Trade war enters more dangerous phase

More bad news on trade

There has been a rash of aggressive trade measures of late:

• The US has threatened 100% tariffs on about US$2.4 billion ($3.3 billion) worth of French exports. This was in retaliation against France’s new digital tax, which the US claims unfairly targets American firms.

• The US has also reimposed tariffs on exports of metal products by Brazil and Mexico, complaining that the two countries had indulged in manipulated currency devaluations that gave their exporters an unfair advantage against US exporters in third-country markets.

• The US has also said it would broaden the range of punitive tariffs on European Union products in retaliation against the EU’s subsidies to Airbus, which the World Trade Organization (WTO) had ruled illegal.

At the same time, talks between the US and China to resolve their trade disputes appear to have stalled. Having given up on achieving a comprehensive trade agreement, the two countries had settled on trying to work out a “phase one” deal that would resolve some of the easier issues — but even this is proving difficult. A spokesperson for the Trump administration said that while a trade deal was in the works, three major obstacles remained — the US’ allegation that China pursues a strategy of forced technology transfers, that Beijing has looked the other way as Chinese entities stole intellectual property, and over how the US’ large trade deficit with China should be reduced. On its part, Chinese state media has insisted that if the US does not roll back the tariffs it has imposed on China in the past year, there would not be a phase one deal. The US offer to scrap proposed new tariffs to take effect on Dec 15 would not satisfy China.

Diplomatic clashes between the US and China over Hong Kong are also compounding the gridlock in US-China trade negotiations. China has angrily suspended US naval visits to Hong Kong and imposed sanctions on four US human rights organisations in retaliation against new US legislation on Hong Kong that China sees as interference in its internal matters. Separately, US Secretary of State Michael Pompeo has lashed out against China on a range of issues including its reported incarceration of large numbers of Uighur Muslims in Xinjiang province.

Given the high stakes for both countries, it is still likely that a phase one deal will eventually be agreed upon. However, the deepening strategic competition between the two big powers makes it less likely that a final deal to settle the more contentious issues will ever be agreed on. Thus, trade relations between the two biggest economies in the world will continue to be marked by ill-tempered disputes. Worse still, if their strategic competition deepens, the result could be a bifurcation of the technology world into two camps — a US camp against a Chinese one. That would be damaging to everyone, but particularly to Southeast Asian nations that would be pressed to choose between the two big powers.

Longer term, less powerful economies will become more vulnerable

These recent developments must be seen in the context of the damage being done to the open global trading system in the past two years.

First, a progressively larger share of world trade is being damaged by trade restrictions. In its latest Trade Monitoring note in November, the WTO reported that the period from mid-May to mid-October 2019 saw a 37% increase in new trade-restrictive measures among G20 nations that account for the bulk of the world economy. Since late last year, the proportion of G20 nations’ trade covered by new restrictions has been in the 2.5% to 3.5% range, significantly higher than in previous periods.

Second, the WTO’s capacity to sustain the rules-based global trading regime is itself at risk. The dispute settlement function of the WTO will break down soon. After two years during which the US has persistently blocked the replacement of vacancies on it, the WTO’s Appellate Body will lack a necessary quorum and so cease to function after Dec 10. This will weaken the functioning of the WTO’s Dispute Settlement Body and could well precipitate a descent into unilateral measures by large trading nations — leaving the smaller trading economies at the mercy of being bullied by the big boys. If this was not bad enough, the US has reportedly threatened to veto the WTO’s budget for the 2020-21 period as well, raising a question on how effectively the WTO will be able to function.

The degradation of the world trading regime, which has been crucial for trade-dependent economies in our part of the world, can be traced to a deeper malaise that is not likely to be overcome anytime soon.

• The rise of China has been far more rapid and unsettling to the existing order than the political elites in the US, Europe and elsewhere had ever anti cipated. The Americans, in particular, feel that the WTO and similar arrangements for global economic governance no longer work in their favour and are being gamed by China and other countries. Some of their concerns may be valid — China has benefited tremendously from membership in the WTO but has not opened its economy enough so that others could benefit from its rapid development. In fact, China’s “Made in China 2025” strategy aroused anxiety among many countries, not just the US, that it would exploit the current system and emerge dominant in the key industries that will dominate the future economy.

• At a broader level, the world is being challenged by a series of disruptions that require a new consensus in global affairs. But there is no global framework that can produce such a necessary consensus on the critical issues. These issues include how to accommodate a gigantic Chinese economy that is wedded to state-centred economic development, climate change and the fair taxation of multinational companies. Neither the United Nations system nor other multilateral frameworks seem capable of bridging the deep divisions among the big nations or of bringing enough countries together to forge a consensus. As a result, powerful countries, starting with the US, are pulling out of multilateral agreements and using their current leverage to extract concessions from smaller nations — while they can. The US’ conduct in the WTO and its withdrawal from the Paris climate accords are examples of this damaging trend.

The global system needs an “adult in the room” who has the economic and political weight as well as the moral authority to exert leadership and rectify the system. The EU is the only entity with that weight, but it is too divided and engrossed with its own internal difficulties to play that role. Indeed, the EU itself may become a recalcitrant big power as well. The EU is embarking on a climate change policy that could disadvantage its competitiveness unless other nations play along with it — it could well mimic US pressure tactics to force other countries to align their policies with it.

Vigorous policy response needed in Asean

With no adult in the room, the smaller nations in our region will be on their own. Southeast Asian countries, either individually or collectively through the Association of South East Asian Nations (Asean), have to formulate a strategy to protect themselves in this much more hostile world. Some of the responses needed include the following:

• At a minimum, the region’s countries need to proactively address areas that big powers might take umbrage at. These could include having a transparent framework for governance in state enterprises and refinements of tax and other incentives used to attract foreign direct investment. A clearer statement of exchange rate policy that is endorsed by the International Monetary Fund could also be needed to fend off accusations of “currency manipulation” by the US.

• A much bigger push to create stronger and more diverse domestic engines of growth. The region is beginning to do well in the infrastructure area but this should be stepped up substantially. More money should be spent on R&D where the region (outside Singapore) lags, as this is necessary to create local technology players. Better funding mechanisms for small but dynamic local firms would also grow small and medium-sized enterprises.

• Related to this, more vigorous programmes are needed to tackle structural weaknesses and enhance competitiveness: In a more unforgiving world economy as we will face, there will be much less room for error. Action is needed in a whole range of areas such as skills development, fighting corruption or making the business eco-system more friendly to investors. Some of this is happening already, but more can be done. For example, Indonesia made huge strides in the World Bank’s Ease of Doing Business rankings until 2017; since then, progress seems to have stalled.

• There should be more efforts to tie up with likeminded trading partners to form protective mechanisms against a more protectionist world. The region needs to go beyond just free trade agreements to build more comprehensive economic partnerships. The Comprehensive and Progressive Agreement for Trans-Pacific Partnership is one example of what can be done, but the only Asean members are Brunei, Malaysia, Singapore and Vietnam. All the 10 members of Asean are in the Regional Comprehensive Economic Partnership, which will help but only up to a point. More such partnerships are needed if small nations are to be able to stand up to the intimidation of large trading powers — even if these partnerships are not ideal.

Conclusion

Even an interim deal between the US and China — if it does materialise — will not help the region except temporarily. Such are the political and economic forces driving protectionism that the region should expect a harsher trade environment for some time to come. Consequently, the region has to do more to help it navigate its way through some turbulent times.

Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy