The Breakdown - A Better(?) Approach to Fixing the Broken Global Trading System

Starting point is 00:00:04 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Sunday, April 27th, and that means it's time for Long Read Sunday. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. All right, friends, well, it will surprise you not a lot of all, that the discourse continues to be squarely focused on Trump's tariffs, and today we here at

Starting point is 00:00:43 the breakdown have done the impossible. We have found a piece that sort of strikes a middle-of-the-line tone around them, or at least extrapolates out and talks about the larger context rather than just focusing on the numbers themselves. The piece is by well-known thinker and Carnegie Endowment Senior Associate Michael Pettus. It's called the global trading system was already broken. Now it's subtitle, but there's a better way to fix it than a reckless tariff regime, gives you a sense of where Michael is headed, but it still gets at some important points. So let's turn it over to an AI version of myself for this fairly long read, and then we'll come back with a quick wrap-up. The sweeping tariffs announced by U.S. President Donald Trump on April 2nd, along with the

Starting point is 00:01:22 subsequent postponements and retaliations, have unleashed an enormous amount of global uncertainty. Much of the world's attention is on the chaotic short-term consequences of these policies, wild stock market fluctuations, concerns about the U.S. bond market, fears of a recession, and speculation about how different countries will negotiate or react. But whatever happens in the near term, this much is clear. Trump's policies reflect a transformation of the global trade and capital regime that had already started. One way or another, a dramatic change of some kind was necessary to address imbalances in the global

Starting point is 00:01:55 economy that have been decades in the making. Current trade tensions are the result of a disconnect between the needs of individual economies and the needs of the global system. Although the global system benefits from rising wages, which push up to the economic demand for producers everywhere, tensions arise when individual countries can grow more quickly by boosting their manufacturing sectors at the expense of wage growth, for example, by directly and indirectly suppressing growth in household income relative to growth in worker productivity. The result is a global trading system in which, to their collective detriment, countries compete

Starting point is 00:02:27 by keeping wages down. The tariff regime Trump announced earlier this month is unlikely to solve this problem. To be effective, American trade policy must either reverse the same, imbalance in the rest of the world, or it must limit Washington's role in accommodating it. Bilateral tariffs do, neither. But because something must replace the current system, policymakers would be wise to start crafting a sensible alternative. The best outcome would be a new global trade agreement among economies that commit to managing their domestic economic imbalances, rather than externalizing them in the form of trade surpluses. The result would be a customs union,

Starting point is 00:03:03 like the one proposed by the economist John Maynard Keynes at the Bretton Woods Conference in 1944. Parties to this agreement would be required to roughly balance their exports and imports while restricting trade surpluses from countries outside the trade agreement. Such a union could gradually expand to the entire world, leading to both higher global wages and better economic growth. Keynes' plan failed to carry the day at Breton Woods, largely because the United States, the leading surplus economy at the time, opposed it. Today, however, there is a chance to revive and adapt his proposal.

Starting point is 00:03:37 To understand what ails the global trading system, consider how wages shape an individual economy. Higher wages are usually good for the economy because they boost demand for businesses while increasing their incentive to invest in efficiency. The result is a virtuous cycle. The growing demand spurs increased investment into ways of producing more, with fewer workers, raising economic productivity, which in turn drives further increases in wages. individual businesses, however, have different incentives. They can boost profits by suppressing wages.

Starting point is 00:04:08 The problem is that although lower wages can benefit an individual business, they reduce the profits of others. In an economy in which business investment is mainly constrained by whether there is demand for more production, if businesses collectively suppress wages, either household and fiscal debt must rise to replace the lost demand, or total production and business profits will decline. Although this phenomenon, sometimes called Mikkel-Kalecki's paradox of costs, name for the economist who first proposed it, mainly describes businesses, it also applies to countries in a global economy. If suppressing wage growth can make manufacturing in one country more globally competitive, it can generate faster growth for that country by subsidizing and boosting

