Globalization in an Age of Crisis: Multilateral Economic Cooperation in the Twenty-First Century

Globalization in an Age of Crisis: Multilateral Economic Cooperation in the Twenty-First Century

by Robert C. Feenstra, Alan M. Taylor

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Along with its painful economic costs, the financial crisis of 2008 raised concerns over the future of international policy making. As in recessions past, new policy initiatives emerged, approaches that placed greater importance on protecting national interests than promoting international economic cooperation. Whether in fiscal or monetary policies, the control of currencies and capital flows, the regulation of finance, or the implementation of protectionist policies and barriers to trade, there has been an almost worldwide trend toward the prioritizing of national economic security. But what are the underlying economic causes of this trend, and what can economic research reveal about the possible consequences?
Prompted by these questions, Robert C. Feenstra and Alan M. Taylor have brought together top researchers with policy makers and practitioners whose contributions consider the ways in which the global economic order might address the challenges of globalization that have arisen over the last two decades and that have been intensified by the recent crisis. Chapters in this volume consider the critical linkages between issues, including exchange rates, global imbalances, and financial regulation, and plumb the political and economic outcomes of past policies for what they might tell us about the future of the global economic cooperation.

Product Details

ISBN-13: 9780226030890
Publisher: University of Chicago Press
Publication date: 01/07/2014
Series: National Bureau of Economic Research Conference Report
Edition description: New Edition
Pages: 464

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Globalization in an Age of Crisis

Multilateral Economic Cooperation in the Twenty-First Century

By Robert C. Feenstra, Alan M. Taylor


Copyright © 2014 National Bureau of Economic Research
All rights reserved.
ISBN: 978-0-226-03075-3


Coping with Shocks and Shifts

The Multilateral Trading System in Historical Perspective

Douglas A. Irwin and Kevin H. O'Rourke

1.1 Introduction

How can multilateral cooperation on matters of trade policy be sustained? How has the multilateral trading system been able to cope with the various challenges that have confronted it in the past? The goal of this chapter is to see if history can provide us with guidance in dealing with the challenges in maintaining open, multilateral trade in the years ahead. These challenges are nonnegligible in light of the prolonged economic fallout from the financial crisis of 2008–2009, the rapid rise of China as a major exporter, and the apparent failure of the Doha Round.

This chapter focuses on the extent to which policymakers have been able to construct a multilateral trading system, and how the system has (or has not) responded to the major challenges that confront it. We draw attention to two broad categories of challenges: shocks and shifts. By shocks we mean sudden jolts to the world economy that can take the form of financial crises and deep recessions, or wars and political conflicts. By shifts we mean slow-moving, long-term changes in comparative advantage or shifts in the geopolitical equilibrium that force economies to undergo potentially painful and disruptive adjustments.

To analyze the consequences of these shocks and shifts, we need a framework. Ours is based on Aesop's fable of the oak and the reed:

"You have reason to complain," said the Oak. "The slightest breeze that ruffles the surface of the water makes you bow your heads, while I, the mighty Oak, stand upright and firm before the howling tempest."

"Do not worry about us," replied the Reeds. "The winds do not harm us. We bow before them and so we do not break. You, in all your pride and strength, have so far resisted their blows. But the end is coming."

As the Reeds spoke a great hurricane rushed out of the north. The Oak stood proudly and fought against the storm, while the yielding Reeds bowed low. The wind redoubled in fury, and all at once the great tree fell, torn up by the roots, and lay among the pitying Reeds.

This fable points to the need for shock absorbers if a trading system is to survive. Some international regimes have been characterized by a greater variety of shock absorbers—or more efficient ones—than others. This helps to explain their relative longevity. At the time of this writing, our own period's trading system seems reassuringly reed-like, while the reconstructed international system of the 1920s proved to be a bit of an oak. Indeed, the liberal international order of the nineteenth century also turned out to be an oak: while the period saw the development of various economic shock absorbers, in the end its geopolitical shock absorbers proved inadequate.

Before describing the ways in which the multilateral trading system can be preserved, we need to define what it is. We begin by discussing the various features of a multilateral trading system that are generally considered desirable. There are a number of aspects of a multilateral order, not all of which are consistent with one another, that policymakers have professed to be worthwhile goals. Section 1.3 examines the history of the international trading system over the past two centuries, focusing on where it has come close to and where it has deviated from the desiderata set out in section 1.2. Section 1.4 discusses and classifies the shocks and shifts to which the international economy has been subjected over the past two centuries. Section 1.5 briefly compares today's shock absorbers to those of the past. Section 1.6 applies the lessons of history to ask where the international economy goes from here.

