The Trump Trade War Recession?

By John Mauldin

 

Publisher’s Note: John Mauldin is recovering from a minor illness. He’ll be back next week. Meanwhile, with trade disputes still roiling markets, below is a still-timely letter he wrote last year. You should definitely read it again. Ed D’Agostino
 

“A conservative is someone who stands athwart history, yelling stop, at a time when no one is inclined to do so, or to have much patience with those who so urge it.”
 

I will never compare myself to Bill Buckley, as a writer or anything else. He was one-of-a-kind and a personal hero who I am disappointed to say I never met but who I read a lot. The response to my recent tariff comments gives me a small hint of how it must have felt to “stand athwart history” and launch the modern conservative movement.

Many of you support the tariffs. And I understand your reasons. I really do.

Free trade used to be a core belief of the conservative movement. Hayek, Friedman, Mises, Rothbard, and numerous other economists eloquently explained why. Several liberal economists agree. Conservative politicians spent the last few decades moving us in that direction, albeit imperfectly and with some big mistakes along the way. But few disagreed with the idea.

Let me be clear on this: I do not think the tariffs on China are going to cause a recession. But if we have a recession, that is precisely what the Democrats will say. Democrats will not run against the Fed, investor sentiment, markets, Italy, or anything else that actually causes the next recession. They will be running against Trump and everything will be his fault. It will be the Trump Trade War Recession. Whether or not it is true is immaterial.

That is neither here or there because a trade war with China introduces too many variables into an already difficult situation. Let’s look at what is actually happening on the ground.

Hoover, Smoot & Hawley

We all wonder if Trump’s trade actions are as random as they appear or if there is a broader strategy. Some of my contacts argue that the relatively strong US economy allows the administration to take a harder line than would normally be advisable. We can ride out a trade war better than China can, the thinking goes.

This only works if the US economy keeps prospering long enough for the tariffs to make China bend. We can postpone a recession for another year or two if the trade war doesn’t intensify and Europe holds together. Since it is intensifying—with a new round of 10% tariffs taking effect this week and more to come in January—we may not get that time.

In other words, tariffs could end the conditions that justified them. Something similar happened before, during the most famous trade mistake in US and global history: the 1930s Smoot-Hawley tariffs.

Similar to today, the Roaring 1920s saw rapid technological change, specifically automobiles and electricity. This created a farm surplus as fewer horses consumed less feed. Prices fell and farmers complained of foreign competition. Herbert Hoover promised higher tariffs in his 1928 presidential campaign. He won, and the House passed a tariff bill in May 1929.

The Senate was still debating its version of the bill when the stock market crashed in October 1929. Today, we use that event to mark the Great Depression’s beginning, but at the time, people didn’t know they were in a depression or even a recession. Most economists expected a quick recovery. Stocks did recover quite a bit in the following months, though not back to their prior highs.

So, when the Senate finally passed a tariff bill in March 1930, the thinking was not that different from what we see today. They thought they could preserve and even extend the good times. But conditions worsened quickly and by 1931, unemployed men were standing in soup lines.


In 1932, both Smoot and Hawley lost their seats as Franklin Roosevelt beat Hoover in a landslide—57% of the popular vote. That history won’t necessarily repeat this time, but it’s surely not a good omen.

Multiplayer Game Theory

John Nash (one of the world’s great mathematicians, Nobel laureate, and centerpiece of the brilliant movie A Beautiful Mind) developed multiplayer game theory. Essentially, an equilibrium develops around the rules as they are at the moment. If somebody changes the rules, no matter how rational the rule change may seem to be to the person who’s making the change, it makes everybody else change their response.

Trump’s actions, especially in regard to China, may be perfectly rational. China is not playing fairly. But his actions change the rules and everybody else is forced to react.

Throw in NAFTA, Europe, and all the other trade negotiations, and things get complicated. Yes, we have a new trade deal with Korea. The US is marginally better off. Trump is trying to do a one-off trade deal with Japan. Abe is cautious because Trump wants to open up Japan’s markets to US agriculture.

We pulled out of the Trans-Pacific Partnership (TPP) because it had flaws—clearly. But it served the purpose of isolating China.

Trying to do bilateral trade agreements with every one of those partners is going to be extraordinarily difficult and time-consuming, if not impossible. And so, everybody reacts to try to change the circumstances to their own benefit.

This is multiplayer game theory on a scale so vast that it is almost impossible for a human being sitting in the middle of the United States working at his job, just trying to get through the day, to understand. And so, they get angry and say we need more tariffs to protect America. Just like every other voter in every other country is trying to figure out how to protect their markets.

