COVER STORY • Global Governance at a Crossroads – a Roadmap Towards the G20 Summit in Osaka • 3

T

he Global Trading
System: What Went
Wrong & How to Fix It

By Edward Alden

Introduction
It has now been more than a quarter century since the UnitedStates, the European Union (EU), Japan and more than 100 othercountries came together to conclude the Uruguay Round global trade
agreement and establish the World Trade Organization (WHO). It wasa time of extraordinary optimism. Mickey Kantor, US trade
representative for President Bill Clinton, had endured many sleeplessnights with his counterparts to bring the deal home by the Dec. 15,
1993 deadline. He promised the new agreement would “raise thestandard of living not only for Americans, but for workers all over theworld”. Every American family, he said, would gain some $17,000
over the next decade from lower-cost imports and faster global
growth. For the world, the end of the US-Soviet rivalry and the dawnof a new era of economic cooperation would “turn mutual assured
destruction into mutual assured prosperity”. He recounted the errorsof the past, when the US after World War I had turned inward andprotected its economy with high tariffs, causing other countries to do
the same in a cycle of beggar-thy-neighbor protectionism thatdeepened the Great Depression. Now instead, he said, the world wason the cusp of a new era of growth led by “the historic engagementof the United States”.
That halcyon moment now seems part of a distant past. The
Uruguay Round would be the last major global trade agreement
concluded – the seventh in a series reaching back to theestablishment of the General Agreement on Tariffs & Trade (GATT) in
1947. The Doha Round launched in 2001 was quietly buried in 2015,
a victim of insurmountable disagreements among the US, Europe
and the rising developing countries like India and China. China’s
entry into the WTO in 2001 would trigger a surge of exports that
contributed to the loss of well-paid manufacturing jobs in the US,
Europe and elsewhere, helping to fuel a populist backlash against
globalization. And in 2016, voters in those US states hit hardest bytrade competition – Ohio, Pennsylvania, and Michigan – would handthe presidency to Donald J. Trump, an avowed economic nationalist.
In his first two years in office, President Trump pulled the US out of
the massive Trans-Pacific Partnership (TPP) trade deal with a dozen
Pacific Rim countries, and launched a flurry of tariff protection
measures unseen in the US since the Smoot-Hawley bill in 1930.
Most other countries responded in kind.
The international economic order is now at a turning point. The
trade skirmishes of the last two years could be merely the first acts
https://www.jef.or.jp/journal/

Author Edward Alden

in what will become a prolonged era of growing nationalism andprotectionism. Gideon Rachman, the Financial Times columnist, hasargued that the nationalist backlash symbolized by Trump’s election
and the 2016 Brexit vote in the United Kingdom is likely to spread toother countries and persist for several decades. But, he noted, thosemovements will have to show that they can deliver not just promises
but real economic results. So far – as the process of the UK
government and parliament’s efforts to leave the EU show – real
economic results have not been delivered. But champions ofglobalization and the “rules-based trading system” cannot simply
wait and hope that the failures of economic nationalism will become
evident. They will have to acknowledge their own failures over the
past several decades, and demonstrate that they can deliver where
the economic nationalists cannot in spreading the gains ofglobalization more broadly.

Global Governance & Global Gains:
What Went Wrong?
For nearly a decade, it looked like Kantor’s rosy optimism about
the mutual benefits from global trade would not be far off the mark.
American households did not see the promised $17,000, but by theturn of the century the annual median household income had risen
by nearly $8,000 to more than $60,000 as the US economy enjoyed
the fruits of the information technology revolution and growing
trade. The rest of the world benefited as well. In the two decades
leading up to the 2008 recession, more people were raised fromextreme poverty than in any other period in human history, mostly
those in China and India.
But the “win-win” story did not last long. The creation of the WTO
had coincided with, and reinforced, a technological earthquake thatwould turn more than 150 years of global economic history on its
head. As economist Richard Baldwin lays out in his book The Great
Convergence, the Industrial Revolution of the 19th century hadlaunched Europe, the US, Japan and Canada on a trajectory thatwould see their wealth surge ahead of the rest of the world. In 1820,
for example, incomes in the US were about three times those of
China; by 1914 Americans would be 10 times as wealthy as Chinese.
Manufacturing clustered in the technologically advanced countries,
while advances in containerized shipping and the lowering of tariffs
through trade negotiations made it possible for these countries tospecialize and trade in the classic Ricardian fashion.
Japan SPOTLIGHT • May / June 201913

