International Trade Since 1914
Summary and Keywords
Long-distance international trade for hundreds of years stemmed primarily from differences in climate. Generally free-trade policy and reduced transport cost superimposed another pattern by 1914; one of greater international specialization based upon land and labor abundance or scarcity. The broadly open trading world of the beginning of 1914 broke down first under the impact of war and then of the Great Depression. By 1945 the United States had emerged as the most powerful nation, committed to establishing a world order that would not make the mistakes of the preceding decades. The promotion of more liberalized trade among the wealthier nations, over the following decades hugely expanded the volume of trade. Trade in manufactures—based on skill endowments and preference diversity—came to dominate that in primary product. Services strongly increased in importance, especially with the rise of e-commerce. Oil displaced coal as the world’s principal fuel, redistributing income to those countries with substantial oil deposits. The greatest threat to the continuing expansion of world incomes and trade came from the Great Recession of 2008–2009, but the World Trade Organization regime discouraged the mutually destructive trade wars of the earlier period. However, the WTO was less successful 10 years later in restraining the damaging United States–China trade conflict.
Long-distance international trade for hundreds of years stemmed primarily from differences in climate. The greatest reaches were achieved by ships sailing between temperate-zone Europe and tropical or subtropical regions. Western Europe supplied manufactures in exchange for “colonial goods”—Chinese tea, Brazilian coffee, Caribbean sugar, southern U.S. tobacco, and East Indian spices. Generally free-trade policy and reduced transport cost superimposed another pattern by 1914; Canadian, Australian, and Argentinian wheat, wool, and beef substituted for domestic British food supplies as Great Britain’s own agriculture sector was run down, Thai rice was exported for Malayan plantations workers, and Australian food was exported for South African miners. Most remarkable among the trade consequences of industrialization was strong demand for a semitropical raw material—cotton, primarily from the United States—that was worked up into textile products in Lancashire and exported, often again to different continents. Then the United States was principally an exporter of primary products from behind high tariff barriers, importing food and raw materials mainly from the tropics, and manufactures and lending services mainly from Britain.
Over the following century this pattern was transformed as the volume of trade expanded hugely. International trade became so intensive that for some countries the sum of their imports and exports exceeds the total value of national production (gross national product, or GNP). Trade in manufactures came to dominate that in primary products, and services strongly increased in importance, especially with the rise of e-commerce. Oil displaced coal as the world’s principal fuel, redistributing income to those countries with substantial deposits. The United States switched out of primary product exports to manufactures and became the largest world trader, only to be overtaken by China in 2012 and by the European Union (if that collection of countries is treated as one).
This expansion of commerce was not a linear process. The broadly open trading world of the beginning of 1914 broke down first under the impact of war and then of the Great Depression. By the outbreak of the next war in Europe 25 years later, world exports were only about 14% higher. However, the United States, having emerged as the most powerful nation in 1945, was committed to a world order that would not make the same mistakes of the preceding decades. A series of international agreements and institutions promoted more liberalized trade among the wealthier nations, while poorer economies were entitled to restrict trade in the interests of development. By the 1980s the effectiveness of this import substituting industrialization policy was called into question, and many developing countries switched to more liberal trade regimes. The largest threat to the continuing expansion of world incomes and trade came from the Great Recession of 2008–2009, but policymakers had learned from the previous world crisis and pursued expansionary policies that substantially offset the fall in demand. In addition, the World Trade Organization regime discouraged the mutually destructive trade wars of the earlier period. Nonetheless, the accumulation of state debt from the expansionary policies and political developments suggested that the world trade order was more vulnerable than before the great recession. The article goes on to describe and explain in more detail how trade patterns have changed since 1914, to discuss the consequences, and to show how governments and firms have attempted to reap greater advantage from these transactions.
Patterns of Trade
On the eve of World War I, world trade in primary products was considerably greater than that in manufactures. One estimate was that food accounted for just under half of primary products. Next in importance came agricultural raw materials (such as cotton, wool, silk, timber, and rubber), with minerals, including fuel, representing less than one-fifth. But fuel was critical for powering the technology behind the expansion of incomes and trade. The steam engine, powering ships, railways, and factories, ensured that the world’s principal fossil fuel in 1913 was coal, ranking third in the volume of commodity trade behind cotton and wheat. Coal was most readily available—partly for reasons of geology and partly because of economic development—in the United States, Germany, and Great Britain. British coal supplied Brazil and Argentina as well as Scandinavia and Italy. Asian coal production was one-tenth of North America’s. Belgium mined more than Japan, the largest Asian exporter.
