"Coronavirus accelerating retreat from globalization"

Douglas Irwin / Photo: Inbal Marmari

Trade expert Prof. Douglas Irwin discusses threats to the world economic order, and how Israel can cope.

Prof. Douglas Irwin is one of the leading US experts on international trade. He lectures at Dartmouth College, a member of the Ivy League. He was a member of President Ronald Reagan's Council of Economic Advisers, worked on the Federal Reserve Board, and was selected last year as one of Foreign Policy Magazine's 100 Global Thinkers. He visited Israel this week as a guest of the Friedberg Economics Institute, whose aim is to promote "the principles of economic freedom" among students in Israel.

Irwin, a sought-after interviewee in the global financial media, is renowned as both a trade expert and an economic historian. Under the threat of the coronavirus, which is casting an ever-darkening shadow over the global economy, he spoke with "Globes" about the effects of the virus, the growing challenge to globalization, President Donald Trump's trade policy, and the way Israel can maneuver in the new situation.

"Globes": Were you afraid to visit Israel?

Irwin: "My one concern was that if the virus continues to spread, we'll have more flight cancellations. Because it doesn't appear that Israel has been affected too much, and I have a direct flight to Boston, I'm fairly confident that we'll return safe and well."

Was the journey different this time?

"The truth is that it wasn't. But I was supposed to fly to Vietnam next week with a student delegation, and it was canceled. It's a matter of minimizing risks. There are consequences for passengers, but what will be interesting to see is how much world trade slows down because of this. China has closed down many factories, economic activity is at a lower level, and it will be very interesting to see the results. All this is related to a broader debate about globalization. There are people arguing that we've become too dependent on (global) supply chains."

Are you worried about a global recession?

"I look more at the past, and less at the future. Last year, it seemed as though world trade may have shrunk, and we have to see about this year. There are very few periods in history in which we have seen world trade shrink other than in a time of recession.

"Furthermore, there's a debate among economists about whether globalization has peaked. There was a huge expansion in trade in the past 20-30 years, powered by policy that encouraged trade, among other things, and enabled the supply chains to develop. If there's an epidemic, it could be one of the forces drawing us back from excessive reliance on supply chains and globalization."

Globalization in retreat

Actually, Irwin says, there are measures showing that the trend in world trade changed ten years ago. "When we look at the volume of global trade as a percentage of global GDP, we see that it has been declining since 2011. This means that we may have reached an inflection point. There is a limit to how much the world's economies can become integrated.

"President Trump is encouraging this development, but it began before him. Even without Trump, if the supply chains prove to be vulnerable, trade would decline anyway." In other words, Irwin says, we may have seen the peak of globalization, the maximum point of global economic integration, after which comes a decline.

Do the coronavirus and the concerns accompanying it fit in with this trend? Are they likely to accelerate it?

"Without a doubt. There is a range of factors at work: policy; unexpected shocks; China's has turned inward, and under President Xi has become far more nationalistic, with a 'made in China' initiative. This poses all sorts of challenges to small open economies like Israel. Israeli economic policy clearly has a great deal of influence on its situation, but there are also external factors, and if other countries begin to close themselves off, it will also affect you, regardless of your policy."

Can you go into more detail?

"I was asked what Israel can do to position itself successfully in the global markets if we're moving towards a more protectionist situation, and trade becomes more difficult. My answer is that you can do what Mexico did: make as many free trade agreements as possible with as many partners as possible. This will diversify your markets, avoid dependence on one market for exports, and guarantee your access to the market."

The fear is that the World Trade Organization (WTO) framework, which ruled the global economy for the past 20 years, is crumbling and liable "to die of neglect," Irwin explains. "And if the WTO framework is abandoned, countries' fates will depend on their bilateral agreements and trade agreements. So what Mexico did was to say strategically, 'Not only do we have the North American Free Trade Agreement (NAFTA) with the US, our biggest trading partner, but we have agreements with the European Union.' They joined the Trans-Pacific Partnership Agreement, and they're trying to reach as many trade agreements as they can."

China is not moving towards a market economy, and has politicized the private sector

Irwin explains that the global economic order is a relatively new phenomenon. Only since China entered the WTO at the beginning of the preceding decade has there been a "global trade architecture" containing not only the Western economies and Japan, but also Africa, Latin America, Southeast Asia, the countries of the former Soviet Union, and also China. Now, however, he says, it appears that the system is not well adapted.

