Future of Global Trade Order and Economic Security (Summary)

Introduction

Recently, the geopolitical landscape has shifted due to significant global events. COVID-19, the conflict in Ukraine, and rising tensions among major powers such as the U.S. and China, have resulted in changes in the trend of globalization. The global trade order and economic security are becoming increasingly important themes in the international community. Is it possible to restore the trade order in such times? What steps can be taken to mitigate the risks to economic security in the modern global climate? How can we rebuild mutual trust in international trade relations?

This joint symposium hosted by RIETI and the Centre for Economic Policy Research (CEPR) will explore these topics under the theme of "The Future of Global Trade Order and Economic Security," and aims to provide valuable insight into these topics. The symposium began with special remarks from the Director General of the Trade Policy Bureau from the Ministry of Economy, Trade and Industry (METI) of Japan, followed by presentations and discussions with some of the world’s leading experts on matters of economic security and global trade.

Opening Remarks

URATA Shujiro (Chairman Emeritus and Distinguished Senior Fellow (specially appointed), RIETI / Professor Emeritus, Waseda University / Senior Research Advisor, Economic Research Institute for ASEAN and East Asia (ERIA))

Thank you sincerely for joining today's symposium, jointly hosted by RIETI and CEPR.

RIETI and CEPR signed the memorundum of understanding on research cooperation in 2014, and so this year marks our 10th anniversary of collaboration. We held an international workshop in Paris in April 2023, graciously hosted by CEPR, and we had a very meaningful and in-depth discussion on many issues. Thank you for holding that successful event.

Today, we face a world where economic globalization is challenged by the U.S.-China confrontation, Russia's invasion of Ukraine, and intensifying military conflict in the Middle East. The global trade order and economic security are important themes for today’s international society. This symposium, titled "The Future of Global Trade Order and Economic Security," will feature two discussion sessions. We will explore whether the current chaotic trade order can be restored, and what kind of economic security cooperation Japan and the EU can provide in this environment.

Special Remarks

MATSUO Takehiko (Director-General, Trade Policy Bureau, METI)

The rules-based trade order that has supported our economic growth faces significant challenges. The COVID-19 pandemic revealed vulnerabilities in our globally integrated production systems, as shortages of essential supplies highlighted risks. We have realized the existing rules-based trade order does not always work, and we need to address the new challenges related to ensuring economic security.

Addressing social issues like climate change and human rights is crucial globally, but responses vary among nations. This disparity can disadvantage companies in progressive countries, leading to calls for new market mechanisms or cross-border adjustments. However, these responses sometimes lead to protectionism, complicating matters.

This poses challenges for the free and fair-trade order, centered on the World Trade Organization (WTO). Japan and Europe have vital roles in upholding this order, ensuring economic security, and addressing social concerns.

CEPR, RIETI, and similar think tanks are instrumental in these efforts. Through policy proposals and research, they foster dialogue and collaboration between Japan, Europe, and global partners, offering crucial insights for restructuring the trade order and enhancing economic security.

Today's discussion is a pivotal step in facing these joint challenges and creating a more resilient and sustainable world.

Session 1: Trade Policy, Industrial Policy and the Economic Security

Chair: URATA Shujiro (Chairman Emeritus and Distinguished Senior Fellow (specially appointed), RIETI / Professor Emeritus, Waseda University / Senior Research Advisor, Economic Research Institute for ASEAN and East Asia (ERIA))

Presentation

Jefferey SCHOTT (Senior Fellow, Peterson Institute for International Economics (PIIE))

Trade policy, industrial policy, and national security have been interwoven in the trading system from the beginning. General Agreement on Tariffs and Trade (GATT) members designed the system to contribute to the reconstruction of Western economies confronting the Soviet empire. GATT rules promoted export-led growth, subsidies and tariffs to protect nascent industries, and large-scale exemptions for poor countries who could not make these types of policy interventions.

