World trade

How to rescue the WTO

The American-led trade order is in danger. But it may yet be saved

THE headquarters of the World Trade Organisation (WTO), on the banks of Lake Geneva, once belonged to the League of Nations. That ill-fated body was crippled by American isolationism. The building’s occupant today is also at the mercy of decisions taken in Washington.

President Donald Trump has circumvented the WTO to impose tariffs on steel and aluminium imports, including those from America’s allies. Complaining of unfair treatment, the administration is blocking nominations to seats on the WTO’s appellate body, which could leave it unable to hear cases after 2019. Most ominously, America is embroiled in a trade war with China. Both sides have imposed tariffs on goods worth tens of billions of dollars and are threatening worse.

The WTO was supposed to contain trade disputes and prevent retaliatory pile-ups. Today it appears to be a horrified bystander as the system it oversees crumbles. Free-traders are right to be deeply worried, but not yet right to despair. For the outlines of a plan to save the system are discernible.

It’s the end of the WTO as we know it

That might seem fanciful, given Mr Trump’s belligerence, but for two things. The first is that the president is not the only person forging American trade policy. The European Union and Japan have been talking to Robert Lighthizer, his low-profile chief trade negotiator, about WTO reform. Mr Trump’s tirades make headlines, but Mr Lighthizer wants to remake the WTO, not abandon it entirely. He could use the president’s threats as leverage to make deals. Think of it as a good cop/bad cop routine, albeit one in which the bad cop has only a faint grasp that he has been allotted the role.

The second thing to understand is that the focus of much of America’s ire, China, arouses deep suspicion elsewhere, too (see Briefing). Since joining the WTO in 2001, China has not turned towards markets, as the West expected. Instead, it has distorted trade on a scale that is far bigger than the dumping and other causes of disputes between market economies that the WTO was designed to handle.

The EU and Japan share America’s desire to constrain Chinese mercantilism. China’s state-owned firms and its vast and opaque subsidies have distorted markets and caused gluts in supply for commodities such as steel. Foreign firms operating in China struggle against heavy-handed regulation, and are required to hand over their intellectual property as a condition of market access.

But holding China to account is hard with the existing rule book. The reforms being talked about by the EU, Japan and America could plug many of the gaps. They would set out how to judge the scale of government distortions to the market, make it easier to gather information on wrongdoing and set the boundaries for proportionate retaliation. They would also define what exactly counts as an arm of the government, and broaden the scope of banned subsidies. And they would lower the burden of proof for complainants, which, given the opacity of the Chinese system, is too high.

Even the sunniest optimist will be able to identify the obstacles to this plan. Most obviously, why would China ever accept a reform that jeopardises its state-run economic model? Put plainly, because America could wreak havoc otherwise. It is in China’s interests to preserve the global trading order because, if China is isolated, the Communist Party cannot achieve the prosperity that cements its legitimacy. The benefits to China of its WTO membership have come not from lower tariffs in America—they were already low—but from the certainty of stable trading relationships. Its “Made in China 2025” plan to boost vital industries sounds threatening, but if China were obliged to produce everything at home, its time frame would be delayed by decades. Sure enough, China and the EU agreed on July 16th to co-operate on WTO reform.

Reaching a global agreement that covered every one of the WTO’s 164 members would also be extremely difficult. The last big round of global trade talks stalled over demands by developing economies such as India for more leeway to protect farmers. New negotiations may be held hostage to these old disputes. Luckily, negotiators can skip around them if necessary, by securing a “plurilateral” agreement between a group of big economies. The WTO would still enforce the terms, though they would not apply to its other members.

Last comes the greatest block to a grand bargain, Mr Trump himself. The president is a fierce critic of the WTO and a believer that bilateral deals suit American interests better. This week he called the EU a “foe” on trade. If he thinks Mr Lighthizer is manipulating him, he will strike back.

And I feel slightly more upbeat than you might expect

A better idea than the Trump administration’s wrecking strategy would have been to unite most of the world around a set of rules in America’s interest, forming blocs so large that China would have had to choose between compliance and isolation. That was the idea behind both the Trans-Pacific Partnership (TPP), a pact from which Mr Trump withdrew within days of taking office, and also a stalled trade deal with Europe.