Trade Sandpile

Something else I keep hearing is variations of, “China is cheating, and we have to do something.” This comment from reader Justin McCarthy is typical.

I get all the handwringing and pearl clutching about trade wars. But it really appears that true free and fair trade is an illusion. China cheats. Why? Because it can. Everyone pretty much acknowledges it. But where are the projections and analyses of the long-term consequences of permitting the status quo to continue? What are the consequences of letting the balance of power shift in China's favor? I see a lot of angst about trade wars but no discussion about the effects of no action.

Justin said this nicely, but I have to disagree. He’s right that “true free and fair trade” is not what we have, nor have ever had. But trade isn’t a binary condition. Today, we see near-total isolation on one extreme (think North Korea) or at the other end extensive trade freedom, as nominally exists within the European Union. There’s lots of room in between.

China cheats in many and various ways, which I have stated are problematic. I’m not happy with the status quo, and I want to change it. The question is, are tariffs the best way to accomplish this? A second question is, even if tariffs accomplish the goal, will there be side effects that reduce or eliminate the benefits? I see a lot of unintended consequences.

A few weeks ago, I described how a sandpile can slowly grow in size, apparently stable, but in reality it has many hidden fingers of instability. At any moment, something could trigger an avalanche.

The global trade system is something like that. Of course, it’s not perfect or even optimal. Countries erect barriers to their advantage. I can point to several countries whose economic policies are mercantilist, but at least everyone knows about them. We see the fingers of instability and leave them alone, lest we trigger an avalanche whose victims are impossible to predict. It is a kind of equilibrium. Everyone’s incentive is to avoid catastrophe and make incremental improvements. That makes trade talks extraordinarily difficult.

The Trump administration doesn’t seem to care about equilibrium. Whether it’s coming from the president himself or those around him, the strategy appears to be “kick apart the sandpile and make everybody rebuild it.” And whether we like it or not, many of Trump’s supporters actually like the concept of throwing a wrench into the system.

So, it is not the case that the US has no choices. We have many choices. Tariffs are the wrong one. But then, that is just me and I am one lone voice and vote.

Victim List

Commerce Secretary Wilbur Ross is a brilliant businessman. He is proving less than effective as a public advocate for administration policy. Earlier this month, he appeared on CNBC to tell us the latest tariffs won’t be so bad.


Source: CNBC

Commerce Secretary Wilbur Ross concedes that prices in the US will increase as a result of the new China tariffs put in place by President Donald Trump.

However, Ross told CNBC on Tuesday, “Nobody is going to actually notice it at the end of the day,” because the hikes will be “spread across thousands and thousands of products.”

“If you have a 10 percent tariff on another $200 billion, that’s $20 billion a year. That’s a tiny, tiny, tiny fraction of 1 percent [of] inflation in the US,” Ross said.

That last part is true. Direct tariff impact will be a tiny part of overall inflation. But it’s wrong to say no one will notice. Plenty of people and businesses are already noticing. And when those tariffs go to 25% in a few months, $20 billion becomes $50 billion. That will be felt by the Walmart nation, and a long list of US corporations.

Cato Institute trade scholar Scott Lincicome assembled a handy list for Reason magazine. It includes 202 companies with links to local news stories that describe how tariffs hurt them. Some are large, some small. This example from the metal industry: The New Hampshire metal-service center has been forced to turn down large orders from potential customers because it can’t source material due to tariffs.

Browse the full list with source links here. Remove sharp objects from your vicinity when you do. The impact seems minor in many cases, but they add up. They spread, too: All these companies have customers and suppliers who depend on them. And we’re not even talking about the farmers who are already being hit with lower prices and higher costs. Think fingers of instability and sandpiles.

Some people say that the service sector is 85% of the economy, so tariffs can’t do that much damage. Much of that service sector serves people who manufacture stuff, buy food, and go to restaurants. It’s that sandpile thing again.

The weirdest part is that tariffs could drive some of these companies to move production outside of the US. That’s the opposite of what we want. We already see it with Harley-Davidson, which is going to make motorcycles for the European market in Thailand, thereby avoiding the retaliatory EU tariffs that would apply were they made in the US. Business-wise, that’s the smartest move Harley can make. But it will hurt US workers, not help them.

Lopsided Polls

Now, I can argue against tariffs until I turn blue, but I doubt it will have much effect. Yes, I voted Republican and that party controls both the White House and Congress. But I now find that I am in the minority. I am literally standing athwart my party yelling, “Stop.”

A recent New York Times poll found that 79% of Republicans favor tariffs.
 
