How should the IMF respond?

As the IMF turns 80, its core macroeconomic mission still deserves to be pursued and prioritized. The ongoing corrosion of globalization—reinforcing and being reinforced by geopolitical fragmentation—increases the vulnerability of all but the largest economies to foreign economic shocks, arbitrary swings in current account balances, interruptions in access to dollar liquidity, and accumulation of unsustainable debt. The increasing politicization of international finance and commerce by China, the European Union, and the United States has, however, put at risk the IMF’s ability to assist member countries and limit exploitative behavior by the governments of the three largest economies. For the sake of global economic stability, the IMF must get out in front of these dangers.

But stability will not be achieved by broadening the institution’s remit in an effort to pander to the changing whims of the largest shareholders, though that response might be understandable as a short-term political approach. Instead, the IMF must emphasize its unique role as a multilateral conditional lender and a truth teller regarding international debt and monetary issues. This role justifies greater operational independence, along the lines of central banks.

First, the broader and more discretionary the core IMF agenda, the greater the vulnerability of member countries to the geopolitical machinations of large-economy governments and the market flows they influence—which is precisely the threat that is currently on the rise.

Second, broad consistency in both substance and process in dealings with member countries is critical to the legitimacy of the IMF’s decision making, especially when members are most vulnerable. Technocratic evenhandedness is essential to successful buy-in by all members over the long run, even at the expense of some local support in short run. Inconsistencies of the sort imposed by the US on successive programs with Argentina or by the EU’s “troika” role in the euro area crisis are likely to grow over time.

Third, although there are other international forums to address inequality, climate, and other global issues, only the IMF can be a quasi-lender of last resort and speaker of truth to economic power on debt and monetary issues. The IMF cannot put up substantial funds for longer-term development and global public goods—or mobilize private financing on an ongoing basis—as others can. It should be ready to trade its seat in these discussions for greater institutional (not just de facto) independence in its core mission.

We are likely at the early stage of a cycle of cross-border distrust among the big three economies feeding demands for self-reliance and then demanding that smaller economies choose sides. The IMF may have only a brief window to build its institutional strength before it is pressured recurrently to choose sides between major shareholders.

More central than ever

The IMF’s core macroeconomic mission is to address member nations’ vulnerabilities that arise through cross-border commerce and financial flows and manage the international monetary system that underlies those flows. In their recent assessment, Floating Exchange Rates at Fifty, Douglas Irwin and Maurice Obstfeld point out that many of the problems the IMF and the Bretton Woods agreements were designed to address are inherent to international finance. These problems remain, even though the postwar fixed exchange rate system was abandoned in favor of today’s non-system:

• Exchange rate flexibility allows for monetary independence, yielding low inflation, but still does not prevent sudden stops and financial crises.
• Foreign economic shocks are still transmitted, often with substantial effects on smaller and lower-income countries.
• Capital flows often drive large rapid fluctuations in current account deficits.
• Interruptions in the availability of dollar liquidity to member economies have major repercussions, sometimes causing financial crises.
• Self-insurance efforts by large-surplus economies—whether through currency manipulation or replacement of imports with subsidies and tariffs—reduce global growth and impose adjustments during recessions on others.

As a result, there is no getting away from crisis lending with conditionality when member economies lose access to financial markets or suffer capital flight. The IMF’s ability to provide credible conditional adjustment financing, cushion groups of economies from common economic shocks, and restore access to market liquidity while restructuring international debt obligations is therefore more, not less, central than ever.

Only the IMF can provide this support on a multilateral, nearly universal basis. Any other institution or bilateral intergovernmental arrangement offering emergency financing will give that lender prejudicial influence over the borrowing country.

Benefits of surveillance

Surveillance of spillovers from the misguidedly excessive self-insurance policies of the largest economies, if consistently pursued, has a good shot at benefiting the global economy. Small achievable changes in the policies of those economies can aid many significantly, boost IMF credibility, and reduce risk. Similarly, by seeking to coordinate on cross-border debt and monetary issues, the IMF can generate benefit by influencing small changes in (or offsetting) behavior by lenders and reserve currency issuers. The more independent the IMF, the greater its legitimacy in its interaction with members.

The IMF must also call China, the EU, and the US to account through surveillance of their increasingly political and bullying control of access to their markets and its spillovers to the rest of the world. When China or the US conditions access to its payment systems or fossil fuel exports on national security goals, uncertainty reverberates through the rest of the world. Emerging markets’ growth prospects rise and fall as the big three economies arbitrarily determine who gets to produce their imports and who does not.

