Why Trade Matters

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The US is in a full-blown “trade war” with China. The possibility of tariffs on goods from Mexico, combined with other trade actions by the Trump administration, could send the entire US economy off the rails. The Federal Reserve is already looking at ways to prevent this disaster in the making.

History teaches that global trade matters. It’s been going on for thousands of years, along with periodic efforts to raise barriers against it. With the invention of the steam engine and the lowered cost of shipping, the modern era of global trade took off in the late 18th and early 19th century.

World War One brought that to an end. The second modern era of trade began in the 1930s and has continued right up to today, when protectionist leaders in the US and elsewhere are challenging the long-standing globalist consensus.

In this week’s WhoWhatWhy podcast, we dig deep into these issues with RAND senior economist Dr. Howard Shatz. Shatz has a Phd from Harvard, studied international policy and Middle East studies at Columbia, and did his post-graduate work at Tel Aviv University and at Brown.

Offering a kind of Trade 101 primer, Shatz talks about the current rise of protectionism via tariffs and other government policies, and how those policies have often backfired in the past, degenerating into mutually harmful tit-for-tat retaliation.

Shatz sees the mounting risk of a trade war between China and the US as an almost Black Swan event, given the historical rarity of full-out confrontations between economies of such size.

Part of the impetus for global trade agreements — like those underlying such organizations as the World Bank, the World Trade Organization, the International Monetary Fund, and specific deals like the North American Free Trade Agreement — is the belief that nations that trade together are less likely to go to war with each other.

As the danger of trade wars increases, there are fears that one of the bulwarks against big-power military confrontations is eroding — with consequences, in a nuclear-armed world, that beggar the imagination.

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Full Text Transcript:

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Jeff Schechtman: Welcome to the WhoWhatWhy Podcast. I’m your host, Jeff Schechtman.

There has always been an underlying assumption, at least in our contemporary debates, that nations that trade together are less likely to go to war with each other. In a very real sense, that’s generally been true. Such was a lot of the practical and political impetus for the wave of globalization that has swept this century. But today, trade itself has become a face of war. All over the world, trade wars seem to be heating up. Whether they might escalate to hot wars is an open question, but for now, simply trying to understand the trade wars themselves is valuable. A listener approached me recently and said he just wished there was some way to really understand what’s going on with this debate about trade. “What’s at stake,” he asked, “Who’s really paying the price? How will it really impact our wallets, and who’s to blame?” All good questions.