By the early 21st century, economic development had transformed the balance between primary commodity and manufactures trade; Asia and North America were vastly more important traders, while coal’s strategic role had been entirely usurped by oil. Manufactures now amounted to about three-quarters of commodity exports (Figure 1). Office and telecommunications equipment, miniscule in 1914, was the largest identifiable manufactures group. Early 21st-century trade was based on new technology and new products, especially computers, semiconductors, and mobile phones—the hardware component of the information technology revolution. Asia dominated the supply of these products, accounting for nearly one-half of world exports. The sector was highly specialized and internationally integrated; developing Asian countries supplied one-third of the world’s exports of office and telecom equipment and, at the same time, bought one-quarter of world imports. North America took one-quarter of world imports, but this still left western Europe as the greatest importer.
The second-largest commodity trade category, based upon a more mature technology, showed a remarkable turnaround between 1914, when the Model T Ford was conquering the world, and the 21st century. North America became the biggest net importer of motor vehicles and components, with Asia the largest net exporter. Western Europe in both periods was the largest exporting and importing region, with the balance still tipped in favor of exports, though the volume of trade was much greater in the first decades of the 21st century.
Asia dominated the much smaller world-clothing exports, supplying just under one-half. But products from China, Korea, Hong Kong, and Taiwan were being displaced in the North American market by Latin American clothing exports. Exports of the “transition economies,” formerly members of the Soviet Union, with a comparable dependence on the western Europe clothing market, were making similar progress.
Trade in fuel became primarily trade in oil. Technological change replaced the coal-fired steam engine with the internal combustion engine and oil-fired steam turbines. Oil not only became essential for transport and industrial power but also substituted for coal as the fundamental raw material of the chemical industry. Most oil was extracted in the United States—also a major user—but the Middle East and the successor states to the Soviet Union—especially Russia—had far larger proven reserves. Around one-fifth of the world’s total was in Saudi Arabia during the first decades of the 21st century. Since the entire population of the country was only about 33 million, Saudi Arabia was almost bound to export massive quantities of oil to more populous industrial regions. The Middle East as a whole was the prime contributor to world fuel exports.
Agricultural trade was left behind in the great boom from 1945, accounting for a mere 15% of world commodity exports in 2017. Opportunities for economies specializing in agriculture were less apparent than in manufactures. Of the 20 countries dependent on agricultural products for more than half their total exports, 13 were in Africa (Elliott, 2006, Table 4.3). Moreover, developing countries tended to concentrate in the slowly expanding primary, rather than value-added, agricultural exports. On the other hand, the largest agricultural exporters tended to be rich countries that protected and subsidized their agricultural production.
Merchandise trade refers to tangible goods and is what is measured for the earlier years of the 20th century. First known as “invisible” trade, trade in services such as insurance and transport are an intangible way of satisfying needs. Intangibility creates measurement difficulties that exclude services from trade data and discussions in the earlier 20th century. Service trade can also be delivered in a variety of ways. The WTO defines Mode 1 delivery as covering services supplied from one country to another (e.g., call center services). Mode 2 delivery refers to consumers or firms making use of a service in another country (e.g., through international tourism). Mode 3 is the most common way of exporting services—a foreign company establishes subsidiaries or branches in another country (e.g., a bank setting up a branch abroad). The least common form of service supply is Mode 4, when individuals travel from their own country to supply in another (e.g., a consultant going abroad to provide an IT service).
Trade in services probably grew much faster by the early decades of the 21st century but nonetheless reached only one-third of the value of trade in manufactures. In 1914 international tourism was restricted to an elite from which only Switzerland earned substantial sums. From the 1960s, cheaper passenger air travel ensured that poorer countries could take advantage of mass tourism as a service export. Spain developed a huge tourist industry for northwestern Europe. In the 1990s, Egypt, Morocco, Tunisia, Mauritius, Cuba, and the Dominican Republic increasingly tapped the demand created by cheap long-haul flight charges and rising affluence in industrialized countries.
Telecommunications and computer-related services are among the more dynamic trade categories (along with business services and payments for intellectual property rights). In the first two decades of the 21st century, the widespread adoption of digital technologies changed the composition of trade, especially in services, and boosted them. Global ecommerce transactions increased by more than 50% between 2013 and 2015 thanks to the Internet giving consumers direct access to online markets. Digitalization contracted trade in goods such as CDs, books, and newspapers from 2.7% of total goods trade in 2000 to 0.8% in 2016, while trade in information technology products tripled between 1996 and 2016, reaching $1.6 trillion. Nearly one-third (32%) of Amazon’s net sales were international. The international streaming revenue of Netflix rose from $4 million in 2010 to more than $5 billion in 2017 (WTO, 2018b).
A downside of this buoyant trade was the rise of a negative externality: increased pollution and global warming from carbon emissions. Carbon emissions can be regarded as an unintended export, when an economy’s consumption of emissions exceeds its production. An economy may have very “clean” domestic production processes but may import goods the production of which abroad generates a great deal of carbon emissions. While both production and consumption of emissions fell in the United States and the European Union over the decade after 2005, there was a substantial increase in China and India. Although U.S. per capita demand for emissions was over three times higher than China’s in 2015, China generated the highest absolute volume of carbon emissions, both in consumption and in production (OECD, 2019).