Let the other international economic and financial institutions—the World Bank, the Organisation for Economic Co-operation and Development, the Group of 20 major economies, and so on—take their seats at every arguably relevant table and maximize their funding. The IMF is the only multilateral institution that deals directly with cross-border spillovers and macroeconomic volatility. The IMF is the only multilateral institution that can engage in macroeconomic conditionality with any hope of legitimacy and of changing borrower policies. The IMF is the only international entity that can force negotiation, albeit not necessarily rapid restructuring, by private sector investors. And the IMF is the only international organization that can chide the big three economies in precise terms with respect to their policies and not just ask for more contributions to public goods.

In surveillance, as in lending and other policy decisions, the EU, the US, and China have a common interest in making sure that each is criticized according to the same criteria, with the same frequency, and through the same public channels. The IMF should lock in on independent frankness rather than a mutual nonaggression pact over US fiscal deficits, Chinese exchange rates, and the EU’s ill-timed austerity, which served the world so poorly in the 2000s and 2010s.

Confronting new challenges

To better achieve its mandated goals and shore up its legitimacy, the IMF should aim for greater operational independence, akin to that of most central banks, while maintaining external evaluation of its competence by its members and having them set its overall goals. This is already taking place to some degree with respect to executive board approval of specific program decisions, for example. Continued progress will likely require narrowing down the IMF’s mandate to its core functions in exchange for more autonomy in specific policy decisions. Yielding some turf is what the Fund must do in terms of governance deals without compromising its evenhanded treatment of members.

Given the growing distrust among the US, the EU, and China, there should be a way forward to a mutual agreement to give the IMF that operational insulation. Securing such an agreement, with clear limits on what the IMF can address, would assure each of the big three economies that the other two will not be able to exercise control in situations that really matter to them. All macroeconomic institutions depend upon such a mutual recognition that it is better to yield control to be confident that there will be no abuse of power in turn. The absence of adequate insulation of IMF operations will likely splinter the global financial safety net, with divergent politicized conditionality; allocate access to funding unevenly, if not unfairly; and diminish stability of the international monetary system.

By focusing on its core mission, the IMF can adapt to the new global economic challenges arising from the fragmentation of geopolitics and the corrosion of globalization. Particularly worrisome is the largest economies’ increasing tendency to link access to their markets to various political loyalty tests or side payments. All manner of access is affected—exports to those countries, employment and technical knowledge in high-tech and other industries deemed “critical,” financial services and liquidity, foreign direct investment into and from those countries, and cross-border aid and lending. Intentional or not, this is the kind of national-security-driven fragmentation that the creation of the Bretton Woods institutions 80 years ago was aimed to prevent.

There are of course other imminent global challenges: climate change first and foremost, but also pandemics, food security, technology competition, trade wars, real wars, and the mass migrations all these induce. For member countries other than the big three, these challenges are likely to be experienced as recurring, increasingly frequent macroeconomic shocks. To the extent that these are simultaneous shocks across many member countries, the IMF should provide special facilities or lending to those members on common terms and insist that the big three economies change their behavior or offset the shocks.

Exercising best practice

For the majority of its members, then, it is essential that the IMF’s advice on macroeconomic policies to manage shocks and the vulnerabilities they expose follow best practice, and is consistent for all members, whatever the source of the shock. This is in the long-term best interest of the big three economies as well. But their governments are increasingly tempted either to insert their geopolitical preferences into IMF decisions or to shield their protectionist self-dealing from surveillance, despite the large impact on others.

The IMF can thus best serve its membership—including the big three—as a bulwark of technocratic multilateralism against politicized bullying in financial and other market access. A significant step in this direction would be greater IMF executive board ability to pass decisions by qualified majority voting—meaning restriction of the largest shareholder’s ability to exercise a veto—except on long-term or quasi-constitutional issues. This exchange of narrowness for the sake of operational independence would be helpful because the IMF would not be putting more US taxpayer funds at perceived risk or using them to serve mission creep.

Another step forward would be to adopt stricter and more consistent rules limiting IMF lending to economies at war, for example, with respect to Israel, the West Bank and Gaza, and Ukraine today. There is, of course, a need for support and eventual reconstruction assistance, but if the IMF is seen as taking sides while conflict is ongoing, it may split the world economy even further. For the first time since the 1980s, military conflicts directly involving the major powers’ allies on opposite sides are occurring and are likely to continue. The IMF should forestall falling into this trap.

Beyond China, the US, and overrepresented EU economies, the IMF’s members, particularly low- and middle-income countries, should view these challenges as an opportunity to have more say on matters that affect them deeply. Enhanced operational independence would go hand in hand with continued IMF accountability to its board for evaluation of its policy execution and for goal setting. The Bretton Woods institutions must be more reliable in the coming years if the big three economies continue to retreat from rules-based globalization in favor of with-us-or-against-us exclusionary economics. For all the immediate pressure on the IMF, well intentioned or otherwise, to respond to its largest shareholders on any given issue, insulation from increasing geopolitical division would be more than prudent. Greater operational independence is the prerequisite for addressing any and all of the other global economic challenges as geopolitics corrodes globalization.