Wrecking strategies do not always fail, however. Sometimes they pay off handsomely. A WTO fit to handle complaints about unfair competition would be a gift to the world. The genius of the rules-based system is that it has torn down barriers by persuading producers that the prize of access to foreign markets is worth the accompanying global competition. When that competition is deemed lawless, political support for free trade withers. A world in which China is pursued by its critics through the WTO, and faces proportionate retaliation when necessary, is far preferable to one in which a tit-for-tat trade war can escalate without limit.

Mr Trump is hard to predict. He may yet abandon the WTO. If he does, other powers will probably go on building links and writing rules—witness the trade deal that the EU and Japan signed this week. But if Mr Lighthizer is able to present Mr Trump with an agreement that the president likes, the world trading system may yet be saved. It might even be improved.

A copper-bottomed sign: why the metal is telling us to panic

It is giving western investors a clear signal to sell risk assets

John Dizard

Most easily or cheaply mined copper deposits have already been identified and at least partly exploited © EPA

Never mind trying to predict the future; how about predicting the present? On Wednesday the Federal Reserve Board upgraded the US growth outlook from “solid” to “strong”, assuring us that household spending had accelerated to “grown strongly”. It lacked only the word “powerful” to sound like a Trump speech.

Copper, however, is telling us not to worry a bit: the metal is telling us to panic. Since the first week of June, the copper price went into steep decline. In the year to date, the metal has deflated by close to 18 per cent. That is going beyond just one Chilean strike being deferred or a Chinese investor club breaking up. The metal is giving western investors a clear signal to sell risk assets or at least reduce their portfolio weighting.

I say this as a long-term optimist about the copper price. Most easily or cheaply mined copper deposits have already been identified and at least partly exploited. When the next recovery comes, it will turn out that the world has not invested enough in new mines or mine expansions.

That, though, is a five-year view. Right now the copper price is saying we are not far from a more general sell-off in risk assets. Take a look at the copper price chart in 2008. The price was strong at the beginning of the year, peaked in May, and then fell like a lump of ore down a mine shaft.

We now know that the US housing market had been coming apart since the previous summer but there was still a strong market for risk assets. Too much cash seemed to be lying idle with not enough yield on offer.

Of course the Fed was reassuring then, as it is now. The good news about the divergence between copper’s implicit forecast and the Fed’s is that there are still people out there who are encouraged to buy your risk position. I am not sure how many will be left by late autumn.

Most of the commentary on the copper price decline concerns Mr Trump’s tariff threats, or pullbacks from tariff threats. Yes, those are bad for growth but are not enough, in my view, to account for the copper crash.

There are always stupid policy mistakes just before an economic crisis hits. In 2008, we had the decision by treasury secretary Henry Paulson to force banks to take a writedown on recent purchases of preferred shares in housing government-sponsored enterprises. The nearest policy “causes” of financial crashes, though, do not explain why the system can be vulnerable to one person’s dumbness.

The great thing about the copper price as an indicator is the metal’s ubiquity. It is needed for wiring in online servers, for engines in delivery vehicles and for air conditioners for property sales offices.

Speaking of property, the Fed has not been highlighting that market. As economist David Rosenberg of Gluskin Sheff notes: “The Fed used the word ‘strong’ five times in this week’s release but has not mentioned housing in the last several statements. Housing has a bigger multiplier effect than any other part of the economy. Mortgage applications have declined and sales have slowed.”

Mr Rosenberg adds: “If the Chinese equity market was not down 20 per cent, maybe you could discount the copper price decline. But the idea of economic decoupling is a hoax. There is not a snowball’s chance in hell [the Chinese weakness] will not flow through to the US stock market.”

Not every Chinese economic or financial correction is followed in the west. The insight offered by copper, though, transcends the effects of any one country’s fiscal or economic policy.

There is no denying that participants in the copper market are trying to rig prices to game the system, but there are too many players from diverse parts of the globe to allow the rigging to work for very long.

Wilbur Ross, the US commerce secretary, blamed speculators for the negative sentiments that deepened after the administration’s first tariffs were imposed. Political people know that “speculators” is just another term for “evil people who create bad headlines”.

Market people, apart from some general partners of private equity firms, know that “speculators” provide the trading capital to offset the positions taken by commercial operators. And non-commercial interest in the metals markets, in particular copper, has declined sharply as risk-averse speculators have taken out their money.

Take the hint. Copper tells you this is not be the time to put on more risk.

