Globalization and Its Discontents Revisited

by Joseph E. Stiglitz

  Think for a moment how the trade war would play out. The first-round effect would entail a 45 percent price increase or so for clothes, televisions, and everything else the United States buys from China. The already-suffering Trump Rust Belt voter suddenly sees his standard of living plummet. Trump might retort: “I gave you fair warning. I told you that I was going to do this.” But they would naturally reply: “We thought you were just strutting, grandstanding. We thought you might use that as a threat, to get our jobs back.” At the next stage, the jobs don’t come back. Rather, Walmart starts buying more apparel from Indonesia and Vietnam. Walmart’s prices will rise because Walmart will not be sourcing its goods from the lowest-price provider; consumers will be worse off, but nonetheless there will be no jobs added, and no real change in the trade deficit.

  But the story doesn’t end here. China wouldn’t be happy with the American tariffs that violate its commitments to the WTO. China believes in globalization and the rules-based system, and wants to show all the other countries of the world the difference between China, a good citizen playing by the rule, and America, at least under Trump, where promises aren’t worth the paper they’re written on.

  China, the fastest-growing aviation market in the world, is not committed to buying airplanes from the United States, and so one would see a sudden collapse in sales of airplanes. Chinese students and tourists have been flocking to America—helping our balance of payments, and in terms of universities, providing the tuition revenues that they need so badly. With the bad mood—not toward the United States in general, but toward a Trump-led America—they may collectively decide not to come. China hasn’t been able to grow enough food to feed its 1.3 billion mouths, and America has made up a large part of the deficit. But China can buy much of its food elsewhere, and another major group of Red States (states voting for Trump) may find that life under Trump is more difficult.

  Finally, while America and China have been discussing an agreement to provide protection for each other’s investment in the other country, that agreement is far from being signed. Already, China is a master in making life difficult for a company that it believes is not behaving correctly—permits are delayed, construction is slowed, inspections become more frequent, laws against corruption (reportedly pervasive) are more vigorously enforced. The huge amounts American firms have invested in China—a major source of their profitability—can be thought of as a potential hostage in an out-and-out trade war. In real wars, governments often seize (temporarily) assets of the countries with which they are in conflict. This would be more subtle. My conjecture is that China would play strictly within the rule of law but would engage in actions which mirrored any actions the United States took, simultaneously taking full advantage of the many tools in their tool kit to disadvantage American firms.

  The business establishment—especially the huge array of firms that derive substantial profits from their activities in China—would be very, very unhappy and put enormous pressure on Trump and Congress to end the trade war. They might join the chorus saying China is unfair, but their voices would be especially loud when it came to the refrain: we have to respond intelligently, with engagement, not with war.

  DOING MISCHIEF: TRADE SKIRMISHES

  It’s hard to conceive that a Republican-controlled U.S. Congress would initiate a full-scale trade war, or leave the WTO, or allow Trump to do so. More likely, whether he scales down his protectionist rhetoric or not, Trump is more likely to engage Mexico, China, the EU, and others in trade skirmishes—a more limited engagement than all-out war.

  Trade laws give the president the right to initiate certain suits—when a country sells its products at below cost (called dumping) or subsidizes them. The United States is the prosecutor, judge, and jury, and it has written the law not based on principles of “fair trade.” Rather, the laws are biased in favor of the American firms bringing the case. During my time in the Council of Economic Advisers, I was frequently involved, and typically opposed the actions. The actions were blatantly trying to protect uncompetitive American firms from competition, driving up prices to consumers. But they did save jobs—though typically at the expense of jobs elsewhere, and often at great costs. The Council’s position was that noted earlier—the job of maintaining the economy at full employment was that of the Federal Reserve, and in the era when I served as chair, it did that job well, with unemployment falling to 4.7 percent in 1997. Later, it fell even more.

  Dumping

  Dumping provides an example of these trade skirmishes. The basic principle of economics is that in a competitive market, price should be equal to the (marginal) cost of production—the extra cost of producing an extra unit. In heavy industry, the major cost is the construction of the factory, so marginal cost can be much less than average cost. When there is a steel shortage, price rises above average cost; when there is a surplus, it falls below. If firms on average make predictions correctly, the periods in which price is above average cost balance out with the periods in which it is below, and the factory breaks even, giving a return on capital just enough to compensate for the risk of the industry. (That is, competition is supposed to drive down profits, taking into account a risk-based return on capital, to zero.) But there is nothing wrong or unfair in having an extended period of price below average costs. If, of course, producers make a mistake and build too much capacity, then the factory loses money. Consumers are the winners from this mistake, the factory owners the losers. In competitive markets, one doesn’t shut down the factory unless the total losses going forward from running the factory are greater than the cost of shutting it down. In China, with its historically unprecedented growth, excess capacity today can be quickly converted into a shortage. The construction of cities requires large amounts of steel, and hundreds of millions of people will be moving into those cities. Thus, it is not unreasonable for them to assume that some of the excess capacity is only temporary.