Because the GATT and WTO were so permissive of flexible development strategies post-war, very limited constraints were imposed on the use of industrial policy. Almost all domestic subsidies are permitted, subject to offsetting countermeasures if the subsidies cause injury abroad. But disciplines on subsidies have always been constrained, to provide the flexibility to promote national champions in preferred industrial sectors, with farming subsidies similarly unfettered. Regional trade agreements even allowed discriminatory practices, bending WTO rules. Recent aggressive use of Article 21's national security exemptions allows unbounded and undisciplined exemptions from WTO obligations.

The past decade has taken the experience of the first five decades of the post-war trading system and imposed terrible challenges on the multilateral rules-based system. Hot and cold wars forced reassessment of critical security needs and encouraged trade and investment interventions. Military conflict has a profound effect on the way we assess national security, and how we prioritize economic policy to support security needs. The WTO's Appellate Body's disablement in the past decade has also hindered enforcement of WTO obligations among major trading nations.

Technological advancements, climate crises, and global health concerns have further complicated national security concerns, forcing government officials and business leaders to consider a broader range of economic activities in their political and security risk assessments. Access to natural resources and industrial components, access to finance and the denial of official and private assets through financial sanctions, cyber security and security of transport and distribution networks are all new security challenges that affect trade and investment.

Countries often respond to these challenges by protecting domestic markets, shifting the burden to foreign partners. However, this weakens economic security ties among allied nations. What can the WTO do about it? The track record of WTO negotiations has been very weak. The disabling of the WTO Appellate Body allows countries to avoid WTO enforcement, and discourages acceptance of new trade rules and obligations. How can you get WTO members to accept new rules if they do not believe the old rules are going to be enforced? This is a key reason that WTO negotiations have stalled to the current degree.

We should examine progress in international trade negotiations in the last 10 years. There has been success in regional trading agreements (RTA) that have promoted trade liberalization and updated trading rules. Looking at what is happening with those RTAs is perhaps a way to move forward, and I think plurilateral talks should draw on these RTA outcomes to develop building blocks for WTO reforms. All the major trading nations participate in one or more of the major RTAs and the plurilateral could start with talks among the largest member of each: the United States in the USMCA; China in RCEP; the European Union; Japan in the CPTPP; and Indonesia in ASEAN.

The initial negotiating agenda should be narrowly focused. Fixing the holes in the WTO dispute settlement system is important for progress, and reviving the Appellate Body is key to WTO dispute settlement, as well as encouraging responsible use of Article 21. But breaking the current negotiating impasse will require adding other issues to the negotiating package to provide incentives for the United States and others to revise their positions on dispute settlement reform. I think including trade and climate issues to the mix could be helpful.

Regarding the climate, the U.S. and Europe must establish agreed accounting standards for carbon taxes, limit subsidies in R&D in renewable energy, reduce steelmaking emissions, and accelerate methane reduction commitments. A two-year moratorium on Carbon Border Adjustment Mechanisms (CBAM) should be considered to allow for necessary discussions. Finally, excessive subsidies must be addressed through fiscal policy reform motivated by concern about deficits; trade negotiations have proven unable to reach agreements constraining domestic subsidies that are the life-blood of national politics.

Discussant Presentation 1

Simon J. EVENETT (Research Fellow, CEPR / Professor of International Trade and Economic Development, St. Gallen University / Founder of the St. Gallen Endowment for Prosperity Through Trade)

The original trading system, shaped in 1947, was heavily Western-centric, lacking ties with the Soviet bloc. From 1989, we from the west wanted the former communist countries to join, but apparently some did not buy into the same set of unwritten rules that we did. This led to issues when one country's success caused harm to Western partners, sparking a blame game and a backlash. Recent events like COVID-19, and concerns about geopolitical rivalry, created a recipe for a system could fall apart. So, what would it take to have kept this system together?

The first condition is ensuring that the global trading system generates sufficient gains for major players to compensate for inevitable losses from trade reform. However, larger countries gain less from traditional trade reforms, and measures taken to provide enough gains in the areas of interest to those large countries frequently need to be renegotiated and to produce sufficient gains, which has not happened. So, one key unwritten requirement was broken.

