Revisiting trade integration in uncertain times. A European perspective.
door Filip Abraham (KU Leuven & Vlerick Business School)
Successive generations of Belgians grew up with the idea that international trade is beneficial. Trade relations open up international markets for Belgian companies that would otherwise confined to a small home market. International trade creates jobs and are a major engine of economic growth. The support for international trade among policy-makers and in the business and academic communities was widespread, in particular for the process of European integration. One should not forget that Belgium is one of the founding fathers of what is now the European Union (EU). Brussels hosts several of the key EU institutions and is therefore known as the capital of Europe.
The last decade or so the tide seems to be turning. Confronted with strong Chinese and Asian competition, companies are experiencing the harsh side of globalization. In political circles some of the traditional belief in international trade is waning. Recently, a leading politician of the largest French-speaking political party (the PS), Paul Magnette, became a hero for anti-globalists when the Walloon regional government temporarily blocked the approval of CETA, the EU free trade agreement with Canada. In the largest Flemish political party, the N-VA, skepticism about the EU is no longer a taboo. Those developments in Belgium fit in a broader European pattern. European integration – let alone globalization – are no longer seen as an unambiguous blessing.
This paper delves into the reasons for this switch of minds. One explanation, discussed in Section 1, stems from the fact that the globalization process has halted in recent years. Section 2 deals with a second main issue that concerns the shifting attitude in Europe towards the benefits of globalization. In Section 3 we focus on the evolution in trade integration strategies followed by the major trading nations of the world. The concluding section derives the main learnings for the approach to international trade integration.
Globalization or de-globalization?
One of the structural breaks in recent history concerns the globalization process. This can be seen in the figure below which measures global cross-border flows in goods, services and financial capital from 1980 to 2014.
From this figure, it is clear why the period 1990-2007 is widely recognized as the era of globalization. Total cross border flows increased from approximately 20% of world GDP in the 1980’s to 53% at the peak of 2007. International trade in goods represents the most important component but cross-border trade in services and most of all international financial flows were rapidly catching up after 2000.
This globalization trend ended with the financial and economic crisis of 2007-2008. This crisis led to a sharp decline in economic activity in advanced economies. The stellar performance of emerging economies as China and India were not able to fully offset the sluggish performance of the US, Japan and European economies.
Those unfavorable growth conditions went hand in hand with a collapse in international flows of capital and international trade in goods in services. The ratio of global cross-border flows in GDP declined from 53 in 2007 to 39% in 2014. In order words, de-globalization was taking place.
Will de-globalization be the ‘new normal’ for the next decades? Pessimists believe this will be the case. In their view, structural rigidities in the advanced economies hamper a return to the globalization path that characterized the decennia before the outbreak of the 2007-2008 economic crisis. At the same time, the volatility of leading economies such as Brazil and Russia demonstrates that emerging economies are not ready to take over the lead of the west. In the longer run, global resource and environmental constraints accompanied by rising geopolitical tensions put a brake on how much countries are able and willing to trade internationally.
Optimists point to the improving economic growth figures that are being recorded in the US, Europe and several emerging economies. Fueled by better growth prospects, international flows of goods, services, capital and companies will resume their previous trend. The past decade of de-globalization amounts to an accumulation of very dark clouds that are now being chased by the sun that is shining again.
An alternative interpretation of the (de)-globalization debate takes a technological stance. In this view, the nature of globalization has been changing profoundly in recent years. The most powerful technological force is the digitization of global trade and investment flows. Digitization has proven to be a facilitator of international flows and international contacts. Think about how easy it has become for a Belgian reader to order a book about globalization published in New York and get it delivered to his office in Brussels. Digital flows can also act as a substitute for the flows of goods across borders. The booklover in Brussels may decide to download the book on a tablet or smartphone replacing a traditional export transaction from the US to Belgium. Finally, digitization is an excellent channel to add complementary services to the book purchase. With a click of the mouse, the reader obtains book reviews, information about publications on related topics and so on. All of this explains the dramatic increase in measures of digital globalization experienced in recent years.
When discussing technological developments that matter for globalization, breakthroughs in augmented (3D) printing and robotization should also be mentioned. Augmented printing makes it possible for a growing number of activities to be produced close to the customer saving on transport costs. Robotization reduces the competitive disadvantage of high labor costs. Companies are therefore less prone to offshore labor-intensive activities to far-away locations in search of lower labor costs. Although less prevalent at this moment, those technologies may well reduce the role of long distance flows across countries. This would further strengthen the intra-regional pattern of cross-border transactions that dominates European and increasingly Asian trade and investment flows.