  America’s dumping duties don’t recognize these subtleties, and a company that is selling below average costs can be charged with dumping under WTO rules. Of course, it would make no sense for a firm to permanently sell below its average costs. It defies rationality.

  But there is another, less benign scenario. A company might sell below costs in order to drive its rivals out of business, thereby establishing a monopoly position, and with that market power, more than recoup the loss. This kind of “dumping” is called predatory pricing. For it to be profitable to engage in predation, there has to be some large barrier to entry. (Normally, as soon as the price rises above costs, there will be entry. There is then no benefit to driving firms out of the market by charging a low price because one simply can’t sustain a monopoly position.) Predatory pricing violates U.S. competition laws, and a company that has been “unfairly” driven out of business can sue. But the courts have frowned on such suits. To win such a case of “unfair pricing,” the complainant has a heavy burden—to show not only that the price is low, below costs, but that the market barriers are sufficiently high that the defendant would have a reasonable chance of recouping the losses. Not surprisingly, there are few successful cases.

  While trade and antitrust dumping (predatory pricing) deal with similar situations of a firm selling below cost, the standards set in the two are markedly different. If the antitrust standard was applied to trade cases, in almost no cases would there be a finding of an unfair trade practice. By contrast, if the trade standard were used in the U.S. antitrust cases, there would be large numbers found guilty of “predation” or dumping—rather than the very few who are. The explanation is simple: the dumping provisions are protectionist—they were designed to protect American industries and they do that.

  There are a few other provisions of the trade agreements that give the United States the right to impose duties as protectionist measures.28 And these are the things that Trump and his team will almost surely take advantage of. They can be outrageous—but at the same time they are of limited scope. China will c
hallenge the application of these provisions before the WTO, with considerable prospects of winning.

  Nonmarket Status and “Surrogate Countries”

  One especially peculiar provision that is likely to be challenged by China is called “nonmarket status.” In a Communist country, prices can be “made up,” so there is no basis of being sure whether a good is being dumped. So a clever alternative system was devised: look for a country that is similar (called the surrogate country), ask what it would have cost to produce the good in that country, and when the good is sold below that number, it can be called dumping. It was clever, in part, because it was so open to abuse. In one famous case, in the late 1970s, when Poland was still a Communist country, the United States alleged that Canada was the market economy most similar to Poland. Never mind the huge disparities in income and wages. Poland was accused of dumping golf carts. The problem was that though one Canadian firm had produced golf carts, it was no longer doing so, perhaps because it wasn’t profitable. So the United States calculated what it would have cost Canada to produce golf carts, if it had. Not surprisingly, the price was far higher than what Poland was charging, and a huge duty was imposed.

  The agreement signed by China when it became a member of the WTO provided that after fifteen years, China would no longer be subject to this special “nonmarket status.” Now, Europe and the United States appear to be trying to wriggle out of this commitment—and this issue too is now being litigated within the WTO.

  Tit-for-Tat

  Protectionists like Trump fail to remember that other countries can play the same games—and have every incentive to do so. Their citizens would expect no less of their government. Trump’s America First policies may be good for some parts of American politics, but it plays badly globally.29

  China (or any other country against which the U.S. takes protectionist measures) may not wait until a final WTO judgment is rendered—China has grounds for bringing similar actions against the United States. The emerging markets, including China, have been good students: they have learned from America how to take protectionist actions within the constraints of the global rules-based system that was intended to circumscribe protectionism.

  There are many easy cases: America’s bailout of the auto and banking sector entailed massive subsidies, giving countries the right to impose offsetting countervailing duties, perhaps even on those borrowing from these banks, on the argument that the interest rates charged are lower than they would have been without the subsidy. Almost surely, there will be tit-for-tat. The United States will gain little, and the world will lose a lot, in this process of partial deglobalization.

  The hope is that, as the Trump administration debates how and whether to implement the protectionist policies, the grown-ups in the room will persuade Trump of the folly of going down the trade war route. Even if the United States simply acts consistently with WTO rules—but moves aggressively using the latitude that those rules allow for imposing trade restrictions in certain limited cases—the grown-ups will explain that others too can act more aggressively.

  Trade wars have something in common with real wars: almost always, everybody—all countries engaged in the war—lose. Even the threat of a trade war has a depressing effect on investment and, therefore, the overall level of economic activity. Earlier, I referred to the painfully constructed global supply chains; a trade war would wreak havoc with such supply chains. The increased costs—and the increased risks—will be shifted onto consumers.

