Global trade policy is undergoing its first major shift since 1995, and that change could represent the largest evolution in international commerce since World War II. Over the past eight months Stratfor has been publishing a series of Trade Profiles to help clarify the motivations of the largest competitors in the world economy as they try to navigate this changing environment. With the series complete, now is a good time to take stock and reflect on the picture that these profiles form when they are combined.
The global trading system we know today was largely crafted by the United States in the aftermath of World War II. In the decades after the war, the United States and Europe joined hands to gradually liberalize their economies, taking peers such as Japan along for the ride. The tariffs on goods gradually fell away as the General Agreement on Tariffs and Trade (GATT) led on to the creation of the World Trade Organization (WTO). The globalized world that then emerged provided a strong foundation for rapid, manufacturing-led growth in such countries as China, which acceded to the U.S.-led institutions once they had grown large enough.
But then the WTO stalled. With a more diverse membership, it could no longer reach a consensus on how to move the conversation on international trade forward, and trade liberalization failed to keep pace with the developments of the modern economy. As Western economies developed such areas as services and digital commerce, rules at the WTO — strong on the trade of goods but weak on services — were left behind. No longer able to advance on a multilateral front, like-minded countries began negotiating trade pacts in smaller groups, such as the Trans-Pacific Partnership (TPP), which was designed to be the model for a comprehensive modern trade agreement, and the fledgling Trade in Services Agreement (TISA), intended to liberalize that sector among member countries. The WTO remained, largely as an enforcer of rules involving the trade of goods, while countries hoped the regional pacts could be signed and ultimately expanded to the whole world. This is the status quo that is now being challenged.
And that challenge is coming from the United States. The world's largest economy is chafing against the ties that bind it by directly questioning the system. It is challenging the WTO itself by refusing to approve judges for the appellate body that handles trade disputes, while also invoking unilateral trade remedy procedures that have not been used since the 1980s. In 2017 the United States withdrew from TPP, and it began to renegotiate its trade deals with Canada and Mexico (the North American Free Trade Agreement) and with South Korea (United States-Korea Free Trade Agreement). The United States' stated desire is to return to a world of bilateralism, where deals are negotiated between two countries instead of many; this is a world that would suit the larger competitors to the detriment of the smaller. The United States' role in the global system is the source of its dissatisfaction. Since 1945 it has been at the center of the wheel of the global economy. Its currency is accepted for trade around the world, and it is the center of gravity in an increasingly borderless system. These have caused investment to flood in and helped to create a consistent trade deficit helped along by a consumerist boom. And foreign investment in the United States now exceeds U.S. investment overseas by $8 billion. These are the facts of life for a country in the United States' position, but they lead the United States to periodically buck against its bonds. And that action puts the whole system at risk.
To see the primary source of U.S. dissatisfaction, look across the Pacific Ocean at China. The world's second-largest economy has taken full advantage of the trade infrastructure put in place by the United States and the European Union, and it has used it as a platform to achieve breakneck growth over the past several decades. WTO membership has allowed China to build a global factory, which takes in materials largely from the developing world and assembles them into products that it sells to developed markets. And with no tariff barriers to hide behind, those markets struggle to defend against the influx. The lack of global rules on such modern trade topics as services and non-tariff barriers suits China well. Because of its historical suffering at the hands of foreign powers, the Middle Kingdom prizes control and sovereignty above all, and it is particularly wary of any interference with its laws and governance. Trade liberalization with goods largely involves the reduction of tariffs at the border, while liberalization with services involves issues inside the border. A world where the trade in goods is liberalized (allowing China to export its products) and the trade in services is not (letting China keep maximum control) is thus perfect for the Chinese. As a result, China is highly motivated to maintain the status quo and defend the WTO, but it is wary of progress and "modern comprehensive trade deals," such as the TPP.
Meanwhile, the European Union is still following the track that it shared with the United States. With a modern, developed economy, the bloc wants agreements with its major trading partners that cover such areas as services and the digital economy. Since its creation, the European Union has seen itself as a normative beacon for other countries to follow, and as such, it wishes to set global standards in trade that will be adopted around the world. Thus, looking at the three major hubs in the global trading system, the United States is seeking a shake-up and potentially regression, China is struggling to preserve the status quo, and Europe is pushing to keep moving forward.
Japan, as well, has been undergoing a transition in recent years. In the decades after World War II, it was often a reluctant liberalizer on the global stage. With a model representing something of a proto-China, it prioritized the export of goods and staunchly resisted any attempts to reform Japanese laws or regulations, helping it protect its weak services sector. But recently there has been a shift. Outflanked by South Korea in key trading markets and increasingly aware of China's rise on its own flank, Japan has decided to join the global conversation. With that Chinese threat in mind, it is particularly motivated to remain as close to the United States as possible. And Japan and Europe have both been keeping the free trade dream alive by pursuing as many large and comprehensive trade pacts as possible, including a large trade deal between them in 2017. The European Union has also signed a pact with Vietnam and has expedited negotiations with Australia, Mexico and one of South America's trade blocs, Mercosur (Common Market of the South). Japan for its part has been instrumental in keeping the TPP (now the CPTPP, or Comprehensive and Progressive Agreement for Trans-Pacific Partnership) alive after the U.S. withdrawal, and it hopes that the United States can be persuaded to rejoin later.
The United Kingdom faces a daunting challenge. It is about to leave the relative comfort of the European Union, which receives 43 percent of its exports and is the source of 54 percent of its imports, and make its way in the outside world. With a sizable overall trade deficit, the world's fifth-largest economy may find it easy to strike trade deals with manufacturing exporters, but in the export of services, where it is strongest, the United Kingdom will find its domestic companies are guaranteed little protection abroad by WTO rules. A post-Brexit United Kingdom is thus likely to end up joining the group of countries — including Japan and the European Union — that are actively signing comprehensive trade agreements and looking to modernize global trade standards to better reflect their economic needs.
India faces a different kind of challenge. With a million workers entering its economy every month, India must find jobs for them all. It would ideally like to do this by creating a manufacturing industry in the manner of China and Japan before it, but that aspiration faces many infrastructural, political and geographical constraints. India's strength is in services, and it remains weak in agriculture and manufacturing. As a result, it is poorly positioned for the current global trading system in which goods trade is liberalized and services face barriers, and it has long been a difficult and protectionist voice in multilateral negotiations. India will thus be looking with increasing urgency for ways to reduce barriers to its services exports, often by negotiating bilateral pacts. But with the liberalization of the trade in goods often being the starting point in any negotiation, it will be held back by its innate protectionism.
World trade is in flux. The United States is making clear that it no longer sees itself as the leader, but that does not mean a new chief will emerge. China and the European Union, the two possible contenders, have differing views on how to proceed, meaning that it is unlikely that two of the world's three economic hubs can align as the European Union and the United States did for so many years. And the one regional pact that has momentum — the CPTPP — includes neither the European Union nor China. China's equivalent pet project, the Regional Comprehensive Economic Partnership (RCEP), looks hamstrung by the divergent interests of its members. It contains China, which is averse to services liberalization; India, which only wants to discuss services liberalization; Japan; and Australia, which would like to discuss comprehensive goods and services liberalization in the manner of the CPTPP. With the United States no longer willing to lead on world trade, the field it leaves behind looks disparate and diverse, with many different countries pursuing their own interests and priorities. As the world shakes out, Stratfor's Trade Profiles series will help to show what these interests are, and it will act as a guide to understanding the reshaping of the global system.