Adam Posen is president of the Peterson Institute for International Economics.

Posen

To read the full article as published by the International Monetary Fund, click here.

To read the full article, click here.

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Until this happens, trade imbalances will persist. This matters especially to the United States because of the role it plays in anchoring global imbalances. Countries that run large, persistent trade surpluses must acquire foreign assets to balance these surpluses. American assets are particularly attractive for this purpose, and the United States allows nearly unfettered access to these assets. As a result, surplus countries prefer to acquire assets in the United States in exchange for their surpluses, which also means that the United States must run the corresponding trade deficits.

This has important implications for U.S. manufacturing, unemployment, and debt. It means that the U.S. share of global manufacturing must decline while that of surplus countries must rise. Because surplus countries are those that subsidize their manufacturing at the expense of domestic consumption, American manufactures are forced indirectly to subsidize U.S. consumption. This is why, during the past five decades, manufacturing has consistently migrated from deficit countries (mainly the United States) to surplus countries (mainly China). Until global rebalances are resolved, this will continue.

It also means that for all the talk of reshoring and friendshoring, the U.S. trade deficits cannot decline as long as surplus economies can continue to acquire assets in the United States with the proceeds of their surpluses. The United States, in other words, has no choice but to run deficits to balance the surpluses of the rest of the world.

What’s more, while many mainstream economists assume that foreign inflows lower U.S. interest rates and finance U.S. investment, as occurred in the nineteenth century, this hasn’t been the case for decades. Foreign inflows instead force adjustments in the U.S. economy that result in lower U.S. savings, mainly through some combination of higher unemployment, higher household debt, investment bubbles, and a higher fiscal deficit.

To rebalance its economy toward manufacturing while reining in debt and generating higher-paying employment, the United States must either transform the global trading regime or unilaterally opt out of its current role. Not only would this benefit the U.S. economy, but it would also benefit the global economy by eliminating the persistent downward pressure on global demand created by the surplus countries.

This won’t be easy, however. Any meaningful resolution of global trade imbalances will be strongly opposed by surplus countries and would result in a diminished global role for the U.S. dollar. 

HOW DOES INTERNATIONAL TRADE AFFECT THE U.S. MANUFACTURING SECTOR?

Last month, Yao Yang, former dean at the National School of Development at Peking University, said on his blog that “America’s industrial base has already been hollowed out. How can it possibly compete [with China]? The United States has obviously made a strategic mistake.”

He’s right, but perhaps not for the reasons he thinks. While manufacturing comprises roughly 16 percent of global GDP, according to the World Bank, the manufacturing share of China’s GDP is 28 percent, among the highest in the world, whereas for the United States it is 11 percent, among the lowest for any major economy. The opposite is true for consumption. While consumption accounts for 75 percent of global GDP, it accounts for 80 percent of the United States’ GDP and only 53 percent of China’s GDP.

To put it another way, while China comprises less than 18 percent of global GDP, it accounts for over 31 percent of global manufacturing and less than 13 percent of global consumption. The United States, which accounts for 24 percent of global GDP, accounts for less than 17 percent of global manufacturing and nearly 27 percent of global consumption.

While the differences in the two countries’ manufacturing and consumption shares of GDP may seem unrelated, it turns out that they are different expressions of the same imbalance. China and the United States are extreme representatives of a common pattern in the global economy. Manufacturing typically represents a disproportionately large share and consumption a low share of the GDP of non-commodity economies with large, persistent surpluses. The reverse is true for advanced economies that run large, persistent deficits.

This clearly isn’t a coincidence, but in which direction does the causality run? Do countries have larger manufacturing sectors because they are surplus countries, or do they run surpluses because they have larger manufacturing sectors? For many years, economists have argued that it is the latter. Surplus economies, they claim, have a comparative advantage in manufacturing that leads them to produce tradable goods more efficiently, and this is why they export more than they import. Deficit countries like the United States, on the other hand, have a comparative disadvantage in manufacturing.

But this misunderstands altogether the meaning of comparative advantage. As I explain below, surplus economies run surpluses mainly because of industrial policies that implicitly or explicitly force households to subsidize the manufacturing sector. Their competitive advantage in manufacturing comes not from comparative advantage but rather from transfers that distort comparative advantage and reduce domestic demand.

WHAT IS THE RELATIONSHIP BETWEEN COMPETITIVE MANUFACTURING AND WEAK DOMESTIC DEMAND?

