Reasons for the new scepticism on free trade and globalisation

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By Jim Leontiades

Cyprus International Institute of Management

One of the oldest and most widely held economic theories is that international trade is a win-win situation. Through the benefits of international specialisation, all parties to agreements which extend free trade can “win”. This is the theoretical basis for free trade and globalisation. It has become so widely accepted that its support has become almost a test of political correctness within the economic profession.

Even so, past experience indicates that there are (should be) no sacred cows in economics.

Questions have recently been raised, particularly regarding the distribution of benefits from trade. It is clear that not all groups within a country win, some groups will probably lose. This is reflected in the demise of entire industries, millions unemployed and the rise of the so-called regional “rust belts”. Such losses are supposedly more than offset by gains, such as the lower price of imports made available to the consumer. Unfortunately, there is no reliable way of measuring these gains or determining whether they are greater than the more visible losses.

Myths and Mercantilism

Questions regarding the distribution of gains and losses also apply between countries. Although all parties to trade may gain, there is no claim that the gains are distributed equally between trading partners. Nowhere is this issue more contentious than between countries with a trade surplus as compared to those with trade deficits. According to the accepted wisdom, countries which aim for a consistent trade surplus (i.e. mercantilists) are pursuing a flawed strategy.

The reason is simple. A steady export surplus means that the exporting country is sending out an excess of goods and services, over and above its imports. Consumers in the surplus countries are thereby losing out, their excess exports represent goods they have produced, but which are enjoyed by others. In payment, the surplus country receives bits of paper, IOUs in the form of bonds and foreign currency. In short, mercantilist countries are the losers. But is this conclusion warranted? There is evidence which strongly suggests the mercantilist countries know what they are about.

China and Germany have both had a trade surplus for decades. On the opposite end of the spectrum, the US and UK have had corresponding deficits. (Taken together, these four countries represent over a third of total world trade). While trade theory 101 indicates that surpluses and deficits should be temporary, these imbalances have lasted well over 20 years with no signs of a correction.

The Mercantilists

Only a few decades ago, China was largely an agricultural country, most of its population living at or below subsistence. The Chinese economic miracle has produced one of the greatest improvements of consumer wellbeing ever recorded. The rapid growth of Chinese GDP since 1990, at two or three times the growth rate of western advanced economies, has brought with it an unprecedented growth in Chinese wages. These have grown to where they are now the equal to those of certain South American countries and will soon overtake those of Greece. A number of firms with facilities there feel that Chinese wages have reached the point where they now have to consider moving to Vietnam and other low wage countries.

In Cyprus, we now see thousands of Chinese tourists, as well as Chinese buyers of luxury homes – something unimaginable only a few years ago. This improvement was made possible by Chinese exports. In the early years these accounted for some 35% of China’s GDP.

Germany, also a country with long term export surpluses (of 40 years) is one of the most successful economies of the developed world. The average German wage, once significantly below that of the US , is now above the average American worker’s wage. Moreover, Germany (unlike many of its EU partners) has maintained a level of near full employment, despite hosting millions of immigrants from both outside and inside the EU.

Deficit countries

This is in notable contrast to many deficit countries. Both the US and the UK, the major deficit countries, have experienced long-term trade deficits, the flip side of the Chinese and German export surpluses. Both have witnessed a slowdown in the growth of the wages of their industrial workers. For the first time in American history, the sons of middle class industrial workers expect to earn less than their fathers. In commenting on globalisation and its impact, the Dean of the Harvard Business School, Nitrin Noria, stated that while globalisation has helped billions in emerging markets, it has “diminished the prospects of the average American worker”.

In Britain a recent finding by a research institute claims that British wages have actually been declining since 2010 and that the country is now in the midst of “the greatest period of wage stagnation in the last 150 years”.

The relative position of these countries regarding their standing in world trade is also changing. China’s share (China mainland) has grown the most. From a world share of less than 4% in 2000, it now accounts for over 13% of world exports. Germany’s share has been almost stable, only changing from 8.6% in 2000 to 8.3% in 2016. The US and UK are the big losers, the American share dropping from 12.2% in 2000 to 9.2% in 2016. The UK saw its share drop from 4.4% to 2.2% over the same period.

In both of the deficit countries, unemployment is at historic low levels and still dropping. Counter to expectations this has not brought about any significant increase in wages. A puzzle which some think is due to the threat of further imports.

There is no question that Chinese consumers have experienced faster growth in prosperity than those in either the US or UK and the same is most likely true with reference to Germany. The evidence suggests that if an economy is growing fast enough, consumers can both save and have sufficient spending power to increase their consumption – to have their cake and eat it. Exports can make this happen.

Changing Competitiveness

At one time, a country’s trade advantages were considered to be relatively stable. Classical trade theory uses examples of advantages based on products derived from a nation’s natural resources. These are closely linked to the country of their location, changing only slowly. Today, it is clear that trade advantage is increasingly based on technology. This is not only extremely mobile and transferable between countries, but often for sale on the open market. The purchase of entire companies can provide a shortcut to upgrading and indeed revolutionising a country’s export advantages in a very short span of time.

Both China and Germany have drawn on the bonds and foreign currency, the “little pieces of paper”, accumulated through their trade surpluses, to make major foreign investments to further increase their export capabilities. Germany has used its foreign currency to make investments in the American automotive market which will further boost its exports.

China, at one time associated with labour-intensive low-tech products, has now undertaken a far reaching programme of investment which will radically upgrade its exports. It will link its labour costs which are still below those of the western economies together with advanced technology to develop a whole new range of export advantages. To that end it is now actively bidding for the purchase of cutting edge companies in the West which are engaged in robotics, artificial intelligence, aircraft manufacture, computers, and so on. The recent introduction of its own home-produced jumbo jet brings it into direct competition against Airbus, Boeing, Rolls Royce and General Electric, an indication of things to come.

Globalisation (and trade) is reshaping the world economy and the economic positioning of major countries. The future will hold some unpleasant surprises, particularly for those which who were once considered to be in the forefront of innovation and change. It has already had political repercussions.

*(Financial TImes, 1.08.17)