Jeff Schechtman: To help us understand this, I’m joined today by my guest, Howard Shatz. He’s a senior economist at RAND and a professor at the Pardee RAND Graduate School. He has a Ph.D. in Public Policy from Harvard, has studied international policy and management in Middle East Studies at Columbia, and has done post-graduate work at Tel Aviv University and at Brown University. Before joining RAND, Dr. Shatz was a research fellow with the Public Policy Institute of California and held research fellowships at Brookings, at the Board of Governors of the Federal Reserve, and has worked as a consultant to the World Bank, and for nations in Latin America, Africa, and South Asia. It is my pleasure to welcome Dr. Howard Shatz to the WhoWhatWhy Podcast. Howard, thanks so much for joining us.
Howard Shatz: You’re welcome. It’s my pleasure to be here.
Jeff Schechtman: The idea of nations trading is certainly not a modern invention. It goes back, literally, thousands of years. Talk a little bit about the modern reinvention of trade and a little bit about how it’s evolved.
Howard Shatz: You’re right. It does go back thousands of years, and we have evidence of that from shipwrecks, for example, in the Mediterranean and from records of the great Mongolian Empire throughout Eurasia, where people could trade freely or could move freely across a vast land area. But the modern invention of trade, we would date to the late 18th century. I’ll go through two iterations. Late 18th century, early 19th century with the invention of the steam engine and then the application of that to shipping. That vastly lowered transportation costs. One of the reasons that it’s difficult to trade is because you have to move a good from one place to another. Throughout most of human history, that’s been very expensive. Again, if you go back into the Medieval times, you’d see these records of trade fleets going from Europe to China and back. They would take years, and they would be extremely expensive. You would need to transport very high-value items.
Howard Shatz: But once shipping prices fell, right, you could transport lower-value items. What did that mean? That meant that for a consumer in one country, goods that could be produced more efficiently or at lower prices in another country were more available. Trade expanded dramatically in the 19th century. By the period just before World War I, the world was highly globalized. Not only were there expensive trade links throughout the world, but there was a lot of investment moving cross border, too. We really didn’t reach that level of globalization until the 1980s, 1990s.
Howard Shatz: What happened in World War I? World War I broke apart the world trading connections because it was the entire world at war. Then we entered into the ’20s and ’30s where leaders tried to reconstruct that, but countries were struggling economically. We went into a downward spiral of trade restrictions, currency devaluation, and that really put the seal on the end of the first big phase of globalization. Now, in the 1930s, we’ll date the modern era to the 1930s. The reason I want to date it to that is because the US Secretary of State, Cordell Hull, spearheaded something called the Reciprocal Trade Agreement Act. Right? What that did was early in the ’30s, under the Roosevelt administration, he saw that it would be helpful to the US, economically, to start to restore some of those trade links, to start to bring down some of those trade barriers, trade barriers that we think of most emblematically from the Smoot–Hawley Tariff Act in the US, but the US was not alone in instituting very high barriers.
Howard Shatz: Secretary Hull and US Congress, through the passage of that act, started negotiating trade agreements with other countries to bring down tariffs. This was all interrupted by World War II. Again, World War II broke up the world trading regime. Right? Then, after the war, the victors, primarily the US and the UK, decided they needed to restore world trade, and basically restore the international architecture, and build new institutions that would help the world recover. There were three institutions that provided the basis. One was The World Bank, which was, at first, designed to help Europe recover. The second was The International Monetary Fund, which was designed to help countries with balance of payments problems. What happens if you owed too much money to another country and couldn’t pay it. Right? The third institution was supposed to be a formal trade institution.
Howard Shatz: Now, that didn’t get passed. What we ended up with instead, and what served the world until 1995 was something called the General Agreement on Tariffs and Trade, the GATT. The GATT went through several different global negotiating rounds and expansion to membership. Each time these rounds occurred, tariffs and other trade barriers were lowered. There were two bedrock principles behind the GATT, and they were really the bedrock principles behind the US Reciprocal Trade Agreement Act. These were national treatment. You had to treat foreign countries the same way you treated your domestic companies and something called most favored nation. Most favored nation has been misinterpreted. It’s been misinterpreted to mean that we are treating someone, say China, better than we’re treating anyone else. We’re treating them as a most favored nation.
Howard Shatz: What it actually means is that if I have a trade agreement with a hundred countries, right, and I extend most favored nation privileges to a country, that means that I have to treat them as well as my best treatment to another country. If I have a trade agreement with China and the United Kingdom, and I say that my tariffs on cars from the United Kingdom are 5%, and I’m treating China as most favored nation. I can’t make tariffs 20% on Chinese cars. I have to make them 5%. All right? The same as the UK. The same as the most favored nation.