In these persistent surplus economies, weak domestic demand is simply the flip side of policies that result in manufacturing competitiveness. The manufacturing sector is subsidized directly or indirectly by households, which leaves them more competitive and leaves households less able to purchase a substantial share of what they produce.

But in order to balance these surpluses, the opposite transfers must occur in the deficit countries. Just as consumers are forced to subsidize producers in the surplus countries through various explicit and implicit transfers, producers are effectively forced to subsidize consumers in the deficit countries.

There are many forms these transfers can take, but the easiest one to understand is through currency values. An undervalued currency, typical of surplus countries, affects trade imbalances by raising the cost of imports and increasing the profits of exporters. It results, in other words, in an implicit transfer from importers to exporters. Because households are all net importers, and because net exporters are mostly manufacturers, these implicit transfers subsidize the manufacturing sector at the expense of households. This makes the manufacturing sector in that country more competitive while reducing the capacity of households to consume.

The opposite happens in the deficit countries. An undervalued currency for one country is the obverse of an overvalued currency for its trade partner, and this overvaluation also represents an implicit transfer, in this case from net exporters (manufacturers) to net importers (households as consumers). Just as manufacturers are subsidized by consumers in the former, so are consumers subsidized by manufacturers in the latter, making their manufacturing sectors less competitive globally.

It is not surprising, then, that global manufacturing naturally migrates from deficit countries to surplus countries, while global consumption migrates in the opposite direction. This has nothing to do with comparative advantage. Manufacturers in both economies are simply responding to the direction of subsidies.

Although I use undervalued and overvalued currencies as an easy illustration of how these transfers between producers and consumers affect trade, they are not the only, nor even the most important, of such transfers. Repressed interest rates, for example, have often been far more important, along with overinvestment in infrastructure, wage repression, and several other implicit or explicit transfers that subsidize manufacturers at the expense of households. (See appendix 1 for a list of such transfers and how they subsidize manufacturing at the expense of households.)

CAN TRADE INTERVENTION BE USED TO MAKE TRADE FREER?

There is no meaningful difference between trade-oriented policies and most forms of industrial policy. Any economic, monetary, or fiscal policy that affects the balance between a country’s domestic savings and its domestic investment must necessarily affect that country’s trade balance, and through its trade balance, it must necessarily affect the balance between the domestic savings and domestic investment of its trade partners. In a closed global economy, where savings must equal investment, any policy that forces up the savings rate in one sector must be balanced by either higher investment or lower savings elsewhere.

That’s where trade intervention can lead to freer trade. Trade surpluses that are caused by beggar-thy-neighbor industrial policies—designed to improve international competitiveness by suppressing domestic demand—can only exist to the extent that they are matched by trade deficits in other countries. In that case, if the deficit countries implement interventionist trade or capital polices directed at reducing their deficits, these will automatically force surplus countries to reverse their own beggar-thy-neighbor policies. This in turn will force an adjustment in the global trading regime such that global trade is once again based on comparative advantage and contributes to expanding global production, not to suppressing global demand.

The point is that there are a wide range of policies that can cause global trade distortions, and while some of these policies can target trade, many of them don’t do so explicitly. That’s why in the interests of a well-functioning global trade environment it is better to target overall trade imbalances, as John Maynard Keynes proposed at the Bretton Woods Conference in 1944, than it to target specific trade violations.

While the World Trade Organization and other existing trade regulatory entities have focused on the latter, they have left us with a world of massive, persistent trade imbalances and perverse capital flows. These conditions are prima facie evidence that existing trade regulatory entities have failed to manage global trade appropriately. That’s why the United States, and most of the rest of the world, would be better off with a radical reorganization of the global trading system.

Michael Pettis is a nonresident senior fellow at the Carnegie Endowment for International Peace. An expert on China’s economy, Pettis is professor of finance at Peking University’s Guanghua School of Management, where he specializes in Chinese financial markets.

To read the full analysis as it is posted on the Carnegie Endowment for International Peace’s China Financial Markets blog, click here.

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Today’s proposals are part of a broader three-pillar approach to EU economic security by promoting the EU’s competitiveness, protecting against risks and partnering with the broadest possible range of countries to advance shared economic security interests.

The initiatives adopted today aim at:

• further strengthening the protection of EU security and public order by proposing improved screening of foreign investment into the EU;
• stimulating discussions and action for more European coordination in the area of export controls, in full respect of existing multilateral regimes and Member States’ prerogatives;
• consulting Member States and stakeholders to identify potential risks stemming from outbound investments in a narrow set of technologies;
• promoting further discussions on how to better support research and development involving technologies with dual-use potential;
• proposing that the Council recommends measures aimed at enhancing research security at national and sector level.