In view of all this, it is not surprising that the widespread belief in a steady progression towards more globalization has been lost. Actually, we cannot even rule out that de-globalization will take place in the years to come. Nor do we have a clear picture about the structural characteristics of future trade and investment flows across borders. This general uncertainty is a fundamental aspect of the rethinking of the role of free trade that is currently taking place.
The benefits of free trade are well documented in the literature on international economics. With fewer barriers between countries, companies gain access to new markets, which is particularly beneficial for small open economies with a limited domestic market. Faced with foreign competition, companies are under constant pressure to focus on their competitive advantage, to be productive and innovative. International trade creates jobs and generates wage growth. Consumers benefit from lower prices, better product quality and a broader choice of goods and services.
Europeans prefer trade integration with countries that are characterized by similar income levels and shared values. This explains the longstanding support for European integration and the pursuit of close links with a selection of other advanced economies. Deals with very different economies are approached with more caution because of the disruptive employment effects that such integration may entail in declining industries.
It is remarkable how this ‘traditional’ European view on trade integration is very much alive in Asia. Most Asians view international trade as a main engine of economic growth and prosperity. Previously, they were relying on exports to the markets of advanced economies. Increasingly however, they consider intra-Asian cross-border flows as the primary driver of trade expansion. Although geopolitical tensions remain severe, this gives rise to an Asian integration process that mirrors the European experience of the past decades.
While European ideas are flourishing in Asia, they are not doing so well in Europe. Globalization is no longer considered as an inherent win-win game. On the contrary, Europe may well be on the losing end of globalization when international competitiveness, employment and wage growth are concerned. Stories about plant closures, offshoring and cutthroat competition from emerging economies dominate the news. So are the reports that argue that globalization is threatening middle-income jobs and widening income inequality within society.
However, the European doubts about trade integration go beyond the concerns about economic growth, jobs and wages. They reflect a growing criticism about the essence of international trade, which is the exchange of goods and services between countries. Partially, this criticism is fueled by environmental externalities that are generated by international transport flows and are not fully captured in transport costs. Likewise, there is the fear that international competition will undermine social protection and regulatory standards in a race-to-the-bottom scenario. This issue came to the forefront at the occasion the delayed signing of the comprehensive CETA trade deal between Canada and the EU. This agreement came under fire out of fear that multinational companies could circumvent decisions of national courts through a separate investor-to-state dispute settlement system.
Underlying the opposition to free trade is a deep suspicion against market forces that is gaining momentum in many European countries. International trade is increasingly seen as a Trojan horse of a ‘neo-liberal’ world order. This idea has a long tradition in Europe because it deals with the optimal balance between market and government intervention in the light of market failures. The advocates of more government control on international flows appear on the winning hand. This shift towards government interference in trade flows is not limited in Europe but seems to reflect a worldwide phenomenon.
Typically for Europe is the revival of what could be called the ‘small is beautiful’ cooperative tradition. For a growing number of European citizens, the world of international trade is an alienating far-from-my-bed-show dominated by large multinationals. This world ignores human relationships that should be central in economic interactions. The future lies in bottom-up cooperation between people that focuses on the production and consumption of local products and services. As local community building is at the core of this view, the imports of products from distant countries is seen as a necessary evil at best.
This bias towards local rather than supra-national issues is also seen in the political arena. This is reflected in a declining support for European integration and an emphasis on regional and national sovereignty. Populist movements are successfully capturing this shift in the attitude of European voters.
The bottom line of this analysis is that the attitudes towards international trade are clearly shifting. Policy-makers cannot longer take the unwavering support for integration on a European level – let alone on a global scale - for granted.
Evolving trade integration strategies
The uncertainties about the globalization process and the shifting attitudes toward the benefits of international trade influence the relationships between the main trading partners in the global game. Roughly speaking, trade blocs can follow five trade integration strategies. Those strategies are (i) multilateralism (ii) minilateralism (iii) regionalism, (iv) strategic globalization and (v) protectionism. Those strategies are not exclusive in the sense that a trading partner would select one strategy and discard the others. By contrast, trade blocs usually follow combinations of those strategies at the same time, depending on the sector and the trading partner involved.
The main point of this section is that the world is experiencing a shift from trade integration strategies that favor free trade to strategies where this not or only partially the case.
Multilateralism is a strategy where countries jointly pursue free trade objectives on a global scale. This can happen in gatherings that bring the main global players (e.g. G7-, G8- and G20-country groups) together to discuss the prospects for international trade and globalization. Alternatively, countries participate in the international trading system through multilateral institutions such as the International Monetary Fund (IMF) and the World Trade Organization (WTO).