Howard Shatz: Now, there was one other… I would point to one other major event. It’s not really an event, but a trend before 1995, then 1995 presents a break, but the trend before that was a technology-change trend. We often will look at trade institutions, and trade policy, and focus on that, but in many ways, it’s swamped by technology changes just like most of the other things that are happening in the economy, domestic and international. What was that technology change? Well, it was the advent of what’s called containerization. Instead of loading goods in different types of boxes and pallets onto a ship, you would put goods into a container that looks like the back of a large cargo truck on the road, and you would stack those containers on ships.
Howard Shatz: When people look at the Port of Oakland, for example, or they look at the Port of Los Angeles, Port of Long Beach, they see these very large cranes that look like Imperial Walkers from Star Wars. In fact, my understanding is that the Imperial Walkers are modeled after what these cranes look like. All right? So this lowered the cost of shipping in an extraordinary way. All right? There’s a good book about this called The Box, but we should always pay attention to technology changes as well.
Howard Shatz: Let me go back to policy, and that was in 1995, the trade institution that the post-war generation had envisioned finally came into existence, and that is the World Trade Organization. That absorbed the GATT, the General Agreement on Tariffs and Trades and had a number of other agreements in it as well, such as a government procurement agreement, a general agreement on trade and services, an agreement on trade-related international property measures as well. That takes us up to the current trade war.
Jeff Schechtman: I want to go back a little bit and talk about, particularly in the pre-world-war period, the tariffs that were imposed at that point and what was, because that’s a good example, what was the rationale for those high tariffs at that point, and for Smoot-Hawley and the things that were part of that period?
Howard Shatz: 19th century tariffs were the main source of revenue for the federal government. We didn’t have an income tax. Right? When you get into the post-income tax era, so income tax is 1913, you then get to the period that you asked about. This is a worldwide phenomenon, and what countries were seeing was that their economies were suffering. What did policy makers want to do? Policy makers wanted to help their domestic producers. They thought that were they to institute tariffs, so I will put a barrier on goods from overseas, that will help my domestic producers. Why will it help my domestic producers? It will make the goods from overseas more expensive. All right? In a very abstract way, if some item from overseas would cost me $1, and I would put a $1 tariff on it so that it would then cost $2, and my domestic producers could produce that for $1.50, then they can compete. Right? Whereas, if I don’t have a tariff, and the foreign good costs only $1, my domestic producers can produce it for $1.50, they can’t compete. Everybody will want to buy the imports if the goods are the same.
Howard Shatz: The rationale was, we will protect our domestic producers, and that will boost our economy. In some ways, it would cause improvements in things that we could see visibly. If I put a tariff on steel, that might help steel companies compete, and I could look at steel companies as they increase production and hired more workers. Right? But there are things that we would not see or second and third-order effects. One of those more distant effects would be that companies that use steel in their products would then be paying higher input prices, all right, and would be less competitive on the market, so maybe they would have to lay off people. Likewise, foreign governments would retaliate as well, so I’ve just helped my domestic producers producing for the domestic market, but my producers who are exporting are going to be disadvantaged when other countries retaliate. What happened was this downward spiral occurred throughout many countries of the world.
Jeff Schechtman: I want to talk a little bit about the other side of that, which is that in an age that is more globalized, particularly with the free flow of money around the world, which really increased dramatically in the ’60s, the other side of that, which is countries that encourage exports also as a way of encouraging the domestic economy. Talk about that.
Howard Shatz: Right. You’re right to peg that in the ’60s. We should peg that, in part, to California. Starting in the ’60s, it was the California technology firms that realized that they could produce in Asia for less. Singapore was the original site, or one of the original sites, for this. Singapore provided low wage rates, pretty educated, skilled labor, and rule of law. That kind of got things started. It became much easier to move money overseas, to make investments overseas. Throughout the ’60s, countries were concerned about too much foreign investment. Sometimes what were called their capital accounts were closed, so it was difficult to make investments in countries. What we really saw in the ’80s and ’90s was a dramatic lowering of barriers to investment.
Howard Shatz: One big reason we saw that dramatic lowering was because of the success of what are called the Asian Tigers. The little Asian Tigers were Singapore, Hong Kong, Taiwan, and if I didn’t have to think of it, I would immediately think of the fourth, but unfortunately, I can’t think of the fourth. It will come to me later. Now, what did these countries do differently? In the ’50s and ’60s, a lot of countries were trying to develop through what is called import substituting industrialization. They were putting up high tariffs hoping that they could spur domestic industry. In some cases, this was quite absurd. You had small countries trying to develop a car industry, right, without hope of exporting those cars. You need a big market to work at scale, to produce cars efficiently.
