With the threat of a trade war looming over the global economy, it may feel like the world has been force-fed another one of U.S. President Donald Trump's signature cocktails — shaken on the rocks, with equal parts tweets and tariffs, and a twist of terror. But if you want to shake off that foggy feeling and get a clearer vision of what will come to pass, focus on the line between a president's tactics, no matter how unorthodox, and the country's grand strategy. Great power rivalry is what gave rise to the global trading order in the 20th century; the return of peer competition will shake, but not necessarily break, that foundation in the 21st.
In Stratfor's 2018 Annual Forecast we pointed to the evolution of U.S. strategy to meet the challenge of an emerging great power rivalry emanating from Eurasia. U.S. trade policy under President Donald Trump may be highly disruptive, but it will gradually contour to the global strategic environment.
Taking Guidance From Hamilton
Ever since powers, big and small, started engaging in commercial trade centuries ago, nondiscrimination — the idea that trading privileges given to one partner must be given to all — and reciprocity, or the expectation that the lowering or erecting of trade barriers would be matched by one's trading partners, have formed two, occasionally conflicting, pillars in international trade. The concepts of nondiscrimination and reciprocity are rooted in the Most Favored Nation clause (a curious superlative, since the entire basis of the term is about not playing favorites in trade.)
Most Favored Nation (MFN) is an old concept. In fact, a young United States inserted an MFN clause in its very first treaty in 1778 with France. At the same time, a pivotal debate was brewing among the Founding Fathers. The United States in the 1790s was wrestling with its former colonial master, Britain, which kept exclusive trading rights for its colonies. As U.S. trade expert Douglas A. Irwin recounts, the United States was left in a pinch without trade access to the West Indies. James Madison and Thomas Jefferson, serving in the House of Representatives and as secretary of state, respectively, tried desperately to persuade President George Washington to employ aggressive reciprocity to coerce the British to open up. Specifically, they called for imposing taxes on British shipping, threatening to close the U.S. market to British goods and granting the French exclusive trading privileges.
But Treasury Secretary Alexander Hamilton saw Jefferson's and Madison's proposals as "unsound and dangerous," driving at a trade war with Great Britain. While Madison argued that the United States' inherent commercial strength enabled it to stand up to Britain, Hamilton hit back, saying: "Tis as great an error for a nation to overrate as to underrate itself. ... We forget how little we can annoy how much we may be annoyed." Hamilton wanted to focus U.S. trade policy on nondiscrimination to reflect its broader foreign policy goal of neutrality to avoid getting caught in a costly war between Britain and France. In the end, the Hamiltonian vision of nondiscrimination trumped Jefferson and Madison's preference for aggressive reciprocity and a treaty was signed that ensured American nondiscrimination in trade in exchange for access to the West Indies.
Transferring the Trade Reins
Even as Hamilton led the Founding Fathers to tie the country's commercial policy to its national security, the United States was still lacking the internal coherence to effectively wield its commercial influence abroad. The founders entrusted Congress with the constitutional right to levy tariffs and to regulate commerce with foreign nations, but this was a construct flawed from the start; strategic direction in U.S. trade policy was near impossible when special interest groups influencing members of Congress on two-year election cycles could hold tariff policy hostage. The protectionist and politically powerful industrial Northeast and Midwest led by the Republicans was in constant battle with the free trade Democrats of the agricultural South, who relied on exports for their economic survival.
It would take a massive global shock to finally shake up this system. The 1930 Smoot-Hawley tariff that capped a long run of Republican-led protectionism compounded the ailments of the Great Depression, opening the door to a Democratic victory for Franklin Roosevelt in 1932. With the tailwinds of the crisis propelling him, FDR persuaded a fractious Congress to cede its authority to negotiate trade agreements to the president through the Reciprocal Trade Agreement Act of 1934. (Congress retained the right to approve and review such agreements.) Critically, Congress also endorsed granting trading partners unconditional Most Favored Nation status, in which U.S. tariff reductions would be automatically — not conditionally — applied to all countries with an MFN treaty with the United States. This effectively meant that reciprocity would be grounded in the principle of nondiscrimination, giving trading partners the incentive to enter trade agreements with the assurance they would not be left out of a better deal down the line. The pieces were in place for the United States to finally build a rules-based system to govern international trade.