COVER STORY 3

The information technology revolution of the 1990s turned thatstory upside down. With the advent of cheap, virtually instant global
communications via the Internet, it became possible – and thenimperative for competitive success – for multinational companies totake their best technologies and relocate production in lower-wagecountries. Manufacturing output rose in middle-income countries
like China, India, Thailand, Poland and others, while falling sharply in
the US, Japan, France, the UK and even Germany. Most developing
countries – which had been reluctant participants in the Uruguay
Round negotiations – abandoned decades of protection and began
opening up to attract global investment and win their share of thegrowing pie. Bilateral investment treaties – which protect foreign
investors against various forms of expropriation – proliferated, withhundreds of new deals negotiated in the 1990s. The most important
accomplishment of the Uruguay Round was not its continued
incremental tariff cuts, but the new rules to protect intellectual
property, which allowed multinational companies to expand
operations overseas with greater assurance that their technologies
would not be stolen by competitors.
All of this should have been good news for the world. The rapid
growth of the developing economies was a long overdue catching up
with their wealthier counterparts. And while growth wascomparatively slower in the advanced economies, they had
continued to see modest gains. According to the World Bank, global
wealth increased by nearly two-thirds from 1995 to 2014, to morethan $1.1 trillion. The share going to middle-income countries suchas China and India grew from 19% to 28%, while the advanced
economies of the West saw their share fall from 75% to 65%. But
there was still more than enough to go around, and the average
American is still five or six times wealthier than the average Chinese.
The global great convergence, however, coincided with a great
divergence within the wealthy countries (and many developing
countries as well). The new technologies and the disappearance oftrade barriers upended the balance between labor and capital in theadvanced industrialized countries, and contributed to soaring
economic inequality. In the early 1960s, the US labor leader George
Meany had been one of the country’s great champions of tradeliberalization, arguing that freer trade would “contribute to thegrowth of employment and improvement of living standards at home
and abroad”. Within a decade, however, the unions had reversed
course, recognizing that global investment by US companies waschanging the balance of power at home that had allowed unionizedworkers to bargain for higher wages. Where once the giant American
14 Japan SPOTLIGHT • May / June 2019

companies had little choice but to share their gains with theworkforce, now they had enormous leverage – workers who insisted
on more could be replaced, either by cheaper workers overseas or bymachines at home. Where wages had once advanced in lockstep withrising productivity, companies began to take home more in profits
and workers saw less in their paychecks.
The new information technologies themselves reinforced thisrising inequality. As machines replaced workers – not just in
manufacturing but increasingly in office jobs of every sort – the needfor highly educated workers rose. In the US in 1979, an Americanwith a college degree or higher earned about 50% more than one
who had only a high school education or less. By 2018, American
workers with a four-year college degree earned almost twice asmuch as those with just a high-school education, and were
unemployed half as often, while those with a professional degree
earned nearly three times as much. The trends have been similar in
all the advanced economies, with the earnings premium fromeducation rising sharply. In many countries, however, higher taxes
on the wealthy and government programs for redistribution havesoftened the blow. It is no coincidence that the two advanced
economies that have seen the greatest rise in after tax income
inequality – the US and the UK – are the ones that have seen thestrongest public backlash against globalization.

Irresponsible Stakeholders
Most of the blame for this state of affairs lies with politicians in theadvanced economies. It has been evident for decades that the growthin global economic competition would require adjustments todomestic economic policy to ensure that the benefits of global
growth were spread more evenly. In my book Failure to Adjust, I
quoted extensively from a memo written to President Richard Nixon
in 1971 by his chief international economic advisor, Pete Peterson.
Peterson warned the president that, as global economic competition
increased, the US would have to up its game by investing ininfrastructure, maintaining the best education system in the world,and funding retraining and assistance for workers who lost their jobs
to imports or automation. Instead, beginning with the Ronald Reagan
administration in the early 1980s, the US has focused primarily on
reducing the tax burden on the wealthy, paying too little attention to
the challenge of helping Americans adjust to an increasinglycompetitive economy.
But it is also true that the countries that were benefiting the most