Howard Shatz: These countries did not develop well. You had the four Asian Tigers following Japan, right, who took a different view. They focused on exports. All right? Now, Japan was mostly with domestic producers, but we get into the Tigers, and they had, in some cases, foreign investment, right, that was producing for the world market. It has become much easier to do that. In fact, when we look at trade agreements, so if we look at NAFTA or other so-called free trade agreements, right, those are, in part, investment agreements. All right? They have investment chapters. They make it easier for countries to invest in each other. So investment barriers lowered. Trade barriers lowered. It became much easier to produce in one place and ship back to the home country.
Howard Shatz: Here we get into the technology changes again. It became much cheaper to produce in one country, ship those inputs to another country for assembly, and then ship those inputs to a third country for final sale. All right. So you needed all three of those things going on. It also became much easier to transmit information, right, so a corporate headquarters in the United States or in Germany could easily communicate with its subsidiary or with a factory in Singapore, or China, or Malaysia. All right? You needed that, too, to really cause this explosion.
Howard Shatz: We would call this production sharing or the creation of global value chains, and that is I will invest in a country or I will produce an input in one country, ship that input to another country based on low transport costs, assemble all of the inputs into an item, and then ship those final items to America, or Europe, or even China, or Japan, or whoever else is interested in buying that product. When we look at the dramatic expansion of world trade, it’s not just one country selling final items to another country. The dramatic expansion of world trade has occurred, in large part, because of the input trade that’s going on. A lot of that input trade is going on because of the investment you mentioned.
Jeff Schechtman: One of the things, also, going back to the ’60s, that seemed to have an impact on all of this is changes in banking, changes in the world flow of capital, which became much freer in that period.
Howard Shatz: That’s exactly right. Now, so we go back to immediately after World War II, or before World War II, we saw what were called competitive devaluations. I would devalue my currency, and that would make my exports more competitive. All right, and we saw a lot of these going on in Europe before World War II. That’s part of the downward spiral that I mentioned. All right? After World War II, one of the things that that generation of geniuses, really, who created the international architecture wanted to do was prevent those competitive devaluations. So we had a very controlled international financial environment. That’s kind of what the, part of the role, of the IMF. Currencies were pegged to the dollar. There was a gold-based exchange rate. It was not a gold standard, but gold was valued at, I think $35 an ounce. Capital accounts were closed. It was, in many cased, difficult to invest in other countries.
Howard Shatz: A watershed moment was when the US withdrew from this arrangement under Nixon. Economically, it likely made sense to withdraw, but it immediately, or it eventually introduced an era of floating currencies, where countries could adjust their exchange rates more easily. Central bankers, banks, had to operate in that environment. In addition, we had the opening of capital accounts, so it became much easier to invest abroad. We saw this especially… Some countries in Asia were the vanguards of this. Dramatic trends in the late ’80s, early ’90s in Latin America. Latin America had been one of the main sites of import substituting industrialization, but a lot of these countries had been stagnant, not growing, had had various debt crises, and just changed the way that they looked at investment. So they became open to investment also. In terms of transferring money, the banks were conduits. Right? I think it’s not so much that banking changed, but of course banks’ businesses respond to incentives, and they respond to opportunities. The opportunity to move the money from point A to point B to facilitate investment opened. Banks certainly took advantage of that to do so.
Jeff Schechtman: The period that we have been in up until now, this focus on globalization and extensive trade, talk a little bit about what was the point at which we tipped into where we are today. Was it NAFTA? Was it before NAFTA? Talk a little bit about that.
Howard Shatz: The point that we’re at today, I would say there are two reversals. They’re not quite reversals, but they’re two issues that we’re dealing with that look at the negative side of trade. One issue is the effect of trade on workers. I’ll talk about some of the roots of that. The other issue is the current trade war with China and China’s behavior as a major trader, also. We’ll peg that second bin as the rise of China. Let me start with trade and labor. Workers have always been concerned about the effects of trade. This is not new. The idea is, if I am a worker in an industry, and we lower a trade barrier to that same industry overseas, and they can produce things more cheaply, I might lose my job.
Howard Shatz: Quite frankly, that’s a reasonable concern. All right? If I’m a worker who’s lost my job, it’s not very comforting to hear a policy maker say to me, “Well, yes, you lost your job, but the overall economy is larger. We’re richer. We’re more productive.” My attitude, if I was a worker who lost my job would be, “Yes, but why do I have to pay for that?” All right? This has always been a concern. In fact, it was one of the reasons why the United States started something called trade adjustment assistance. I think this has its roots in the Kennedy administration. In fact, one of the negotiating rounds that I mentioned under the GATT was called the Kennedy Round, so that was one of the trade barrier lowering rounds that we did. We’ve had trade adjustment assistance. It really became much more prominent in the NAFTA debate.
