Special Interview 2Interview with Christina L. Davis, Professor of Government, Harvard University

Outlook for Trade Wars
& Global Governance
By Japan SPOTLIGHT

Trade wars are the biggest concern today for the global economy. We had an opportunity to interview
another distinguished expert on international trade and political economy, Prof. Christina L. Davis ofHarvard University.
(Interviewed on July 12, 2018)

Trump Administration’s
Trade Policy

Davis: It’s difficult. They are trying to backout of a globally integrated trading systemand you can’t really take it apart now. The
idea that you can selectively target Chinese
JS: Firstly, you discuss in yoursmartphones and semiconductors as a way to
Financial Times article a few
stop them having access to high technology
weeks ago the claim by US
is simplistic and will lead us in the wrong
President Donald Trump that his
direction because China is quickly developing
trade policy is based on national
its own domestic capacity for highsecurity. You suggest that this is atechnology. I know from both Princeton andsomewhat abusive use of theHarvard that there are leading scientists there
concept of national security. Could
and incredibly smart students, and I am sure
you elaborate on this?
within the Chinese universities there is also
Dr. Christina L. Davisan abundance of talent, and so we are not
Davis: Yes indeed. It really is a challenge togoing to be able to stop China fromrules for predictable and fair trade whendeveloping the next step of industrial capacity, and high technology
countries — on an arbitrary basis — define national security
is clearly a priority. For the US to try and enforce intellectual property
broadly. The GATT first and then the WTO have recognized that there
rules that are commonly agreed on — yes. To try and move forward
may be circumstances where countries need to use economic policy
those rules — yes. But stopping trade and investment deals out ofin times of national crisis related to war and conflict and economic
concern for security threats is more difficult. There are some
sanctions etc., and that is why there are special provisions that allow
American companies producing technology that could be used byfor trade restrictions for national security. But the norm has always
another country for cyber warfare or other military applications; sobeen to avoid using those, and it’s very worrisome now to see thethere are some technologies for which you do need a review
United States invoking with Section 232 a national security basis forprocess. But again, that is where the Trump administration has taken
tariffs on steel and aluminum and now considering automobiles.
a reasonable principle and gone too far. There are few industries
That’s very different from the idea of trade sanctions in times of war,
where one might say that they are so close to direct defense
or of course those that accompany enforcement of a UN Resolution
applications that a restriction could be justified.
for security actions. So the US measure is quite unusual — in US
policy this rule has been on the books but not used; in the WTO,J S : A p p a r e n t l y, t h e r e s e e m s t o b e n o c l e a r
Article 21 on national security exceptions has been in the rules but
rarely invoked. So both within the national context and theinternational rule concerning FDI.
multilateral trade system, this is an extreme step.
Davis: Think about the OECD effort to have a multilateral investment
JS: Meanwhile, this national security concept seems
agreement in the 1990s — and of course because they couldn’t
reach a multilateral agreement governments have continued to rely
to have been used for foreign direct investment
on bilateral investment treaties that are largely about protecting a(FDI) restrictions, and today I suppose that thefirm from expropriation. Most of these bilateral agreements don’t
conflicts between China and the US do seem to beeven consider a lot of these issues about the conditions for when issomewhat concentrated on high-tech competition.
investment allowed, what are the review principles, and so on.
FDI restrictions based upon national security seemto be closely related to this high technology
competition. How do you view this phenomenon?

https://www.jef.or.jp/journal/

Japan SPOTLIGHT • September / October 201827

Special Interview 2
JS: Under these circumstances, don’t we need somerules on FDI?

Davis: I do agree that there is a real gap in global governance on
foreign investment and it would be in the interests of most countries
to negotiate a multilateral framework. And I think maybe
multinational firms might now see it is as being in their interest too
to come to an agreement. The US has long had this process toreview FDI implications for its national security. The policy hadn’t
been used as much and so wasn’t a major public issue, and now ofcourse because they are using it more often against Chinese firms it
has become controversial. But at the same time, other countries are
imitating this type of policy — Europe is developing its own
FDI national security review process and so is China, so we will
begin to see more politicization of foreign investment.
JS: I suppose there should be a balance between
national security and national efficiency in thisdomain.
Davis: Another interesting aspect when thinking about theinvestment-trade link is that these multinational firms are gettingcaught in both sides of the trade war; they make an investment in the
US to build a factory that will export some cars to the US and somecars to China and Europe — and now they are getting hit with tariffs
as retaliation. There are articles about how German car companies or
Nissan are going to have their American factories suffer because of
the European and Chinese retaliation against automobiles. A lot ofthese companies built in the US hoping to both sell to the US andexport from the US and then they get caught in the trade wars. I cansee multilateral investments facing higher risk premiums because ofthis type of uncertainty now. It’s not as easy to hop trade barriers
when you are not sure which side is going to be retaliating, and it’s
expensive to build these factories and then have them not reach theintended market.

