China’s Economic Reckoning
The Price of Failed Reforms
Not since the end of World War II has international trade policy been so central to global politics for such a sustained period of time. As a presidential candidate, Donald Trump campaigned against trade agreements, winning the election with the support of midwestern states devastated by the loss of their manufacturing base. The United Kingdom’s decision to leave the European Union was motivated in part by a sense that decisions affecting its domestic economy should be made in Britain, not Brussels. Across Europe, right-wing parties skeptical of the international institutions that have promoted and supported trade liberalization are enjoying electoral success not seen since the 1930s.
These events have initiated yet another round of clashes in the long-running battle between self-described free traders and so-called protectionists. But their debates have proven tired at best and counterproductive at worst. For one thing, neither side believes in truly free trade or true protectionism. Both recognize that trade has had significant consequences for the distribution of wealth and that, at the same time, many communities depend on export markets.
Meanwhile, policy elites on both sides have tried to distance themselves from the fray, subscribing instead to a modern consensus in favor of ever more trade liberalization, and they continue to invoke economic growth as the primary justification. To the extent individuals lose jobs or find wages suppressed by overseas competition, the argument goes, new, better-paying jobs will be created elsewhere in the economy, while the overall gains can be used to compensate the losers.
The bipartisan acceptance of this justification is baffling. In domestic economic policy, trickle-down economics has become a pejorative term. Few believe that simply cutting taxes, for instance, creates widely shared benefits. Instead, debates about tax reform are driven by arguments about winners and losers, not overall benefits to the economy. Yet in international economic policy, a bipartisan consensus has until recently favored cutting trade barriers such as tariffs, which are simply taxes on imported products, and letting the market distribute the gains. The ongoing anti-trade backlash is the inevitable result.
The United States needs a new approach to trade policy, one that does more than seek to maximize overall economic growth, particularly when the benefits go disproportionately to global corporations and the wealthy. We call this new approach “trade policy for all,” and it involves three core principles. First, trade policy should strengthen the middle class and support foreign policy goals. Second, it should seek to reform domestic and international trade institutions, both of which are rigged to serve elite interests. And finally, redistribution needs to be central to trade policy rather than an afterthought.
A MEANS TO AN END
Although economic growth is an important objective of trade policy, it is a means to an end, not an end in itself. The framers of the U.S. Constitution believed that trade policy should serve a variety of U.S. interests and thus assigned power over tariffs and foreign commerce to Congress, the federal institution most in touch with local communities’ diverse needs and wishes. Few would support a trade policy in which 100 percent of the benefits of growth go to a single individual, however much GDP rises. Economic growth is a tool for bettering the quality of life for all Americans. And it provides an engine that allows the United States to defend its interests abroad while remaining the land of opportunity at home. In this vein, a new trade policy should adopt two primary goals: building a strong middle class and serving U.S. foreign policy.
In the past, support for the middle class was, in fact, one of the paramount aims of trade policy. In the nineteenth century, the U.S. government used trade policy to push workers’ wages up and develop infant industries. In the middle of the twentieth century, trade policy expanded U.S. exports abroad, creating more jobs at home. The goal of a strong middle class need not dictate liberalization or protectionism. Either, or both, might be appropriate depending on the context. But what is clear is that it is not enough to simply assume that what’s good for big business is good for the United States.
In recent decades, sustained trade liberalization has consistently favored capital at the expense of labor. Today, large U.S. corporations make many of their products and a great deal of their profits overseas. As a consequence, corporations often lobby the government for trade deals that allow them to cut wages at home and offshore jobs. Companies that rely on intellectual property, such as pharmaceutical firms, might lobby the U.S. government to lower trade barriers on products in exchange for stronger intellectual property protections overseas. As a result of these trends, the gains from trade liberalization in the United States come disproportionately in the form of returns to the shareholder class, while institutions that support the middle class, such as labor unions and pension programs for workers, have languished. The economists Christoph Lakner and Branko Milanovic produced a chart—dubbed the “elephant chart” because of two peaks in the middle and one at the very right that resemble a head and a trunk—showing that the lion’s share of economic growth from 1988 to 2008, the period in which trade liberalization accelerated with the creation of the World Trade Organization (WTO) and the spread of preferential trade agreements, went to the global elite and the middle class in emerging markets, most notably China. Meanwhile, incomes among the lower-middle and working classes in countries such as the United States stagnated.