1.2 Free Trade and Multilateralism

Robert Keohane (1990) has defined multilateralism as "the practice of coordinating national policies in groups of three or more states," to which other political scientists have added the criterion that the coordination take place on the basis of certain agreed-upon principles. A multilateral system of world trade, therefore, refers to the cooperative efforts of various countries in the realm of trade policy. Since countries do not need to cooperate with each other to increase trade barriers and diminish trade (something they can manage quite well on their own), the goal of such cooperation is usually to reduce trade barriers and expand trade. For example, the purpose of the 1947 General Agreement on Tariffs and Trade (GATT) is to undertake "reciprocal and mutually advantageous arrangements directed to the substantial reduction of tariffs and other barriers to trade and to the elimination of discriminatory treatment in international commerce ... with a view to raising standards of living, ensuring full employment and a large and steadily growing volume of real income and effective demand, developing the full use of the resources of the world and expanding the production and exchange of goods."

Thus, a multilateral system is a means to an end, the end being a growing world economy and all the benefits that flow therefrom. Does such a system require institutional arrangements such as we have today? After all, one might argue that an idealized world with no trade agreements but universal free trade would also constitute a multilateral trading "system." Before considering whether institutional arrangements are required to have a multilateral system, it would be useful to consider the desirable properties of such a system.

First, a multilateral system of trade should be open. Openness has several dimensions. One is that countries should have access to each others' markets. This does not necessarily mean free trade in its purest sense, but that government-imposed barriers or hindrances to trade be kept within some defined limits. Another dimension is inclusiveness, that the system be open to the participation of all countries who are willing to abide by the terms agreed to by others. This usually means nondiscrimination, that the system not be an exclusive club, or that the most favored nation (MFN) clause has wide applicability.

Second, a multilateral system of trade should be stable. Once again, stability has several dimensions. One is that government trade barriers be predictable or reasonably certain to the entities engaged in trade. No country would want to see its exports suddenly shut out of foreign markets because of an abrupt and unanticipated change in import duties or quotas. This would be disruptive to world commerce and would stifle trade to the extent that it increased uncertainty about the terms on which trade can take place. How can this certainty be provided? This may require formal or informal "rules of the game," taking the form of informal norms or explicit trade agreements.

Another dimension of stability is that the system should have a well-functioning adjustment mechanism. This chore is usually performed by the international monetary or financial system. Trade should not be conducted and balanced bilaterally, but rather the system of payments should facilitate multilateral trade. An example of such a system at work is provided by figure 1.1, which gives a stylized representation of the world trade settlements system in 1910. As can be seen, the international trading system on the eve of World War I was a multilateral one, in the sense that countries ran up trade surpluses with some partners that they then used to finance deficits with others. For example, India ran a large trade deficit with the United Kingdom, but ran surpluses with continental Europe, the United States, Japan, and China. The United Kingdom, meanwhile, used its surpluses with India and other countries to finance its deficits with continental Europe and the United States.

The polar opposite to a multilateral trading system, in this sense, is a bilateral trading system in which pairs of countries engage in what essentially amounts to barter trade, balancing trade on a bilateral basis. This is not just a theoretical curiosum, since something along these lines has been observed on several occasions over the past century. Communist countries often resorted to barter-style arrangements, for example, in order to keep their domestic price systems insulated from world market conditions, and so did the Nazis when dealing with their informal empire in Southeastern Europe during the 1930s. More prosaically, Western European countries typically had inconvertible currencies after 1945, and it took the establishment of the European Payments Union to bring about a properly multilateral trading system during the 1950s. The economic advantages of multilateralism in this sense are obvious and large, since they are the same as the advantages of trade financed by money relative to barter.

Yet another aspect of stability is flexibility in the face of shocks. If rules are written to maintain openness, the question is whether openness can be preserved in times of stress when there are pressures to deviate from the open regime. If the pressures are not accommodated to some degree, and find no other outlet, the system could break, as Aesop's fable reminds us. If the pressures are too easily accommodated, because the system has safety valves, the system may not remain very open. This balancing act lies behind the "escape clause" (Article XIX) of the GATT, which allows countries to restrict imports of goods that threaten serious injury to domestic producers. If interpreted too strictly, it is no escape clause at all; if interpreted too loosely, there will be no discipline in the use of trade restrictions. An optimal mix of rules and flexibility is required in order to make sure that countries agree to join and to remain in a rules-based system, and that those rules effectively discipline behavior. Similarly, there is an optimal mix between the need to constrain individual states' freedom of action, in the interests of all, and the need to respect national sovereignty and democracy (Rodrik 2011). Bagwell and Staiger (1990) suggest that the escape clause can be rationalized in precisely this way: as a means of avoiding the breakdown of cooperative arrangements at times when trade volumes are unusually high. As we will see in this chapter, different shocks may require different types of shock absorbers, but the basic message of Bagwell and Staiger—that flexibility is required for cooperation not to break down—is a crucial one in our view.