Could the WTO Work to Prevent Trade War?
JS: There are lots of expectations about the WTO, but

it doesn’t seem to be functioning that well. How doyou think the WTO could work to prevent tradewars?

Davis: One hopes this system can be used to enforce rules, and theadministrations of both former President Barack Obama and Trump
have filed complaints at the WTO to try and resolve some of theconcerns that the US has with China, and Japan and Europe havejoined in with complaints against China, so the dispute system is one
path to work out these issues. Negotiations need to go forward as asecond path, and that has been where the WTO really hit a roadblockwith the Doha Round failing to bring a result. If we think about why
China can still have reasonably high tariffs, it’s because after joining
in 2001 they haven’t had a new multilateral trade round that throughreciprocity forced them to lower tariffs. Under the new concerns
about state-owned enterprises or the desire to strengthen investment
28 Japan SPOTLIGHT • September / October 2018rules, all of those should have been negotiated in a quid pro quo
trade round, but nothing came of it and so now we are left with a
trade war outside of the multilateral rules.
JS: Do you think the WTO dispute settlement
mechanism would work well in the current
circumstances?
Davis: It hasn’t worked completely. The Trump administration
complains that the system is unfair if the US loses. The US
frustration is just because the US loses on anti-dumping, and hedoesn’t notice that if they tallied all of the cases the US does win the
majority of the complaints that it has brought to the WTO. There is asense in this administration that the dispute settlement process is
not enough, and so that is one reason why they have tried to enforce
US trade interests through means outside of the WTO, and that ispart of the dissatisfaction with dispute settlement, and it reflects a
sense that the rules themselves don’t cover the issues that areimportant. For example, expropriating technology from foreign firms
is just not in the rules and would be difficult to bring as a case to thedispute system.
Regarding the WTO preventing trade wars, I wish that Europe andMexico and Canada had focused on their WTO dispute challenging
the US policy and not undertaken retaliation. That has been thepolicy of Japan and Russia and India. Russia and India do not do
retaliation because their markets are not big enough and it would not
hurt the US — but they were able to use the WTO dispute to at least
show that they were responding to Trump’s tariffs. So for thosecountries, dispute settlement gave them something they could dowhen the US was hurting their interests, and for Europe they should
first file a complaint, and then they have had their retaliation later
based on a ruling of the WTO against the US policy. But because they
retaliated first, their policies would likely suffer as a violation of therules when challenged by the US.
JS: As you mentioned, the WTO has the role of rulemaker, besides its dispute-settling mechanism.
Almost everybody is saying now that this rulemaking function is already dead, after the collapseof the Doha Round. How do you see the role of the
WTO as a rule-maker?
Davis: I think that is a critical weakness, and we need to think about
the ability of countries to negotiate new rules. The one silver lining
from the current trade conflict is that it could motivate countries like
China and India to engage with the WTO more seriously. If we were
to consider why the Doha Round failed, I think that too many
countries thought that the status quo was just fine and would
continue; so they didn’t want to make tough concessions for new
rules. But the US is saying that the status quo is not acceptable andthrough this trade war is raising the costs for other countries. So totry and get back to its rule-making function, the WTO needs a traderound that would rethink the rules, and as I wrote for my Financial
Times article, I think that China should take the lead. By this I do notmean that China should write all the rules in their own favor, but

Special Interview 2
rather that China needs to take the lead by making hard concessions,
opening their markets and surprising countries with an agreement toprovide more transparency on state subsidies. I don’t know if thatwill happen, but such proposals would be the kind of action that isneeded to strengthen the multilateral trade system.