  RENEGOTIATING TRADE AGREEMENTS

  Trump has expressed enormous confidence in his negotiating skills. He has said the United States must renegotiate its trade agreements. There is much to be said for doing so: the design of agreements like NAFTA paid too little attention to the ever-changing nature of the economy, and to the fact that an agreement that might be “right” in 1992 when it was signed, might need updating a quarter century later. Remarkably, for all the criticism, as this book goes to press, he hasn’t laid out what he means by a “good” trade agreement. In his fixation on bilateral trade deficits (which, I explained earlier, simply don’t matter) he presumably would like to do something that would reduce Mexico’s surplus with the United States but not reduce the U.S. surplus with Canada. It’s not easy to see how there’s much he could do about either.

  There are a few minor things, like changes in the rules of origin—what percentage of a good that is called “NAFTA-produced” must be produced in one of the NAFTA countries. Before pulling out of the TPP, the United States agreed to loosen the rules of origins—effectively allowing a car with 90 percent Chinese content to be called Japanese. American auto manufacturers would like to go the other way—giving them a little advantage over Japanese or Korean cars that might have more Chinese parts. That would improve the trade balance with the rest of the world but might even lead to a greater bilateral trade deficit between Mexico and the United States.

  Earlier, I discussed the investment agreements that are embedded in trade agreements. (In the case of NAFTA, it’s called “chapter 11.”) I suspect Mexico and Canada would readily agree to redoing, or eliminating, these provisions. The problem is that America’s big multinationals love these provisions dearly—simply because they believe it may help ward off increases in regulation or taxation, and it increases their bargaining power with workers, driving down wages.

  In short, not only was NAFTA far from being the worst trade deal ever, but in any case, Trump will struggle to significantly improve it. There are, of course, new areas of commerce, not covered by NAFTA, like high tech and data, which a new agreement would deal with. Ironically, the position of the United States is likely to be similar to that in the TPP agreement which he scuttled.

  STRATEGIES FOR COUNTERING THE NEW PROTECTIONISM

  Trump, with his protectionism and America First policies, has put the world on notice: countries have to look after themselves and their interests. Borders matter, treaties don’t, and America is not to be trusted—it will do what is in its shortsighted interests. Trump’s extremism may have had a particularly adverse effect on American soft power, because it had already been eroding—as a result of the Iraq War and the way it was conducted, Guantanamo, and other factors discussed in the introduction.

  The economy only works because of trust: if every contract had to be litigated, the market economic system would break down. Fortunately, the kind of businessperson that Trump has shown himself to be is rare. Indeed, the response to such people is typically one of shunning and ostracism. We raise our children to be trustworthy; their word is their honor. We celebrate those who live by their ideals, and we castigate those who break their word, even when they get away with it.

  International relations are more complicated. Still, the basis of most diplomacy consists of leaders of one country meeting with those of another, in an attempt to develop understanding and trust. American diplomacy has been based on trying to enhance trust in the United States, to increase confidence that the United States will not abuse its economic and military power. Trump has gone in exactly the opposite direction, announcing that we may not honor our treaties, what matters is power, and America will exercise that power in (what he perceives to be) its own shortsighted interest. For countries without power, the natural question is, what can and should they do? A set of precepts is evolving:

  1. Diversify. Don’t be dependent on any single country, and particularly, don’t be too dependent on the United States, either for exports or for imports. Latin America, for example, will strengthen its ties with Europe and China. Most countries are already reasonably diversified. Mexico is the exception, with some 80 percent of its exports going to the United States in 2016.30 And Mexico is also highly dependent on the United States for meeting its gas needs. Countries like Mexico had always reasoned: for the United States to cut off gas supplies would hurt America as much or more than it hurts Mexico. But there was an underlying assumption of rationality. That assumption—certainly as it applies to the United
States—is now being questioned. The United States would, of course, be hurt by retaliation for its New Protectionist policies. It is not clear whether more reasoned heads will prevail.

  2. Redo the global architecture without the United States. Part of the new diversification strategy will entail a new set of trade agreements. While the United States has played a pivotal role in the creation of the current global architecture, it has occasionally been an impediment to reaching agreements. One of the reasons that the world couldn’t agree on what was called the Development Round of trade negotiations—negotiations that began in 2001 and were finally abandoned in 2015—was that the United States refused to remove its agricultural subsidies, including and especially on cotton. The United States also played an important role in stopping the creation of the Asian Monetary Fund, which would have helped fight the East Asia crisis, and tried to stop the Asian Infrastructure Investment Bank. Some countries are beginning to realize that with the United States out of the picture, this is the time to strike, to create trade or other agreements that might not otherwise be possible. Countries are likely to be wary in general of agreements in which there is an imbalance of power—there is always the risk of a Trumpian leader who will attempt to take advantage of others through the exercise of power. Thus, countries are likely to explore more South-South agreements and strengthen existing ones. Chile, Colombia, Mexico, and Peru have created what is called the Pacific Alliance. They are seeing the New Protectionism in the United States as providing the imperative to push it further.