Published daily by the Lowy Institute

Trumponomics: The art of the trade deal

Too many trade negotiators share the Trump mindset, counting success in terms of how many export-promoting elements are embodied in these bilateral and plurilateral FTAs.

Photo: Richard Ellis/Getty Images
Photo: Richard Ellis/Getty Images

President’s Trump’s trade policies are still evolving, but they are turning out to be rather different from his pre-election rhetoric. Concerns about an all-out trade war are fading away, as is the threat of bilateral 35%-45% tariffs against Mexico and China. The planned renegotiation of NAFTA could turn out to be little more than the updating that President Obama had already proposed. Border taxes have been put on the backburner.‘Buy America’ is, so far, just what previous presidents have done. Thus the reality seems to be constrained by incumbency.

There is, however, one worrying aspect of trade policy-making that, if not unique to the Trump mindset, has been honed to a degree that makes it a Trump trademark: to see trade deals as an arm-wrestle to squeeze the lion’s share of the benefits out of each individual trade negotiation. This zero-sum mindset might be a key to success in property development, but it is counter-productive to maximising the overall benefit for America from global trade. The problem is not just that the benefits of trade would be shared inequitably (with weaker nations getting little): this strategy also ensures that the overall benefits that available for sharing are less than they could be.

The current China dealings illustrate the issue. Instead of declaring China to be a ‘currency manipulator’, and addressing the bilateral trade deficit with prohibitive tariffs and direct limits on imports, it turns out that Donald Trump has ‘great chemistry’ with the Chinese leader and the new-found friendship can be deepened by China importing American beef and LNG. The details remain to be worked out, but there could be more bilateral favours to come.

Such special deals fly in the face of the central tenet of the hugely beneficial post-World War II trade expansion: multilateral trade agreements are superior to bilateral, because bilateral deals result in trade diversion, whereby imports are not sourced from the cheapest supplier. When China agrees to import, say, beef or LNG from America, it is importing less from some other country (in this case, there is a good chance that this would be Australia). If America was the cheapest supplier, there would be no need for this kind of cosy arrangement: America would get the export order because it offered the lowest price.

The lowest-cost supplier which missed out on this export opportunity could well feel disgruntled enough to impose limitations on its own imports. This is the way trade wars get underway. The Smoot Hawley tariffs of 1930 may not have been the cause the 1930s depression, but they certainly made it worse.

The multilateral global trade framework evolved specifically to address this problem through the ‘most favoured nation’ principle, the key element of the GATT, which morphed to become the WTO. If a WTO country agrees to lower its tariffs (say, in bilateral trade negotiations), then this lower tariff should apply to all WTO countries. The idea was that you can’t do a deal giving a specific trade partner advantage through a lower bilateral tariff (presumably in exchange for similar favours to promote your exports). By itself, this principle may not have been enough to reduce tariff levels, without a growing realisation after WWII that unilateral reduction in tariffs would benefit the country making the cuts. In the full-employment environment of the time, we came to understand that it didn’t make sense to deprive ourselves of the benefits of cheaper imports. The outcome was a spectacular fall in tariff protection: advanced economies now have minimal tariff protection.

The victory, however, was only partial. Grossly inefficient agricultural protection remains, notably in Europe.‘Buy local’ requirements are pretty-well universal(look at Australia’s submarines). All sorts of non-tariff barriers are imposed. Politics and vested interests triumph over sensible economics and the greater good.

The WTO has shown itself unable to make progress in multilateral agreement. Just as lamentable, it has tolerated - even condoned - the wave of so-called ‘free-trade’ deals that contradict the central idea that trade should be with the cheapest (most efficient) supplier. These FTAs are now the main game and Australia is among the most enthusiastic players. Perhaps the only justification is that if others are doing FTA deals, you have to join in. This is, of course, exactly why multilateralism is such a vital principle of global trade.

What explains this failure to implement what may be the only idea that almost all economists agree on? Too many trade negotiators share the Trump mindset, where success is counted in terms of how many export-promoting elements are embodied in these bilateral and plurilateral FTAs.

The main weakness in the economists’ pro-free-trade counter-argument is that it assumes full-employment and no adjustment-costs when resources (i.e. human beings) have to shift from one industry to another when trade opening occurs. The economics textbooks assure us that the benefits from trade are large enough to compensate all those who lose from opening, but it is only an assumption that the losers will, in fact, be compensated.

Since Trump’s astonishing electoral victory, economists have moved a long way in recognising what was long-obvious to many others: adjustment costs are high and past efforts at compensation have been inadequate. As for the ‘full-employment’ assumption, more economists are coming to acknowledge just how damaging the feeble recovery from 2008 has been (with many recognising the fixation with fiscal deficits as an important failure). It doesn’t help much to point out that a very small proportion of the job losses in manufacturing were caused by international trade per se because technology was the main disruptor of the old-style blue-collar jobs that have disappeared. No-one is going to point the finger of blame at technological progress when globalisation is a convenient defenceless scape-goat.

Anyone brought up on the micro-view embodied in ‘the art of the deal’ would do exactly what Donald Trump is doing: if you are powerful, you will want to ‘divide and rule’ through bilateral negotiations. Each one should be an overwhelming victory. But if you add together multiple micro-deals, each of which involves purchasing from a supplier which is not the lowest-cost most-efficient provider, the sum of the deals is less than it could be. This is true even if you are a fervent believer in ‘America First', focused only on benefit to America. This is why leaders of countries need to understand the macro economy-wide view, even if they are past-masters of the business deal.

What does this mean for Australia? We stand to lose from Trump-style US bilateral deals with China, Japan and others. Our best defence might be to vigorously pursue plurilateral agreements (such as the Regional Comprehensive Economic Partnership), endeavouring to include some form of ‘most favoured nation’ clause which inhibits members from doing bilateral deals which disadvantage other members of the Partnership.

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