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Trading Lessons

The Last G-20 Meeting Marks the End of Free Trade

Economics / Global Economy Mar 29, 2017 - 01:47 PM GMT

By: John_Mauldin

Economics

BY GEORGE FRIEDMAN : In the last G-20 meeting, its members agreed to drop the forum’s commitment to free trade at the insistence of the United States. That agreement was reached at one meeting and was contained in a single document—such agreements and documents are far from written in stone.

In spite of that, it must be regarded as a historical moment. Excluding the free trade commitment from the agreement marks a fundamental shift in a concept that has been central to global economics for more than a generation.


Free Trade as a Tool, Not a Principle

Trump has argued that free trade is not a principle, but rather a tool for improving the economic conditions of nations. If free trade failed to do so, it should be discarded.

Trump also argued that many nations, such as China, had not practiced free trade, although they had benefited from it. In any event, the US would examine trade relations and tariffs against a simple criterion: Does it benefit the US?

In the end, each nation pursues its own interests. For the most part, free trade has appeared advantageous to all of them. But the problem is that we are in an export crisis, as we have previously discussed (read more in our free report Germany’s Invisible Crisis and How the World Should See It).

As long as the global economy remains sluggish—growing at less than 2 percent—those export numbers will not rise. Exporters are hostages to importers, and importers are not buying.

The problem is figuring out how to pump up economies so they can afford more imports. Exporters are depending on importers to improve their own economies so that they can buy more exports. But increasing demand based on domestic consumption alone is difficult.

Low exporters can do it, but increasing consumption in order to buy more goods from other countries can only undercut recovery. Politically, in the post-2008 world, recoveries must be based on domestic consumption buying domestic production.

Free Trade Is Powerful Only in Theory

We’ve written about this before, but free trade theory is powerful. It dictates that if all nations focus on selling what they are most efficient at producing, everyone will benefit. The theory of comparative advantage that Ricardo laid out makes a lot of sense abstractly, and the international system has since been in awe of the principle.

But this principle has two problems.

The first is distribution. Ricardo wrote at a time when labor was fungible. A farm laborer could adjust to working in a factory in 1800, for instance. Thus, as product profitability shifted, new products would be produced, and laborers would shift jobs.

But steel workers are not computer coders, and they probably won’t learn the skill. Labor is no longer fungible. The outcome of this is that when you close steel mills to take advantage of software product, GDP may increase, but so will the worst kind of unemployment: non-cyclical unemployment that leaves workers without an equivalent salaried job for the rest of their lives.

The second problem is timing. A favorite phrase of economists is “in the long run.” The problem is that that human clock and the economic clock run at different rates.

Over the next 50 years, abandoning an industry to focus on another makes sense. But to a 45-year-old worker, this means his life will be ruined. Put enough lives at risk, and the political system will intervene.

2008 Triggered a Political Shift

The 2008 crisis was not a normal cyclical event. It changed the entire economic dynamic of most of the world. That has triggered a massive political shift.

Free trade was easy to absorb prior to 2008. The situation for many was deteriorating, but cushioned by growth, and not progressing that quickly. After 2008, deterioration accelerated and the cushion kept getting thinner.

The law of comparative advantages meant that the production of many things would shift overseas, either by building factories in low-wage areas or importing products. The focus was on those things at which the US excelled, such as technology, financial services, and the rest.

This created the social distinction that dominated the last US election. The law of comparative advantages benefitted coastal areas and parts of the interior, while much of the interior lost ground at a rapidly increasing rate.

The US West Coast and the Northeast—home to technology, financial services, and such things—emphatically supported Hillary Clinton. Depending on the circumstances, the rest of the country (a vast generalization) saw free trade as a threat to their current incomes and future hopes.

They voted for Trump.

The US then told the G-20 that free trade is off the table, and the G-20 agreed. Because regardless of who is president, the US is the 800-pound gorilla.

And so we come to the upcoming visit of China’s President Xi Jinping to Trump’s Mar-a-Lago Florida estate to meet with a president who can’t budge on free trade and still maintain his constituency.

Xi can’t give up on free trade without increasing pain in China, a country he is struggling to manage. Ricardo is wincing. Machiavelli is grinning ear to ear.

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John Mauldin Archive

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