The second primary goal of trade policy should be to advance foreign policy aims. Trade policy has always been a tool for geopolitics. Trade liberalization helped rebuild Europe and Asia after World War II and was a central part of the strategy that won the Cold War. Restricting trade can also be part of a coherent negotiating strategy. Critics cry “protectionism” when an administration raises trade barriers, but raising barriers to give countries an inducement to negotiate (on trade or other matters) can be entirely consistent with using trade as part of a successful diplomatic strategy. Consider, for example, the use of economic sanctions on Iran or North Korea in order to force those governments to the negotiating table. Economic sanctions are quintessentially a restriction on trade, used to accomplish a geopolitical aim. Few have a problem with this from a “free trade” perspective.
In recent years, U.S. leaders have adopted foreign policy rhetoric more widely with respect to trade agreements, but the geopolitical aims of the agreements have become obscured. If trade agreements are linked to diplomatic objectives, the connection between the trade agreement and diplomatic strategy must be clear. Negotiating trade agreements with countries such as Australia, Jordan, and Israel to shore up support for important military allies—with minimal impact on the U.S. economy—makes sense. Entering into the Trans-Pacific Partnership makes less sense when justified by vague references to encircling China. The Obama administration resorted to this anti-China justification after the government’s own estimates of the TPP’s impact projected virtually no benefit to the U.S. economy as a whole—less than half a percent increase in U.S. GDP by 2032—while exposing certain sectors of the U.S. economy, such as textile manufacturing, to increased foreign competition. If a trade agreement is meant to have foreign policy goals, it should be designed, negotiated, and justified on the basis of those specific objectives.
INNOVATING FOR BETTER TRADE
Part of the reason trade policy has not focused on the right goals is that trade institutions, both domestic and international, have been set up to privilege the most powerful economic actors. By way of example, consider how the Office of the U.S. Trade Representative negotiates agreements. The USTR gives a variety of industry advisory committees privileged access to the proposed text of trade agreements. During the recent TPP negotiations, even members of Congress were not allowed to debate these provisions in public because the government classified the proposals. The effect of this system is to skew trade-policy making in the interest of specific industry groups. The interests of ordinary workers and small businesses that don’t have such access fall by the wayside.
Domestically and internationally, trade-policy making needs to change. The USTR’s process must become more transparent and more responsive to the interests of ordinary Americans. The U.S. International Trade Commission, which already estimates the effects of U.S. trade agreements on the national economy and specific sectors, should also be required to perform impact assessments on a geographic basis to provide a sense of how individual communities and states will fare.
More broadly, foreign- and trade-policy makers need to understand that playing hardball with and within international institutions does not mean abandoning international cooperation—and that it may be essential to reform. Liberals often conflate how the United States engages with international institutions with the substantive policy outcomes that the United States pursues. But making changes to the international system may require the United States to exercise legally negotiated rights, such as to block appointments to the WTO’s appellate body. The United States remains the largest economy in the world and hence the country most able to use such rights to pressure institutions to change. One might, of course, object to the underlying policies that a particular administration pursues with these tactics, but the tactics themselves are built into the law.
This more aggressive approach is especially important when institutions lack the capacity to deal with today’s problems. WTO rules were negotiated before China was a member, and those who negotiated China’s accession to the WTO assumed that it would transition into something close to a Western-style market economy. That has not happened. The result is a multilateral trading institution that is ill-equipped to deal with the scale of Chinese government intervention. U.S. tech companies are regularly forced into technology transfer practices as the price of doing business in China. The Chinese government heavily subsidizes industry, including technologically innovative industries such as renewable energy, in ways that are difficult to counter through WTO rules. Although this has been good for consumers, it has hurt the ability of the United States to develop the kinds of high-tech manufacturing jobs that could replace the manufacturing jobs it has lost.
These tensions cannot be resolved through polite sparring. The United States and Europe withdrew from the original General Agreement on Tariffs and Trade when they acceded to the WTO—part of a strong-arm move to get other countries to agree to the dramatic expansion of trade rules to include disciplines on services and intellectual property. A similar willingness to remake institutions through tough, innovative negotiations is the only way to achieve a trade policy that works for all Americans.
More than a century ago, U.S. President Theodore Roosevelt commented that “the American public does not wish to see the tariff so arranged as to benefit primarily a few wealthy men.” This sentiment has never changed. After years of tired debates over free trade and protectionism, it is time for a new approach.
THE TWO-STEP SHAM
For years, proponents of trade liberalization have argued that trade policy should follow a two-step process. First, barriers to trade should be reduced to boost economic growth. Second, if the market does not distribute those gains fairly, Congress should use tax-and-transfer schemes to share the gains. As a matter of economic policy, broad-based tax-and-transfer schemes are thought to distort market choices less than trade barriers. As a matter of politics, this two-step process has brought consensus among policy elites that the United States should cut trade barriers and defer disagreements about distributional politics to other policy arenas.
