been decades in the making. Current trade tensions are the result of a disconnect between the needs of individual economies and the needs of the global system. Although the global system benefits from rising wages, which push up demand for producers everywhere, tensions arise when individual countries can grow more quickly by boosting their manufacturing sectors at the expense of wage growth—for example, by directly and indirectly suppressing growth in household income relative to growth in worker productivity. The result is a global trading system in which, to their collective detriment, countries compete by keeping wages down.

The tariff regime Trump announced earlier this month is unlikely to solve this problem. To be effective, American trade policy must either reverse the savings imbalance in the rest of the world, or it must limit Washington’s role in accommodating it. Bilateral tariffs do neither.

But because something must replace the current system, policymakers would be wise to start crafting a sensible alternative. The best outcome would be a new global trade agreement among economies that commit to managing their domestic economic imbalances, rather than externalizing them in the form of trade surpluses. The result would be a customs union like the one proposed by the economist John Maynard Keynes at the Bretton Woods conference in 1944. Parties to this agreement would be required to roughly balance their exports and imports while restricting trade surpluses from countries outside the trade agreement. Such a union could gradually expand to the entire world, leading to both higher global wages and better economic growth.

During the Treaty of Versailles John Maynard Keynes, not yet the world-renowned economist he was to become, suggested that the Americans write off the money the British owed them to reduce the need to extract reparations from the defeated and then concentrate on getting Europe's economy going again.

Just six months after the treaty was signed John Maynard Keynes published “The Economic Consequences of the Peace”, the book that made his name. Today however Keynes’s critique of the Treaty of Versailles is seen as problematic. In fact, Keynes himself shortly after stated that he regretted having written the book.

Keynes himself regretted it, and so should historians and economists today. Mentioned in an article early in 2017, telling to me that sometime in 1936, after the March 29 “election” in Germany which consolidated Hitler’s power, Elizabeth Wiskemann, a German-born, Cambridge-educated historian, met [Keynes] at a social gathering in London. Suddenly, she reported later, she found herself saying, “I do wish you had not written that book [meaning The Economic Consequences of the Peace, which the Germans never ceased to quote], and then longed for the ground to swallow me up. But he said simply and gently, ‘So do I’” 1

Keynes’s plan failed to carry the day at Bretton Woods, largely because the United States—the leading surplus economy at the time—opposed it. Today, however, there is a chance to revive and adapt his proposal.

 

Mind the Gap

To understand what ails the global trading system, consider how wages shape an individual economy. Higher wages are usually good for the economy because they boost demand for businesses while increasing their incentive to invest in efficiency. The result is a virtuous cycle. The growing demand spurs increased investment into ways of producing more with fewer workers, raising economic productivity which, in turn, drives further increases in wages.

Individual businesses, however, have different incentives. They can boost profits by suppressing wages. The problem is that although lower wages can benefit an individual business, they reduce the profits of others. In an economy in which business investment is mainly constrained by whether there is demand for more production, if businesses collectively suppress wages, either household and fiscal debt must rise to replace the lost demand, or total production and business profits will decline.

Although this phenomenon, sometimes called Michal Kalecki’s Paradox of Costs (named for the economist who first proposed it), mainly describes businesses, it also applies to countries in a global economy. If suppressing wage growth can make manufacturing in one country more globally competitive, it can generate faster growth for that country by subsidizing and boosting manufacturing exports. But if all countries suppress wage growth, growth in global demand is reduced, and all countries suffer.

In a highly globalized world where some states are more successful than others at suppressing labor costs, the result is an asymmetry in the demand for and supply of goods. Because businesses do not have to make products in the same places where they sell them, local labor costs become crucial to the competitiveness of manufacturers. Businesses that shift production to countries where labor costs are lower relative to workers’ productivity can produce goods more cheaply, making their products more attractive globally.

In any given state, wage suppression puts downward pressure on domestic consumption while subsidizing domestic production. This results in a rising gap between production and consumption, which, if it remains within the economy, must be balanced by raising domestic investment (which can further exacerbate the gap between production and consumption). Otherwise, the gap invariably reverses, either via raising wages or by cutting back on production.

But in a globalized economy, there is another option: running a trade surplus. This allows the country to export the cost of the gap between consumption and production to trade partners. This is why, in 1937, the economist Joan Robinson referred to the trade surpluses that resulted from suppressed domestic demand as the consequences of “beggar-my-neighbor” policies.

It is also why, at the Bretton Woods conference in 1944, Keynes opposed a global trading system that allowed countries to run large, persistent trade surpluses. A system that accommodated these surpluses, he said, would encourage countries eager to expand manufacturing to subsidize it at the cost of domestic demand. The result, Keynes explained, would be downward pressure on global demand as countries fought to remain competitive by suppressing wage growth. The countries most successful at doing so would become the winners of global trade. Their share of global manufacturing would expand while that of their trade partners contracts.