Starting point is 00:04:47 manufacturing exports. But if all countries suppress wage growth, growth in global demand is reduced, and all countries suffer. In a highly globalized world where some states are more successful than others at suppressing labor costs, the result is an asymmetry in the demand for and supply of goods. Because businesses do not have to make products in the same places where they sell them, local labor costs become crucial to the competitiveness of manufacturers. Businesses that shift production to countries where labor costs are lower relative to workers' productivity can produce goods more cheaply, making their products more attractive globally. In any given state, wage suppression puts downward pressure on domestic consumption

Starting point is 00:05:26 while subsidizing domestic production. This results in a rising gap between production and consumption, which, if it remains within the economy, must be balanced by raising domestic investment, which can further exacerbate the gap between production and consumption. Otherwise, the gap invariably reverses either via raising wages or by cutting back on production. Today's episode is brought to you by Crypto Tax Calculator. If you're looking for accurate crypto taxes with no guesswork, check out Crypto Tax Calculator. Get accurate CPA-endorsed tax reports with full support for IRS rules.

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Starting point is 00:07:09 If you are in this space, you owe it to yourself to at least check out Ledger and their ecosystem what they have available to you. So thanks, once again, to Ledger for sponsoring the show. But in a globalized economy, there is another option, running a trade surplus. This allows the country to export the cost of the gap between consumption and production to trade partners. This is why, in 1937, the economist Joan Robinson referred to the trade surpluses that resulted from suppressed domestic demand as the consequences of Beggar My Neighbor policies. It is also why, at the Bretton Woods Conference in 1944, Keynes opposed a global trading system

Starting point is 00:07:48 that allowed countries to run large, persistent trade surpluses. a system that accommodated these surpluses, he said, would encourage countries eager to expand manufacturing to subsidize it at the cost of domestic demand. The result, Keynes explained, would be downward pressure on global demand as countries fought to remain competitive by suppressing wage growth.

Starting point is 00:08:08 The country's most successful at doing so would become the winners of global trade. Their share of global manufacturing would expand while that of their trade partner's contracts. Keynes instead called for countries to learn to provide themselves with full employment, by their domestic policy. In such a world, he argued, there would not be important economic forces calculated to set the interest of one country against that of its neighbors. At the time that Keynes and

Starting point is 00:08:33 Robinson were writing, the cost of Beggar Thy Neighbor policies came mainly in the form of higher unemployment, as higher exports, unbalanced by higher imports, undermined manufacturers in trade deficit countries, and forced them to lay off workers. But after the world abandoned the Bretton Wood system in the early 1970s, government, including the U.S. government, learned to allay the costs of unemployment, either by lowering interest rates to encourage consumer lending, or through unrestricted deficit spending. The United States thus disguised the employment consequences of running a consistent trade deficit, but it did so through surging household and fiscal debt. The link between the internal imbalances of one country

Starting point is 00:09:14 and those of its trade partners has implications that economists sometimes fail to fully understand. In every economy, internal and external economic imbalances must align, just as each country's external imbalances must align with the external imbalances of the rest of the world. This means that countries able to control their internal imbalances will at least partially drive the internal imbalances of trade partners. It is why in any globalized system, as the economist Donnie Roderick has explained, countries must choose either more global integration or more control over the domestic economy. Within Roderick's formulation, there are at least two very different ways of understanding globalization.

Starting point is 00:09:54 In the one most analysts assume describes the world, major economies all chose to give up broadly the same degree of control over their domestic economies in favor of more global integration. Global trade is thus generally balanced as market forces reverse government policies that create internal imbalances. If a country runs large, persistent trade surpluses, for example, its currency will appreciate or its wages will rise, making its goods more. expensive. That will, in turn, cause the trade surplus to shrink as the welfare of domestic households

Starting point is 00:10:25 expands. In the other model of globalization, one that better describes the world as it is, some major economies exert less control over their domestic economies in favor of more global integration, whereas others choose to retain control over their domestic economies, perhaps by controlling wage growth or determining domestic prices and allocation of credit, or restricting trade and capital accounts. To the extent that the latter set of states intervene to prevent their domestic economic imbalances from reversing, they effectively impose their internal imbalances on countries that retain less control over their trade and capital accounts. If they choose industrial policies aimed at expanding their manufacturing sectors, for example, they are also