Future EU actions will continue to be informed by the on-going risk assessments and by strategic coordination with Member States to reach a shared understanding of the risks that Europe faces and of the appropriate actions.

Legislative proposal to strengthen foreign investment screening

Foreign investments into the EU benefit the European economy. However, certain foreign investments may present risks to the EU’s security and public order. The Commission has reviewed over 1,200 foreign direct investment (FDI) transactions notified by Member States over the past 3 years under the existing FDI Screening Regulation. Building on this experience and extensive evaluation of the functioning of the current regulation, today’s proposal addresses existing shortcomings and improves the efficiency of the system by:

1. ensuring that all Member States have a screening mechanism in place, with better harmonised national rules;
2. identifying minimum sectoral scope where all Member States must screen foreign investments;
3. extending EU screening to investments by EU investors that are ultimately controlled by individuals or businesses from a non-EU country.

Monitoring and assessment of outbound investment risks

The EU is one of the biggest foreign investors in the world and recognises the importance of open global markets. It also acknowledges the growing concerns regarding outbound investments in a narrow set of advanced technologies that could enhance military and intelligence capacities of actors who may use these capabilities against the EU or to undermine international peace and security.

This is currently neither monitored nor controlled at EU or Member State level. The Commission’s White Paper on Outbound Investments is therefore proposing a step-by-step analysis of outbound investments to understand potential risks linked to them. This analysis will include a three-month stakeholder consultation and a 12-month monitoring and assessment of outbound investments at national level, which will contribute to a joint risk assessment report. Based on the outcome of the risk assessment, the Commission will determine, together with Member States, if and which policy response is warranted.

More effective EU control of dual-use goods exports

Today’s increasingly challenging geopolitical context requires action at EU level to improve the coordination of export controls on items with both civil and defence uses – such as advanced electronics, toxins, nuclear or missile technology – so that they are not used to undermine security and human rights. Today’s White Paper on Export Controls proposes both short and medium-term actions, in full respect of the existing rules at EU and multilateral level. The Commission proposes to introduce uniform EU controls on those items that were not adopted by the multilateral export control regimes due to the blockage by certain members. This would avoid a patchwork of national approaches.

The White Paper also provides for a senior level forum for political coordination and announces a Commission Recommendation in Summer 2024 for an improved coordination of National Control lists prior to the planned adoption of national controls. The evaluation of the EU Dual-Use Regulation is advanced to 2025.

Options to support research and development in technologies with dual-use potential

With a White Paper on options for enhancing support of research and development (R&D) of technologies with dual-use potential, the Commission launches a public consultation. Announced by President von der Leyen in November 2023, the White Paper contributes to the ‘promote’ dimension of the European Economic Security Strategy, aiming at maintaining a competitive edge in critical and emerging technologies with the potential to be used for both civil and defence purposes.

The White Paper reviews current relevant EU funding programmes in the face of existing and emerging geopolitical challenges and assesses whether this support is adequate for technologies with dual-use potential. It then outlines three options for the way forward: (1) going further based on the current set-up, (2) removing the exclusive focus on civil applications in selected parts of the successor programme to Horizon Europe, and (3) creating a dedicated instrument with a specific focus on R&D with dual-use potential. Public authorities, civil society, industry, and academia can have their say in an open public consultation and inform the Commission’s next steps until 30 April 2024.

Enhance research security across the EU

In today’s complex geopolitical context, the openness and borderless cooperation in the research and innovation sector may be exploited and turned into vulnerabilities. Results of international research and innovation cooperation can be used for military purposes in third countries, or in violation of fundamental values. Higher education and research institutions can fall victim to malign influence by authoritarian states.

Against this background, the Commission presents a proposal for a Council Recommendation to provide more clarity, guidance and support to Member States and the research and innovation sector at large. EU action is required to ensure consistency across Europe and to avoid a patchwork of measures. By joining forces at all levels and across the Union we can mitigate the risks to research security and ensure that international research and innovation cooperation is both open and safe. The overall approach follows the principle ‘as open as possible, as closed as necessary’ as regards international research cooperation.

Background

On 20 June 2023, the European Commission and the High Representative published a Joint Communication on a European Economic Security Strategy, to minimise the risks in the context of increased geopolitical tensions and accelerated technological shifts, while preserving maximum levels of economic openness and dynamism. It provides a framework for assessing and addressing – in a proportionate, precise and targeted way – risks to EU economic security, while ensuring that the EU remains one of the most open and attractive destinations for business and investment.

The strategy identified four risk categories to be addressed as a matter of priority: supply chains; physical and cyber-security of critical infrastructure; technology security and technology leakage; weaponisation of economic dependencies or economic coercion.

