PEIO Conference in Salzburg

Václav Ocelík, Dawid M. Walentek and I are going to present our working paper ‘The Instability of Globalization: Applying Evolutionary Game Theory to Global Trade Cooperation’ at the 12th Annual Conference on ‘The Political Economy of International Organization‘ (February 7-9) in Salzburg. The line up looks really amazing, and we are excited to get feedback on the first paper of our new research project.

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How Trade Wars Can Be Won

Contrary to Donald Trump’s famous statement, it is an old adage of economists that trade wars cannot be won, but that they only lead to endless rounds of retaliatory measures which lead to economic losses on both sides. However, important trade partners of the USA have reacted to Donald Trump’s aggressive trade policies quiet conciliatory: the NAFTA agreement was renegotiated and Mexico made significant concessions in favour of the US car industry; EU commission president Jean-Claude Junker promised to increase imports from US liquefied natural gas and soybeans to reduce the trade surplus of the EU; and the beginning trade talks between China and the USA mainly address Chinese concessions on the protection of intellectual property rights and on the reduction of its trade surplus. President Trump may indeed win the trade war – and the success of his protectionist policies will have devastating effects for the open economic order as we know it.

Rapid trade liberalisation implies social and political costs, but these costs are almost always excelled by the economic gains of international trade. As a result, countries find themselves in what game theorist call a prisoner’s dilemma situation, where they face incentives to exploit the cooperation of their counterparts. However, the steady repetition of the game allows them to play ‘tit-for-tat’ and to reciprocally reduce their trade barriers step by step. Consequently, protectionism should only be successful in the very short run, when it exploits the one-sided trade liberalisation of other countries. In the long run, other countries should retaliate against protectionism by re-establishing trade barriers themselves, and protectionist countries would forfeit the economic gains of international trade. In the end, destructive trade wars should motivate all players to return to trade liberalisation, and the open economic order would be stabilized.

However, countries with an interest in an open economic order should not retaliate against every single trade barrier. Sometimes they need to be generous, if they want to sustain the system of international cooperation. Many trade barriers are established for reasons beyond protecting uncompetitive industries. For example, European consumers regard non-tariff trade barriers against genetically modified foods and seeds as legitimate. And the USA justifies its current trade measures by referring to its national security interests – a motivation, which is allowed for by WTO law. If other countries reacted on all such trade barriers with strong countermeasures, the liberal trading order would have collapsed a long time ago. Thus, countries always need to balance between generosity and retaliation, but it is usually uncertain at the outset, which is the right strategy to stabilise international cooperation on trade.

Retaliatory trade measures are further impeded by asymmetries between the different economies within a trade war. Generally, smaller economies are much more dependent on international trade than larger economies, because they generate less comparative cost advantages and economies of scale on their own market. But even some larger economies are highly trade dependent. Economies with strong export industries – like that of China or Germany – gain much more from trade liberalisation than the USA, which suffers from deindustrialization and an increasing trade deficit. Export economies have much more to lose, if international trade breaks down, and so they may be willing to make concessions in order not to lose access to big and important export markets like that of the USA.

When the stakes are high and the situation is uncertain, instead of risking a full- blown trade war many countries may be tempted to stabilise trade cooperation by appeasing a protectionist culprit. In respect to trade cooperation with the USA, the stakes are always high, because the US represents the biggest export market in the world. And the situation is also rather uncertain, because the somewhat erratic behaviour of the US administration is difficult to assess. How far is Donald Trump willing to go? How long can he withstand, if the US economy is suffering from retaliatory measures? Because of the size of the US market and the unpredictability of President Trump’s strategy, appeasement seems to be the easier and cheaper option. The rationale of Donald Trump’s strategy is to exploit exactly these concessions, which result from the US market size and the prevailing uncertainty among America’s trade partners.

The problem with appeasement is that it makes protectionism a winning strategy for the USA in general and Donald Trump in particular. As long as other countries do not retaliate, their generosity and cooperation can be successfully exploited. This may have two negative consequences: The chances that Donald Trump changes his strategy or that he is voted out of office in 2020 are declining, if he is able to protect the jobs of American workers with little negative repercussions for the US export industries. And if protectionism turns out to be successful, the strategy may be copied by politicians in other countries. The Brazilian president Jair Bolsonaro gives an obvious example, how elections can be won by following the role model Donald Trump. As a result, protectionism may not be a short-living phenomenon, but we may witness the beginning of a protectionist era in the international system.

