The World: A Brief Introduction

by Richard Haass

  Trade and Investment

  Trade at the international level is the exchange (buying and selling) of manufactured goods, agricultural products, and services (including such things as insurance, banking, and legal work) across borders. It is a necessity, because no country is self-sufficient in raw materials, grows all the food it needs, has enough domestic demand for all it produces, and manufactures all that it wants to consume.

  All things being equal, trade is a good thing, although it can also eliminate certain jobs and hurt some firms and workers. On balance, though, trade creates jobs and boosts the overall welfare of a country. Imagine a country of 100 million people. That is a country with 100 million potential consumers. But there are close to 8 billion people in the world. Trade dramatically expands the size of the potential market that producers can reach. It is thus a boon for those who work for companies that export, with statistics showing that export-oriented jobs tend to be relatively high paying. As a company sells to a larger market, its average cost of production decreases, and the company can then sell its products more cheaply. Trade can be an engine of increased productivity, economic growth, development, and poverty reduction.

  Trade also broadens the array of goods that consumers can purchase. Barely any coffee or tea is grown in the United States, but Americans wake up to these drinks because of trade. Trade gives people access to the most innovative and highest-quality goods and services produced around the world. Trade also allows consumers to purchase things at lower prices if those goods come from countries able to produce them more cheaply due to lower labor costs (whether stemming from greater efficiencies, the incorporation of advanced technology, and/or lower wages) or greater access to raw materials. Imports can also stimulate innovation because they expose domestic producers to new ideas and products that they can incorporate and build on. Competition from abroad also motivates domestic producers to improve their products or prices.

  THE GROWTH OF TRADE

  Total global trade as a percentage of world GDP

  Sources: World Bank; World Trade Organization.

  Underpinning these ideas is what is known as the theory of comparative advantage, introduced two centuries ago by the British political economist David Ricardo. The theory posits that international trade allows a country to specialize in producing those things it can make more cheaply and import those it cannot. The Germans thus export chemicals, the Saudis oil, the Swiss watches, the Canadians timber, the Japanese cars, the Americans machinery, and the Chinese textiles. The idea is that trade works best when every country does what it does best. Those things it cannot make or cannot make well, it imports from others.

  Countries that participate in international trade run either a trade surplus (if the value of their exports is greater than the value of their imports) or a trade deficit (if the value of imports exceeds the value of exports). That is their trade balance. It is impossible for every country to run a surplus because overall trade in the world must balance out. Some countries will run overall deficits. They will also likely run bilateral deficits with some countries and bilateral surpluses with others. Deficits tend to reflect the relative strengths of currencies (a strong currency makes imports cheaper and exports more expensive, leading to a deficit) and the extent to which people in a country have access to money and prefer to spend (which adds to the consumption of imports) rather than save. Not surprisingly, trade deficits get bigger following tax cuts that tend to stimulate spending and discourage saving. None of this matters so long as a deficit is not the result of unfair trade practices or currency manipulation and the country can pay for what it imports with a currency that others will accept. If not, then it will have to cut back on imports or increase the value of its exports.

  One additional complication needs to be inserted here. It is increasingly difficult to measure exports and imports, because few items are made entirely in one country. Instead, the production process is fragmenting, with components and raw materials coming from around the world and assembly taking place in multiple countries. This is the case for everything from automobiles to iPhones. A good may cross one or more international boundaries (even the same one) several times during production. This phenomenon is known as a global supply chain (sometimes called a value chain in that the value of the good or service increases at each stage of the process). In fact, the buying of unfinished goods or services that contribute to production currently accounts for three-quarters of international trade.

  Most official statistics fail to capture the complex reality of global supply chains, in the process making trade surpluses and deficits appear starker than they are. Depending on the sequence of steps in the manufacturing process, a country may get 100 percent of the “credit” for producing a good—in other words, the final value of the good is logged as an export—when in fact it only carried out its final assembly and received merely a fraction of the final sale price. There is research indicating that on average close to one-third of global exports are accounted for by importing foreign goods and using them in the production process. This reality has among other things real implications for statistics: the U.S. trade deficit with China may be in the realm of 30 percent lower than what is reported due to the fact that many of China’s exports to the United States include elements from third countries.

  The rise of global supply chains also has policy implications. After all, while imposing tariffs (import fees) may protect some industries from competition, it will make the importation of goods used to produce other goods more expensive and thus make domestic products more expensive and less competitive. Also, government actions designed to weaken the home currency and create a competitive advantage for exporters have the side effect of making essential imports (of raw materials or components) more expensive for domestic producers. Finally, while there is growing talk in Washington about “decoupling” the American economy from the Chinese one, the existence of complex global supply chains makes this easier to talk about than to bring about. While there may be significant decoupling in strategic sectors that have implications for national security, such as 5G and semiconductors, it is unlikely that the world’s two largest economies can be separated to a significant extent.