A Rightful Role for Trade in National Security Strategy
The principle of unconditional MFN was enshrined in the postwar General Agreement on Tariffs and Trade (GATT) formed in 1948 and its successor, the World Trade Organization (WTO), which governs global trade today. But the United States still practiced informal conditionality in assessing its trading partners. In the wake of the world wars and at the onset of the Cold War, the United States was following a strategic imperative to tether its trade ties to a foreign policy that would ensure American primacy and isolate the Soviet Union. As the GATT steadily expanded, incoming members were formally granted unconditional market access along with an implicit security guarantee that U.S. naval power would protect trade on the high seas for everyone's commercial benefit. And for security allies that were particularly relevant to the U.S. containment strategy, the accession process into the GATT was expedited by the United States, whether or not those countries had actually proven their free market credentials.
When Japan applied for GATT membership in 1952, for example, the United States lobbied other GATT members to swallow their concerns over competition from Japan's heavily protected manufacturing industry to accept Japan's entry in 1955. As Christina L. Davis and Meredith Wilf demonstrate in their study on GATT/WTO accession, South Korea was able to join in 1967 within a couple of years of applying and only after three working group meetings despite Seoul's heavy trade restrictions and state intervention in the economy. To wrest Poland out of the Soviet bloc, the United States granted MFN status to it in 1960 to set the ball rolling for GATT accession in 1967.
To wit, the ease of GATT membership during the Cold War was largely conditioned on the United States' construction of both formal and informal alliances during a period in which competition in the international system could be drawn along very thick, bold lines. The United States had the structure, both internally through its executive authority to negotiate trade agreements and externally in its containment strategy against the Soviet Union, to neatly fuse its commercial and national security strategy.
Those lines naturally started to blur again with the waning of the Cold War. With the United States left as the sole superpower and with no clear adversary around which to shape its commercial strategy, the GATT/WTO accession process was effectively put on autopilot through the 1990s and early 2000s. As the WTO became bloated with its near-universal membership, free trade agreements proliferated through the 1990s and 2000s as groups of countries tried to enhance their trading privileges and expand their market access. (Free trade agreements, along with customs union agreements, are exempt from the MFN principle on nondiscrimination and thus allow smaller groupings of countries to grant each other deeper trade concessions.)
A prolonged absence of great power conflict allowed free trade liberals to drown out skeptics with an argument that even the most blatantly state interventionist and authoritarian governments in the world would eventually become part of a lasting "democratic peace" once they opened up their markets and politically evolved within the Western fold. It was this idealistic exuberance that brought countries such as China in 2001 and Russia in 2011 into the WTO despite their obvious lack of commitment to free market principles, much less democratic reform.
The distortionary effect of China's economic rise — facilitated by its WTO entry — is understood all too well now. For years, China's mercantilist brand of state capitalism allowed heavily subsidized state-owned enterprises to dump artificially cheap goods on the global market, all while the state was using intellectual property theft, investment restrictions and strict localization regulations to work toward the goal of autarky, or economic self-sufficiency, in high-value strategic sectors. China's rise against a backdrop of hyperglobalization, the spread of automation throughout the manufacturing industry over decades and an underlying demographic drag on economic growth has produced a great deal of economic pain for millions of workers trying to make a living in an environment where their skills and wages are no longer competitive.
Old Solutions to Old Problems
Economic frustration was allowed to fester for years before it found a strong voice in the executive branch with Trump's election. Globalists championing free trade expansion focused far more on the benefits of cheaper inputs, lower consumer costs and the global reach of multinational corporations in search of growing markets and far less on the political and social consequences of large segments of the workforce left on the sidelines. The world now finds itself in a situation in which the American president is focused on answering the call of those workers with an extraordinary amount of executive power at his disposal to levy tariffs and walk away from free trade agreements.