Reasons for These Patterns
The explanations for these patterns of long-distance trade are found in market forces, policy, technological change, and economic development. Market forces in the case of “colonial goods” were practicable long-distance transport technology, tastes for a varied diet and stimulants, and a sufficiently productive economic system that allowed substantial numbers of people to indulge their tastes. Within Europe, climate guaranteed that wine could be readily manufactured in the south but not in the north. Vines might be cultivated in northern European heated greenhouses, but far more expensively than relying on southern sun. On the other hand, the gray skies and rain of the north allowed the growth of abundant grass for wool-bearing sheep, creating the basis for cloth exports. Even if the south could produce woolen cloth better than the north, it was still advantageous for both regions if the south exported wine to northern Europe in exchange for imports of wool. Both regions could consume more wine and cloth if they specialized in supplying the product in which they possessed a comparative advantage (as long as transport costs were low enough to make trade feasible). The south held a comparative advantage in wine because the southern sun ensured that resources in wine production yielded more, relative to wool production, than in northern Europe. This was Ricardo’s (1817) famous example.
The trade pattern of 1914 reflected not only climate and mineral endowments but also land abundance. European settlement of the New World created the land-abundant, labor-scarce production zones of the prairies and pampas, ideally suited for land-intensive agriculture (Ohlin, 1933). But the principle of comparative advantage applied here also. Incomes in land-abundant Argentina were higher from supplying beef and leather to the manufacturing countries of more densely populated Europe than if the Argentines had specialized in manufacturing themselves.
The great expansion of international transactions from the second half of the 20th century was different, based upon neither land availability nor climate but on diverse preferences, skills, innovation, and scale economies (Dixit & Stiglitz, 1977; Krugman, 1979). Supplying world, instead of national, markets for manufactures supported longer, higher-volume production runs. With greater output, the fixed costs of specialized equipment and services could be spread more widely, so that unit costs fell. Moreover, the prospects of tapping a global market encouraged the direction of more resources to research and innovation than would have been worthwhile in a purely national or regional economy.
Economies of scale explain why a high proportion of international trade entailed transactions between subsidiaries of the same multinational company (intra-firm trade). Intra-firm trade accounted for around one-third of merchandise exports from Japan and the United States at the beginning of the new millennium and a similar proportion of all U.S. goods imports and one-quarter of all Japanese goods imports. Much of this trade was finished goods destined for affiliate companies that were mainly involved in marketing and distribution.
Economies of scale, when coupled with preferences for product variety, also explain the exchanges of manufactured goods between national economies, but in the same industry (intra-industry trade). Greater specialization meant that the number of “industries” increased so that more two-way trade was recorded at a given level of product classification. Sophisticated manufacturing products were more likely to benefit from economies of scale in production and were easier to “differentiate” to the final consumer, and so facilitated trade in similar products. Intra-industry exchange accounted for more than 60% of manufactures trade of the United States, Canada, and most European countries by the end of the 20th century.
New manufactured goods were likely to be innovated close to their market, and the largest market for innovative products was usually located near high-income and high-productivity users or consumers (Vernon, 1979). Once a product was accepted, it could be standardized, and proximity to the market for the purposes of judging acceptability was no longer necessary. Larger-scale production could be based in regions where costs were lowest. So, most of the world’s televisions, for instance, were made in the United States during the 1950s, but subsequently manufacture migrated to Hong Kong, Taiwan, and elsewhere in Asia. The locations of car production and components for information technology showed a broadly similar evolution during the later 20th century. This evolution of production costs behind the product cycle is a major motive for foreign direct investment, for encouraging firms to become multinationals.
Relocation of production may not be inevitable, however. The United States may have lost out unnecessarily in the location of steel and car production. Inefficiency of production in the United States might have been remedied. Destructive interactions between large firms subject to little competition and the U.S. dominant trade union have been allocated responsibility (Lindert, 2001). These U.S. firms could have been more productive and from the 1980s did become so, under pressure from Japanese direct investment in the U.S. market and expansion beginning in the 1970s.
An alternative response to the product cycle of becoming multinational, foreign direct investment, is contracting with suppliers abroad to supply elements of the product. This is foreign outsourcing. If firms in high-wage economies respond to import competition from low-wage countries by moving non–skill-intensive activities abroad, then trade will shift employment toward skilled workers within industries. For the period 1972–1990 in the United States, outsourcing can account for between one-third and one-half of the increase in the relative demand for skilled labor that occurred in U.S. manufacturing industries during the 1980s (Feenstra & Hanson, 1996).
