MILAN – The global economy is undergoing a far-reaching transformation. Change is being driven by shifts in countries’ populations, productivity, wealth, power and ambitions, and accelerated by U.S. President Donald Trump’s moves to reshape supply chain structures, alter cross-border investment incentives and limit the movement of people and technology across borders.
The tensions that these changes are producing are most apparent in escalating disputes over trade. Notwithstanding some dislocations in emerging economies, markets’ reaction to the tit-for-tat tariffs so far has been only muted. Investors probably assume that it is all just part of a renegotiation process that will ultimately produce new rules of engagement for global business — rules that are even more favorable to the powerful.
But such assumptions may underestimate the complexity of the issues at play, beginning with the politically salient matter of where investment and employment are created. On their own, tariff and trade barriers, if viewed as transitory negotiating tactics, will not significantly change global investment patterns or the structure of global supply chains and employment.
Protectionists like Trump argue that the power of tariffs and other trade barriers lies in their ability to curb cheating and free-riding. The implication is that such measures can help to eliminate the tensions, imbalances and polarization associated with globalization.
“Cheating,” of course, is in the eye of the beholder. State subsidies for specific sectors, including preferential treatment of state-owned enterprises, may be regarded as cheating. So may requiring technology transfer in exchange for market access, public procurement favoring domestic entities, acceptance of unsafe work environments and exploitative labor practices, and exchange-rate manipulation.
The test of free-riding is whether a country contributes too little, relative to its capacity, to the provision of global public goods, such as defense and security, scientific and technical knowledge, mitigation of climate change and absorption of refugees. The culprits depend on the topic in question.
But whatever the downsides to cheating or free-riding, tackling these behaviors is unlikely to eliminate the conditions that have contributed to economic, social and political polarization. After all, labor arbitrage has been the core driver of the organization of global supply chains for at least three decades — accelerating, of course, with China’s rise — with significant distributional and employment effects. It seems unlikely that, had China and other emerging economies adhered to the letter of World Trade Organization rules, the distributional effects of their integration into the global economy would have disappeared.
What, then, is the real purpose of the tariffs? Trump could be interested only in leveling the playing field, at which point he will accept global market outcomes. But it is more plausible that this is all part of his strategy — echoed by leaders in a growing number of countries worldwide — to win support by asserting national priorities and sovereignty.
Such efforts are pushing the world toward a more balkanized system. Moreover, the challenges and fears raised by advances in technology, especially digital technology, with regard to both national security and economic performance are also propelling the world toward greater fragmentation.
Fifteen years ago, few would have predicted that mega-platforms like Google or Facebook would become key players in areas like image recognition, artificial intelligence and the development of autonomous vehicles (including military vehicles). Yet that is exactly what has happened. In fact, Google is now a defense contractor (though it may not renew its contract).
Given the security implications of these developments, as well as a host of issues like data privacy and security, social fragmentation and foreign interventions in elections, countries are unwilling to leave the internet unregulated. But they are also unwilling to delegate regulation to a supra-national body. As a result, many are taking matters into their own hands, leading to a growing divergence among countries regarding internet regulation.
Reflecting the national security tilt of these initiatives, the scope and authority of the Committee on Foreign Investment in the United States — responsible for reviewing the national security implications of foreign ownership of U.S. companies or operations — has recently been expanded.
Despite these efforts, however, the fact remains that innovation cannot easily be blocked by national borders. On the contrary, the diffusion of ideas may well become the most consequential dimension of globalization in the future.
While this may complicate national security planning, it represents powerful new opportunities for business, even as trade faces headwinds. Already, there has been an explosion of innovative, digitally based business models, many of which could become powerful engines of inclusive growth, especially in emerging economies. Digitally enabled ecosystems, with open architecture and low barriers to entry, are one example of an emerging model with considerable economic potential.
There is one more crucial dynamic that will shape how the global economy will develop in the coming decades: the strategic rivalry between China and the U.S. At this point, it is impossible to say precisely what form this rivalry will take. What is clear is that every part of the global economy will be affected by the mix of cooperation and competition that emerges.
In the face of a powerful rival, one might expect the U.S. to pursue a strategy focused on building, expanding and consolidating alliances with natural allies — that is, countries with similar governance structures and shared views about the benefits of international cooperation and open markets. Instead, Trump has alienated longtime allies and attacked multilateral structures and institutions, all while antagonizing China in what is quickly becoming a two-player game.
This is a bizarre strategy. Whatever advantage Trump thinks he will gain by positioning the U.S. in opposition to its natural allies will be dwarfed by the losses. A split between the U.S. and its traditional allies, if it becomes a permanent feature of the new global order, would lead to deeper fragmentation among the world’s market-oriented democracies. That will surely shift the long-term balance of power in China’s favor, as it moves steadily toward becoming the world’s largest economy.
Michael Spence, a Nobel laureate in economics, is a professor of economics at New York University’s Stern School of Business and a senior fellow at the Hoover Institution. © Project Syndicate, 2016
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