Future of Global Governance
JS: Regarding other global governance schemes
such as the G7 or G20, to my knowledge the G7
summit did not go well last time. In yourassessment, has the G20 been working well?
Davis: Well, the G20 was useful during the financial crisis of 20072008 as a mechanism to bring everyone together and see that tit-fortat retaliation and raising trade barriers would be dangerous. I thinkthat the high point for the G20 was that it provided a meeting point
during that crisis; I don’t see it rising to the occasion now, but one
could hope that the 20 leading countries could get together to reachan informal agreement to restrain the use of national security for
restricting trade and investment. Maybe this will occur in a future
meeting, but the G20 hasn’t played that role yet.
JS: How do you think we can restore global

governance today? Maybe the G20 does notnecessarily constitute the only mechanism with
global governance functions.

Davis: I think that strengthening the WTO is important, and trying to
get a trade round to work through these difficult disputes. It is one of
the most important institutions for global governance and is facing
challenges both on the enforcement and the rule-making side and so
this should be the first priority. If the G20 can support that effort, it
would be a useful contribution. I also see the OECD having a role andthis is where global governance is not just the elites meeting andcoming up with rules, because the crisis we face right now is a
populist backlash against elites, and so we need to think creatively
about how can we come up with better ways to design tradeadjustment programs so that the small sectors that lose from trade
are given the right time for transition and training programs. Are
there ways we can learn from other countries or think of new models
and share those so that we can prevent the kind of anger that is
popping up in the US and other countries? That is where the OECD
can function as a think tank in coming up with new ideas. At thesame time, the OECD has been working with the WTO on measuring
value-added trade. One of the challenges right now is that the Trumpadministration portrays trade as win-loss in terms of your tradebalance — if you have a surplus or a deficit. We need to spread abetter understanding of a global market and global production; it’sreally nonsensical to think about trade in terms of national tradebalances.
JS: So you see the OECD as a good venue for sucheducation?

Davis: As an educator I have my own role teaching students andresearching policy, but think tanks also need to consider how they
can — at the elite level — come up with policy plans and consider
ways to improve education and understanding among the public: theOECD has expanded the scope of its activities from governance ofbusiness practices to include standards of education. Could they
ever bring that together and help countries? How do you educate
your population about the winners and losers from trade?
JS: The OECD once published a kind of report on thecost and benefits of free trade, and I think it was wellreceived, particularly by the American delegation.
Would you agree that such efforts to clearly
elucidate the merits of free trade are important?
Davis: I remember reading extensively the OECD reports on the costof agricultural protection, and by giving clear numbers about how
much money is being spent on agricultural protection it reallycontributed to the public awareness but also the ability forgovernments to negotiate. Simply putting a clear metric formeasuring agricultural protection served one role in providing
education on the costs and benefits, and a second role in giving ametric to negotiate agricultural agreements that are now part of theWTO. So there might be new ways where the OECD could educate
about value-chains of trade and facilitate more effective negotiations
in a global economy.
JS: Also, structural reforms including domestic

policies would be very important to maximize thebenefits of free trade. Is that correct?

Davis: Indeed. How do we encourage structural reform in a way that
supports the livelihoods of people in communities? Thinking about
the timing of these reforms is important, and Japan has taken theslow path to structural reform in the agricultural sector which has
been expensive for the national budget, but on the other hand has
perhaps helped to avoid a rural backlash against globalization
because the young people have been able to get jobs by moving tocities while older people remaining in the countryside are given ahigher income through extensive government support. So I think thatstructural reform is necessary but doesn’t always have to be rapid,
and shock therapy is maybe economically efficient but politicallydangerous.
JS: Perhaps we can create a sort of peer-review
pressure by discussing trade liberalization andstructural reform simultaneously. I believe the OECDis a good venue for such international discussion.
Davis: Yes, as a comprehensive organization it is the right place tothink about both domestic economic policies relating to everythingfrom pensions to corporate governance, and to external policies oftrade liberalization and financial liberalization. So I think the OECD is
one of the few organizations that has the breadth to fully address
structural reform and liberalization as a joint process. One of theJapan SPOTLIGHT • September / October 201829

Special Interview 2
problems of the WTO is that it just deals with trade liberalization andhas assumed domestic governance will undertake structural reformand do trade adjustment assistance for declining sectors.
JS: For security issues and geopolitical risks, theseshould be discussed together with trade andstructural reform as we live in a complex,
intertwined world where everything is closely
related. In that sense, the OECD may not be thevenue for discussing security, and perhaps we needother venues like APEC.