Volume of Trade
World trade growth reflected increasing prosperity (because economic development typically involves more specialization in a finer division of labor), technical progress, and national trade policies. Two world wars and the Great Depression in the first half of the 20th century (Figure 2) were the biggest blows to economic and trade growth; between 1913 and 1950, trade per head stagnated.
In the First World War blockades were intended to prevent the enemy from importing, and the French and British were more successful than the Germans in this respect, though the exports of all three collapsed (Findlay & O’Rourke, 2007). U.S., Canadian, Japanese, and Swedish exports expanded strongly, as did their imports, but less so. After a slump in 1921, trade resumed an upward trend until 1929, when it fell by about 30% during the Great Depression (Figure 2), which triggered strong and widespread political reactions.
The outbreak of war again in Europe in 1939 ensured by 1943 that there was no trade between the three major blocs: German-controlled Europe, Japanese-controlled Asia, and the rest of the world. By 1944 French imports had contracted to little more than one-twentieth of their 1938 value, as a net supplier of goods to Germany. In the United Kingdom exports fell to one third of prewar levels, whereas U.S. exports tripled. Exports from Japanese-occupied Indo-China had virtually ceased by 1945. The Belgian Congo’s exports boomed because the Allies wanted its minerals, whereas exporters of less strategic commodities, like palm oil, performed less well (Findlay & O’Rourke, 2007)
After 1945, despite the acceleration of population growth, exports accelerated more strongly, especially from the 1990s. The Great Recession of 2008 and the subsequent European debt crisis temporarily reversed the upward movement—trade fell by about 10% (see Figure 2). But by 2017 the expanding trade volume trend from the 1990s had not obviously been curtailed.
Gravity equations explain this rising trend because the models predict that bilateral trade volume depends positively on economic sizes of the pairs of trading nations as well as negatively on the distance between them (Anderson & Wincoop, 2002). Hence economic growth, by increasing the size of trading nations, expands the trade between them, other things being equal. Distance between trading partners is one contributor to general trade costs. But in addition to distance (the costs of domestic and international transport), currency, marketing, and border-related costs, all the costs necessary to get a product form producer to consumer are included. Typically, they can amount to the equivalent of a 170% tariff for rich countries. For developing countries these costs can be twice as high. Consequently, the structure and volume of trade is strongly influenced by these costs.
Before 1914 a driver of trade volume was falling transport costs. After 1945, despite bigger ships, containerization, and “open registry shipping” (ship registration in low-regulation countries), real costs did not fall until after 1995 (Findlay & O’Rourke, 2007; Hummels, 2007). Higher fuel, wage, and shipbuilding costs combined with anti-competitive practices to offset the influences on shipping cost decline, although speed of shipments increased. When deflated by a GDP deflator, commodity-deflated real sea freight rates (ships carried most international trade) hardly fall at all (Shah Mohammed & Williamson, 2004). However, air freight rates fell rapidly in the 1950s, 1960s, and 1990s, increasing the competitiveness of high-value lightweight exports (Figure 3). Despite the remarkable fall in computer costs, the impact of computers took longer to reduce trade costs because their usage was so small to begin with (unlike sea freight). Then, between 1996 and 2014, international trade costs as a whole declined by 15% (WTO, 2018b). Transport costs account for the largest share of cross-country variation in overall trade costs for goods in 2014 but still accounted for less than half the total—almost matched by information and transaction costs.
As the gravity model implies, Europe’s relatively high income and the close proximity of the countries ensured the region accounted for more than half of world trade in 1913 (Figure 4). Though containing most of the world’s population, Asia accounted for only 12% of world exports, mirroring low productivity and incomes. For similar reasons, the entire continent of Africa contributed only 5% of world exports in 1913, despite the buoyancy of South Africa’s gold and diamond trade. Exports from the American continent, less than half those of Europe, were mainly primary products, despite the high incomes of North America and temperate-zone South America.
In the aftermath of World War II, regional trade patterns revealed the geographical dispersal of destruction. North America and Latin America attained their largest shares of world trade, while war-torn Asia and Europe achieved their smallest. In 1950, the trade:output ratio was approximately 7%; by the end of the century, it had risen to around 22.5%. Between the two dates, a slowdown in the rate of the rise of the ratio during the decade after 1974 may be traced to the Organization of Petroleum Exporting Countries’ contraction of the oil trade and to the resulting price rises and unemployment. These 10 years saw two bouts of double-digit inflation and three years of stagnant or declining output. Greater stability returned in the following decades, and growth in the trade:output ratio resumed.