Howard Shatz: NAFTA did affect workers, some workers, negatively, but what’s always left out… Again, it goes to what’s seen and what’s unseen. Right? We can identify workers who lost their jobs because of trade. It’s much harder to identify workers who have gained jobs because of trade. Those would be workers who work in export factories. They would also be workers who work in companies that use imported inputs. Every country uses an enormous amount of imported inputs. They’d also be workers who would gain from consumers having more disposable income because they’re buying cheaper imports who could spend on other things. Right? So we have this debate in NAFTA. In truth, NAFTA was not large enough to have truly deleterious effects on the US labor market. It did affect some workers negatively. There’s no question.
Howard Shatz: The next step was a WTO ministerial. A ministerial is a meeting of trade ministers. The WTO has regular ministerial meetings. The ministerial in, I believe it was Seattle, and I believe it was 1998, resulted in protests and riots. That was a big shock because the WTO was starting to deal with new issues, which were creating more unease, including investment, cross-border investment issues, among others. That was kind of the second big shock.
Howard Shatz: Then we get to China in the early 2000s. Right? The US economy was doing pretty well in the early 2000s. Right? Our trade with China was expanding dramatically, and so people were concerned about China, but in general, most people were doing well. But there was always this concern about trade and labor. Then we get to the Great Recession. Right? The Great Recession badly affected employment. Right? We can’t trace that back to trade, but the big concerns about trade stemming from the Great Recession were that countries would start to up barriers just as they had done in the precursor to the Great Depression in the ’20s and ’30s. Right? So the G20 leading economies all agreed that they would not create trade restraints. All right? This was as of 2008.
Howard Shatz: Now, it turns out there’s a very good group in Switzerland who’s been monitoring this. It turns out that there have been thousands of trade restraints put on. These are generally small. We don’t necessarily see major effects on employment. The big effect on employment has been the rise of China. There have been some analysis that says this has caused large-scale layoffs. The papers are good. I think it’s fair to say that increased trade from China has negatively affected some workers, a large number of workers, but again, it’s the issue of seen and unseen and what trade would’ve looked like in the absence of China. I think it’s fair to say that trade has negatively affected some workers, and this is a long-standing issue. But this also leads to China.
Howard Shatz: That’s the other big bin that we’re looking at. The rise of China is unprecedented. China has been the fastest-growing large economy for the past 30 years. It is still a developing economy. Its per capita income in dollar terms, so if you were to take all of the income that is produced in China and divide it by all of the people who live there, they would each get about $8000. In the US, per capita income is about 56, $57,000. Now, I’m not looking at distribution at all. I’m just looking at averages. But you could see, on average, China’s still a poor country, but in the aggregate, China is a very rich country. China’s the second-largest economy in the world. The US is about 20 trillion. China is about 13 trillion. China, if we were to count the European Union as one economy, China would be behind that. The European Union would be second, but if we look at national economies, China is number two.
Howard Shatz: This entry into world trade has been very dramatic. What has happened, number one, China has become the largest exporter of goods in the world. That means that other companies in the US, or Germany, or elsewhere in Europe, or anywhere else have a tougher competitor. Now, China has also become the site of a very large manufacturing ecosystem. The production chains I was talking about before, a lot of that’s happening throughout Southeast Asia, and then sending inputs to China for assembly. More and more, China is using its own inputs produced in China to do this.
Howard Shatz: Third, China is, because of its trade links, is building infrastructure around the world. It has an initiative called One Belt, One Road, where it is trying to link up Eurasia, Africa, all the way through to Europe. There are concerns that it will use that to create higher barriers to trade from other countries. That’s always a concern. I’d say those are the two new broad concerns. One is a heightened concern about the effects on labor. Second is a concern about the effects of China as a major player in the world economy.
Jeff Schechtman: What that doesn’t take into account, though, is the lowering of cost of goods in the US, for example, as a result of this, and that that’s had an impact as well.
Howard Shatz: Right. For example, take clothing. All right? Clothing, now, and shoes, now, are much cheaper than they ever have been. That’s a direct benefit to people who buy clothing and shoes, which is everybody, but it’s especially a benefit to people at the lower end of the income scale.
Howard Shatz: Someone in the top 10% of the income scale can buy expensive shoes made in Italy or expensive shoes made in the United States. Someone at the lower income scale could certainly do that, but that means that it would take a large share of their income. With increased trade from China, from other parts of the developing world, those goods are now much cheaper. That also extends to inputs. Inputs are cheaper, too. If I’m a manufacturer, and I use 30 different components, and I now get half of those components from China at a much lower price, I can lower my own prices for my final good. I can increase my sales. I can expand my employment.
