Is free trade dead?
Published 12 July 2023
If you look around you, at the clothes you’re wearing, the watch on your wrist, the phone in your bag, the food you ate for breakfast, you have probably effectively already “traded”, or engaged in a form of trade, with many countries already today.
The post-Second World War settlement was premised around the notion of liberalising trade and investment between countries. That was partly on geopolitical grounds, with a strong belief that if you increase economic interdependence between countries future conflict is less likely. It was partly on economic grounds: more trade and investment leads to more economic growth. Indeed, there is considerable evidence to suggest this is the case: through specialisation, competition, transfer of knowledge, innovation, investment, transfer of managerial skills and so on.
The post Second World War settlement facilitated a progressive reduction in barriers to trade (mainly tariffs). This was a rules-based system, with countries choosing to adhere to the rules of the General Agreement on Tariffs and Trade (GATT), and its successor, the World Trade Organization (WTO). A key principle of those rules was non-discrimination between countries. As a result of the reductions in barriers, changes in shipping costs, and development in information and communications technology, we have a substantial increase in trade and investment reflected in the rise in the importance of trade as a share of gross domestic product (GDP), what economists call ‘openness’.
In the last 15-20 years, there has also been a rise in supply chain fragmentation, offshoring, complexity of supply chains, in good part it is driven by technological change which makes it much easier for firms to manage complex relationships across the globe.
More or less, since the financial crisis of 2008, the share of trade in world GDP has started to decline, as well as the share of imported intermediates used to produce exports. This has led to some discussion of whether globalisation has peaked, and we are moving into a world of deglobalisation, reshoring - bringing back production home - and trading more with our ‘friendly partners’.
That story is too simple. But international trade and investment is changing in several ways:
1. Perceptions of what society wants from trade and investment are also changing - with concerns around the distributional impacts (winners and losers), climate change, the environment and biodiversity, consumer protection, human rights, workers’ rights and food standards leading people to be more concerned about the way we trade, rather than thinking that trade is always necessarily a ‘good thing’.
2. On-going technological change, leading to the rise of the digital economy and digital trade. Approximately 25% of world trade is now digitally enabled in some form or another. This is having a substantial impact on services industries, which in turn is significant for the UK. Nearly 50% of what the UK exports is services. Nearly 80% of UK GDP is in services.
3. Governmental / national concerns, in particular with rising geopolitical tensions between, for example, the US and China, but also arising from the Russian invasion of Ukraine means that there is increasing concern about both national security and economic security.
Governments have become much more interventionist and are much more prepared than previously to engage in active industrial policy and trade restrictions, be this tariffs, subsidies, restrictions on investment, restrictions on trade flows, and anti-coercion instruments. This is taking place in an environment where the rules-based system, underpinned by the WTO is far less effective than it used to be. Many such policies may contravene WTO rules, but countries are either ignoring this and going ahead anyway and/or have less recourse to dispute settlement.
The good: Many policies being implemented have positive elements. It is important to address climate change, to consider supply chain resilience (e.g. access to semiconductors) and to consider technological competitiveness. We should care about human rights, labour and food standards. The principles behind these policies may be valid, but some of the policies themselves are concerning, and previous experience suggests it is far from obvious that these policies will deliver the expected results.
The bad: Some of the policies will have a negative impact on other countries be this on investment, trade, and ultimately jobs. This may be particularly so in developing countries that may find it harder to respond to such policies. The policies are increasingly unilateral and protectionist with a narrow focus on domestic investment and jobs and risk undermining the rules-based trading system. At a minimum, this may lead to competitive, distortionary, and ultimately growth-reducing policies, and at a maximum, it may destabilise the world economic order, and thus also the political order.
The complicated: While growth and (trade) policies to promote growth are imported perhaps, controversially, growth can be over-rated. Growth is not an end in and of itself, but a means to having a better society, and I would argue, a more equitable society. Growth should be there not just for a few individuals or countries but for everyone. It is what we do with growth that matters, as opposed to just having growth.
As with growth, trade is not an end but a means. Policymakers need to be clear about what those ends are both in the short term and in the long run and to consider whether government intervention is even needed. All policy involves trade-offs, governments intervene on efficiency grounds to increase growth; on equity grounds to address distributional issues, and increasingly for economic security. Achieving all three is difficult and balance is needed. Trade policy by its very nature is also about relations with other countries and that means it requires cooperation and coordination, which is increasingly hard to achieve, and overlaps with foreign policy and hence why trade policy is complicated.
Trade, and investment liberalisation, have led to much more interconnectedness between countries, and have contributed to peace and prosperity and the sharing of values. But there are limits to the sharing of values across countries. The challenge is how to manage this while meeting the objectives of efficiency, equity and economic security. We may need smart domestic policy interventions but not knee-jerk reactions, and we need long-term planning. In so doing this should consider more carefully the impact of trade and interconnectedness on people and regions. We need to be more inclusive. We also need to think of trade rules that minimise conflict, and how these can be enforced. At the moment this seems difficult. The world trading system has been based for many years on multilateral processes. But we are moving into a world which is more plurilateral with groups of countries agreeing on narrow areas of focus. It is important not simply that this does not further undermine the multilateral system, but that we work towards rebuilding an effective multilateral system which has served us well over the past 60-70 years.
Perhaps most importantly, we need to remember that both growth and trade are but a means to an end, and so policymakers need to be clear about what society wants and how to achieve it.
This blog is based on a talk at the University of Sussex on 3 July 2023.