By the earlier decades of the 21st century, the greatest transformation in the regional pattern of world trade since 1914 was the expansion of East Asia and the Pacific (of which the most important trader was China), accounting for 30% of world exports (Figure 5). Japanese export growth was particularly rapid. But Japan’s import/GDP (gross domestic product) share remained virtually unchanged over 20 years at 9%, while the export share rose from 8 to 12% in the early 1980s. After Japanese export growth came that of the four “little dragons” (South Korea, Taiwan, Singapore, Hong Kong), followed by Malaysia and Thailand, demonstrating the continent’s altered position in international economic relations. Chinese merchandise exports increased almost 7.5 times in volume after 2000, so that by 2017 China was the largest (single state) exporter in the world. Chinese merchandise imports increased by less, just under six times, like Japan earlier, a source of concern to the United States. As their relatively poor economic performances foreshadowed, the trade shares of Africa, eastern Europe, and Latin America contracted. Europe remained a dominant export region partly because of the international trade between the many component states
Strong economies tended to be economies open to trade, both because they pursued liberal trade policies and because their innovativeness and high productivity created great scope for international specialization. Trade intensity depended also on size. Small countries such as the Netherlands, with over 80% of GDP entering international trade as exports in 2017, were more open than large economies such as the United States, with an export:GDP ratio of 12% in the same year. As already pointed out, the explanation is the differential opportunities within their borders. But since 1913, when the Dutch export ratio was 17% and the United States 3%, both economies have become more trade-intensive.
Other things being equal, technical progress in transport and communications over the period should have raised trade:GNP (gross national product) ratios. In the opposite direction, some trade policies encourage import substitution and domestic self-sufficiency, against the pull of the market. Working with the grain of the market means that countries that became more open to trade were more likely also to more prosperous. Though not all agree (Chang, 2005), it is consistent with the pattern of a sample of 19 major economies in 1913 and 1992 (Figure 6); the slowest growers were the Indian and Argentine economies, both of which reduced their openness over the eight decades. The fastest increases in GDP per capita were experienced by Japan, Taiwan, and South Korea, which became more open than others in the sample. Brazil and Mexico were faster growers that also were less open (had a lower share of exports in GDP) in 1992 than in 1913. But they grew only about as fast, respectively, as Italy and the United Kingdom. These last countries, starting in 1913 from a higher base income per capita, had less opportunity for “catch-up” growth.
The scatter diagram of 174 countries in 2015 (Figure 7) confirms the previous pattern; economies that are more export-intensive have higher incomes per head, or countries with higher incomes per head tend to be more export-intensive. India is richer than Nepal and more export-intensive, Korea is more export-intensive than China and also richer. Of course, the relationship is only very approximate and must depend on other influences; Japan is more export-intensive than the United States but has a lower national income per head. Nonetheless, if import-substituting industrialization policies were generally successful, there should be a negative association between trade openness and national income per capita rather than the positive one shown in Figures 6 and 7. More sophisticated analysis confirms a causal relationship from trade to economic growth (Frankel & Romer, 1999); trade raises income by encouraging the accumulation of physical and human capital and by increasing output for given levels of capital.
Some of the gains from trade are because of re-allocation from less to more efficient firms and activities (Melitz & Trefler, 2012). So, though trade and specialization can raise world well-being, there are often losers. Trade changes the prices of goods and services and hence the returns to the factors of production making them (Stolper & Samuelson, 1941). Widening wage differentials between skilled and unskilled workers in North America from the 1980s, as well as higher unemployment among the unskilled in western Europe, has been blamed on international competition from rapidly industrializing Asian economies. Countries in the developing south increased their production of labor-intensive manufactures and their imports of skill-intensive goods, raising their demand for unskilled but literate labor relative to more skilled labor (Wood, 1995). In the industrialized north, trade reversed the skill composition of labor demand. The rise of China as an international trading power and the country’s admission to the World Trade Organization in 2001 increased these concerns about shifts in labor demands. Biased technical progress is an alternative or complementary explanation to trade for the wage and unemployment patterns (Goldin & Katz, 1998). New technologies such as computers put a greater premium on skilled workers.
Policies to Influence Trade Patterns and Volumes
Most national trade policies have been reactive, a response to the demands of the politically influential for insulation from trade-induced price changes. But such policies usually damage interests in other countries. To prevent mutually harmful trade policy wars between sovereign states, various international institutions have been created. Their success in the second half of the 20th century is apparent in the burgeoning of trade.
Before 1914, the larger continental European countries, France, Germany and Spain, declined to follow Great Britain’s free trade policy, with the shrunken agricultural sector that implied. Instead, to offset falling transport costs, they raised tariff barriers against imports that could also be produced at home. As later industrializers, these countries’ agriculturalists retained sufficient political power to resist the flood of produce from the regions newly settled by migrants from Europe. Established interests would have lost out—or believed they would have—from greater openness to trade. Prussian Junkers and French peasants envisaged the prices of their farm produce falling, the former suffering declining rent rolls and the latter being forced to migrate to the cities in search of alternative work.