Dear gods, have we come to this? In this graph, 73% of Republicans favor both tariffs and tax cuts while 6% oppose tax cuts and favor tariffs. I keep talking to more and more of my friends, nominally Republican, and we agree that we no longer have a party that represents us. Certainly, the Democrats don’t. I’ve shown the data in the last few weeks that independents are an increasingly small minority. When 79% of Republicans favor tariffs, and 80% of Democrats oppose tariffs, the world has truly turned upside down.


So where is this going? Barring some titanic shift in the midterms, the president will stay on course and Congress won’t stop him. We should know in the next week or two what happens with NAFTA. Trump has a meeting with Xi in late November.

My sources in China believe that something will happen to stave off the major effects of tariffs. But if Trump is looking for Xi to capitulate or somehow lose face, he is going to be waiting forever. Xi will use it to his favor.

Further, China is growing their exports to other nations so fast that they can replace whatever they might lose to the US within a few years. Trump may think that China needs us, and to some extent they do, but we need them as well. The world works much better when everybody works together.

The Seven-Body Problem

For mathematicians, it is well known that if you have three large objects that have gravitational impact on each other, you can determine where they have been in the past, but you cannot predict where they will be in the future. It is called the Three-Body Problem. We are well beyond the three-body problem in economics.

We’re going to see quantitative easing in our future on a scale that will shock everybody.

Remember that I said it. You heard it here first.

We have at least a seven-body problem, and there is no way to predict what will happen. And Trump throws in the uncertainty of tariffs and a trade war with China.

He does this at a time when optimism on whatever index you want to look at is at an all-time high, unemployment is low, the economy is booming, and with Republicans hanging on by a slim margin with elections coming up, he could lose his ability to do or pass anything for the next two years.

Not unlike 1929. You’d better have your hedges and strategy together.

There is no reason for the US to go into recession unless a trade war begins to really impact the economy. It doesn’t have to impact a lot in order for future expansion plans by businesses to be impacted.

I am getting nervous.

Your wondering when we get back to some kind of centrist consensus analyst,



John Mauldin
Chairman, Mauldin Economics

Europe Redefined

The European Parliament elections are a benchmark for a continent in flux.

By George Friedman

 
The biggest takeaway from the European Parliament elections, which were held last weekend, is that the political center continued its decadelong retreat. This election is a milestone in that regard, though it is difficult to articulate why, considering the European Union has no clear constitution that defines its institutions and its powers. Instead it is governed by treaties among nations. Treaties among nations are necessarily compromises, and compromises necessarily make for ambiguity. Some institutions are controlled by constituent governments, of course, through which democracy is mediated by domestic elections. But the European Parliament is the only institution in which the votes of EU citizens create the membership. The multiplicity of authoritative bodies and their overlapping powers only adds to the ambiguity.
From the beginning of the European project, few European governments were prepared to cede power to pan-European institutions. The European Union is not a multinational state. Yet the European Parliament reflects the idea of Europe as a single political entity. The rest of the European Union reflects the fact that it is the nation-states that have joined together in a treaty organization, the elected governments of those nation-states retain ultimate authority, collectively over the EU, and ultimately over themselves.
Before the Maastricht Treaty went into effect in 1992, there were several disagreements between European nations over policy issues, with many going their own way. These faded for a while but never completely disappeared. Nations occasionally chose to disregard European rules and go their own way, but they were bound together by their original ideology, which dictated simply that after two world wars of staggering horror, Europe sought an exit from its past. The creation of economic unions (one of the stipulations of the Marshall Plan) was designed to eliminate what was thought to be the fundamental cause of these wars: nationalism. The thought was that binding nation-states together economically would reduce the chance of war. It worked insofar as there were no wars, though that had as much to do with the general weakness and dilapidation of Europe as it did with the fear of battle.
Nationalism may have been the original motive for the EU’s creation, but after 1992 the bloc adopted another principle: technocracy, which arose from the ashes of the Soviet Union. The Cold War had been an ideological battle. Europe’s leaders envisioned something that moved beyond ideology. They wanted a government of experts, a government that made decisions without the burdens of outdated systems of belief about what government should do. Beneath the nation-states, and beneath the democratic parliaments, emerged a cadre of what might be called technocrats, a disinterested class committed to efficiency and governance. The EU managed the enormously complex system through regulations, and the regulations were formally approved by political masters but were generated and controlled by the civil service.
All this worked to some extent until 2008, when the competence of the technocrats was brought into question, and when national leaders became more responsive to the problems in their own countries for fear that they would lose their jobs. The idea that the technocracy of Europe was not ideological was an illusion. Technocracy is itself an ideology, deciding what is better and worse based on the consensus of the moment, rather than on explicit principles.
The consensus between 1992 and 2008 was the belief that economic growth, seen as the inhibitor of war, was all-important. The distribution of wealth, or the damage done to some through the impositions of efficiencies leading to growth, was simply a price to pay. Somewhere along the way, a tacit consensus emerged between center-left and center-right parties of a Europe with common values. In their shared vision, Europe’s laws aligned not with the wishes of their voters but with the principles of the parties and the technocrats who shared them.
The measure of a technocracy, though, is its competence. It appeared to many that Brussels was incompetent, and that their pious repetition of the centrist belief in European values was merely a cover for the interests of the European elite.
This came to a head with the Muslim migration issues, and it did so in three ways. First, it raised the issue of whether the EU principles could compel nations to accept migrants based on European principles from which some states and many people dissented. Second, there was the awareness that when migrants came, they would not live in the elite, affluent neighborhoods of the member states – in other words, the places that advocated the loudest for open doors. Third, it raised fundamental questions about the limits of EU power and the rights to self-determination of member states.
Over the past 10 or so years, the EU’s center held in the face of the British referendum to leave the EU, the Greek crisis, the election of governments in Poland and Hungary that pursued the wishes of their electorates rather than the EU, and of Italy, which resisted the EU’s attempt to impose a solution to its financial crisis.
Naturally, the center responded by demonizing all of these centrifugal forces. Also natural was the spread of these movements labeled as populist.  What they were was a return to what Europe had always been and truthfully never left, for all the efforts of the EU. Nationalism was re-emerging, drawing the lower classes into the system, insisting on controlling who may reside there, and treating Europe as a treaty rather than a nation. The EU was created to suppress such forces, and the EU was losing control of the situation. As happens to those who believe that they have the right to govern, they could not accept the idea that the right to govern was slipping away.
Hence the importance of these EU elections. The centrist parties weakened a little. The nationalist parties strengthened a little. And, depending on where you draw the line between left and right, left-of-center parties fared pretty well. But what is important is the fact that the elections showed that the center parties are losing control over the political system, however slowly. (Losing, but not yet having lost.) The decisions on this will not be made in the European Parliament but in the national parliaments, which are directly representative of their citizens. I suspect that one more economic crisis or attempt by the EU to impose behaviors that many oppose, such as migration into Europe, can break the increasingly fragile structure. Since the technocrats can’t imagine losing authority, this will be led by an unwillingness to adjust to changing realities, the weakness of all treaties.