Howard Shatz: This is all well and good, except it comes back to, let’s go back to clothing and shoes. Everyone in the US benefits, but the people who would have produced clothing and shoes in the US are not benefiting. So what do they do? Well, in some cases, they find other companies to work for. In many cases, they earn a lower wage than they would have. In some cases, they get retraining, and they might end up earning a higher wage than they did. In some cases, they move. If we want to look at that, just economically, moving, they can increase their wage, they can find a new sector, right, and that could be good. They might move and not be successful, and that would not be good, economically. But then if we want to broaden this, and this comes back to some of the concerns about trade, and it needs to be recognized. Right?
Howard Shatz: If an adult in his or her 40s or 50s loses a job because of trade and has to move, they haven’t just lost their job, they’re losing their social network. They’re losing their familiarity with the town or the city where they lived.  So there are social costs to this, also. If we look, just economically, trade almost always benefits a country, more trade benefits. If we look at it socially, there are costs and benefits, aggregate costs and benefits. For some people, it might be very good to move. For other people, it might be not good to move.
Jeff Schechtman: One of the things that we’re looking at now beyond China, and China’s a particularly unique case, as you so clearly explained, but much of the trade debate now is also focused on things like the EU as well. Talk a little bit about that.
Howard Shatz: The EU has tremendous market power. The EU’s a very, very interesting entity, economy, because, in some ways, it punches above its weight economically. It punches below its weight politically. The EU is a terrific market. One of the things that EU trade policy officials do is they, when they make trade agreements, they try to instill EU standards in the partners that they’re making agreements with. In fact, that’s one of the concerns about China’s increase is who will control standards. Now, the best recent example of the EU inserting standards isn’t actually from a trade agreement. It’s from a regulation that the EU passed called the General Data Protection Regulation. This is about protection of data, privacy. People, I think, most of our listeners, when they log into a website now, they’re much more likely to see a notice about cookies. That all comes from the General Data Protection Regulation. In fact, there’s a law in California, a relatively new law, that’s been modeled on that.
Howard Shatz: If we look at the EU’s buying power, you could say, “Well, it’s an EU regulation. I’m a US company. I’m not going to bother with it,” but if I want to sell into the EU, if I want to do business there. I have to honor that regulation. Then you could say, “Well, okay, I’m just going to honor it for what I do in Europe, but it’s just much more efficient for me to just blanket honor it,” which is why, when you go to a US website, and you’re a US citizen based in the US, you might have to go through the same procedures based on the European General Data Protection Regulation.
Howard Shatz: When we come to trade agreements, some of the issues that come up are trade in genetically modified organisms. That’s one reason that the US and the EU have not been able to complete a trade agreement. Something called geographic indications, the Europeans want to make sure that anything labeled Champagne actually comes from Champagne in France. Anything labeled Chablis actually comes from Chablis in France, that you can’t label a Californian wine Chablis or mountain Chablis. Right? So, that’s another issue. Quite frankly, it would be extraordinarily beneficial to the US, and to Europe, and to the world if the US and the EU had a more formal free-trade agreement, but there are these barriers that stop them.
Howard Shatz: So, the EU has a lot of power that way. Whether it chooses to exercise that power, this is something that we’re going to see. Until earlier this year, and I will bring this back to China, until earlier this year, the EU viewed China as a strong supporter of the international institutional system. It was concerned about barriers in China, but, like the US, but unlike the US, it viewed China as basically a foundation of the institutional system including the trade system. Recently, the European Commission issued a report that changed that somewhat and said that China, in some ways, is also challenging the institutional system. Europeans have been much more uneasy about it.
Howard Shatz: What we want to watch for in the future is will the EU use its market power in some way to try to change China, perhaps use that power differently than the US is doing, but views now seem to be more similar to those of the US. The other thing about the EU I should add, and just so listeners understand the institutional differences, we talked about NAFTA. NAFTA is a free-trade agreement. For all items covered under an FTA, when Mexico exports them to US, there’s no tariff. When the US exports them to Mexico, there is no tariff, but the US can charge different tariffs on anybody outside the free-trade area, and Mexico can charge different tariffs. The US can charge a 5% tariff on cars, and Mexico can charge a 10% tariffs on cars as long as it’s not from the US or Mexico.
Howard Shatz: With free-trade agreements, you then say, “Well, how do I prevent pass through?” How do I prevent people from sending their cars to the US at a 5% tariff and then sending them to Mexico at a 0% tariff? We have something called rules of origin.  A car has to have, or any item has to have, a certain percentage made within the free-trade area. That’s been a point of negotiation between the US, Canada, and Mexico, the rules of origin. The EU is entirely different. It’s a customs union. Which means that there’s not only free trade within that territory, but every single country has the same tariff. If I export an item to France, I will pay a specific tariff on that item. If I export the same item to Germany, I will pay the exact same tariff. So, I can’t tariff shop. We don’t care about rules of origin. The only thing I, as an exporter, am concerned about is where’s the market. Where am I going to minimize my transport cost?