The international political legacy of World War I was instability. The Austro-Hungarian, Turkish, and Russian empires were dismembered, and the 1919 Versailles Treaty exacerbated currency volatility and international distrust. These sources of instability were reflected in more aggressive and uncooperative trade-reducing policies compared with the generally mild protectionism before World War I.
The unconditional most-favored nation (MFN) clause in commercial treaties exemplified the earlier cooperative international economic relations. The contracting parties were bound to accord each other the same treatment as given or might be given to the nation that was most favorably treated by all. Already, the introduction of maximum and minimum tariffs and finer classifications of traded products were undermining the effectiveness of the clause as a liberalizing device. Then, in 1918, France renounced all treaties containing MFN clauses and instituted the principle of reciprocity in 1919 for all future treaties (though eight years later France returned to the MFN treaty). The United States abandoned its former adherence to the conditional MFN approach and adopted the unconditional clause in 1922. But U.S. policy tended to discredit MFN because of the U.S. refusal to reduce its own very high tariff by negotiation, while claiming to benefit from tariff reductions negotiated between Europeans (League of Nations, 1942). In short, the United States, by now matching Great Britain’s share of world trade, tried to gain a free ride on the liberal economic order.
This stance contributed to stagnation of trade and to the difficulties of export industries between the wars. Under the aegis of the League of Nations (which the United States declined to join), the World Economic Conference of 1927 achieved a detailed multilateral trade agreement signed by the principal trading nations, in many respects a precursor of the 1947 General Agreement on Tariffs and Trade (GATT). But any prospect of a beneficial impact was soon destroyed by the world depression that began in 1929. Failure of multilateralism was finally acknowledged with the abandonment of the 1933 World Economic Conference.
As a consequence, during the 1930s preferential trading blocs flourished—the British Commonwealth, the French Empire, and German informal empire in central and southeastern Europe. The missing ingredient, present in the later 1940s, was U.S. willingness to adopt the role appropriate to its economic strength. Trade policies in the second half of the century differed because, after the Soviet blockade of Berlin in 1947, the United States assumed leadership of the non-Communist world and pressed for a multilateral liberal trading regime.
The fruit of this leadership was the GATT, designed to prevent trade conflicts and promote freer trade. Two major principles underpinned the agreement: the most-favored nation clause and bilateral bargaining over trade-barrier reductions in a series of “rounds.” Before negotiations started, each member passed to all others a preliminary list of tariff-reduction concessions that each nation proposed to request. When negotiations began, they were to present a corresponding list of concessions they were prepared to grant. Negotiations would then take place between two or more countries.
U.S. leadership and the scope for reducing the high U.S. tariffs at first provided the drive for progress. By the mid-1950s, it was estimated that a net reduction in U.S. duties of 50% had been achieved since 1934 by tariff concessions alone. Most of these had been accomplished in the period after 1945.
The Kennedy Round of 1964–1967 reduced tariffs on industrial products by an average of 35%. The Tokyo Round, which concluded in 1979, adopted further gradual tariff reductions. But for the most part it did not successfully attempt to address the trade consequences of industrial subsidies by permitting countervailing duties. The most ambitious attempt at multilateral trade liberalization, the eighth GATT round, began in Uruguay in 1986. The negotiations included services, agriculture, and the Multi-Fibre Arrangements (imposing quantitative restrictions on textile imports from newly industrializing countries). However, more players than ever before, in addition to complex linkages, reduced the chances of success.
After 1945 and before the 1980s there was a divergence between the liberalizing trade policies of rich countries and the import substituting industrialization (ISI) policies of the rest of the world. The Prebisch-Singer view, formed in the years between the World Wars, was that the terms of trade between primary and manufactured products would continue to decline. Hence countries that wished to develop should attempt to increase manufacturing by restricting imports of manufactures and contracting their commitments to agriculture and extractive industries. The GATT exempted developing countries from the liberalizing principles it otherwise encouraged for this reason. However, terms of trade did not continue to decline after 1945, and there is a continuing debate about the success of ISI, with South Korea advanced as one of the beneficiaries and Argentina instanced by those condemning the policy. From the 1980s, policies of developing economies began to converge on those of developed economies, driving the world trade:GDP ratio higher than ever by the end of the century.
In 1995, the newly formed World Trade Organization (WTO) took over the functions of the GATT but now covered services and intellectual property as well. Members of this trade club agreed to abide by its rules or pay penalties. Much of the WTO’s activities were concerned with avoiding the mutual damage that trade disputes cause by adjudication of these rules. The WTO Agreement did not regulate the actions of companies or countries engaged in “dumping”—exporting a product at a price lower than normally charged in the own home market, or subsidizing exports. Rather, the focus was on how governments were permitted to react to dumping. Since 1995 over 500 disputes have been brought to the WTO and over 350 rulings have been issued.
