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The Times, They Are a-Changin’

The consequences of the war in Ukraine will be far reaching because the conflict is acting as a catalyst for deep-seated shifts in global economic governance, and trade in particular.

Nearly fifty days after Russia invaded Ukraine, the costs of war are escalating at every level. The death toll, difficult to determine for a variety of reasons, is thought to be high and rising, with possibly ten thousand or more killed in the city of Mariupol alone.

Forecast economic costs are also high. The World Bank estimates that Ukraine’s economy could shrink by over 45% this year alone. It thinks Russia’s economy will shrink by over 11% as sanctions bite. The effects won’t be confined to Russia: the OECD estimates that global growth will be cut by a full percentage point in 2022.  The negative effects may be particularly severe in various low and middle income countries that are exposed to surges in the price of commodities such as food products and fuels. World trade growth is expected to slow down.

Beyond these shocks lies a more subtle but nevertheless potentially far-reaching effect. This reflects the conflict’s impacts on global economic governance. A  little over a decade since Russia acceded to the WTO (and a little over two decades since China did), economic relations are speedily moving from the presumption that interdependence between countries that were bound by common rules is a good thing, to an embrace of a more  fragmented world. This is a world in which countries actively seek to be more discriminatory, based on non-economic criteria. Or, in the recent words of Emmanuel Macron, one in which countries are “open to the world, but in which we wish to choose our partners and not depend on them”. In truth, the Russia-Ukraine war is better seen as a catalyst of more long-standing trends favouring such an outlook. Some of which ironically, are the result of the very forces created by post-war economic integration and interdependence.

Slow train coming

What we know as the rules-based system emerged in the aftermath of the two world wars. The aim was to contain the rivalry between power blocks that led to beggar-thy-neighbour economic policies, and military conflict. In trade, the embodiment of this aim was arguably the Most Favoured Nation principle, pushed primarily by the US under president Franklin D. Roosevelt and his Secretary of State, Cordell Hull. The principle became international law under GATT Article I in 1947.

The Uruguay Round of negotiations (1986-1994) that led to the creation of the WTO in 1995, expanded trade rules to services and intellectual property. They also put in place a system of binding dispute settlement that greatly enhanced the enforcement of rules. Indeed, the last decade to the 20th century could be considered to be the high watermark of integration via multilateralism. Aside from the completion of the Uruguay Round, China’s accession to the WTO was essentially finalised (it formally joined in 2001). Russia and other eastern bloc countries were integrated into the IMF, and Russia began the process of acceding to the WTO.

But the late 1990’s also marked the point at which the tide began to turn on economic integration. Anti-WTO riots in Seattle captured long-mounting perceptions that trade and technological progress was worsening inequality between and across nations. The concerns were amplified in the aftermath of the global financial crisis of 2008-2009. This led to a growth of protectionist interventions, often by stealth through mechanisms such as subsidies and government procurement. And to a rise in populism, embodied by the Trump presidency in the United States, and its very deliberate attempts to wind back the strength of the rules-based system.

These tensions reflected to a large extent the success of international trade rules in interacting with technological progress, to transform the organisation of production and trade. The rise of global value chains meant that countries increasingly specialised in tasks in those value chains. The key, however, is to specialise in tasks that captured a higher level of value added. This in turn creates incentives for  policy interventions that would allow countries to better do this. Moreover, the rising role of intangibles – capitalism without capital– fundamentally altered dynamics of competition between businesses and its distributional effects. The scramble for ideas, increasing returns to scale, network and agglomeration effects meant  that production and value would be unevenly distributed, and that there were gains to first movers. That is, countries that intervened via policy and moved to set the rules would be better placed to capture value. In sum, the stage was set for greater rivalry. And ironically,  in part at least because of the very rules designed to promote interdependence via liberalisation.

Blood on the tracks

It might have been possible to contain rivalry had geopolitics and economics not combined in potent ways. Such a combination is in a sense inescapable: the economic rise of emerging powers like China was always going to have geopolitical ramifications. The issue is more a perception of bargains that have not been kept.

When developed countries normalised trade relations with China and then agreed to its accession to the WTO, the driving idea was that deeper global economic integration would steer China to a growth model that was economically and politically more liberal. China for its part accepted very stringent conditions of accession in the expectation that its partners would also play by the rules.

Twenty years after accession, the dominant perception amongst China’s  partners is one of “buyers remorse”. China if anything has become more authoritarian. Its industrial policy is highly interventionistic, including in sensitive areas such as the acquisition of technology . And even when they do not violate the letter of China’s WTO commitments, China’s policy instruments likely undermine the value of these commitments to partners. Meanwhile, China’s perception is that, having undertaken obligations unprecedented for a country at its level of development, its partners have used WTO rules to single it out and constraint its growth.

The idea that liberal, rules-based trade and investment relationships would promote geopolitical stability was also the driving force behind western, and specifically, European, attitudes to Russia.  When Russia acceded to the WTO, the then Director-General of the WTO, Pascal Lamy, portrayed it as a “win-win deal” and “good for the Multilateral System as a whole”.

Seen against this background, Mr. Macron’s words at Versailles about being more selective about partners and not depending on partners highlight the extent of dashed expectations. The regrets some US politicians have regarding China’s WTO admissions are similar in many respects to the regrets European politicians have around Russian Gas. The economics of integration were to have driven political change, but did not.