Howard Shatz: That’s also how the EU’s different, and there are a few other customs unions in the world, but the EU is, by far, the most sophisticated and the best of those. Many other countries will say, “We have formed a customs union, or we are going to form a customs union,” but very often there are internal barriers or other administrative issues that just don’t make them a very good customs union. The EU has gotten it mostly right.
Jeff Schechtman: Finally, Howard, talk about trade wars and what history tells us about trade wars as it relates to the context of what we’re seeing take place today.
Howard Shatz: Trade wars cause damage. Trade wars increase costs for everybody. They slow down the growth of GDP, but we shouldn’t overestimate the effects. Right? They can create a drag on GDP. At the level of tariffs we’re talking, they are unlikely to cause recessions or certainly not depressions. They will just slow down growth, and sometimes that’s hard to see. Right? What’s the difference between an economy growing at 3% and an economy growing at 2.5%? For many people, it’s difficult to see the difference. There is a difference, especially over time. First, they create a drag on growth. Second, and part of the way they do that, and the second, is they will make items more expensive. But they will also disrupt trade patterns.
Howard Shatz: Let me jump to the present. I think it’s hard to apply, other than economic theory, what we know, the things I’ve said, GDP will slow, items will become more expensive, we will all be a little bit poorer. I think it’s a little harder to apply history to the current situation because we haven’t seen two economies of the magnitude of the US and China engaged in such a trade war. In some ways, it’s what a statistician would call an out-of-sample prediction. We have all these things in the historical record, but we have something that’s bigger and different.
Howard Shatz: What are we likely to see? We are likely to see, in the era of production chains or value chains, we are likely to see those value chains change. We are likely to see production move out of China in some ways. We’ve already seen firms are now looking at investing or moving their production to Vietnam, or Bangladesh, or elsewhere. We are likely to learn exactly what items we get from China that are not replaceable or that are hard to produce elsewhere. I think sometimes we don’t actually know that it turns out some important input comes only from China. So, then, how do you substitute for that? We are likely to see, especially in China, we’re seeing this now, more calls to nationalism. I think the trade war is hurting China’s economy. China wants to maintain growth for political stability, so China is calling on its population to hunker down. They can confront this.
Howard Shatz: The US is dealing with that less so because the US has much more choice in terms of where it buys items except for those items that it can only get from China. The big concern, and it’s something… You said something very interesting in the introduction. When we talk about out-of-sample, we have evidence, I wouldn’t say this is strong evidence. We have evidence from the pre-World War II period that cutting off a country’s opportunity to trade, cutting off a country’s opportunity to growth does sometimes get to be viewed by the country as a security matter. It raises risk of confrontation. I won’t say risk of war, but it raises risk of confrontation beyond economics. We haven’t seen this in decades because the post-World War II era was all about lowering barriers again and again. But we had, in the pre-World War II era, we did have the raising of barriers, and it was thought, at the time, that countries would not stand for economic opportunities being cut off.
Howard Shatz: What we’re seeing in the world today, it’s easy to look at US actions, and these are unprecedented, and these will have an effect, but it’s not just the US. It’s the G20 with something on the order of 14,000 small measures that have raised trade barriers. It’s China with a not-as-open economy as Europe and America, and signs that China is, in some ways, raising barriers, maybe not overtly. It is concern about Belt and Road. Will that cause an increase in barriers? In general, we see this slight raising of barriers around the world beyond the trade war. The trade war is a visible symptom of that. The trade war is a very big step, but not the only thing that’s happening here in terms of raising barriers. That said, the world is still more open than it was, say, in 1970 or 1980, possibly even early 1990. So, we step back. We step backward, but we’re still well-ahead of where we used to be. The concern is that we’ll continue stepping backward.
Jeff Schechtman: Dr. Howard Shatz, thank you so much for spending time with us on the WhoWhatWhy Podcast and for helping shed some light on this whole range of issues. Much appreciated.
Howard Shatz: You’re welcome. I was pleased to be here.
Jeff Schechtman: Thank you, and thank you for listening, and for joining us here on Radio WhoWhatWhy. I hope you join us next week for another Radio WhoWhatWhy Podcast. I’m Jeff Schechtman. If you liked this podcast, please feel free to share and help others find it by rating and reviewing it on iTunes. You can also support this podcast and all the work we do by going to whowhatwhy.org/donate.

Related front page panorama photo credit: Adapted from StockSnap / Pixabay, Pxhere, Clker-Free-Vector-Images / Pixabay, and Webflippy / Pixabay.

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