Davis: APEC or the G20 are the two global governance institutions
that both talk about some security issues as well as economic
issues. APEC is an interesting group in that it has such a broad
membership, but it has not to date been proposing creative solutions
to economic problems, and so it seems less likely to me that it would
come up with a solution. Maybe if Japan and China were to take theinitiative together there would be a possibility. The fact that APEC
does not include Europe is difficult because it really means Japanand China must jointly push forward an agenda. The US right now isquite passive if not hostile to such efforts. It would be great if Japanand China could see a mutual interest and join hands on a proposal
on how to resolve national security linkages and economic
governance.
JS: In your Financial Times article you seem toregard China as playing an important role in tradeliberalization from now on. Could it be a leader ofthe WTO?

Davis: I think they should and it would be in their interest to do so,but in terms of whether they will, I am not confident. The leadershipof China right now appears more focused on internal control and has
not been putting forward ambitious liberalization proposals. They
have endorsed liberal rules at Davos, and more recently havechastised Trump’s policies as being the wrong way to go and said
that we should support multilateral trade rules. In this sense, therhetoric of China has indeed been very supportive of the WTO. But
we haven’t seen them come forward — either unilaterally or at a
WTO ministerial or APEC ministerial — with a proposal that would
show a willingness for China to take a reform itself, whether it’smarket opening with lowering tariffs or rules strengthening ontransparency of trade or new policies on competition and digitaltrade. Nothing like that has been forthcoming, and while I do thinkthat China should become a leader and I hope it will, I have not seen
evidence to date.
JS: To my knowledge, China is very much interested

in a domestic policy agenda as it has a problem in
its structural economic reforms. In this context it
might be better to discuss trade and domestic
policy issues simultaneously, outside of the WTO.

30 Japan SPOTLIGHT • September / October 2018

Davis: I don’t think that China wants to discuss its domestic
problems internationally. I agree with the need to consider structuraladjustment jointly with liberalization but structural adjustment is verymuch touching on sovereignty, and so countries like China that areespecially sensitive about control over domestic policies are lesslikely to want to have those issues discussed at a multilateral venue.
JS: Coming back to the OECD and APEC, these areinformal venues and not for negotiations. At thismoment, perhaps it would be better for us to havegood discussions in such informal venues rather
than negotiation venues.

Davis: Informal venues can be useful for building confidence andtrust, and certainly we have seen a breakdown in both of these, so
I think there is a role for summits to try and improve relations, andyou can’t go forward and make new formal rules when you don’t
trust the other side and think they will cheat. I think this is a goodtime to move forward if possible with building confidence andshowing some mutual interest in reaching an agreement throughtalking at an informal level; if we can get past the name-calling andinsults from the last informal meeting at the G7, then perhaps we canbuild better relations among leaders and confidence and this would
lead them back to a formal setting. Informal meetings are nevergoing to be enough because there is always this tendency to have avague declaration of agreement on peace and prosperity, and thisdoesn’t do anything when it comes down to protecting a specificindustry. What is allowed and what isn’t allowed requires a more
specific rule and it requires someone to interpret that rule when it isapplied in a specific case.
JS: Do you think such informal meetings could

create peer pressure?

Davis: For normal times, yes. I am a little worried, however, whether
peer pressure will be effective now that populism is the political tide.
Trump and other leaders actually gain popularity with theirconstituency by causing a fight at a multilateral venue. So far fromthere being peer pressure, it may be that getting into a fight at somepublic forum is helping their domestic stance of fighting for thenational cause. Thus, peer pressure has to be done very carefully to
avoid a backlash.
JS: Apart from the OECD or APEC, there seem to belots of proposals concerning possible restoration of
global governance, and one of them seems to be therole of middle powers such as Japan, Canada andthe EU. Can they join forces in order to restore free
trade?

Davis: Yes, we certainly saw this with the TPP where Japan stepped
up when the US withdrew, and Japanese diplomats worked very hardto keep the agreement going forward. It wasn’t easy to persuade
Vietnam and other countries that wanted access to US markets that
there still was something to gain from an agreement without the US.