An old movie is playing in emerging markets

But vulnerability to foreign funding need not mean an unhappy ending

In the second quarter, emerging markets currencies had their worst fall against the dollar in seven years © Bloomberg

If it walks and quacks like an emerging markets balance of payments crisis, is it really an emerging markets balance of payments crisis? We are not yet there, and hopefully it will not come to one. But the patterns recently displayed by global financial markets are sufficiently redolent of capital flight from poorer countries in the past that caution is in order.

Start with foreign exchange. In the second quarter emerging markets currencies had their worst fall in seven years. July started better, but the downward pressure is back on a steady course of interest rate tightening in the US. This attracts capital to the dollar.

Equity investors have been pulling money out of emerging markets for 10 weeks straight. So have bond investors, though that outflow appears to have been staunched — for now.

Seasoned market watchers have seen this movie many times before. In times of low global interest rates, emerging markets are flooded with cheap lending from the rich economies, reflected in large current account deficits.

The debt that accumulates as a result, especially when denominated in hard currency, lands them in a zone of instability where a reversal of capital flows can violently disrupt creditworthiness and economic activity. Fears of exactly this phenomenon can be enough to trigger the reversal.

With so much painful history to recall — the Latin American debt crisis in the 1980s, the “Tequila” and Asian financial crises in the 1990s — emerging countries should have learnt not to fall into the same trap again. And some have indeed done just that.

On many measures, macroeconomic performance is better — for emerging markets as a whole, inflation rates are at historic lows. Governments are nowhere near as indebted as in advanced economies. And markets have become more discriminate, differentiating between countries and rewarding those that seem to be managing their economies well.

Where there is danger, it resides in the private sector: emerging market companies now carry more debt as a share of their countries’ economic output than their counterparts in rich countries. At a 94 per cent debt-to-GDP ratio, up from 63 per cent in just a decade, capital flight could stop an exposed country’s growth in its tracks.

A debt crisis, moreover, is no less political for originating in the private sector: as Argentina and Turkey have both shown in recent months, financial brittleness can quickly threaten political credibility.

What can emerging country policymakers do? Ideally they would not start from here. It is crucial to manage well the capital inflows in the boom: using tax and regulatory tools to favour direct investment or equity over debt; put in place moderate capital controls up front (so investors are not caught unawares) to stem outflows in a crisis; and make the domestic economy resilient to a changed environment. That can mean limits on leverage and policies to channel foreign funds into productive investments.

This advice is admittedly of limited use to those already exposed to capital flight. But they are also not bereft of protective policy tools. They can minimise the pain of a refinancing crisis — which would also make one less likely — by incentivising a switch into longer-term funding.

They can streamline the domestic framework for private-sector debt restructuring. If capital heads for the door, they should not waste too many resources defending exchange rates, especially at the cost of stifling growth with high interest rates. Growth is, after all, the best solution to debt, for debtors and their creditors alike.

We Can’t Make Unemployment Great Again

Present employment trends look unsustainable without some sort of demographic shift or economic slowdown

By Spencer Jakab

It almost seems like old times following Friday’s jobs report, but how old exactly?

The somewhat light U.S. nonfarm payrolls growth of 157,000, even as unemployment dipped back below 4%, is a return to the not-too-hot and not-too-cold pace of recent years. Wage growth, a concern recently given so much anecdotal evidence of a tight labor market, cooled off a bit, too. That at least shouldn’t make Federal Reserve rate setters any more aggressive in their rate-raising cycle.

But the continuation of this happy stasis depends on something that is very hard to predict:

How many more people are waiting to reappear in the labor force? Participation had dropped from 66.2% in early 2008 to a generational low of 62.3% in mid-2016. Since then it has stabilized a little below 63%, helping the economy add jobs without too much in the way of wage pressure or alarmingly low unemployment.

The stabilization in the share of people willing and able to work is a matter of demographics on the one hand and the best labor market in a generation on the other. But even if participation stays at the same level for the next 12 months, a calculator from the Federal Reserve Bank of Atlanta shows that the current pace of payroll growth—it has averaged 211,000 year-to-date—would bring the unemployment rate to 3.3%, a level not seen since the early 1950s. That was a time of American industrial supremacy.

While the Trump administration is using the threat of tariffs to bring back something of that swagger, along with plenty of nostalgia about that simpler time, things just aren’t that simple.