Law and ordnance

Guns from the United States are flooding Latin America

A US-made gun is more likely to murder a Mexican than an American



LIKE A CRIMINAL and his fingerprints, every gun leaves its mark on the ammunition it uses. Such traces are what Sergio Sandoval de la Peña pores over daily in Mexico City’s ballistics lab. A series of dark-green circles, like the sub-woofer of a speaker, appear on his computer screen. It is a digitised three-dimensional model of a cartridge, found at the scene of a robbery this year and placed under a microscope. Checking the marks against hundreds of thousands of potential matches, Mr de la Peña concludes that the gun that ejected it was also used in a murder last year.

The ballistics technology employed to work such wonders comes courtesy of the United States. Alas, so does the gun, according to Mr de la Peña’s database. A study of weapons found at crime scenes suggests that 70% of gun crimes in Mexico involve American-bought weapons. The share of homicides in Mexico involving a firearm grew from 16% in 1997 to 66% in 2017. That suggests around half of Mexico’s 33,000 murder victims last year were killed by a gun manufactured in the United States, which had 14,542 gun homicides in 2017. An American-made gun is more likely to be used in a murder in Mexico than at home.

Mexico is far from alone. Across Latin America, the share of murders involving guns is creeping upwards. Many countries already beset by organised crime and weak states have their troubles compounded by their proximity to America, the country with the rich world’s most permissive gun laws. Changes signed by President Donald Trump may only worsen the situation.

Guns and doses

Most guns enter Mexico after being legally bought in the United States. Criminal groups typically use associates to buy them, smuggling guns in the opposite direction to drugs. Beyond Mexico, American guns often arrive through ports from Florida, hidden among other imported goods. In Honduras, where half of all unregistered weapons come from America, smugglers have been known to wrap guns in foil and submerge them in paint to avoid detection from X-ray machines. Less creative, bigger groups simply pay off customs officers.




Does the availability of American guns boost murder rates? The expiration in 2004 of an assault-weapons ban in the United States provided a real-world experiment. A study found that in Mexican municipalities bordering Arizona, New Mexico and Texas, where the guns were put back on sale, the murder rate shot up soon after. Murder rates adjacent to California, which maintained a ban, stayed flat.

