Is the global trade system broken?

The Economist

Today’s trading system may be bent, but it is not broken. Import tariffs are low. Quotas are relatively uncommon. In 2016, some $15.4trn of merchandise flowed between countries belonging to the World Trade Organization.

In the 1930s, the trading system was broken. The Great Depression was fraught with government-imposed tariffs, quantitative limits on trade, discriminatory deals and foreign-exchange controls. It got so bad at times that some international commercial relationships even devolved into barter. Economic historian Douglas Irwin recounts an example in 1932 of Hungary needing to come up with 29,000 pigs for the 20,000 wagons of wood it wanted to import from Czechoslovakia for fuel.

The major powers repaired the wreckage by founding the General Agreement on Tariffs and Trade in 1947, which in 1995 became the WTO. Today that same system coordinates policymakers so that they do not collectively take the world into a trade war, in which most countries would lose.

To understand how the WTO prevents countries from scratching their itch for tariffs, a little economics is required.

Suppose the WTO did not exist. Because of America’s market power, President Donald Trump would like to increase tariffs on imports. And if that were all, his new tariffs could make America slightly better off than it is today.

But two things flow from Trump’s would-be tariffs. First, they make exporting-country partners worse off and by more than America benefits. Tariffs are worse than zero-sum. Second, many partners have market power of their own and would act on it. China would reciprocate with tariffs, as would the European Union. Recent estimates from Alessandro Nicita, Marcelo Olarreaga and Peri da Silva find average tariffs would increase from roughly 3% today to about 35% in such a WTO-less world.

Thus, a Trumpian tariff attempt to make America a little bit greater again would backfire. The small initial gain—when only he imposed tariffs—is more than offset by the costs suffered from bad reciprocal behaviour. The WTO’s innate value, as shown by the work of Kyle Bagwell and Robert Staiger, is to restrain countries by making the ultimate costs of that first tariff hike clear.

The WTO is facing challenges. Tariffs, it turns out, can be straightforward to haggle over and to monitor so that they are kept low. But Chinese, European or American policymakers still have that market-power incentive to help out their producers. With duties kept low, sometimes governments switch to subsidies instead.

For the WTO, striking the right balance on subsidies is tricky. Rules are needed to ensure that they aren’t abused. But the rules also require more nuance than with tariffs, because subsidies sometimes make good economic sense. And in an ever-changing world, it has proven hard for the rules-makers to know exactly where to draw the line.

Then there is China. After its entry into the WTO in 2001, its government cut tariffs and undertook domestic policy reform. But its economic model of state-infused capitalism, referred to by Harvard Law Professor Mark Wu as “China, Inc”, also evolved in ways that sat awkwardly alongside the world’s trade rules.

The “Made in China 2025” industrial policy, its apparent tolerance of industrial espionage and intellectual-property theft from foreign companies, and its cheap loans from state-owned banks to Chinese manufacturers all rub up against the spirit, if not the letter, of the global trading system.

American politicians remain vexed that American exports to China have not sufficiently materialised. While much of that is driven by natural economic forces, some of it may be due to these nontransparent, subsidy-like policies.

The WTO has not failed. No one has requested its judges rule on whether these latest Chinese policies are breaking the system. On the dozens of earlier occasions when asked to intervene over different policies, the WTO has largely ruled against China. And China has complied. When deployed properly, the WTO dispute-settlement system has succeeded.

President Trump could bring to Geneva a new set of sweeping legal challenges. His Section 301 investigation into China’s allegedly unfair trade practices could result in unprecedented transparency, putting Chinese policies under the spotlight for the world to judge.

Even other WTO members’ response to Mr Trump’s questionable trade actions—his steel and aluminium tariffs in particular—leaves room for optimism. The EU established an early template, announcing plans to respond to Mr Trump’s unconventional behaviour within the WTO’s framework. China followed the EU’s example, making a similar WTO argument that served to constrain its own retaliation. And other countries have not given up on the WTO dispute settlement—some have even announced their intentions to formally challenge Mr Trump’s tariffs.

The WTO has proven resilient before. Despite the synchronised global downturn of 2008-09—which also included a trade collapse and Great Recession—the system held strong, with no return to the trade policy of the 1930s.

While the WTO is not broken, the debate over a “broken” trading system could be referring to one that is “in despair.” To that line of argumentation, I am much more sympathetic.