A year ago, the world looked set to continue on its post-World War II path to ever closer economic integration. The European Union seemed to have weathered or, at least, papered over the worst of the post-2008 crisis, as Greece slipped from the front pages. The United States was concluding negotiations with its Asian partners on the Trans-Pacific Partnership trade deal and looking ahead to an equally ambitious trade deal with Europe. While the OECD continued to try to ensnarl global financial services in a choking morass of red tape through BEPS, information exchange, and other anti-growth initiatives, the world seemed set on continuing to connect economies with ever more robust ties.
What a difference a year makes! Today, the U.K. is consumed with figuring out what Brexit means (beyond, of course, “Brexit”). One estimate suggests that it will take 30,000 additional civil servants to negotiate all the trade deals and draft all the laws it will take to extricate the U.K. from Brussels. In the United States, President-elect Donald Trump has promised to kill the Trans-Pacific Partnership, renegotiate NAFTA, and generally upend U.S. trade relationships around the world. There is no estimate yet on how many more civil servants will be needed to handle all those negotiations in Washington. Either Italy or France could elect a populist government that would further challenge existing structures.
Despite Mr. Trump’s protectionist instincts and the difficulties of figuring out just what Brexit does mean, economic integration is likely to continue, albeit a bit more slowly than otherwise. Mr. Trump may attempt to play King Canute and order the wave of goods, services, and people away from American shores but he is likely to be as unsuccessful as Canute was in stopping the waves. Here are three reasons why:
- Cutting existing ties is expensive. It took decades for trade to recover from the body blow of World War II. Once it did, economic ties between countries, firms, and individuals expanded until today much of the world is so interconnected that it is almost impossible to imagine a return to the less-interconnected world of the 1950s. For example, a recent Wall Street Journal story noted that car seats made by Adient in the United States involve parts from plants in four states and four Mexican locations. This is not an isolated example: Fourteen thousand trucks a day cross the U.S.-Mexican border at Laredo, Texas (moving in both directions). One study estimated that 40 percent of the content of the goods assembled in Mexico originate in the United States. Undoing the supply chains underlying all those goods would be costly for everyone involved.
- Undoing integration would dramatically reduce consumer choice. Lucky Foods can deliver broccoli from its fields outside San Miguel de Allende, Mexico, to Texas grocery stories in 24 hours, with product tracking that tells it from which field each piece came. It takes just 24 hours more to get it to stores in Canada. Mexico’s expanded growing season makes fresh vegetables available to Americans for more of the year. U.S. consumers are unlikely to happily return to 1950s-style canned vegetables if the movement of goods across the U.S.-Mexican border were to slow.
- International investment into the United States is an important driver of the U.S. economy. Iconic U.S. brands like Sara Lee, Arnold, Brownberry and Thomas’ English Muffins are owned by Grupo Bimbo, the Mexico-based firm that is the largest bread producer in the world. Borden Milk is owned by Mexico’s Lala, which is the second largest dairy producer in the United States. Cemex, also based in Mexico, is the second largest cement manufacturer in the United States.
King Canute presumably got soaked when he waded into the water to command the waves to stop. Mr. Trump risks serious economic harm if he tries to reverse the economic integration of the world economy. Assuming he’s too clever to do that, what might the Trump administration plus Brexit (plus a possible Five Star government in Italy plus a possible National Front win in France) mean for the world economy?
Uncertainty. If there is a lesson from the Trump campaign for how President Trump will govern it is that he is more unpredictable than most politicians. As his acceptance of a phone call from Taiwan’s president illustrated, and his subsequent musings about whether or not he would remain committed to the “One China” policy, foreign policy will not be run from the State Department but from the president’s Twitter account. Compound that with the uncertainty introduced by the British referendum and the U.K. government’s floundering response and the future is particularly hazy. Add in the upcoming elections in France, Germany and probably Italy and things get even murkier. Uncertainty is generally bad for businesses.
Direct intervention. As his deal with Carrier to “bring back” jobs to the United States shows, President Trump will be directly intervening in the economy. This will not be a laissez-faire administration. Similarly, the May government in the U.K. has shown a fondness for industrial policy and aggressive measures to keep the economy growing. Rather than a new Reagan-Thatcher era, Trump-May seems more likely to repeat the economic policies of the Carter and Callaghan governments, at least in these dimensions. Both the National Front and the Five Star Movement promise more intervention in the economy as well, furthering my gloomy sense that we might be about to relive the 1970s.
Rewriting tax codes. Both the U.K. and the U.S. can be expected to be more aggressive in asserting their interests in the global tax system debates now underway. Even the Obama Administration has stuck up for U.S. businesses like Apple, preferring to tax their profits when repatriated to the United States to letting the EU members grab the revenue. As the U.K. fights to maintain London’s status as a major financial center, tax policies will be a valuable tool. Moreover, since neither May nor Trump are committed to any particular philosophy of tax, and both will be looking to conclude deals, we shouldn’t expect a philosophically consistent tax reform but rather a bundle of provisions that pays off a large enough coalition to be enacted. This will likely leave room for offshore financial centers to continue to play a role in cross-border transactions.
Rewriting regulations. As the U.K. moves to bring government authority back from Brussels, it will have the chance to rewrite a great many regulations. Similarly, Trump pays (at least) lip service to a deregulatory effort, and at least some of his Cabinet nominees seem inclined to reduce the scope of federal regulations. In the past, the combination of a Tory government in the U.K. and a Republican one in the United States has at least slowed international regulatory efforts. This time, however, the commitment of both May and Trump to more than the rhetoric of broad deregulation is uncertain. No one really knows what a Five Star government’s regulatory policy might look like, including, it appears, the politicians in the “movement.” The National Front promises more regulation rather than less, making it likely that the French election campaign will be a competition to promise special interests extra benefits despite the initial “Thatcherite” rhetoric of the Republicans’ candidate, Francois Fillon. At the least, we should expect some shifts in regulatory emphasis around the world.
I believe that greater trade in goods, services, and capital will advance the world economy and that the fundamental problem in the world today is the lack of growth. As a result, comments like Trump advisor Steve Bannon’s declaration that “I’m an economic nationalist” and incoherent policy statements like Theresa May’s “Brexit means Brexit” and the Five Star platform worry me. The world economy is adrift, with growth rates well below where they need to be to expand opportunity for the world’s poor and ensure our children have better lives than we do. “Economic nationalism” and incoherence are not ingredients to boost growth. Nonetheless, even Donald Trump, Theresa May, Marie Le Pen, and Beppe Grillo will find it impossible to undo the deep integration of the world economy. Of course, they can slow progress and even wreck particular industries, and probably will. With just a little luck, we may later look back on this period as a slight detour on the road to a prosperous world rather than a complete wrong turn.