By Erik Jones for the Aspen Institute Italia
Multilateral cooperation and the coordination of macroeconomic policies and trade bring benefits to all concerned. If Donald Trump continues to deny that fact and to ignore how interdependent economies are — especially those of North America and Europe — he will end up damaging American growth. Europe too will suffer, despite its high levels of integration, especially if it fails to bridge gaps between its various member states.
Given the record performance of the New York stock exchanges, the continuing fall in American unemployment rates, and the very real prospect that the Republican tax reforms will add further stimulus to macroeconomic growth, the case that Donald Trump as president is somehow bad for the US economy is getting harder and harder to make. That case is nevertheless still plausible — at least when we look beyond the short-term effects. It is more ambiguous when the focus of attention is not on the United States but on Europe. Even there, however, there is cause for concern.
To understand why that is so, you have to start by re-examining the lessons of the past. Almost 50 years ago, Richard Cooper published a ground-breaking book in the United States called The Economics of Interdependence. He conceived this book during the early 1960s while he was working as an economic policy-maker in the Kennedy and Johnson administrations, and he developed the argument as part of a high-level study group within the Council on Foreign Relations. These details are important because the message Cooper had to communicate was controversial, particularly coming from a member of the foreign policy establishment.
No country, he argued — not even the United States — can ignore how other countries react to their economic policies. The problem is not good diplomacy (or good manners). It is structural. If policy-makers ignore how other countries react to what they do, then they will never achieve their objectives: the reactions of others can do much to offset any benefits a discrete policy action may deliver. Indeed, a country will almost inevitably be worse off going it alone than working with others. Compromise and cooperation are always better than having countries set their economic policies at cross-purposes.
The Atlantic Community
The subtitle of Cooper's book underscored the geographic focus of his attention. He called it "the economics of the Atlantic community". If the United States needed to worry about how some other specific part of the world would respond to its policy actions, that other place was Europe. Moreover, Cooper had good reason to be concerned. At the time he was writing, Britain was going through a painful devaluation of the pound and a second rejection of its bid to join the European Economic Community, Germany was flirting with Keynesianism and struggling to fend off speculative capital inflows, France was experiencing an outburst of student unrest and openly challenging the role of the dollar at the center of the Bretton Woods system, and Italy was dealing with a dramatic upsurge in strike activity and a rapid acceleration of price inflation.
Such problems complicated how the US made its economic policy, and they could not be solved in isolation. The countries of Europe needed to learn how to work together and US policy-makers needed to work with Europe.
Neither side of the Atlantic was eager to embrace that lesson about the importance of cooperation and compromise in economic policy-making. As the French economist and statesman Robert Marjolin explained in a report commissioned by the European Commission to explain the failure of Europe's first attempt at monetary integration, the crisis of the 1970s was the result of the divergence among the countries of Europe and across the Atlantic. Ultimately, however, both sides relented. That is why we have the euro today; it is also why we have the Group of Seven leading industrial countries (G7). The origins of both institutions lie in the crisis of the 1970s. Neither arrangement is perfect, nor were their predecessors. But the logic of Cooper's argument was compelling: any framework for cooperative economic policy-making is better than none.
America First, Ambiguity in Europe
Donald Trump's administration represents a significant departure from the legacy of Cooper's argument; Trump has abandoned consideration of others together with the multilateral framework for policy coordination. Trump campaigned on an "America first" platform that denies any need for cooperation in mutual interest. Instead, his rhetoric privileges transactions, deal-making, and zero-sum games. He also campaigned on the assertion that previous arrangements were disadvantageous to American interests. His administration considers every agreement up for renegotiation. This attitude is increasingly encouraging other countries to push back against the Trump administration and to try to undercut its economic policies. So far, the Trump administration welcomes the challenge. Unfortunately, it also invites the consequences.
The Trump administration's policies will ultimately damage American economic performance. That conclusion flows directly from the economics of interdependence. By abandoning the Transatlantic Trade and Investment Partnership (TTIP), the White House ensures that US-based multinationals will not benefit from the efficiency gains associated with broadly-accepted industrial standards or streamlined certification and testing requirements. By withdrawing US support from global financial regulation, he threatens to complicate the cross-border movement of capital and to bring back financial market instability. By downgrading forums for macroeconomic policy coordination, he makes it more likely that macroeconomic policies deployed on both sides of the Atlantic will work at cross-purposes. As Trump's critics are quick to point out, working-class Americans will be among the first to suffer the consequences of these actions, but the whole of the American economy will be affected and so will the broader Atlantic community.
The implications of Trump's policies in Europe are more ambiguous. The short-term boom in the United States is a net gain for Europe and the longer-term suffering of the Atlantic economy does not necessarily imply a downturn in European economic performance, because increasingly Europe has alternatives to the United States. The situation is very different now from the 1970s, both within Europe and across the global economy. The European Union is more tightly integrated than the economic community that preceded it.
The transatlantic economy remains important, yet the world's center of economic gravity has shifted from West to East. The collapse of communism has expanded the European marketplace. China is a major source of trade and investment. And while many emerging market economies are wrestling with important problems, they also present significant opportunities that did not exist in the twentieth century.
It is possible to imagine that Europe could develop beyond its dependence across the Atlantic; indeed, Europeans may come to see the Trump administration as a reason to strengthen their cooperation with one another and with other potential markets. Europe might even emerge with strengthened leadership in the global economy. One plausible scenario has it that the failure or distraction of political leadership in the United States might become a positive (if painful) opportunity for the European economy. Unfortunately, however, this scenario is unlikely. The reasons are bound up with the structural problems identified in Cooper's original argument. To see why, it is enough to look at the implications for money and trade.