The WTO attempts to include as many countries as possible in a gradual reduction of trade barriers through comprehensive negotiation rounds. Likewise, it aims at establishing a framework of ground rules that govern global trade and investment. The dispute settlement system of the WTO allows countries to lodge a complaint against member states that do not follow those rules. While rights and responsibilities of countries are not always equal, the idea is to promote transparency in order to avoid discrimination between participating countries.
The WTO achieved its heydays in the 1990’s but has been losing influence afterwards. Fewer and fewer countries are attracted by comprehensive trade deals that bring together a large number of countries with different characteristics and aspirations. It is safe to say stay that the multilateral free trade system goes through an existential crisis as the Director-General of the WTO readily admits. Discussing the performance of his own organization in a recent speech, he argued that “the perception in the world is that we have forgotten how to negotiate. The perception is ineffectiveness. The perception is paralysis…..the moment that we begin to do things then I think they will begin to look at the WTO again.”
Due to the loss of confidence in the multilateral system, countries shifted to minilateral trade integration strategies. Minilateralism shares with multilateralism the ambition to integrate markets but does this between a set of participating member countries rather than on a global scale. This is attractive because countries select (many of) the trading partners with whom they want to collaborate.
Minilateralism constituted the core of the US trade strategy under President Obama. Motivated by both geopolitical and economic considerations, his administration negotiated the ambitious Trans-Pacific Partnership (TPP) with a group of South-American and Asian countries. Similarly, the US turned to Europe to explore the prospects for an equally ambitious Trans-Atlantic Trade and Investment Partnership (TTIP).
Obama’s minilateral strategy came to an abrupt end when his successor, Donald Trump, sent a letter of withdrawal of the TTP on his first day of office. This decision was in line with his campaign rhetoric that the TPP would be “the death blow for American manufacturing”. Given Trumps all but benign view on both minilateral trade agreements and Europeans it is unlikely that the TTIP will be on the books any time soon.
During the past decennium, minilateralism has been a cornerstone of the EU strategy towards trade integration. Following the highly successful free trade agreement with South Korea of 2011, the EU recently concluded the CETA agreement with Canada and is involved in trade negotiations with Japan, ASEAN and Mercosur to mention a few important trading partners. In spite of a growing resentment against such agreements in some member states, the EU considers the minilateral approach as a path towards pursuing free trade without having to give up European strategic interests and values.
Regionalism is defined as minilateralism within a regional setting. Working together with trading partners in the same region makes sense because countries in the same region are more likely to share common borders, common interests and a common culture.
The EU is the most prominent example of regionalism. Internally, trade barriers have been removed and supra-national decision-making is taking place in important policy domains. Externally, the EU has concluded separate agreements with neighboring countries such as Switzerland, Iceland, Norway and Turkey.
It is hard to overestimate the contribution of sixty years of EU integration in generating economic growth and creating prosperity in Europe. In recent years, the EU engine seems to be running out of steam. Brexit, the struggles in the euro-zone and anti-EU populist movements in several countries point to internal problems that are to be addressed in the years to come. Externally, relations with powerful neighbors as Russia and Turkey are strained.
In the rest of the world, regionalism is facing uneven prospects. The NAFTA agreement between the US, Canada and Mexico faces serious challenges with the announcement of President Trump that he wants to renegotiate the agreement because it is “the worst deal in history”. By contrast, regionalism in Asia has really taken off. The regionalist experience in South America and Africa is one of both successes and failures.
Strategic globalization starts from the premise that some sectors and geographic markets are of strategic interest for a country. In the view of its policy-makers, the country must have a strong presence of its companies in those markets or sectors. In order to guarantee this, the national government actively supports the position of domestic companies in those strategic sectors and markets.
Sectors can be strategic for several reasons. They may be developing innovative technologies that can be used in many industries. They may be strategic for national security and foreign policy. They may be a symbol of national pride or just employ a lot of workers. Markets are strategic when they have a comparative advantage that companies of other countries and their governments want to get access to. This comparative advantage can be a large and/or growing market, the capacity to innovative, low labor costs, a skilled work force, and key natural resources and so on.
Strategic interests have always been a powerful force in international trade relationships. But strategic globalization is clearly experiencing a renaissance in the last couple of years. It is the core of President Trump’s trade strategy to put America first. It is also the basis of the Chinese drive to become the dominating world power. The adoption of strategic globalization by both China and the US leaves a divided Europe scrambling for an appropriate response.