  THE GLOBAL SUPPLY CHAIN OF A BOEING 787

  Component parts by country of origin

  Source: Boeing; The Wall Street Journal.

  The benefits of trade are not just economic. Trade can serve strategic ends—for example, by bolstering alliances. But trade can also be good for ties with potential adversaries. Countries that trade together may think twice before going to war with each other or doing other things that might disrupt mutually beneficial trade. Trade among European countries and across the Atlantic clearly failed to prevent the outbreak of World War I, but there is reason to believe interdependence can be a factor that encourages restraint. Japan’s behavior in the run-up to World War II, when it lacked mutually beneficial trade ties with adversaries, supports this line of thinking. Such interdependence constitutes one rationale for U.S.-China trade.

  Free trade is a form of trade in which goods and services easily cross borders and can be purchased at a “market price” that reflects the costs of production and transit along with whatever profit the manufacturer seeks. The principal alternatives to free trade tend to be protectionism, which involves erecting barriers to imports to shield domestic producers from foreign competition, and mercantilism, which sees trade surpluses as highly desirable and embraces policies including protectionism that promote exports and limit imports. Both will ultimately lead to retaliation and the breakdown of arrangements meant to promote trade and through it growth and peace.

  At times the phrase “fair trade” is proposed as an alternative to free trade. It is a phrase that is attractive on the surface because it is hard not to support something described as “fair.” Often the term is coupled with calls for reciprocity, for matching what another government does.
Again, in principle this is reasonable. But fairness should not be confused with outcomes; trade need not be balanced to be fair so long as what is done is consistent with obligations under relevant trade laws and commitments. Otherwise, fair trade can become a euphemism for both protectionism and mercantilism if it is used to advantage exports or discourage imports.

  UNFREE TRADE

  There are a number of barriers to free trade. The oldest and most common instrument is tariffs, a tax added to the price of a product when it enters a country. The “tax” is paid directly by the importing business (and collected by the importing government) and then is normally passed on to consumers in the importing country in the form of higher prices. The tariff is not paid by the exporting country, but it will make the exports in question more expensive and less competitive. When goods are affected by a tariff, the volume of exports and the profit from exports will likely fall.

  A tariff makes something more expensive and thus less attractive to would-be consumers, who will either buy something similar at a lower price—be it made by a domestic producer or another foreign producer—or forgo the purchase. Tariffs can be put in place for many reasons, be it to protect firms that could otherwise not hold their own against imports, to retaliate against other countries that use tariffs or other tools to protect their companies, to bring about a change in the overall balance of trade, or as a kind of sanction in response to disliked policies that have nothing to do with trade. Tariffs were a mainstay of U.S. policy in the 1930s when the Smoot-Hawley law was passed and have become a common tool under the Trump administration starting in 2017. The danger, of course, is that tariffs can simply raise prices and reduce the volume of trade, slowing economic growth and poisoning political relationships in the process.

  There are also “nontariff barriers,” which, as the phrase suggests, make it difficult for goods produced in one country to reach another. Quotas—ceilings on the amount of a specific item (for example, cars)—on goods allowed to be imported from another country are one such nontariff barrier. Nontariff barriers need not be quantitative. Europe has put into place rules that limit or preclude imports of genetically modified foods. For a time, Japan refused to import metal baseball bats, citing baseless safety considerations. Bureaucracies can put into place all sorts of regulations and procedures that make it difficult for products to reach their intended destinations. There can also be rules stipulating that domestically produced components make up a certain percentage of a final product. Again, the idea is to limit the degree to which imports can reach the market, in the process protecting jobs in competing industries in the home country. The problem is that consumers will have to pay a higher price or accept lower quality or both. Exporting countries often live with such obstacles because it is better to have some exports reach consumers than none. But exporting countries have also been known to retaliate, reducing access to their markets as a consequence. In such circumstances, everybody loses.

  There are other less obvious or visible barriers to free trade. One is subsidies, essentially economic grants, low-cost loans, or purchases made by governments to or from domestic companies or industries that offset part of their costs of production and thereby allow them to set lower prices than they normally could. This pricing ability allows them to compete more effectively domestically (against imports) and abroad (where they are competing for market share). For a long time, Airbus was a beneficiary of subsidies, a practice that contributed to its emergence as a serious competitor to Boeing. China’s large firms (so-called state-owned enterprises) depend on extensive government subsidies to a degree that distinguishes them from practices elsewhere.