Trade wars and tariff increases are a breakdown of the system that makes sustained trade expansion possible. One of the most infamous episodes, associated with the radical contraction of world trade during the Great Depression, was apparently triggered by the 1930 U.S. Hawley-Smoot tariff. The final adoption in June 1930 was followed by higher tariffs in Canada, France, Italy, and Spain, among other countries. The U.S. tariff also helped precipitate full British “Empire preference” through stronger Canadian lobbying. A trade war between France and Italy in 1932 and 1933 used the more trade-destructive quotas rather than tariffs. Though the costs of tariff disputes were generally small in themselves, they were likely to be associated with, and exacerbated by, conflict over exchange rates and therefore monetary and fiscal policy; foreign exchange controls, floating exchange rates, and public works were introduced because the optimum values of the then-standard policy instrument were too extreme to be feasible (Foreman-Peck, Hughes Hallett, & Ma, 2007).
In the new international order after 1945, the GATT and then the WTO were intended to prevent trade wars and resolve disputes. One of the longest running trade disputes was the United States–EU disagreement over subsidies to Airbus and Boeing. Formed in 1970, Airbus was a merger of government companies of France and Germany, later joined by Spanish and British organizations. Airbus overtook Boeing’s order book (315 aircraft compared with 284) in 2004. The United States issued a request for consultation in 2004 in accordance with WTO rules. Aircraft manufacturer Boeing’s R&D designs and production lines benefited from U.S. government defense contracts. U.S. government support for Boeing is therefore a good example of a successful industrial policy, designed to increase exports in an industry with marked scale economies. Eventually, the WTO in 2019 ruled against the United States, confirming that the United States was illegally supporting Boeing to the detriment of Airbus (WTO, 2019).
Exchange rate policies can also lead to trade disputes and contributed to the largest dispute, in terms of trade value affected. The United States believed that China was holding down its exchange rates to boost exports and maintain domestic full employment, so exporting unemployment to the United States. Another U.S. complaint concerned subsidies to state-owned producers (e.g., in the supply of primary aluminium). A third was about limited market access (a WTO ruling in 2019 concluded that, as the United States had complained, China’s administration of its wheat, rice, and corn tariff rate quotas was inconsistent with the obligation to administer the quotas transparently, predictably, and fairly). A fourth was about the expropriation of intellectual property rights.
The United States began a trade dispute with apparently untargeted measures announced in early February 2018 for solar panels and washing machines. Then targeting became explicit, supposedly because of China’s infringement of intellectual property rights. Additional import duties of 25% were to be imposed on $50 billion equivalents of imported goods from China (mainly on high-end technology products, including those not exported to the United States). Some two-thirds of those import tariffs were applied after July 6, 2018. This tariff policy might be interpreted not as aimed at reducing the U.S. trade deficit with China but as holding back China’s technological advance. China retaliated with equivalent import tariffs on U.S. goods, focused on low-end products, such as agriculture (especially soy) and energy. China’s intention presumably was not to impose tariffs on imports of advanced technology products not yet produced in China because this would simply handicap China’s technological advance. Since then, the list of Chinese imports on which the United States aimed to increase tariffs expanded to cover an additional $200 billion of goods, but a truce in late 2018 postponed the 25% U.S. import tariff on these. China’s second batch of retaliation was more moderate ($60 billion) because it did not import enough from the United States to match.
The World Bank estimated that the Chinese economy would grow more slowly in 2019 by 0.3 percentage points and the U.S. economy by 0.4 percentage points. More important than these small numbers, the dispute—and that with the European Union and China over steel and aluminium—may well signal a shift in the liberalizing world trade order that the United States supported since 1945.
Trade wars aside, tariffs in the early decades of the 21st century were fairly minor barriers to trade. In 2017 the Effectively Applied Tariff Weighted Average (customs duty) for the World was low at 4.57% and the Most Favored Nation (MFN) Weighted Average tariff was 7.74%. Non-tariff measures could be more restrictive of trade than tariffs. These are often imposed in the supposed interests of health, such as the European Union’s prohibition of imports from the United States of hormone-added beef or chlorinated chicken.
Voluntary export restraints were a more subtle restriction of trade, adopted by, among others, the United States in the 1981 to constrain imports of Japanese cars. Because the exporter accepts these restrictions voluntarily (perhaps to avoid the imposition of other, more severe measures), the rules of the liberal trading order were not violated. Moreover, the supply restriction raises prices in the importing country and therefore the profits of companies whose governments have agreed to the export restraint. Both sets of producers gain but the consumer loses. One estimate of the consumer welfare loss on domestically produced U.S. cars in 1983 was $2.3 billion (Fuss & Waverman, 1992).