COVER STORY 3

from the new globalization, especially China, have been slow to wakeup to what the changing balance of global economic power meant for
their position in the system. The two golden eras of global commerce– in the latter half of the 19th century and again in the latter half ofthe 20th century – occurred under rules that were largely establishedby a dominant economic power: the UK in the 19th century and the
US in the 20th century. Charles Kindleberger, who wrote the seminal
book on the causes of the Great Depression, argued that the
downturn was worsened by a fading UK’s inability to manage theglobal economic system, and the unwillingness of the US to step up
and play a bigger role.
The world today again faces the same governance gap – a US thatno longer has the economic muscle nor the political will to organize
the global system, and a rising China that is reluctant to play agreater role. Indeed, for most of the period since joining the WTO,
China has sought maximum economic advantage with minimum
regard for the rules and obligations of WTO membership. It has
heavily subsidized industry after industry, used discriminatory
regulations to disadvantage foreign companies and favor its own
national champions, and engaged in a broad campaign of technology
acquisition using every tactic from forcing foreign investors to sharetechnology with Chinese competitors to outright cyber-theft. And formany years it intervened in currency markets to hold down the valueof its currency, the renminbi, to gain competitive advantage. These
are the issues at the heart of the ongoing trade dispute between the
US and China.
The US, as well as Europe and Japan, can certainly be blamed for
not responding sooner and more forcefully to these Chinese
provocations. It wasn’t until the second term of the Barack Obamaadministration that the US moved beyond the occasional WTO
complaint and finally initiated a slew of WTO dispute settlementcases to go after the growing list of the problems with China. In
retrospect, the US took a gamble in treating China so delicately. In
2005, for example, former US Trade Representative and then Deputy
Secretary of State Robert Zoellick gave a speech urging China tobecome a “responsible stakeholder” and work “to strengthen theinternational system that has enabled its success”. But he warned:“The United States will not be able to sustain an open international
economic system – or domestic US support for such a system –without greater cooperation from China as a stakeholder that shares
responsibility on international economic issues.”
He was right. Since the election of Trump, the US has all butabandoned its post-World War II role as the chief architect andguardian of the rules-based trading system. The Trumpadministration has embraced a zero-sum view of the global tradesystem, using tariffs as a weapon to block access to what is still theworld’s largest market and try to force trading partners from Canada
and Mexico to South Korea, Japan and the EU to renegotiate longstanding trade arrangements in ways designed to shift investment to
the US. With China, the administration has engaged in an aggressive
effort to block China’s drive for technological parity with the US. It
has largely shut off Chinese acquisitions of American companies on
security grounds, and is pressuring US allies to restrict transactions
with Chinese high-tech companies such as Huawei and ZTE. Someadministration officials are pushing for a deeper de-coupling of the
US and Chinese economies, reminiscent of the economic
containment strategy pursued against the Soviet Union during theCold War.

Better Globalization: Is There a Blueprint?
If history is a guide, there is every reason to believe that disputes
over the relative gains from the global economy will worsen. Both the
US and China are likely to dig more deeply into their respective
corners. Under President Xi Jinping’s leadership, China has beenfunneling more resources to state-owned enterprises, interfering
more deeply in the management of foreign enterprises, and using its
economic muscle to influence the behavior of smaller countries.
Pressure from the US is likely at best to lead to a tactical pause rather
than a change in direction. In the US, concern over China’s economic
practices and its increased global assertiveness is shared among bothparties. Future presidents, either Democratic or Republican, areunlikely to embrace the more unconditional engagement of the former
administrations of Obama and George W. Bush.
The great power rivalry will force smaller countries to look out for
their own narrow economic advantages through new bilateral orregional trade arrangements. The recent EU trade agreements with
Mexico, Canada and Japan – as well as the decision by the othermembers of the TPP to move forward without the US – are signs of
this Plan B in action. But these middle powers are also the countries
with the most to lose from the weakening of the rules-based trading
system and the return to great power economic competition. The
WTO’s dispute settlement system – the most ambitious
accomplishment of the Uruguay Round – nearly leveled the playing
field for smaller countries. The alternatives will almost certainly leavethem in a worse position.
Japan SPOTLIGHT • May / June 201915