The 1950s ended with labor-force participation far lower than today, still below 60%. The entry of women into the workforce, baby boomers reaching adulthood and, of course, immigration all fed labor-force growth in the ensuing decades. Three times as many people work today as in 1953.

Without some sort of unexpected demographic shift or economic slowdown, present trends look unsustainable. Either payroll growth will slow or wage growth will accelerate, and possibly both.

Trade Fight Complicates Beijing’s Stimulus Calculus

Chinese slowdown is likely to lead to another, but more modest ramp-up in debt

By Nathaniel Taplin

In the past, most urban Chinese worked in construction and factories; today more jobs are in the service sector, which is still doing well. Photo: Zhu Xiang/Xinhua/Zuma Press 

It is an inconvenient time for a Chinese downturn—unless you are a trade warrior in Washington. Signs of distress are clear: Chinese stocks are in a bear market, the yuan is at a one-year low and investment growth is at its slowest this millennium.

In the past, the Chinese state has often stepped in with lots of financial firepower to smooth downturns—primarily by getting government-owned banks to lend more. Once the stimulus kicks in, it has resulted in higher commodity prices and big movements in currencies. The most lasting impact is an increase in China’s frightening debt burden, now more than 250% of gross domestic product.

Should investors expect a repeat this time? In short, yes—but probably less than before, because China’s political landscape has changed, as has the economy. Moreover, the current downturn is unlikely to be as severe as the last big ones in 2009 and 2015.

Another reason for a more modest stimulus is that President Xi Jinping has championed higher-quality, less debt-intensive growth. Reluctance from Beijing to launch a big stimulus could enhance the Trump administration’s leverage with China on trade later this year.

Although China’s growth targets receive a lot of attention, that isn’t what Beijing really cares about. Instead it’s the labor market and financial stability. A change in employment patterns is one big reason Beijing’s response to slowing growth may be more modest this time.

In the past, most Chinese not working on the farm were employed in construction and in factories producing industrial goods for the domestic economy and consumer goods for export.

These companies are struggling with heavy debt and tightening credit.

Change in employment by Chinese job sectors from 2007 to 2017.

Source: CEIC

But today, most urban Chinese work in the service sector for companies like tech giants Alibaba and Tencent or other companies serving China’s surging consumer market. That sector is still doing well.

Nearly 100 million more Chinese worked in services in 2017 than in 2010, according to Chinese government statistics. Meanwhile employment in industry—including the export sector—peaked in 2012 and there are now around 130 million fewer workers than in services.

So what will a modest stimulus look like and how will it play out inside China and in global markets?

To maintain stability and keep people working, China’s first priority is to ensure its overleveraged banks and businesses stay afloat by preventing housing, steel and cement prices from falling sharply as investment dips. Commodity prices are still likely to sell off further, until the new round of stimulus feeds through. But big cuts to excess steel capacity and to China’s enormous housing overhang make a crash less likely.

Another goal of a modest stimulus will be to prevent heavy capital outflows and protect the country’s $12 trillion bond market. Beijing will try to ease enough to keep banks lending to small businesses but not too much that people will fear a big devaluation and move their money out of the country. China’s newly reinforced capital controls make this less likely, but rising U.S. interest rates will pose a test.

If Beijing can strike that balance, the stock market should stabilize and bond defaults will remain modest. Domestic consumption should stay healthy, though a decline in exports would hurt workers and could reduce consumer spending.

What might change the current calculus? Inside China, investors would be wise to keep a close eye on housing and factory-gate prices—steep falls in either would hit indebted industrial and property companies hard. A more substantial stimulus effort would likely follow, pushing commodity prices back up higher and heaping pressure on the yuan.

If big capital outflows do reappear and the yuan falls further, Chinese companies or local governments could default on dollar bonds. Alternatively, a strong defense of the yuan by China’s central bank could suck too much cash out of domestic money markets, triggering a deeper downturn. 
Then there is the trade conflict. Exports remain solid for now. And a weaker yuan, down around 6% against the dollar since April, may help offset pressure from tariffs.

The most likely outcome remains a muddle-through. Monetary policy will be eased, if not as sharply as in the past, and some of the progress on indebtedness will be undone. China will avoid its long-feared debt crisis this time.

Less likely but still possible is a rapid fall in prices for housing or steel and a new wave of cash flowing out of China. Major turbulence in global commodity, currency and debt markets won’t be far behind.