Whereas the Hamiltonian preachers of trade nondiscrimination ruled the globalist era, the Trump White House is subconsciously channeling Jefferson and Madison in putting its faith in U.S. commercial clout to get what it wants out of its trading partners and in calling for a return to aggressive reciprocity to level the playing field against trade offenders like China. To that end, the White House is digging up trade tools such as Section 301, Section 232 and the International Emergency Economic Powers Act to try to frame the country's economic challenges as a fundamental threat to national security and justify the use of extraordinary, unilateral measures, even if that means rubbing up against the rules-based order that the United States engineered.
Trump's narrow focus on the plight of a few American workers is out of sync with the evolution of the global strategic environment.
But Trump's narrow focus on the plight of a few American workers is out of sync with the evolution of the global strategic environment. The president is reacting not only to years of economic discontent swelling at home, but also to a nebulous era in the global arena in which the West wandered from ethnic wars in the Balkans to sectarian wars in the Middle East without a clear adversary in its sights. The lack of definition to the strategic environment explains the president's skepticism toward multilateral postwar institutions, from NATO to the United Nations to the WTO, that are too bloated and divisive to take decisive action against emerging threats. In his mind, the United States should not have to shoulder the world's security burdens if they stem from a legacy role from another time.
And so, Trump's tactics, however crass and seemingly disjointed, become easier to understand. After launching broad steel and aluminum tariffs to invigorate the president's base and shake up U.S. trading partners, the White House provided conditional exemptions for trading partners who could essentially prove their worth to the United States. And while Trump is sitting comfortably in the Oval Office (or his equivalent at Mar-a-Lago), leaders from around the world are busy assembling whatever concessions they can to present to the American leader in hopes that a trade war can be averted. The United States has already eased up trade pressure on South Korea in negotiations over the United States-Korea Free Trade Agreement, but finalization of that deal is hinging on the outcome of its diplomatic management of North Korea. Japanese Prime Minister Shinzo Abe, who has not yet secured a tariff exemption, is trying to offer joint coordination through the WTO against Chinese trade abuses while playing up Japan's credentials as a critical security ally to the United States in the Pacific. French President Emmanuel Macron, German Chancellor Angela Merkel and British Prime Minister Theresa May are offering similar proposals for coordinated WTO action against China while trying to showcase their commitment to higher defense spending to help ease Trump's concerns over NATO. To France's annoyance, Germany is even trying to go a step further to remove big economic irritants to Washington, such as a French-led proposal in the European Union for a digital tax that would target U.S. tech giants. Germany is also offering to start a discussion on a new trade deal with the United States. It remains to be seen whether any of these trading partners throw in sanctions cooperation against Iran in their barter with Trump.
Great Power Rivalry Is Back, but Has U.S. Strategy Caught Up?
Amid these negotiations, the question left outstanding is whether the White House will give enough consideration to the emerging global strategic environment in deciding its next moves. The United States lost its balance in the post-Cold War interregnum, but great power rivalry is returning to the global arena. As the United States' own defense strategies articulate, a threat is emerging from Eurasia as China and a weaker Russia riding China's coattails are finding common ground in challenging the U.S.-led order. In this environment, U.S. grand strategy, independent of who is sitting in the White House, dictates that the United States will use a variety of means, including security and commercial alliances with the likes of Europe, South Korea, Japan and India, to contain and prevent a Eurasian threat from fundamentally challenging U.S. security. But if the White House's economic nationalist agenda has a weak connection to the global strategic environment, allies will have to question the United States' credibility as a security guarantor and hedge their bets, leaving the United States with a weaker foundation to wield its influence overseas to challenge the growing Eurasian threat.