  Another device used to tilt the playing field in favor of a country’s exports and to penalize imports is currency manipulation. Steps by a government’s central bank (which controls the amount of money in circulation and the costs of borrowing through interest rates) to decrease the relative value of its currency against the value of the currencies of its trading partners will make imports more expensive to would-be consumers (thereby reducing demand) and its exports cheaper to potential consumers in other countries. China practiced currency manipulation when it was entering world markets and pushing to expand its exports.

  Currency manipulation that drives the value of a currency down can boost exports and reduce imports. This is the goal of mercantilist practices. But there is a price to be paid for such behavior, because it will likely make citizens unhappy if they can no longer afford to buy preferred goods made outside their country. And currency manipulation invites currency manipulation by others (leaving everyone no better and arguably worse off as trade slows, which in turn slows economic growth) or leads to other forms of retaliation, such as tariffs. This, too, happened in the run-up to World War II.

  Dumping is yet another behavior inconsistent with free trade. Dumping occurs when a country exports something at a price below what it would sell for at home. It might even be below what it costs to produce. The motive for engaging in such “irrational” behavior is to gain market share in a foreign country, after which it may be possible to raise prices without losing out. Dumping can also be used to keep workers working in order to skirt domestic political problems caused by unemployment. In such cases, there is normally a hidden government subsidy. Members of the General Agreement on Tariffs and Trade (GATT) agreed to the first Antidumping Code in 1979 and expanded it in 1994 with the creation of the World Trade Organization (WTO).

  Trade also requires that patents and copyrights be respected, that rights be paid for, and that technology and work not be stolen. Companies that spend money on research and development and introduce new techniques and products deserve to make a profit on the basis of their efforts. If they do not make a profit, they may lack the funds for further investment or the incentive to continue to innovate. The same holds for individuals who produce creative work. Such protection has become more difficult in the internet age. China, in particular, has stolen valuable intellectual property, and its companies have then introduced it into their own products that are sold at home and abroad.

  One last barrier to free trade is fundamentally different. It comes about when exports are blocked not by the would-be importing country but by the exporting country. Such export controls are put into place for national security reasons, to keep certain technologies with military or intelligence applications out of the hands of trading partners who are viewed as potential or actual adversaries. Export controls used for legitimate reasons of national security are thus a necessary exception to free trade. The danger, of course, is that national security can be used illegitimately as a cover for protectionism.

  TRADE TALKS

  Trade does not just happen. Mostly it is the result of painstaking negotiations that reduce tariffs and other obstacles to the free movement of goods and services across national borders. Such negotiations can be global, regional, multilateral in just about every imaginable configuration, or bilateral (between just two countries). Trade agreements are becoming increasingly broad, setting standards for things like working conditions and environmental practices. Many agreements also come with a process for resolving inevitable disputes that emerge when one country judges the behavior of another to be inconsistent with the terms of the agreement.

  Modern trade pacts can be traced back to the post–World War II period, when, in 1947, twenty-three countries signed the General Agreement on Tariffs and Trade. GATT’s emphasis was on reducing tariffs inhibiting the flow of manufactured goods, and in that the organization succeeded: the average global import tariff on goods has more than halved, falling from more than 20 percent in 1947 to 9 percent in 2018. Roughly two and a half decades later, GATT was superseded by the World Trade Organization, which now counts 164 members and has a broader mandate that in principle empowers it to promote free trade not just in manufacturing but also in agriculture and services and to protect intellectual property, including patents, copyrights, and select techno
logies. The WTO also includes a dispute settlement system, which is often referred to as the organization’s “crown jewel” because it allows trade complaints to be brought before an appellate body that determines whether WTO rules are being violated and issues rulings to the parties. Altogether there have been nine rounds of global trade talks, the most recent of which, the Doha Round launched in 2001, ended without agreement, largely because it was impossible to reach consensus on how agricultural products would be handled.

  Global trade negotiations have been most effective in reducing tariffs on manufactured goods. All members of GATT—and now the WTO—must provide other members with most favored nation (MFN) status, which reduces tariffs on their products to the lowest level offered to any other country with MFN status. Tariffs were then essentially cut through negotiated bargains, either sector by sector or through “formula” cuts, which were across-the-board reductions. Lower tariffs facilitate trade, and average tariffs have fallen sharply over the decades. Dumping is much less prevalent. The volume of world trade increased from just over $120 billion in 1960 to $6.5 trillion in 2000, a principal reason the world economy increased fivefold in those same forty years. International merchandise trade as a percentage of global GDP rose from just under 20 percent fifty years ago to around 45 percent today. World merchandise trade volume is now in the range of $20 trillion, three times what it was in 2000 and hundreds of times what it was in the aftermath of World War II. International trade continues to grow, although the rate of growth has slowed.