But even in the unlikely event that the United States were to repeal the second amendment, Latin America’s gun problem would not abate. Many national armies and police forces have a habit of losing their weapons. In Guerrero, a state in Mexico, one weapon in five belonging to the state police ends up “lost or stolen”. Central American police forces are notorious for selling seized weapons they should destroy, says Mark Ungar of Brooklyn College.

In Honduras the profits from gun sales to private individuals, over which the army has a monopoly, are the second-biggest contributor to soldiers’ pensions. Many American weapons used in crime in Brazil are trafficked through Paraguay, which has loose gun controls. Between 2013 and mid-2018 Paraguayan companies legally imported 648,000 guns and 331m rounds of ammunition, a large share from the United States. Last year America briefly banned commercial arms sales to Paraguay to reduce the smuggling, prompting the country to impose its own controls.

Jair Bolsonaro, Brazil’s president, has signed two decrees this year making it easier for Brazilians to own and carry guns. Shares of Brazil’s large gun firms have soared. Mr Bolsonaro has said he will legalise imports of American guns too. Legal weapons can become illegal ones with ease through theft or corruption, observes An Vranckx of Catalystas, a consultancy. Brazil’s murder rate dipped after 2003 when new rules made it harder to buy a gun.

One place American guns are turning up less is Venezuela, largely because there is a ban on their export there. A ready supply of weapons from elsewhere has helped push the country’s murder rate to the world’s highest. Lately the economic crisis may have stemmed the flow: the import of weapons, like all other imports, has probably dropped. A decline in productivity at the state-owned factories which make bullets may explain why the murder rate has slipped back of late.

What can be done to stop the flow of weapons? One idea floated in Mexico was to ban American steel firms and other businesses that supply gun manufacturers from Mexican government contracts, and to make workers from any firms that sell guns apply for visas if they want to visit Mexico. But that idea lost steam when Mr Trump became president. Indeed since his election things have got worse. In January Mr Trump said responsibility for approving arms exports would shift from the State Department to the Department of Commerce, which applies looser rules.

So Latin American countries will have to do more themselves. National, interlinked databases of registered weapons can help police keep hold of their guns. Purging the dirtiest cops, as Colombia has done, helps to keep weapons out of criminal hands. Rather than waiting for the United States, Latin America will have to place its own institutions under the microscope.

The Fed’s Inflation Problem

Even if low inflation persists, it might not count as a reason for the central bank to cut rates.

By Justin Lahart


Federal Reserve Chairman Jerome Powell Photo: Mark Wilson/Getty Images 


The Federal Reserve is worried that even as the economy continues to do well, inflation is running cold. So what, if anything, should the central bank be doing about its dilemma?

For now, the Fed is sitting on its hands. Its policy-setting committee left interest rates unchanged at the end of its two-day meeting Wednesday, and it reiterated its pledge “to be patient” on adjusting rates in the future—a signal it will likely stay on hold when it next convenes in June.

But the Fed did note that inflation slipped in the first quarter. This is a concern. By the Fed’s preferred measure, consumer prices excluding food and energy—the so-called core—were up 1.6% from a year earlier in March. That compares with a year-over-year gain of 2% in December.



The first-quarter cool-down makes it unlikely that core inflation will reach 2% again by the end of the year. Indeed, if core prices increase at a 2% annual rate in each of the final eight months of 2019, core inflation still would only reach 1.7% in December.

The Fed has an inflation target of 2% but, after years of mostly falling short of that mark, the central bank increasingly has become worried that too-low inflation is becoming ingrained in consumer expectations. Since expectations feed into actual prices, the risk is that inflation will remain persistently below the Fed’s target. That would be problematic if a recession were to hit since deflation, or falling prices, would be that much closer. (Hello, Japan.)

So the Fed might end up lowering rates in an attempt to push inflation higher. Some investors seem to think this is possible: Interest-rate futures imply there is a better-than-even chance of a rate cut by year-end.

But the drop in inflation may owe more to idiosyncratic factors than a general cooling. Morgan Stanleyeconomists note that a variety of alternative inflation measures that exclude items with the most extreme price increases and decreases suggest there has been little change in inflation’s underlying trend this year. Moreover, with a strong job market likely to push the unemployment rate even lower in the months ahead, worries about low inflation might not persist.

Or perhaps inflation will stay stuck below 2% even if the economy does well. The question then would be whether rate cuts would successfully push prices higher or simply bring rates closer to zero, leaving the Fed with nothing to show for its efforts.

The World’s Next Big Growth Challenge

The economic performance of lower-income developing countries will be crucial to reducing poverty further. Although these economies face significant headwinds, they could also seize important new growth opportunities – especially with the help of digital platforms.