As a successful exporting nation, China embraces the process of globalization as an instrument for strengthening its worldwide presence. This was the message of President Xi’s speech at the 2017 Davos summit meeting when he declared that “The problems troubling the world are not caused by globalization. Pursuing protectionism is like locking oneself in a dark room. Countries should view their own interest in the broader context and refrain from pursuing their own interest at the expense of others. China will keep its doors wide open. We hope that other countries will also keep their doors open to Chinese investors.” The bottom line of the speech is clear: China pursues its strategic interests and will support the opening of markets if other countries do the same.
The attitude of President Trump towards globalization is very different. In his view, trading partners have abused the American openness towards international trade by running large trade surpluses. He expects this to end. If not, the US will impose protectionist measures against the ‘abusers’.
Protectionism is a strategy that denies access to the home market for foreign companies. This weakens the position of foreign companies and will benefit domestic firms to the extent that they are sufficiently competitive to take the place of their foreign competitors.
Protection is motivated by several objectives. Concerns about the profitability and employment levels in domestic companies that are struggling with import competition usually play a prominent role. In some sectors, there is the perception that national security and self-sufficiency would be endangered by a foreign domination of the industry.
Protection by a country invites retaliation by its trading partners. Protection easily spreads from country to country in what could be described as geographic domino effects. Frequently, retaliation is not restricted to the sector where the initial protectionist measure was imposed. Companies in other industries are being hurt by the sectoral domino effects from a trade conflict in which they were not involved in the first place.
Are we moving into an era of protectionism? This is not yet the case. However, some signs are pointing in this direction. According to the 2016 WTO report on trade monitoring, the world is experiencing a worrying rise in the rate of new trade-restrictive measures put in place each month, hitting the highest monthly average since 2011. [nvdr: de recente cijfers voor 2017 geven een daling aan in vergelijking met 2016.]
This paper discusses the benefits of international trade in a changing global landscape. The analysis leads to five recommendations for European trade policies.
First, the economic benefits of open markets for economic growth, productivity and innovation are substantial. The European economy would be hurt considerably if borders around the globe were to be closed. This is particularly true for small open economies such as Belgium.
Second, the realization of the benefits of trade integration becomes more difficult. In a world where globalization is stagnating, European companies are under pressure from global competition, and the world’s leading powers actively pursue their own strategic interests, a strategy oriented towards trade integration is not evident.
Third, the EU should not abandon its minilateral strategy under pressure of changing trade policies in the US and other countries. On the contrary, EU should actively pursue comprehensive trade pacts with selected trading partners. Those agreements should incorporate the changing nature of the globalization process and the growing importance of digital flows. In dealing with its trading partners, the EU should speak with one voice and not succumb to the internal divisions that has so often weakened its position in the past.
Fourth, the shifting attitudes in Europe towards trade integration should be taken into account in EU trade policy. In practice, this means that EU comprehensive trade agreements should not solely target economic objectives but also incorporate social and environmental values that are of concern to European citizens.
Fifth, regionalism within the EU needs a new impetus. The EU must negotiate a Brexit deal that limits the negative impact on international trade. Profiting from the economic upturn, the remaining 27 member states should resume efforts to remove internal barriers and strengthen mutual cooperation within a commonly agreed legislative, regulatory and social framework.
- Abraham, F. and J. Van Hove (2016) "David versus Goliath? Smaller European exporting firms facing Asian competition on global markets.” Scottish Journal of Political Economy, Vol. 63, No. 1, February 2016, p 18-40
- Bremmer, I. (2014) “The New Rules of Globalization” Harvard Business Review, January-February 2014.
- Ghemawat, P. (2016) The Laws of Globalization and Business Applications. Cambridge University Press.
- McKinsey Global Institute (2016) “Digital Globalization: The New Era of Global Flows”, March 2016.
- Van Bergeijk, P.A.G. and S. Brakman (2010) The Gravity Model in International Trade. Advances and Applications. Cambridge University Press.
 See Abraham and Van Hove (2016) for an empirical analysis of Chinese and Asian competition on the export performance of Belgian firms.
 This figure is taken from the report of globalization of Mc Kinsey Global Institute (2016).
 See data in the report from Mc Kinsey Global Institute (2016).
 It remains an open question to what extent the intervention of Paul Magnette was motivated by local political motives. A paradox is that the resistance was targeting Canada, a trusted trading partner with high regulatory and social standards.
 This is a well-known finding in the gravity literature in international trade (e.g. Van Bergeijk, P.A.G. and S. Brakman,2010) and international business (e.g. Ghemawat, 2016).
 Strategic globalization is sometimes called guarded globalization as in the recent article by Bremmer (2013).
 To paraphrase G. Orwell: All sectors and markets are equal, but some are more equal than others. They are called strategic.