Many would also consider fairness to be a desirable attribute of an international trading system. For example, it would not seem fair to many if powerful countries extracted numerous trade concessions from weaker countries without providing much in return. The need for fairness is operationalized via the concept of reciprocity in WTO (World Trade Organization) trade negotiations. Another desirable property of such a system is that trade disputes be settled by negotiation or arbitration, rather than by the use of unilateral economic sanctions or actual violence. Warfare is the antithesis of a multilateral trading system, since during wars states try to prevent their enemies from exporting (in the case of a mercantilist war) or importing (in more modern wars). Furthermore, the fear of such embargos, or preemptive embargoes in anticipation of war, can be an important factor leading to war in the first place. The WTO tries to satisfy the need for peaceful resolution of trade conflicts through its dispute settlement system of arbitration.

The next question is whether these goals—openness with deference to national sovereignty, stability with built-in flexibility, and so forth—can only be achieved through an institutional multilateral structure. Why is a multilateral trading system necessary, as opposed to having each country determine its own trade policy by itself without interference from others? It is not immediately obvious whether such a system needs to be "created" by policymakers or whether it can arise spontaneously without formal coordination. Many countries have unilaterally chosen policies that conform to these desirable outcomes. In a model with a high initial level of tariffs, most of the features of the current trading system—multilateral negotiations, gradual liberalization, reciprocity, and MFN—can develop endogenously, according to Ethier (2004), if government behavior is dictated by a political support function consistent with how governments claim to behave, and if reasonable substitutes for each country's exports are produced elsewhere.

Yet, as we shall see, historical experience suggests that such good behavior may not arise automatically and spontaneously from countries choosing their own trade policies independently of one another. An institutionalized multilateral system may be necessary to achieve the goals of free and open trade. Without a multilateral system in place, countries may pursue selfish, mercantilist, beggar-my-neighbor policies without regard to the welfare of their trading partners, and the world as a whole may find itself stuck in a prisoner's dilemma. Or perhaps, without the benefit of external constraints, policymakers may succumb to domestic interest groups and impose trade restrictions that are detrimental to the country itself, as well as to others. Therefore, without international agreements on trade policies, countries may pursue policies that restrict trade either to redistribute income to their own country at the expense of others (beggar-my-neighbor policies, as modeled by Bagwell and Staiger 2002) or to redistribute domestic income to politically powerful groups (beggar-myself policies, as modeled by Maggi and Rodriguez-Clare 1998).

In either case, politicians have self-interested reasons for reducing trade that can only be overcome to the betterment of all if they agree to refrain from those trade-restricting policies. Thus, a multilateral trading system may be needed to correct these externalities (terms of trade or domestic politics); without an institutionalized system, the world economy will not flourish as much as it could.

While such concerns give rise to a powerful reason to adopt multilateral trade agreements (Bagwell and Staiger 2002), such agreements have only emerged relatively recently. Countries may have engaged in mutually destructive beggar-thy-neighbor policies in the past, but this did not automatically give rise to a multilateral institutional response. For this to occur, geopolitical conditions had to be right. Furthermore, key actors had to want an international, cooperative outcome. Although many economists dislike the notion, ideas sometimes matter in history. They clearly mattered during the mercantilist era, while the idea that dependence on trade was dangerous mattered a lot after 1918. Flawed ideas about macroeconomic policy have also mattered a great deal for the international trading system, as the history of the Great Depression clearly shows. A complete account of the development of the international trading system therefore has to go beyond the limits of simple economic models, informative though these are, and integrate insights from political science and traditional history as well (Baldwin 1996).

1.3 1860 and All That: A Brief History of the International Trading System

To what extent has the world trading system conformed to these features of a desirable multilateral system? To what extent have governments worked to create such a system with these goals in mind? We examine four different historical epochs: the mercantilist period (between 1492 and the early nineteenth century), the nineteenth century order (lasting until 1914), the interwar period (from 1919 to 1939), and the postwar system of the GATT and the WTO (from 1947 to the present).

1.3.1 The Mercantilist Era

Broadly speaking, the international trading system between 1492 and the Industrial Revolution can be described as mercantilist. There are several key features of this system, or perhaps nonsystem, that are relevant for us.

First, the geopolitical system of the time was essentially Darwinian. The Military Revolution of the period implied rising military costs, and conferred substantial advantages on larger countries, as well as on countries that were more efficient in raising revenue. The costs of not remaining militarily competitive included extinction, and the number of sovereign states within Europe declined substantially during the period.


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