Policies of appeasement only embolden the bully. The EU and China can only fight the spectre of protectionism if they retaliate forcefully against trade barriers, and make protectionism a losing strategy. Retaliatory measures and the resulting trade disputes will harm the European and Chinese economies in the short term, but they are the only way to inflict costs on the US economy and to ensure that Donald Trump does not win from protectionist measures. Only when Donald Trump’s trade policies are unsuccessful will domestic opposition and pressure rise from his electorate to change these policies. And only when protectionism is unsuccessful will it lose its appeal for populist governments of other countries. Thus, even if trade wars are harmful in the short-run, they may be the only instrument we have to fight the rise of protectionism in the long-run.

Central Asia

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I have just arrived back in Amsterdam from a three weeks trip through Central Asia (Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan). I met wonderful people and saw amazing landscapes and architecture. However, this was the most difficult region I have ever travelled so far. The border controls are a pain and the transnational infrastructure is really weak. These countries have been part of one country (the Soviet Union) until 1991, but it seems they spent the last 25 years on disintegration – despite the fact that they are all landlocked countries and need open borders for international trade. That is really a puzzle for a scholar, who researches regional integration efforts!

 

Brexit

When I went to bed yesterday evening, I was very optimistic that the UK would remain a member of the European Union. This morning, my first action was not to make coffee, but to look online in order to get a confirmation for my optimism. The result of the referendum woke me up much quicker than any coffee could ever do.

My life and my academic work is closely connected to the idea of regional integration in general and European integration in particular. I own a Master degree from a British university, I wrote my PhD thesis about the European Single Market, my current research explores the possibilities for regional integration in other world regions, and I – as a German citizen – live and work in Amsterdam, which was occupied by German troops only 75 years ago. From my perspective, it is difficult to understand, which hopes and fears pushed the British decision to leave the EU, and I followed the debate with some anxiety. From my days in London, I remember ‘Cool Britannia’ as a proud, self-confident and open country. What happened during the last 15 years that parts of the country strive for independence time and again, that the country chooses isolation in Europe, that people like Nigel Farage get popular, and that an MP gets shot on the street?

The EU faces a severe dilemma right now. On the one hand, it needs to take care that ‘Brexit’ remains to be a unique event and that no other member states follow. (I hope desperately that the Dutch people stay cool and are able to see the advantages of the EU for a relatively small country. I do not want to lose my privileges as an EU citizen in Amsterdam.) One strategy to keep others in the EU will be to make an example of Brexit and to let the British people and economy suffer from that decision. It would be rather easy to cut off the UK from the Single Market and to cause a recession, which threatens other member states to follow the British example. On the other hand, this strategy is dangerous, because it is based on deterrence and not on the positive appeal of European integration. Euroscepticism will rise even further, if the European Peoples feel to be forced into the EU by economic pressures beyond their control. The result may be just another wave of anger, defiance and disrespect.

The EU had its best days under the Commission President Jacques Delors, when it proactively engaged in new projects like the Single Market or the Monetary Union. The picture today is completely different, and the EU only reacts to threats like the Euro crisis or the refugee crisis. The last integrative project, namely the European constitution, failed, because it dealt only with formal, but not with substantial issues. Now, a new policy project is needed, which explains the European people why they need the EU and what they can gain from European integration. After the excess of neoliberalism and in times of growing inequalities, this project needs to be a social-democratic one. The suffering social-democratic parties of Europe need to get back on their feet and to develop visions of Europe beyond austerity policies and closed borders. We need a new alternative to the reactive policies, which are supposed to be without any alternative.

It is obvious that a return to the nation-state and a break-up of international cooperation and integration cannot be the answer to today’s problems. I am afraid that the British people will learn that lesson very soon. If they stay inside of the European Economic Area, they need to implement most of the EU’s decisions without having a vote on them anymore. Thus, the regaining of sovereignty will be a mere illusion. If the UK really aims to regain sovereignty, it needs to leave the Single Market and faces trade barriers to its most important trade partners (see the analyses of the European trade networks in this blog). Economic interdependence is part of our wealth in Europe and real sovereignty comes at very high costs.To put it into the words of Jean Monnet: ‘The sovereign nations of the past can no longer solve the problems of the present. They cannot ensure their own progress or control their own future.’ Let us be a bit more friendly than the former French President Charles de Gaulle, if the British people experience that.

 

Happy New Year 2016!

I have to admit that I became a bit lazy with posting news on my homepage. However, much has happened since my last post in April 2015. Most notably, we finished the manuscript for our book on Comparative Regionalism. It will be published this year with palgrave. Thus, I deleted the page ‘Work in Progress’ in order to motivate all of you to buy the book :-).