Customs Unions and Regional Trading Blocs
Free-trade areas and customs unions are instruments of trade policy that discriminate between members and non-members and thus appear to contradict the MFN principle. They were nonetheless accepted as consistent with a cooperative international trade regime after 1945 because they could be seen as moves in the direction of liberalization. This is more obvious for a free-trade area (FTA), such as the Latin American Free Trade Area, established in 1960, or the North American Free Trade Area (United States, Canada, and Mexico), which went into effect on January 1, 1994, and was recast in 2018. The academic consensus is that NAFTA boosted U.S. GDP by less than 0.5%, a contribution of perhaps $80 billion dollars to the economy. However, the structural change occurring at the same time provoked hostility to the agreement. Employment in the U.S. car industry fell by one-third, while Mexican car industry employment more than quadrupled. Such adjustments might have occurred without the free trade area, but it was NAFTA that was frequently blamed.
An FTA is intended to reduce barriers between members and does not require members to standardize barriers against the rest of the world. By contrast, a customs union, such as the European Union, is a group of countries among which there is free trade and which maintains a common tariff with the rest of the world. Harmonization of the external tariff can raise barriers higher against certain non-participants. Members of the European Union, formed in 1958 by France, Germany, Italy, Belgium, the Netherlands, and Luxembourg, delegated their international economic relations to the Union in Brussels. By 2013, when Croatia joined, the Union included 28 countries, though it seemed likely to lose one, Britain, in 2019.
FTAs and customs unions have two opposed effects. The first is trade creation, whereby a country begins importing a good previously produced at home. This is benign as far as world resource utilization is concerned, implying that expensive domestic supplies have been replaced with cheaper partner-country imports. The second is trade diversion, whereby a country begins to import from a partner country goods or services that have a higher resource cost than those previously imported from the outside world. New Zealand dairy exports, after British entry to the European Community (EC) in 1973, were such a case; they were displaced in favor of higher resource-cost continental European imports.
An FTA or a customs union could therefore bring about an inefficient use of world resources if trade creation was less than trade diversion. In fact, EC trade creation was as much as four times greater than diversion. The stance of the 1947 international regime was warranted in this instance by the conventional cost-benefit analysis criterion; the gainers from trade creation could have compensated the losers from trade diversion and still have been better off. In this sense, society was better off.
Firms or governments can attempt to influence the international trading order by establishing cartels. By sharing markets and agreeing on prices they avoid the pressures of competition. A successful cartel may exploit monopoly power, even prohibiting supply, to achieve political ends as well as to boost profits. By the outbreak of the First World War there were 114 international cartels of firms known to the public. The war destroyed most, but they began re-forming afterwards. Then, though generally they lacked virtual monopoly power, four did not, and three of them were in the chemical and pharmaceutical industry.
The international trade regime established in 1947 tolerated international cartels as well as free trade areas or customs unions. Fuels in the short term are difficult to replace and therefore promising for cartels and for sanctions. An economy entirely dependent on foreign sources for fuel imports is potentially vulnerable to political pressure if suppliers are sufficiently unified. Italy might have discovered this in 1935 when League of Nations oil sanctions were briefly considered to counter the invasion of Abyssinia, but oil sanctions were rejected.
In 1973, matters were different. The Organization of Petroleum Exporting Countries (OPEC) was founded in Baghdad (by Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela) in 1960 to unify and coordinate members’ petroleum policies—that is to raise prices by restricting supply. OPEC’s hour struck when the Arab-Israeli war of 1973 triggered a display of unity and determination to sever Western support for Israel by threatening an oil export embargo. Crude oil prices quadrupled, and almost all oil-importing countries were obliged to transfer huge additional sums to oil exporters, which, for most importers, meant marked reductions in purchasing power.
A second oil shock in 1979, with the withdrawal of Iranian oil from international markets caused by the overthrow of the shah, was less disruptive. The recently created International Energy Authority quelled the panic buying that had been so damaging during the first shock. Thereafter, higher oil prices encouraged the development of higher-cost fields, such as those in the North Sea, and more energy-efficient production and consumption technologies.
As the largest and most profitable oil producer, Saudi Arabia is the natural leader of OPEC, being able to act as swing producer. This was amply demonstrated in 2008, when Saudi Arabia increased production, causing the oil price to drop from near $100 per barrel to around $30 in a few months.
Even though the winners from trade expansion should be able to compensate those displaced by foreign competition (and remain better off) if there are gains from trade, they rarely do. Democratic politics is likely to ensure that the losers complain vociferously, but those who have found new, profitable niches or employment options will stay silent. This asymmetry can have adverse consequences for a liberalized world trade regime and for international cooperation, as became apparent in the decade after 1929. It is therefore imprudent to predict inevitably continuing trade expansion, even assuming such externalities as carbon emissions can be controlled.
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