This trade two-step is a sham. Trade contributes to serious distributional problems, and the political process has never adequately compensated the losers from trade. First, markets do not allocate the gains from trade evenly or fairly. As the economists David Autor, David Dorn, and Gordon Hanson have recently shown, liberalization has led to severe job losses and wage suppression in U.S. communities exposed to competition from Chinese imports produced with low-cost labor. Despite the trade consensus that workers will adjust or be made whole, Autor, Dorn, and Hanson found that even a decade after what they term the “China shock,” these communities had not bounced back. To be sure, trade liberalization might also create new jobs elsewhere in the economy. But a computer programming job in Arizona does not help an unemployed autoworker in Michigan. In a country that spans a continent and an economy that is the world’s largest, localized effects do not come out in the wash.
Congress has done little to make these hurting communities whole. In 1962, it created the Trade Adjustment Assistance program to retrain and help relocate displaced workers. But the TAA has never enjoyed the funding or political support to make it an effective program. Instead, it has been a political football, with its funding repeatedly cut and even allowed to lapse, only to be renewed for a few brief years whenever Congress needs to muster support to approve a new trade agreement. Already by 1974, labor unions declared that the TAA was “burial insurance,” and a 2012 report prepared for the Labor Department condemned the program as ineffective.
The TAA’s failure caused trade liberalization’s proponents to cast about for other policy tools to mitigate harm. The Clinton administration hit on the idea of including chapters in U.S. trade agreements requiring U.S. trading partners to uphold labor and environmental standards. U.S. Presidents George W. Bush and Barack Obama both used improvements to these chapters to pacify critics. But these chapters too have failed. Little if any evidence exists that these provisions have slowed the outsourcing of U.S. jobs to countries with lax labor and environmental standards. The political will and legal ability to enforce them have also been lacking. The United States has lost the only trade case that it has brought under these chapters (against Guatemala).
The solution is to commit to redistribution within trade policy—that is, trade agreements themselves need to address the distribution of gains among winners and losers, rather than leaving that to a separate tax-and-transfer process. We can think of at least three ways to incorporate distribution into trade-policy making. First, domestic trade laws have long protected notions of “fair trade.” U.S. companies competing with foreign companies that are subsidized by their government or sell their products in the United States at unfairly low prices (a practice called “dumping”) can petition the government to raise tariffs on the foreign products. Currently, these so-called trade remedy laws focus on economic factors in assessing whether competition is unfair. But trade remedy laws could be amended to allow labor groups, for instance, to petition the government to raise tariffs on goods produced in countries with excessively low wages. Indeed, the European Union has already amended its trade remedy laws to consider more than purely economic factors.
Second, a commitment to redistribution and the protection of values other than simply economic growth should be embedded in trade agreements themselves. Trade agreements usually contain rules constraining how nations conduct investigations into trade remedies. Such rules should be amended to permit “social dumping” inquiries such as those described above. Trade agreements could also take a development approach even within developed countries. The TPP (now the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, or CPTPP) contains a development chapter that encourages states to invest in infrastructure and education programs and to take other measures that promote “inclusive economic growth includ[ing] a more broad-based distribution of the benefits of economic growth.” Such a chapter could easily impose firm obligations on countries to monitor and address domestic inequality resulting from trade liberalization. Such commitments could be subject to reporting requirements, as human rights obligations currently are, and a failure to take steps to address trade-induced economic harms could give rise to an international trade case, just as a failure to comply with rules on economic liberalization does.
Third, tax-and-transfer schemes could be embedded directly into trade agreements. If the theory is that the winners could compensate the losers, then that commitment to compensation should be made up front, in trade agreements themselves. For example, a small financial transaction tax in regional trade agreements such as the North American Free Trade Agreement could provide a large pot of money to fund programs—including infrastructure programs and education as well as the more traditional job retraining and relocation—that would help hurting communities. Trade implementation legislation could also require that sectors expected to be big winners from trade agreements pay a tax to support the losers from trade.
These proposals will not be popular with large segments of the trade community, who worry about weighing down the institutions and politics of trade with issues they do not consider to be “core” to trade. But these distributional concerns already burden trade policy. The question is not whether to address distribution but how to do it. Given the history of failed promises to the losers from trade liberalization, the distributional issues of trade must be addressed within trade policy itself.
More than a century ago, U.S. President Theodore Roosevelt commented that “the American public does not wish to see the tariff so arranged as to benefit primarily a few wealthy men.” This sentiment has never changed. After years of tired debates over free trade and protectionism, it is time for a new approach. Trade policy should make all Americans better off, not just a few. If we start with the principles that the goals of trade are to build a strong middle class and advance foreign policy aims, that we need to redistribute within trade, and that our policymaking institutions need serious reform, we can build a new U.S. trade policy—one that works for everyone.