Keynes instead called for countries to “learn to provide themselves with full employment by their domestic policy.” In such a world, he argued, there would not be “important economic forces calculated to set the interest of one country against that of its neighbours.”

At the time that Keynes and Robinson were writing, the cost of beggar-thy-neighbor policies came mainly in the form of higher unemployment, as higher exports, unbalanced by higher imports, undermined manufacturers in trade deficit countries and forced them to lay off workers. But after the world abandoned the Bretton Woods system in the early 1970s, governments, including the U.S. government, learned to allay the costs of unemployment either by lowering interest rates to encourage consumer lending or through unrestricted deficit spending. The United States thus disguised the employment consequences of running a consistent trade deficit, but it did so through surging household and fiscal debt.

 

Export to Import

The link between the internal imbalances of one country and those of its trade partners has implications that economists sometimes fail to fully understand. In every economy, internal and external economic imbalances must align, just as each country’s external imbalances must align with the external imbalances of the rest of the world. This means that countries able to control their internal imbalances will at least partially drive the internal imbalances of trade partners. It is why, in any globalized system, as the economist Dani Rodrik has explained, countries must choose either more global integration or more control over the domestic economy.

Within Rodrik’s formulation, there are at least two very different ways of understanding globalization. In the one most analysts assume describes the world, major economies all chose to give up broadly the same degree of control over their domestic economies in favor of more global integration. Global trade is thus generally balanced as market forces reverse government policies that create internal imbalances. If a country runs large, persistent trade surpluses, for example, its currency will appreciate, or its wages will rise, making its goods more expensive. That will, in turn, cause the trade surplus to shrink as the welfare of domestic households expands.

In the other model of globalization—one that better describes the world as it is—some major economies exert less control over their domestic economies in favor of more global integration, whereas others choose to retain control over their domestic economies, perhaps by controlling wage growth, or determining domestic prices and allocation of credit, or restricting trade and capital accounts. To the extent that the latter set of states intervene to prevent their domestic economic imbalances from reversing, they effectively impose their internal imbalances on countries that retain less control over their trade and capital accounts. If they choose industrial policies aimed at expanding their manufacturing sectors, for example, they are also implicitly imposing industrial policies on their trade partners, albeit ones which result in a relative contraction in those partners’ manufacturing industries.

This is precisely the kind of globalization that Keynes and Robinson opposed. It is the kind of globalization that allows governments to pursue Kaleckian strategies that are expansionary for their economies but contractionary for the global economy as a whole.

If globalization is to thrive, the world must revert to a kind of globalization where countries export in order to import and where a country’s production, consumption, and investment imbalances are resolved domestically—not foisted onto trade partners. The world requires, in other words, a new global trade regime where countries agree to restrain their domestic imbalances and match domestic demand with domestic supply. Only then will states no longer be forced to absorb one another’s internal imbalances.

The best way to achieve this kind of globalization is to create a new customs union, along the lines of what Keynes proposed at Bretton Woods. States that join would agree to keep trade between them broadly balanced, with penalties for members that fail. But they would also erect trade barriers against countries that don’t participate to protect themselves from imbalances outside the customs union. Trade would not be expected to balance bilaterally, of course, but rather across all trade partners. Its members would have to commit to managing their economies in ways that would not externalize the costs of their domestic policies. In that system, every country could choose its preferred development path, yet it could not do so in ways that inflict the costs of domestic imbalances onto trade partners. (Smaller, less developed economies might receive some limited exemptions from the union’s rules.)

Many countries, especially ones that have structured their economies around low domestic demand and permanent surpluses, might initially refuse to join such a union. But organizers could start by gathering a small group of countries that comprise the bulk of global trade deficits—such as Canada, India, Mexico, the United Kingdom, and the United States—and bringing them into it. These states would have every incentive to join, and once they did, the rest of the world would eventually have to participate. If deficit countries refuse to run permanent deficits, after all, surplus countries cannot run permanent surpluses. They would instead be forced to raise domestic consumption or domestic investment—either of which would be good for global demand—or they would have no choice but to reduce domestic overproduction.

If the world created such a customs union, international trade “would cease to be,” as Keynes wrote, “a desperate expedient to maintain employment at home by forcing sales on foreign markets and restricting purchases.” The reason countries maximize exports would no longer be to export the cost of subsidizing domestic manufacturing but rather to maximize imports and household welfare.

If such a customs union isn’t possible, however, the most likely outcome is the beggar-thy-neighbor game predicted by Robinson in which states endeavor “to throw a larger share of the burden upon the others,” as she wrote. “As soon as one succeeds in increasing its trade balance at the expense of the rest, others retaliate, and the total volume of international trade sinks continuously.”

That seems to be the condition into which the world has been heading. It is what has delivered Trump’s tariffs, along with rising trade complaints from people around the globe. Until policymakers change the incentives for economies, international trade tensions will not abate.

1. C.H. Hession, John Maynard Keynes: A Personal Biography of the Man Who Revolutionized Capitalism and the Way We Live, 1984, p. 306-7.

 

 

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