COVER STORY 3

In the face of such trends, what are the prospects for a renewed,
and perhaps more stable, globalization? There are three key
elements:

A Trade War Truce
Winston Churchill was famously quoted as saying that Americans
can always be counted on to do the right thing, after exhausting all
the other alternatives. And Trump’s trade war seems to beapproaching the point of exhaustion. After a flurry of threats andtariffs, the president appears to have lost his appetite for more, waryof negative market reaction as the 2020 presidential elections
approach. And while the US economy remains strong, the solewinner from the whole effort has been the profits of US steel
companies. Trump had hoped to use the tariffs to bludgeon allies
into more favorable trade deals, but the only victories to date havebeen modest renegotiations of the trade agreements with Canada,
Mexico and South Korea.
China poses the most difficult challenge. The tariffs against China
are far more popular in the US than those on allies. But even here,
there is little confidence that that US sanctions and bilateral pressurealone will produce big changes in Chinese economic practices. The
Trump administration appears to be waking up to the reality that the
US and China will face years, perhaps decades, in which economic
cooperation and economic conflict will be inter-mixed. In such a longstruggle, the US will need all the allies it can get.

Filling the Leadership Vacuum
Even if the US and China reach some kind of temporary truce, theabsence of trade conflict will not by itself strengthen or reform therules-based trading system. The two economic superpowers could
instead begin to carve up the world into zones of influence, offering
special favors for countries that cooperate and levying sanctions
against those that don’t. Countries like Japan and Australia – close
US allies that depend especially heavily on the Chinese market –would find themselves in an unenviable position, tugged back andforth between their two most important partners.
There is growing recognition of this danger and attempts to bringthe US and China back into the fold. The EU and Canada have led
efforts to reform the WTO dispute settlement system, especially theAppellate Body that has been a target of US complaints. The US has
supported efforts by the EU and Japan to launch new WTO
negotiations focusing on e-commerce. The upcoming G20 summit in
Osaka, with Japan in the presidency, is an opportunity to discuss
16 Japan SPOTLIGHT • May / June 2019

bolder proposals. These should include work on curbing distortive
industrial subsidies, guidelines for limiting currency manipulation,and efforts to curb harmful tax competition that has allowed many
multinational companies to avoid taxes and erode the revenue basethat governments need to tackle the challenges of globalization andautomation.
It is far from clear whether the G20 has enough coherence, orsense of common interest, to step up to this role. It came closest in
the early months of the 2008 financial crisis. But such a coordinatedleadership effort is desperately needed. The last time the global
economic system faced similar uncertainty over the rules was in theearly 1970s following Nixon’s decision to pull out of the fixedcurrency regime established by Bretton-Woods. At that time,negotiations and coordinated efforts by the major economic powers– including Japan, Germany, France, and the UK – were critical tore-establishing confidence in the international financial and tradesystems. A similar effort is needed again. China and the US will be
reluctant participants at best, but may become weary of theirbilateral struggles and willing to consider other paths forward.

Meeting the Challenges at Home
No reconfiguration of the international rules will matter in theabsence of domestic policies that start to tackle rising inequality. In
the US, this is the issue that will be at the heart of the 2020
presidential election, with Democrats calling for an array ofmeasures including a higher minimum wage, cheaper or free college
education, health care for all, and increased taxes on the wealthy.
The disruptions caused by global economic competition are only
likely to accelerate with the advance of automation and artificial
intelligence; McKinsey & Co. predicts that as many as one-third ofworkers could need to change occupations or acquire significant new
skills over the next decade as machines replace tasks long done byhumans. If governments cannot do a better job of helping theircitizens manage this transition, discontent with the economic rules –including global economic rules – will continue to grow.
The post-World War II economic order, which has done so muchto spread prosperity across the world, is in the midst of the largest
challenge it has yet faced. It will require courage and creativity to finda better path forward.
Edward Alden is a senior fellow at the Council on Foreign Relations, and theRoss Distinguished Visiting Professor at Western Washington University. He is
the author of Failure to Adjust: How Americans Got Left Behind in the Global
Economy.