"China was added to the WTO on the basis of the assumption, which appeared reasonable at the time, that it would move towards a market economy, like Eastern Europe when the Soviet bloc collapsed. True, the state played a major role in the Chinese economy, and there were many state-owned businesses, but it appeared that they were on a track in which the private sector could prosper and the government sector would shrink, if it were not privatized. Under President Xi Jinping, they have moved in a completely different direction. They have made the private sector political by insisting that Communist Party members must be on the board of directors and in management positions. They have the 'made in China' initiative, which is explicit economic nationalism, and they have strengthened their support for government-owned businesses.

"The question is whether there can be a comprehensive trade framework containing state capitalism (China) and market capitalism (US) under the same umbrella. My tentative answer is no. There's an incompatibility here, which causes not only economic problems, but also political problems - a sense of unfairness. People feel that it's unacceptable for private companies to have to compete with government-owned companies having no budgetary constraints. When you add national security considerations, economic rivalry, and geopolitical tensions to the mix, it looks as if the peak of globalization, in which we're highly integrated with China, can't continue."

This narrative appears similar to the one being presented by President Trump, who says that China has not played by the rules.

"I'm very critical of all sorts of aspects of President Trump's trade policy, but I'm more cautious when it comes to China." Irwin explains that the measures by Trump and his team of advisors have not solved the basic problem between China and the US, and they have no coherent strategy for containing China. "The question is not whether something has to be done; the question is how to do it," he says.

Another term for Trump will threaten international trade

Putting China to one side, however, Irwin is more critical of Trump's attack on the institutions regulating international trade. Underlying Trump's trade policy is a fundamental error, he explains: Trump's focus on the trade deficit of the US, which imports more than it exports.

"One of the reason that Trump is so harmful to US trade policy is that not only does he judge whether we win or lose according to the balance of trade, but that he wants to shape new trade agreements in order to manage the results of trade, instead of the rules. We want a trade regime that will establish the rules, without governments getting involved in which sectors succeed or do not succeed, or looking at the balance of trade each year and deciding whether it's good or bad. Trump is a businessman who was in the real estate sector and gambling, both of which are classic zero-sum games. In gambling, you try to beat the house, and in real estate, either you get the property or someone else does. International trade, however, is not a zero-sum game. It's very hard for him to think that both sides can benefit, and that balance of trade deficit is not an indication that one side is winning and the other is losing."

But his economic nationalism message has an audience.

"According to surveys by Gallup, since 2011, the proportion of Americans who regard trade as an opportunity, not a threat, has risen dramatically. Look at what happened to the markets as a result of these actions. Look at what happened to US industry - they have to rethink their supply chains. Workers in industries in need of steel imports are being affected - there are layoffs. The farmers are a large group of voters, and they're very dissatisfied."

Judging by your advice to Israel about signing bilateral trade agreements, it appears that you have already accepted the new situation.

"You can't just assume that the WTO framework will survive without change and continue to maintain relatively free and open trade. There's Aesop's fable of the oak and the reed. The oak is strong, but a big storm can knock it down, while a reed bends with the wind. This was the tradeoff in designing the trade system. The WTO was designed as a strong oak, but sometimes you need flexibility in the system to allow local interests to get what they want in a way that doesn't topple the tree and destroy the entire system."

And this is the risk you see now.

"Exactly."

This is a pessimistic note to finish on.

"The optimistic part is that when you have a high level of economic integration, as we have today, interests in preserving it are created. I don't think that the system will collapse, because too many people make money from its continued existence. It's a Tim Cook effect (CEO of Apple, who has Trump's ear, U.P.). It's US farmers from the Midwest, who like Trump and don't like the quotas imposed on China. There's opposition.

"If we look at Trump's first term and the rhetoric he brought with him to the job, compared with what he actually did, if all we have are steel quotas and quotas on China, and there is still a free trade agreement in North America, and there is still the WTO, there is still trade with the EU, it's not such a big change. With China, you could say that some kind of rift is inevitable, but there's still a high degree of integration. It's not a giant change. The rhetoric is not reflected in policy."

So does everything depend on whether Trump gets another term?

"Exactly. Because then the targets will be the EU and the WTO, and these are big things that can disrupt the world trade order."

Published by Globes, Israel business news - en.globes.co.il - on March 16, 2020

© Copyright of Globes Publisher Itonut (1983) Ltd. 2020

Douglas Irwin / Photo: Inbal Marmari
Douglas Irwin / Photo: Inbal Marmari
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