The Trouble With Finance
Europe has achieved its goal of monetary union, with 17 member states sharing a common currency. Compared to any participating country, moreover, the euro area is much more self-reliant in terms of trade and production and much richer in potential for connecting savings to investment. This should insulate European countries from the kind of volatility they used to experience as a result of movements in the dollar against other currencies (and it does, to the extent that such movements no longer have second- or third-order implications for intra-European exchange rates). Nevertheless, even before the financial crisis, movements in the euro-dollar exchange rate quickly emerged as a major source of shocks for Europe's national economies, creating losers as well as winners. During and after the crisis, the euro-dollar exchange rate has often frustrated Europe's monetary policy-makers, particularly when market participants anticipate a divergence in macroeconomic policy decisions across the Atlantic and so move funds from one side of the Atlantic to the other in order to capitalize on expected exchange-rate movements.
Trump's election has enhanced the conflict between changes in the Eurodollar exchange rate and monetary policy-making. The dollar appreciated strongly against the euro after Trump's surprise victory and on the back of expectations that the new administration would work quickly to streamline regulations, revise the health care system, and undertake sweeping tax reform. European exports benefited from the resulting change in relative prices, though the results were uneven across countries and industries. Meanwhile, the effective loosening of European monetary policy collided with the European Central Bank's efforts to slow down its large-scale asset purchasing program, as a first step to normalizing monetary policy-making. This in turn fueled arguments, particularly in Germany, that the ECB should move more quickly to bring an end to its monetary accommodation.
The result of the euro's depreciation against the dollar was an increase in inflation divergence across the euro area. It also widened the gap between the headline rate of inflation and the core rate that excludes energy and processed food prices, which tend to rise under the influence of a depreciating currency. These impacts were more inconvenient than unexpected; Europe's monetary policy-makers do not target the exchange rate, but they are adept at building exchange rate movements into their analysis of macroeconomic performance and monetary conditions.
Once the ECB adapted to the change in global economic circumstances, however, the luster began to come off the Trump administration's policy agenda and the dollar began to depreciate against the euro. Again, Europe's monetary policy-makers found themselves wrong-footed as the appreciating euro began to tighten European monetary conditions, creating the danger that market participants will lose confidence in Europe's recovery. This would cause prices to rise more slowly than the ECB believes is necessary for growth and employment.
What remains unclear is whether the European Central Bank will have to delay any further reduction in its large-scale asset purchasing program as a result of the euro's appreciation. Again, this is not a new problem for Europe's monetary policy-makers. They faced a similar dilemma when the euro depreciated strongly against the dollar soon after the monetary union was created and when the dollar collapsed against the euro in the period from 2002 to 2006. Nevertheless, the exchange rate volatility induced by the Trump administration is a painful reminder that cooperation across the Atlantic is better than the alternative.
Trade (and Brexit)
The politics of trade provide another illustration of this structural interdependence. The British, in exiting the European Union, are seeking to retain access to European markets. The Europeans, while unhappy that the UK is leaving, nevertheless have a strong interest in maintaining close economic relations. They also have an interest in ensuring that Britain's departure does not disrupt European manufacturing "value chains" or result in the reintroduction of customs borders (for example, between Northern Ireland and the Irish Republic, which is a problem negotiators seem narrowly to have avoided).
The difficulty is that any trade arrangement that Britain negotiates with the rest of Europe will hinge in many respects on the trade relations that Britain negotiates with the United States. The issues here are technical and run from the sanitary and phytosanitary standards that govern the trade in agriculture to the certification of regulatory compliance in manufacturing and the documentation required for tracing the rules of origin for complex products. To cite just one example: if the UK makes it easier for American firms to export genetically modified organisms into British agricultural markets, that could make it harder for British farmers to sell their own produce in the rest of Europe.
Other regulatory standards — including record-keeping for "rules of origin" — are a further complication. The issue is not that the British will be unable to show equivalence or to meet European reporting requirements; rather it is that the translation of one set of standards into another is precisely the kind of activity that takes place at customs facilities (and that constitutes the "friction" in the global marketplace). Regulatory convergence across the Atlantic would make this situation much easier to manage. Conversely, the kind of transactionalist deal-making favored by the Trump administration will make it harder.
The failure of Donald J. Trump's administration to work with its European allies in a multilateral framework for macroeconomic policy coordination or trade negotiations will do much to divide the Europeans even as it slows down economic performance across the Atlantic economy. If we expand the conversation to include areas like corporate taxation (following the recent US tax reforms) and financial regulation, the situation only becomes more challenging. There is nothing surprising about this situation.
The Atlantic economy experienced these problems already in the 1960s and 1970s. The difference now is that the US government is turning away from the lessons that were learned from that previous period. And while the governments of Europe are more inclined to resist that temptation and to hold on to the conventional wisdom about the economics of interdependence, the consequences of US policy actions are too great to be ignored.
Europeans are certainly capable of confronting this new challenge as a united front, but doing so will depend upon their willingness to strengthen the solidarity between those who stand to win and those who stand to lose from this new post-Atlantic economic arrangement. European economic performance depends upon close cooperation. That has been true at least since the 1960s. Faced with the turbulence coming out of the White House today, such cooperation is imperative.