Michael Spence

spence115_PIUS UTOMI EKPEIAFPGetty Images_jumia salesman

MILAN – The global economy is undergoing very large structural shifts, driven by three megatrends. One is the digital transformation of the foundations on which economies are built and run. Another is the growing purchasing power and economic strength of emerging economies, and China in particular. Lastly, there are broad-based political-economy trends, which include rising nationalism, various forms of populism, political and social polarization, and a possible breakdown of the multilateral framework within which the global economy has functioned since World War II.

The media devote most of their attention to the economic, social, and regulatory challenges arising from these megatrends, and to the trade, investment, and technology tensions between China and the United States. Yet a significant share of the world’s population lives in poor countries, or in poorer parts of developing countries. Furthermore, the rapid reduction in global poverty over the past three decades is primarily the result of sustained growth in developing economies.

The future growth prospects of today’s early-stage (that is, lower income – some growing and others not) developing countries will be of huge importance in reducing poverty further. Although these countries face significant headwinds, they could also seize important new growth opportunities – especially with the help of digital platforms.

The headwinds are certainly considerable. For starters, advances in digital technologies – robotics, machine learning, sensors, and vision – directly threaten the labor-intensive manufacturing and assembly upon which lower-income, non-resource-rich economies have traditionally relied.

Moreover, climate change has had its greatest economic impact in the tropical and subtropical regions where most lower-income countries are located. The effects of global warming are highly disruptive in fragile economies, and, taken together, constitute a major new obstacle to growth.1

Fertility rates, meanwhile, remain astonishingly high in some countries, especially in Sub-Saharan Africa. In a few of the poorest – Niger, Mali, and the Democratic Republic of Congo – the rate is 6-7 children per female. The resulting flood of new entrants to the labor market is far outstripping the number of jobs available.

No known growth model can accommodate or keep up with this kind of demographic surge. Even sustained economic growth of around 7% per year won’t be enough. And although fertility tends to decline as incomes rise, that does not happen immediately. Empowering women, therefore, may be the most effective way of starting to address the challenge.

Conflict also disrupts growth. Although many conflicts appear to have a religious or ethnic basis, some scholars believe that their root cause may be economic, with ethnic divisions serving as a way to exclude other groups from access to scarce resources and opportunities. Whatever its source, inequality of opportunity has a highly disruptive effect on governance and hence growth.

But these obstacles are not insurmountable. For one thing, developing countries now have huge potential export markets in middle-income countries, and no longer depend entirely on advanced economies for access to global markets.

There is also a renewed awareness of the importance of infrastructure in enabling growth. In addition to roads, railways, and ports, electricity and digital connectivity are crucial. In this regard, the rapid expansion of cellular wireless technology, combined with the installation of high-capacity undersea broadband pipes around Africa, represents major progress. Meanwhile, China’s “Belt and Road Initiative” – though criticized by much of the West, and the United States in particular – could bring dramatic improvements in physical and digital connectivity to Central Asia and parts of Africa.

Further advances in critical infrastructure will create important growth opportunities for developing countries via e-commerce, mobile payments, and related financial services. The experience of China strongly suggests that these digital platforms, and the ecosystems that develop around them, are powerful engines for incremental, highly inclusive growth.

China, of course, is a very large, homogenous market. If smaller, lower-income developing countries are to benefit from equally rapid inclusive growth, the digital platforms will have to be regional and international in scope.

Some are starting to emerge. Jumia, a Nigeria-based e-commerce platform covering 14 African countries, recently went public on the New York Stock Exchange, amid considerable excitement. True, the company faces similar obstacles to those that Asian and Latin American platforms previously had to overcome, including a lack of reliable payment systems, low trust between buyers and sellers, and logistics and delivery bottlenecks. But the experience of other regions shows that these shortcomings can be addressed over time.

The bigger risk to these platforms stems from the inevitable and necessary increase in regulation of the Internet around the world. In particular, diverse national regulatory regimes may inadvertently or deliberately disrupt or block the international development of e-commerce ecosystems, hurting lower-income countries in the process. Avoiding the creation of such unintended obstacles should therefore be a high priority for the international community.

Today’s lower-income countries already face a tough task in trying to emulate the impressive growth of developing economies before them. An underperforming global economy, and rising national and international tensions, will make that task even harder. If the world is serious about reducing poverty further, it must pay far more attention to their progress.