At the same time, the U.S. trade assaults on China fit well within this broader strategic construct. China's global economic expansion is married to a modern imperative to protect strategic trade routes, resources and markets from foreign (namely, U.S.) interdiction. Thus, Chinese naval expansion and economic self-sufficiency in strategic technologies at the expense of the United States are fundamentally at odds with the United States' imperative to maintain naval primacy and prevent the rise of a Eurasian challenger.
But cutting China down to size in the commercial sphere is a lot more complicated in the modern era of seamlessly integrated supply chains and overlapping trade dependencies. Any move against a colossal economic power like China can easily boomerang to harm the United States. Trade relations are also not zero-sum, and countries caught between big powers can hedge their bets by economically hitching themselves to both sides. And with the WTO's near-universal membership now covering 98 percent of global trade, the United States doesn't have the leverage that it had during the Cold War to facilitate or accelerate membership into the club when everyone, including China, is already in the door. China can continue to rely on WTO mechanisms to maintain market access and WTO internal divisions to try to blunt U.S. reform efforts aimed at holding countries such as China more accountable for their trade abuses. This may be maddening to the United States, but the White House also isn't likely to invite a global trade war and recession by pulling out of the WTO and destroying the credibility of the institution entirely.
Since the United States cannot effectively exercise its commercial clout against China from within heavily saturated postwar institutions, nor can it afford the consequence of destroying that institutional order, it will have to get creative. Operating under the assumption that the WTO is structurally unfit to address a litany of complaints against China, the United States is creating the room for unilateral action parallel to any dispute channels it maintains through the WTO. The United States can hang a credible threat of a costly trade war over Beijing to coerce concessions in back-channel negotiations. A slide toward aggressive reciprocity can also be seen in the United States' moves to match any economic restrictions that China imposes on American investors with those of its own in the name of national security. Such actions of course push the WTO into riskier territory, but they also will likely fall short of shattering the global trading order altogether.
Free trade agreements are political dynamite when running on a populist campaign, but they still have utility in an era of great power competition.
Multilateral free trade agreements, however contentious, are another tool at the United States' disposal. Free trade agreements are political dynamite when running on a populist campaign, but they still have utility in an era of great power competition. Remember, free trade agreements (and customs unions) are exemptions to the Most Favored Nation principle on nondiscrimination. If a group of countries with like-minded interests wants to get together and reward one another with special trading privileges, then those left out of those arrangements potentially have a lot to lose. And this is where the United States can use China's state capitalism to its advantage; by modernizing free trade agreements with high labor, intellectual property, environmental, digital and even political standards that Beijing cannot fully satisfy, the United States can use the power of reward and exclusion to bring allies more tightly into its fold. At the same time, unlike the decades of GATT/WTO accession, higher standards in free trade agreements also imply a smaller pool of candidates, since the United States would not be able to turn a blind eye to strategic allies with obvious trade defects.
This brings us to the Trans-Pacific Partnership, a globe-spanning free trade agreement that Trump ditched shortly after coming into office on the grounds that it would destroy more American jobs. So why is the White House now suggesting it may come back to the pact? The Trans-Pacific Partnership was originally designed by the United States to set a new bar for free trade pacts, with much higher labor, environmental and intellectual property protections. The pact notably left out China while incentivizing key allies such as Vietnam and Japan to meet higher U.S. trade standards in exchange for access to the world's largest consumer market. The Trump White House may have gambled that its exit from the deal would send the other signatories scrambling to negotiate their own bilateral deals with the United States, but instead they forged ahead with the revamped Comprehensive and Progressive Agreement for Trans-Pacific Partnership, dropping several of the U.S. demands from the original draft. Not only is the United States at risk of being excluded from tariff-free zones in competitive markets, but it is also losing the chance to ground its economic competition with China in a strategic trading framework. There are still a number of hurdles ahead, not the least of which is how domestic apprehension toward greater foreign competition will be assuaged in entering new trade deals. Nonetheless, the suggestion that the White House could reclaim a spot among this trading club points to a growing recognition of where U.S. trade policy and grand strategy can meld once again as peer competition returns to the global stage.