To address these risks, the Strategy is structured around three pillars:

• Promoting the EU’s competitiveness and growth, strengthening the Single Market, supporting a strong and resilient economy, and strengthening the EU’s scientific, technological and industrial bases.
• Protecting the EU’s economic security through a range of policies and tools, including targeted new instruments where needed.
• Partnering and further strengthening cooperation with countries worldwide who share our concerns and those with which we have common economic security interests.

To read the press release as it appears on the European Commission’s press corner, click here.

For more information

Communication: advancing European economic security: an introduction to five new initiatives

Proposal for a Council Recommendation on enhancing research security

White Paper on options for enhancing support for research and development involving technologies with dual-use potential

White Paper on export controls

White Paper on outbound investment

Proposal for a new regulation on the screening of foreign investments

Memo on European Economic Security

Factsheet – Proposal for a Council Recommendation on enhancing research security

Factsheet – White Paper on options for enhancing support for research and development involving technologies with dual-use potential

Factsheet – White Paper on export controls

Factsheet – White Paper on outbound investments

Factsheet – Proposal for a new regulation on the screening of foreign investments

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It’s been a rocky year for global trade. The World Trade Organization now expects trade in world merchandise to have grown just 0.8% in 2023, less than half of the 1.7% growth it forecasted earlier in the year, buffeted by rising inflation, high interest rates, and simmering geopolitical tensions.

What’s in store for 2024? Can we expect more of the same? Or will the situation start to stabilize? Our experts share their insights on what to watch out for over the next 12 months.

Globalization will continue to involve in 2024, not unwind

Richard Baldwin, Professor of International Economics at IMD

Globalization is under fire in many nations, no doubt about it. International commerce – and indeed the whole idea of economic openness – has been challenged by a long series of massive shocks ranging from Brexit and President Trump’s tariffs to the pandemic, the Russo-Ukrainian war, battles in the Levant, and rising geoeconomic tensions.  

Newsfeeds are filled with headlines about de-globalization and the adoption of inward-oriented trade and industrial policies. But the headlines can be deceiving. The facts are that global trade in goods – as a share of global income – has recovered from COVID-19 lows, even if it has not reversed its downward trend.  Digitally enabled trade in services, by contrast, never faltered, even in the depths of the pandemic, and continues to power ahead. As we head into 2024, my research suggests that trade in goods will continue to stagnate while trade in digitally enabled services (e-services) will continue to boom.

A stabilization of US-China geoeconomic tensions
The US and China are now strategic rivals in the economic, political, cultural, and military spheres. But neither wants this intense competition to lead to WWIII. The US is actively trying to prevent China from acquiring technology that would counter the US’s military edge and promoting the diversification and de-risking of the American supply. This involves encouraging more production in the United States while hindering production in China of a narrow range of goods, most notably including the highest-end semiconductors, technology related to quantum computing, and advanced AI that has military and surveillance uses. Apart from these goods, the Biden administration is not pursuing policies aimed at hindering China’s economic prosperity.  

China’s retaliation to date has been very measured – limited to requiring export licenses for a few inputs that are critical to semiconductor production (gallium, germanium, and graphite). These are best seen as a ‘shot across the bow’ of the US restrictions aimed at preventing China from developing the capacity to produce or purchase the very highest-end semiconductors.  

Both sides are trying to cool down the conflict. As one White House official put it, “The United States and China are in an intense competition, and we believe the best way to manage that competition is through equally intense diplomacy.” Biden and Xi met for the first time in about a year on the sidelines of the Asia-Pacific Economic Cooperation Summit in November 2023, sending a signal that they are committed to working out how to cooperate where they can. I hedge my conjecture with a famous Lenin quote, “There are decades where nothing happens; and there are weeks where decades happen.” Great power rivalries are usually stable but beware that things can go south quickly.  

Climate-related disruptions in production and trade will continue
Extreme weather events are becoming more frequent and climate-related disruptions will increasingly impact international business and international trade globally. What’s more, the interconnectedness of global trade will only amplify the risks of climate-related disruption.  Some extreme weather events disrupt production directly via droughts, floods, or overheating of workers. Others – such as low water levels in the Rhine, or hurricanes that damage ports – disrupt international transportation directly.

How do we know that extreme weather is becoming more common due to climate change? Nothing is certain in the business of climate change, but there are many hints that the unusual weather the world has seen in recent years is not a fluke. These clues include record-breaking heatwaves on land and sea and in most parts of the planet, severe floods and droughts, and extreme wildfires. To withstand the challenges of extreme weather events, policymakers, and business leaders will need to work together to build more resilient and adaptable systems.