Starting point is 00:11:07 implicitly imposing industrial policies on their trade partners, albeit ones that result in a relative contraction in those partners' manufacturing industries. This is precisely. This is precisely. precisely the kind of globalization that Keynes and Robinson opposed. It is the kind of globalization that allows governments to pursue Kaleckian strategies that are expansionary for their economies, but contractionary for the global economy as a whole. If globalization is to thrive, the world must revert to a kind of globalization where countries export in order to import and where a country's production, consumption, and investment imbalances are resolved domestically, not foisted onto trade partners. The world requires, in other words, a new global trade regime

Starting point is 00:11:49 where countries agree to restrain their domestic imbalances and match domestic demand with domestic supply. Only then will states no longer be forced to absorb one another's internal imbalances. The best way to achieve this kind of globalization is to create a new customs union, along the lines of what Keynes proposed at Breton Woods. States that join would agree to keep trade between them broadly balanced with penalties for members that fail. But they would also erect trade barriers against countries that don't participate in order to protect themselves from imbalances outside the customs union. Trade would not be expected to balance bilaterally, of course, but rather across all trade partners. Its members would have to commit to managing their economies

Starting point is 00:12:29 in ways that would not externalize the costs of their own domestic policies. In that system, every country could choose its own preferred development path, yet it could not do so in ways that inflict the costs of domestic imbalances on trade partners. Smaller, less developed economies might receive some limited exemptions from the union's rules. Many countries, especially ones that have structured their economies around low domestic demand and permanent surpluses, might initially refuse to join such a union, but organizers could start by gathering a small group of countries that make up the bulk of global trade deficits, such as Canada, India, Mexico, the United Kingdom, and the United States, and bringing them into it. These states,

Starting point is 00:13:10 would have every incentive to join, and once they did, the rest of the world would eventually have to participate. If deficit countries refused to run permanent deficits, after all, surplus countries cannot run permanent surpluses. They would instead be forced to raise domestic consumption or domestic investment, either of which would be good for global demand, or they would have no choice but to reduce domestic overproduction. If the world created such a customs union, international trade would cease to be, as Keynes wrote, a desperate expedient to maintain employment at home by forcing sales on foreign markets and restricting purchases. The reason countries maximize exports would no longer be to export the cost of subsidizing domestic manufacturing,

Starting point is 00:13:53 but rather to maximize imports and household welfare. If such a customs union isn't possible, however, the most likely outcome is the beggar-thy-neigh-neigh-neighbor game, predicted by Robinson, in which states endeavor to throw a larger share of the burden upon the others, as she wrote. As soon as one succeeds in increasing its trade balance at the expense of the rest, others retaliate, and the total volume of international trade sinks continuously. That seems to be the condition into which the world has been heading. It is what has delivered Trump's tariffs, along with rising trade complaints from people around the globe. Until policymakers change the incentives for economies, international trade tensions will not abate.

Starting point is 00:14:34 All right, back to Real NLW here, just for a very quick wrap-up. There are really two points being made in Michael's piece. The first is a specific policy remediation and something he'd like to see, which is a return of some version of the customs union that was proposed by John Maynard Keynes at Bretton Woods back in 1944. Michael shared some specific arguments for this type of thinking and this type of remediation for this global trade problem. But the second part, which I think in many ways is more significant, is the acknowledgement

Starting point is 00:15:02 that even if the cure has been or felt in some ways worse than the disease, an acknowledgement that Trump didn't come in like a wrecking ball to a highly functional system. He came into something that was creaking, bloated, problematic, with issues both discreet and comprehensive, where something had to give. Now, we can and will continue to debate the scalpel versus shotgun strategy here, but I think that the more that we can have conversations, particularly around this president, that start with being able to acknowledge the context in which he's operating, the better off will be. For now that that's going to do it for today's breakdown. Appreciate you listening, as always, and until next time, be safe and take care of each other. Peace.

The Breakdown - A Better(?) Approach to Fixing the Broken Global Trading System

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