Nationalism, Immigration, and Economic Success

Jason Furman

CAMBRIDGE – One of the central challenges facing the world’s advanced economies is slowing growth. Over the last decade, growth rates in the advanced economies have averaged 1.2%, down from an average of 3.1% during the previous 25 years.

History shows that slower economic growth can make societies less generous, less tolerant, and less inclusive. So, it stands to reason that the past decade of sluggish growth has contributed to the surge of a damaging form of populist nationalism that is taking hold in a growing number of countries.

As in the darker decades of the twentieth century, today’s nationalism takes the form of heightened opposition to immigration and – to a lesser degree – free trade. Making matters worse, today’s toxic nationalism will exacerbate the economic slowdown that fueled its emergence.

Turning this vicious circle into a virtuous one – in which increased openness drives faster growth – will depend, at least in part, on making immigration more compatible with inclusionary forms of nationalism.

The economic evidence on this issue is clear: immigration makes a strong contribution to economic growth. Moreover, immigration is more necessary than ever, because population aging and lower birthrates across advanced economies are producing a retirement boom without a commensurate cohort of native prime-age workers to support it.

For example, Japan’s working-age population has been shrinking since 1995. In the European Union, immigrants accounted for 70% of labor-force growth from 2000 to 2010. And in the United States, immigration is the primary reason the workforce will continue to grow; if the US relied only on native-born workers, its labor force would shrink.

Faster growth is beneficial even if it must support a larger population, because working immigrants pay taxes that help support pensioners and retirees. In general, it is much better to be a fast-growing country with a vibrant, expanding population than a country with a dwindling population, like Japan.

Moreover, in addition to expanding the workforce, immigrants actually boost per capita GDP by increasing productivity – that is, the amount that each worker produces. The reason is that immigrants are much more likely to be entrepreneurial and to start new businesses.

In Germany, for example, foreign-passport holders started 44% of new businesses in 2015. In France, the OECD has estimated that immigrants engage in 29% more entrepreneurial activity than native-born workers do, which is similar to the average for the OECD as a whole. And in the US, immigrants take out patents at 2-3 times the rate of native-born citizens, and their innovations benefit non-immigrants as well.

There can be little doubt that immigrants expand the overall pie; but what about their effect on how that pie is shared? Here the evidence is less clear. There are certainly winners and losers. Yet, on balance, the available evidence suggests that immigrants do not reduce wages for native-born workers. In fact, it is more likely that immigrants increase wages overall.

One recent study of France, for example, found that each 1% increase in immigrants’ share of employment within a given département raises its native-born workers’ wages by 0.5%. It would seem that in addition to contributing to the size and productivity of the workforce, immigrants also often complement the skills of native-born workers, helping them earn more.

My professional focus is on economics, so I have emphasized the role of growth. But that clearly is not the only factor behind the rise of populist nationalism. The fact that developed countries are changing culturally also matters, perhaps even more so. In the US, for example, the foreign-born share of the population has risen from 5% in 1960 to around 14% today. As Harvard University’s Yascha Mounk notes in his insightful new book, The People vs. Democracy, that is the highest share since the last major anti-immigrant backlash in the US: the early twentieth-century “yellow peril.”

The trends are similar, and sometimes even more dramatic, in other developed countries. The foreign-born share of the population in Sweden, for example, has gone from 4% in 1960 to 19% today, representing a much larger shift than that in the US.

All countries face a choice when it comes to immigration. They can pay an economic price to follow a more exclusionary course, or they can reap the economic benefits from greater openness. But while public policies can help ensure that the benefits of openness are realized, we should not lose sight of their political and economic limitations.

Looking beyond policy solutions, we also need to establish a cultural expectation that immigrants will not just bring diverse perspectives, but also join their new country as citizens. That means speaking the language, honoring national traditions, and – as I saw first-hand while discussing these issues at Les Rencontres Économiques in Aix-en-Provence, France – cheering for the national soccer team.

In the US, in particular, that is the vision of immigration and inclusive nationalism that we should be working toward – including the better soccer team.

Jason Furman, Professor of the Practice of Economic Policy at the Harvard Kennedy School and Senior Fellow at the Peterson Institute for International Economics, was Chairman of President Barack Obama’s Council of Economic Advisers from 2013-2017