Simultaneous Speech Translation (SST) will continue to transform international commerce
Microsoft recently launched speech translation technology that allows participants in a Teams meeting to see live captions of the conversions that are translated into a language of their choice.  This is a big deal. There is even a story in the Old Testament suggesting that language-linked divisiveness was divinely inspired. The book of Genesis discusses a building that humans were constructing to reach the heavens: “The Lord said, ‘If as one people speaking the same language, they have begun to do this, then nothing they plan to do will be impossible for them. Come, let us go down and confuse their language so they will not understand each other.’” The structure came to be known as the Tower of Babel, where “babel” means a confused noise made by a number of voices. 

Not to put too fine an edge on it, simultaneous speech translation is dismantling the Tower of Babel. English speakers – who have long had an edge when it comes to international commerce, especially trade in services – are in for some competition. With machine translation being so good, and getting better so fast, English speakers will soon find themselves in much more direct competition with the billions of service workers who don’t speak English.  Machine translation won’t let them speak perfectly but perhaps well enough to participate in remote office work. The result will be a tsunami of global talent in the online service sectors. This will increase the choices facing employers or remote workers, generate more opportunities for high-skill low-wage workers in emerging markets, and create a lot more competition for advanced economy workers who have jobs that can be done remotely.

Super election cycle will disrupt trade policy

Simon J Evenett, Professor of International Trade and Economic Development at the University of St. Gallen, and Fernando Martin, Head of Analytics at Global Trade Alert

Nearly two billion people living in some of the most important economies on Earth will vote next year in elections. The run-up to polling day doesn’t normally make for enlightened trade policies because plenty of opportunistic politicians will try to blame foreigners for their own countries’ deficiencies. Already governments are maneuvering to deliver short-term political highs by whacking trading partners. The European Commission’s investigation into fast-growing imports of electric vehicles from China is cynically timed to deliver a verdict just before the elections to the European Parliament. Few US politicians will resist the siren call of being tough on Chinese trade and investment as November 2024’s American elections approach. Furthermore, so tight is that US election that the Biden Administration’s patience with the EU on steel will likely snap, leading to transatlantic trade tensions in 2024.

Geopolitical tension may tempt governments to weaponize trade flows
With geopolitical tension top of many executives’ minds, security of supply considerations will remain an important narrative for many governments and corporate buyers during 2024. Will Russia again tighten the screws on grain exports from Ukraine? Will China retaliate against harsher US trade and investment measures by curbing exports of the so-called ‘rare earth’ minerals, critical to the production of many IT products? Derisking pressures – a term used by many to signal reduced dependence on China and other geopolitical foes – won’t go away.

Furthermore, should events in Gaza spiral out of control, some petrol Arab states may find it impossible to resist national pressures to impose oil embargoes. These are unlikely to cause the same damage as witnessed during the 1970s. Even so, oil price hikes are the last thing most economies need as their central banks get inflation under control.

The impact of trade policy pressures will start to be felt
A number of slow-burn trade policy pressures will come to the fore during 2024. October 2023 saw the European Union’s Carbon Border Adjustment Mechanism (CBAM) come into effect. This scheme will impose additional taxes on imports from outside the EU that cannot show they have paid enough charges for the carbon generated during a good’s production. Importers will start receiving their first CBAM bills early in 2024 and there will inevitably be harsh words about EU implementation practices. Some nations may take the EU to court at the World Trade Organization. Others may just retaliate straight away by jacking up trade barriers on EU exports and argue that it is better to negotiate with Brussels from a position of strength. Expect headline-grabbing standoffs over carbon taxes. Other sore points include the EU’s regulations on sourcing products from areas with extensive deforestation and plans in the works to impose extensive regulation on cross-border supply chains operating into and out of the European Union.

The world won’t shatter into trade blocs along geopolitical lines
Despite these concerns, the much-feared split of the world economy into separate trading blocs is unlikely to happen during 2024. The most likely trigger would be an outrage perpetrated by either China or the United States. To many Western governments, any attempt by China to invade Taiwan would be a step too far and would likely result in harsh economic sanctions on Beijing. Yet those American military experts who claim to track this matter aren’t publicly warning that this outcome is likely in 2024. Schism isn’t impossible in 2024, just very, very unlikely.

Africa and Asia will remain bright spots for trade policy
Against this gloomy backdrop are some positive trends that will keep creating opportunities for forward-looking businesses. Africa is pushing ahead with implementing a massive continental free trade agreement, strengthening ties between nations likely to see the fastest population growth through to 2050. Plus, by and large, the sourness expressed across the Atlantic towards globalization and trade finds no counterpart across the Asia-Pacific region. The mistake here is to let zero-sum narratives in the West dominate senior executive decision-making. After a divisive election season in 2024, some may conclude that the derisking needed involves limiting exposure to slower-growth, surly Western economies.