Michael Spence, a Nobel laureate in economics, is Professor of Economics at NYU’s Stern School of Business, Distinguished Visiting Fellow at the Council on Foreign Relations, Senior Fellow at the Hoover Institution at Stanford University, Advisory Board Co-Chair of the Asia Global Institute in Hong Kong, and Chair of the World Economic Forum Global Agenda Council on New Growth Models. He was the chairman of the independent Commission on Growth and Development, an international body that from 2006-2010 analyzed opportunities for global economic growth, and is the author of The Next Convergence – The Future of Economic Growth in a Multispeed World.

Japanese Currency: A No-Go in US Trade Talks

Tokyo may be willing to compromise on a variety of issues, but not on its monetary policy.

By Xander Snyder        

Remember the Trans-Pacific Partnership? Among the things it was intended to have accomplished, had it survived the 2016 U.S. election cycle, was the resolution of certain trade issues between the United States and Japan. Even as recently as last year, Tokyo had hoped that the U.S. would join the amended version of the TPP, now called the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, to obviate the need for these potentially painful discussions. But it seems as though those talks have finally arrived. In mid-April, representatives from the two sides met in Washington for negotiations initiated in no small part by the threat of tariffs on Japan’s most important export: automobiles.

As with China, the most high profile of Washington’s trade disputes, the Trump administration’s explicit goal is to reduce the trade deficit with Japan, which currently stands at $68 billion – the vast majority coming from Japanese auto exports. But that’s where the similarities end. Washington is much less concerned with the national security implications of sensitive Japanese technologies than it is with Huawei in China, and Japan has already made most of the structural concessions the U.S. is demanding from China today. With Japan, the U.S. is instead asking for concessions that would nibble at the margins of the deficit such as increased Japanese purchases of agricultural products from U.S. farmers who have become collateral damage in the trade war with China. (Ironically, U.S. farmers are facing competition from countries that joined the TPP, since CPTPP-countries are now exporting to Japan at a lower tariff rate than can U.S. agribusinesses. This concern led Trump to at least briefly reconsider joining TPP last year.)
    


 
One issue on which the two will almost certainly disagree is currency. U.S. negotiators have added Japan to a list of countries it believes are manipulating currency. Currency manipulation is, of course, a loaded if nebulous designation. If a central bank maintains a loose monetary policy that results in a weakened currency, is that currency manipulation, or just run-of-the-mill monetary policy?

Insisting that monetary policy be excluded from trade talks is a lesson Japan learned from experience. In 1985, Tokyo signed an agreement, known as the Plaza Accord, that was designed to devalue the U.S. dollar relative to the yen by about 50 percent over a two-year period. As the dollar declined, the yen appreciated, making it more difficult to sustain the exports that fueled its economic growth. The Bank of Japan responded by loosening its monetary policy to keep the economy humming, which in turn expanded an already growing credit market, which by then had begun to extend ever riskier loans because of growing competition between banks in the first half of the decade. Debt grew, and when the debt-fueled asset bubble popped, it ushered in nearly two decades of stagnant growth, known not-so-fondly as the Lost Decade.

The financial calamity raises an obvious question: Why did Japan make such a bad deal? In 1985, the U.S. was beginning to embrace globalization, and the degree to which it would affect U.S. manufacturing was only beginning to become clear. At the time, Washington was concerned that if it didn’t protect domestic manufacturing, it would add fuel to the fire of broader, economy-wide protectionism. Former Treasury Secretary James Baker believed this could pose a great-depression-like risk, since “the isolationism and protectionism of that era [during the aftermath of World War I] in part helped cause the Great Depression.” Wary of protectionist policies that would undermine the post-WWII alliance structure between the U.S., Japan and Germany, the three countries (along with France and England) agreed to devalue the dollar so as to not upset the security equilibrium that had existed for 40 years.

Still, Japan’s economy today is different. For starters, it has already experienced decades of economic stagnation, leaving a bitter memory for policymakers to invoke and, if necessary, exploit. Second, Japan has already been extending cheap credit into the economy for decades – interest rates there hover at or below zero, with the BOJ’s short-term target interest rate at -0.1 percent. In other words, it does not have the flexibility to decrease interests rates by very much if any sort of external shock (such as a rapid currency revaluation) were to hit its economy. Aggressive monetary easing, moreover, is one of the three “arrows” of Abenomics – Prime Minister Shinzo Abe’s ambitious plan to drag the economy out of the lost decades for good – and not something Tokyo can sacrifice without abandoning its efforts to jumpstart flagging domestic consumption or without pulling the rug out from under an economy that has become accustomed to ultra-cheap credit.

Japan simply doesn’t have the flexibility, or frankly the desire, to allow trade talks to pollute its currency. Exports still account for nearly 18 percent of Japan’s economy, so it will be unwilling to make any major concession that allows for its monetary policy to be dictated by the U.S. Japan may be willing to make compromises throughout the negotiations, such as purchasing more U.S. liquefied natural gas and weapons – two things it needs anyway – or lowering tariffs on U.S. agricultural goods to CPTPP levels, but not on issues related to currency exchange rates. This will remain the third rail for Japan throughout its negotiations with the U.S.