In sum, whereas the presumption had been that greater economic interdependence would drive geopolitical convergence, the thinking is now that a presumption of geopolitical divergence should drive less interdependence and more fragmentation. The European Union’s proposal for an anti-coercion policy instrument both recognises that countries like China use trade measures to impose political pressure, and provides a framework for the EU to respond to such occurrences outside multilateral rules, which would in the past have been the normal response.

In this context, it is easy to see how the forces described above that drive concentration in production and trade will stimulate, rather than lessen, incentives to pursue fragmentation. That is reinforced by the obvious spillovers between trade and nationals security that arise in areas of data, artificial intelligence and robotics. These have already led to heightened restrictions on trade and investment through instruments such as export restrictions and FDI screening.

 Oh mercy 

What we are likely to see, therefore, is a trend toward a more regionalised approach to trade and investment. That in itself is not new. Indeed, multilateral trade rules explicitly allow for preferential free trade agreements, and as March 2022 there were 354 such agreements in force. The issue was more whether such regionalism would be “open” i.e. eventually leading to broad-based integration, or more conducive to increasing rivalry between competing geopolitical blocs.

The latter now seems the more likely route. The incentives for cooperation look particularly poor at then moment. Because of its size and relatively low exposure to trade, the United States could generally wear the costs of trade and investment restrictions in sensitive areas such as technology, whereas China would suffer much higher costs given its “hub” role in manufacturing and dependence on foreign inputs.  This might have been expected to push, however grudgingly,  China towards a more cooperative stance. But the signs are that confronted with the desire by western partners for a more discriminating approach to trade, China is likely to respond by accelerating its attempts to reduce interdependencies.

The issue is not confined to China. For some time now, observers have pointed to the emergence of a fragmented world  on matters of digital economy governance i.e. on matters such as data and artificial intelligence, that are increasingly fundamental to economic organisation. Divergences between what we can roughly describe as a US-type bloc, a EU-type bloc, China, and the rest of the world partly reflect differences in regulatory philosophies and different approaches to balancing of economic and non-economic policy objectives. But increasingly, these differences are seen as ways of leveraging control for the purpose of industrial advantage.

The key issue is that if multilateral institutions cannot perform a restraining function, there is little to contain a costly spiral of rivalry between competing regional blocs. Hopes for a more benign form of “re-globalisation” on a regional basis probably assume tacitly that there are  multilateral safety nets of the sort that existed even a few years ago.

Moreover, the issue here is at least as much about the tacit contribution that rules made to global governance as it is about their formal contribution. What multilateralism helped to do was create a common mindset in policy making. This accepted the proposition  that abiding by principles such as non-discrimination might be painful at times, but was collectively and individually beneficial. The impetus in the US and the EU to launch the Uruguay Round lay as much in the prospect of opening foreign markets as it did about pushing domestic policy on a more liberal track. That mindset is now gone from western countries, and was arguably never really deeply anchored in the emerging ones such as the BRICS.

Bringing it all back home    

Russia’s invasion of Ukraine, and the responses to this, seem to have given a decisive push to the forces that already favoured economic fragmentation in international relations. It is far from clear that that a benign form of “re-globalisation” will appear, as compared to a downward spiral into rivalry between blocs marked by economic conflict. The way in which technology has reshaped trade provides parties with both the incentive and the ability to try and impose costs on rivals. Further fallout from the Ukraine conflict, such as unrest in developing and developed countries from high food prices, will feed into political forces that have a reflexive aversion to trade and international cooperation.

How could “re-globalisation” be managed in a way that reduces the drift toward conflict? We should start with the recognition that geopolitical rivalry is here to stay and that countries have largely “written down” the idea that interdependencies can mitigate that. The aim is therefore to ensure that forces for rivalry are channelled into more benign modes. Here the old GATT/ WTO logic can come in handy: price-based measures are better than quantitative measures, and subsidies are better than trade restrictions.

The area of subsidies rules in particular is ripe for reform. Arguably, current rules rule out subsidies that are welfare-enhancing at a local and global level (e.g. specific subsidies that are required for low emissions production) while allowing ones that are likely distorting (e.g. energy subsidies). Connected to that, rules on trade defence measures – which are one of the first ports of call in economic conflict – need attention. Economically, they are currently a mess. A reform would see them targeted more squarely on the issues raised in level playing field discussions e.g unpriced externalities, and less as a thin fig-leaf for protectionist interests.

The natural rejoinder to all this is that if countries have demonstrated a revealed preference for rivalry, why should we expect them to cooperate on mitigating the forms and costs of that rivalry via the sorts of reforms contemplated above. The optimistic view is that there is still a residual degree of clear-sightedness regarding the value of tying ones own hands. The more realistic view is that the willingness to cooperate will need to be re-learned via some very painful lessons of experience. One can only hope that it will not be too late by then.


About the Author

Amar Breckenridge

Amar
Breckenridge

Amar Breckenridge is a manager in Frontier Economics' public policy practice, and leads its work on international trade policy.

Amar’s work on trade spans trade policy analysis and modelling, support to dispute settlement and litigation, and trade negotiations. Amar spent five years as a staff economist at the World Trade Organisation prior to joining Frontier.

He is also a member of the Experts Network at ICTSD.


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