Richard Baldwin is Professor of International Economics at IMD and Editor-in-Chief of Vox since he founded it in June 2007. He was President/Director of CEPR (2014-2018), a visiting professor at many universities, including MIT, Oxford, and EPFL, and a long-time professor of international economics at the Graduate Institute in Geneva. Richard is an expert in global economic policy and theory, specializing in international trade.

Simon J. Evenett is currently a Professor of Economics at the University of St. Gallen and on 1 August 2024 will join the Faculty at IMD. He is also the Founder of the St. Gallen Endowment for Prosperity Through Trade, home of two of the leading independent monitors of how governments shape international business.

Fernando Martín leads the Analytics Unit at the Global Trade Alert. His work focuses on trade and industrial policy with a special focus on geopolitics and geoeconomics. He holds a PhD in business economics from KU Leuven and an MSc in political economy of Europe from the London School of Economics and Political Science.

To read the full article, click here.

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For a number of overlapping reasons, today’s industrial policy seems different from policy in the past. It is often forcefully pursued by major highincome industrial economies, including the United States, the European Union, and Japan, as opposed to emerging economies. China’s use of industrial policy is both motivating these new users—sometimes to deploy industrial policy themselves, sometimes to defend their economies from China—and driving some of the associated WTO challenges. Today’s industrial policy objective is also often less about learning for the first time how to competitively produce a good or acquire the necessary technological absorptive capacity to do so, which is what often motivated past infant industry policies for developing countries. Instead, the objective appears aimed at returning parts of a supply chain for industries ranging from semiconductors to personal protective equipment (PPE) that were once present but that have since been offshored.

Industrial policy today is also sometimes motivated by objectives other than increasing firm-level productivity or generating spillovers to other sectors and thus enhancing national economic growth. Instead, industrial policy is aimed at diversification in the name of supply chain resilience, fear over the weaponization of exports by trading partners, maintenance of technological supremacy, or the desire to offer future policymakers more control over economic activity in response to expected shocks. In the presence of cross-border supply chains, some governments are seeking to coordinate their industrial policies with key partners, as opposed to implementing everything at the national level in an attempt at reshoring. Overlaying other considerations is the existential threat of climate change, an important driver behind many modern industrial policy initiatives.

To explore these interrelated motivations for today’s industrial policy and its numerous implications for the WTO, this paper is organized as follows. The next section briefly introduces the historical economic approach to industrial policy, borrowing from Harrison and Rodríguez-Clare (2010). The starting point of this literature is typically market failures, developing countries, and how industrial policy can improve firm-level productivity growth and possibly national economic growth.

Section 3 turns to the dominant economic framework motivating the WTO. It draws on Bagwell and Staiger (1999, 2002) as well as key WTO rules and the role of enforcement. The WTO is interpreted as providing an institutional setting for large countries to coordinate policies and set rules on behavior to neutralize the international externality implications of their actions and solve a prisoner’s dilemma problem. This section also explores the economic understanding of current subsidy rules with implications for industrial policy. It describes unease with the evolution of those rules, gaps in knowledge, and important data and measurement shortcomings.

The subsequent two sections form the heart of the paper. They introduce four areas in which modern industrial policy has emerged as a major issue for the WTO. Section 4 tackles the myriad challenges introduced by China. Section 5 examines areas of supply chain resilience, supply chain responsiveness, and climate change. The four issues are not cleanly separable; the last three are independent areas of concern, but China plays a critically important role in each. The last section concludes by motivating the need for further economic research.

Chad P. Bown is the Reginald Jones Senior Fellow at the Peterson Institute for International Economics.

To read the abstract published by the Peterson Institute for International Economics, click here.

To read the full working paper, click here.

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Despite decades of attention and lobbying efforts within the labor community, government parties to trade agreements fail to protect vulnerable workers from carrying the burden of globalized trade. Women and young children continue to be forced into labor, trafficked, sold across borders, worders. Union participation continues to decline globally, and union leaders are arrested or disappeared. Throughout supply chains, factories continue to enslave and torture with impunity. Millions of workers still lose their lives in workplace accidents.

Since the turn of the century, U.S. trade policy has reacted to such labor exploitation by requiring trade partners to commit to the ILO’s four “fundamental” labor rights, namely (1) collective bargaining and freedom of association; (2) prohibitions against child labor; (3) prohibitions against forced labor; ander (4) non-discrimination in employment. Yet, prior U.S. administrations have proved hesitant, if not unwilling, to enforce those commitments, mainly when doing so threatened more pressing foreign policy and geopolitical objectives.

To read the full summary as it was published by the Social Science Research Network, click here.

To read the full paper, please click here.

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