The Coming Technological Cold War

The conflict between the United States and China over trade and technology is an increasingly high-stakes zero-sum affair. And it is not just about amassing data and talent to achieve economic and geostrategic primacy; like the original Cold War, it is also about the future of liberal democracy.

Manuel Muñiz

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MADRID – Lurking behind the Trump administration’s trade conflict with China lies an abiding fear that the United States could be losing its advantage in the global technology race. And it’s not just Trump. In US policymaking circles more broadly, China’s “Made in China 2025” policy – intended to ensure Chinese dominance in cyber capabilities, artificial intelligence (AI), aeronautics, and other frontier sectors – is viewed not just as an economic challenge, but as a geopolitical threat. Everything from US telecommunications infrastructure and intellectual property to America’s military position in East Asia are considered to be at risk.

The fact that technology is driving geopolitical tensions runs against the predictions of many scholars and policymakers. As recently as the mid-2000s, some suspected that geography would no longer play a meaningful role in the functioning of global markets. Globalization and technology would lead to a “flat” world with perfect competition, where talent would automatically spread evenly across regions and frontiers; skilled workers would connect to productive processes remotely and only when needed.

In fact, talent in the twenty-first century is more unevenly distributed than ever before. A few key hubs – Cambridge, Massachusetts; Silicon Valley; Shenzhen, China – are now host to a significant share of the world’s high-skilled digital and tech workers. It isn’t entirely clear why this is happening. But some scholars have begun to attribute the concentration of digital talent to the role of “tacit knowledge”: insider know-how such as the industry practices and procedures, or technical expertise that is valuable only under very specific conditions.

As knowledge has become increasingly clustered, so, too, has technological research and the commercial development of new innovations. This trend can be measured by the number of unicorns – startup firms with a valuation of at least $1 billion – appearing in particular regions of the world. By that metric, China and the US alone account for almost all of the world’s technological entrepreneurship. In the field of innovation, we are quickly moving toward a G2 world.

Moreover, there is growing evidence that productivity growth is becoming concentrated within companies that have leveraged digital technologies to scale. Over the past decade, a narrow cohort of what the OECD calls “frontier firms” have accounted for almost all productivity growth globally, while “laggard companies” – that is, all other firms – have made essentially no productivity gains at all. This imbalance has created the illusion of an aggregate slowdown in productivity growth, when the real issue is the increasingly acute segregation by firm type.

A world in which technological know-how, innovation, and productivity growth are heavily clustered is more zero-sum – and thus more prone to geopolitical competition. The regions that attract talent effectively cut everyone else out of the technology transfer process, thereby producing a few big winners that are able to achieve rapid productivity growth and competitive dominance. Under these conditions, Sino-American competition for talent and frontier firms is increasingly inevitable.

Further compounding the problem is the fact that China is not a democracy. The government is using cutting-edge technology not only to repress dissent and monitor the population, but also to respond to citizens’ needs and improve public services. By helping officials manage increasingly complex social, political, and economic systems with near-complete information, these technologies nullify the forces that brought an end to earlier authoritarian systems, not least the Soviet Union. It might well be that AI and big data are boons to authoritarian regimes.

We should brace ourselves for the coming conflict. Like the original Cold War, the contest between the US and China for technological dominance will produce ripple effects worldwide, potentially leading to a sharper backlash against globalization – one that adds national-security concerns to distributive grievances. The temptation will be to break up global markets, and retreat to islands of proprietary data and technologies.

Indeed, America and Europe’s longstanding support for open markets and their belief in strict competition policy will be put to the test. Will European and US markets remain open to Chinese firms? Will Western antitrust authorities break up their countries’ tech giants at the risk of ceding the global market to Chinese national champions? Much will depend on China’s willingness to level the playing field at home, which would mean pursuing economic liberalization and curtailing politically motivated state intervention in the economy. As matters stand, China appears to be heading in the opposite direction.

If an authoritarian regime excels in the technological race, and if emerging technologies enable it to deliver better governance without the need for more political openness, governments around the world will take note. That is why the looming technological cold war will not just be about amassing data and talent to achieve economic and geostrategic primacy; like the original Cold War, it will also be about the future of liberal democracy.


Manuel Muñiz is Dean of the IE School of Global and Public Affairs in Madrid and Senior Associate at the Belfer Center for Science and International Affairs at the Harvard Kennedy School of Government.