Special Interview 2This was a big step. The idea that put a waiver on the intellectual
property rights claims that only the US had wanted was quite useful
because it puts pressure on the US to eventually join if it wants toachieve those. So I think that Japan’s role in the TPP was quite good.
It went forward with liberalization in a way that could apply pressure
on the US while still saying that they wanted the US to join, andI hope that we’ll see this with other countries in future. The EU-Japanagreement is similar where they have gone forward with theirliberalization showing that they can reach good agreements that havea lot of the policies that the US would probably want. Now US
exports will face pressure from that because they are at a
disadvantage.

Long-Term Impact of Trade Wars
& Future Prospects
JS: Presumably, in the long term the global economy

interests and the farm interests that have traditionally supported theRepublican Party are all in favor of free trade, and so there is a
scenario where the Trump administration’s position will continue but
retrench when there are signs of concessions from China after theelection. So this may prove to be a short period of tensions. The
negative view is that China also faces domestic political pressure anddoes not want to make a concession. The Trump administration has
already shown that it does not answer to the Chamber of Commerceor traditional Republican ideology. So, I would put it 50-50 as to thepossibility of the short trade war being over by December, or if weare actually going to see this continue, because the current trend in
the US is towards a dramatic challenge of the trade system. China
has yet to learn how to navigate this trade conflict and they mightmake mistakes. That is how wars happen, if both sides think they
can win; but in reality they can’t, you can get into a long war that
nobody wants.

is going to significantly suffer from these tradewars. In the short term it may not be so serious.
How do you see the impact of trade wars on the
global economy?

JS: Japan is concerned that further possible tariffs
on autos could break global supply chains and thefallout could be enormous. Do you think that tariffs
on auto imports will be possible?

Davis: The actual amount of trade restricted is still small enough that
we are probably not seeing a major negative impact. At this point,even the US stock market is holding up OK, although China issuffering a little from stock market decline and its currency losing
value. I think we are still at an early stage and if this expands further
it would include more trade, which would certainly harm economic
welfare. More serious damage could arise if the trade conflictcontinues further because there will be such a loss of confidence thatbusinesses would stop investing, and then the harm would not justbe the tariff barriers but rather all of these foreign firms that might
have otherwise invested in a new plant but now don’t know if theyshould because there might be new trade barriers. It could easily
make a lot of investors more cautious about expanding production,and of course this is what lays the basis for economic decline
because everyone becomes nervous about investing. I think there isa direct effect from trade barriers hurting specific jobs such as
farmers or some industries abroad such as steel. I think that if thiscontinues we will lose business confidence and this could trigger
major economic consequences.

Davis: In the same way that the administration went forward on
steel, they are likely to do the same on autos and there will be
retaliation from other countries. This will be the next step in the trade
conflict, and this will heat up in September and October. Will there bea concession, and will the firms put the burden on consumers? In
some ways they should, because the best way to stop trade wars isfor consumers to realize that they are the ones who pay the cost ofprotectionism; a tariff is a tax. If we can get the public to realize thatraising tariffs means raising taxes, you wouldn’t see as much
populist support for this tough talk on trade. I actually would like to
see the automobile companies directly pass on the cost of the tariffto the consumer, and then consumers would have to express theirconcerns to their elected officials.

JS: How about the outlook for this US-China tradewar? I think the Chinese economy may notwithstand the pressure very well and may have to
make concessions eventually. The US might have aninterest in national security concerns in Asia
including the Korean Peninsula, which might lead toits making concessions.
Davis: The Chinese government may make concessions to forestall
any further harm to their economy. The US — especially if the Trumpadministration enjoys a victory in the November election — will be ina good position to accept some concessions to stop the tariffs. The
Republican Party has long supported free trade, and the business

JS: The impact on global supply chains could involve
so many countries and this would make the whole
picture very complicated.
Davis: Doesn’t this also neutralize the effect though, to the extent
that all are going to face the tariff? It’s interesting that General
Motors and Ford have come out against the auto tariff because they
have realized that they will also suffer from tariff retaliation and theyalso have companies overseas.
JS: This is how we will learn about the outcomes ofglobalization.
Davis: Yes. Let us hope we learn the right lessons!

Written with the cooperation of Joel Challender, who is a translator,
interpreter, researcher and writer specializing in Japanese disaster
preparedness.

Japan SPOTLIGHT • September / October 201831