The second condition revolves around the appearance of legitimacy of each country's economic growth model from the other partners’ perspectives. People are more willing to accept losses from international trade if they perceive competition to be fair. Due to the original trading system being conceived with market economies in mind, other economies that joined the system later do not appear legitimate in the same ways, so this condition has not been met either.

The third condition is that a deal is a deal. You should not be able to sign a deal and afterwards say you regret it. Furthermore, if you sign a deal, you have to comply with it. Neither of these two conditions have been held.

The fourth condition is subtler but was starkly revealed during COVID-19. Countries that have liberalized their markets must trust that their trading partners will not weaponize trade when goods are urgently needed. COVID-19 exposed these vulnerabilities, and the situation was made worse especially because export controls are permitted under WTO rules which, in this respect, is now understood to have been a flawed design.

Lastly, a hegemon is needed to guide the system and bear the costs of negotiation, but the current landscape lacks this, with one power uninterested and another unwilling to take on responsibilities. Without a hegemon, the system falters, as seen in recent years.

Where do we go from here? Intelligent unilateralism, or improving national business environments as an insurance policy against foreign bad practices, is the single best guarantee against bad practices, and the guarantee that all small countries in Europe have taken to heart. For example, Switzerland does not count on protection from rules, they look for the best business environment to support innovative firms, and this is a lesson for many countries around the world.

Discussant Presentation 2

TAMURA Akihiko (Senior Advisor, RIETI)

The free trade regime, through GATT and the WTO, is based on the assumption that the international division of labor, concentration, and exchange through trade is most efficient system and that it optimizes economic welfare. This assumption is justified only when the countries can be engaged in trade with sufficient level of mutual trust. With normal trading relationships being reasonably pluralistic, there was no excessive concentration that would allow one country to control the survivability of another country. That is why the scenario of achieving efficiency through international division, concentration, and exchange was plausible. But recently, the vulnerabilities derived from excessive concentration due to globalization have gone well above the comfortable zone and geopolitical changes have led to exacerbated mutual mistrust among WTO members.

Thus, mutual mistrust is the root cause of the problem facing the free trade regime. If we can rebuild supply chains with a balance between efficiency and resilience so that the weaponization of interdependence can be avoided, mutual trust can be restored. However, pursuing this at extreme speed would undermine economies of scale, and that could drastically diminish the economic welfare of the international community. Therefore, in tandem with a long-term effort to reconstruct supply chains to the extent reducing interdependence and thus restoring mutual trust, we must also take short-term measures to prevent disruption of the supply chains with bearing the necessity of legal clarity in mind.

Dr. Schott’s proposal of reasonable use of GATT Article 21 can be evaluated as one way to achieve this. Having said that, there have been four panel reports dealing with this article in the WTO, but in all of these cases, the argument is whether the invocation of the article is meant to be completely self-determined or whether it has justiciability. Also, not all cases of weaponization of interdependence involve Article 21. China’s import restrictions on Lithuania and Australia are a classic example of weaponization, but they are only related to sanitary and phytosanitary (SPS), anti-dumping (AD), countervailing duty (CVD), and not directly related to Article 21.

Among various methods to reconstruct countries’ supply chains, the idea of importing countries’ claiming that the exporting countries are engaged in unfair trade practice and ADs and CVDs should be invoked to secure the level playing field (LPF) is one traditionally accepted option in that these trade policy tools are clearly prescribed in the WTO treaties. On the other hand, the idea of imposing some import duties or restrictions by claiming that exporting countries’ production is supported by forced labor or environmental destruction and thus undermines the LPF, is championed especially in some values-oriented, developed countries but may be legally precarious and a challenge in convincing the Global South.

CEPR’s Important Topics of Common European Interest (ITCEI) project aims to analyze which parts of the supply chain would benefit from resilience improvements through public interventions, to consider the externalities of resilience measures, and to identify how trade vulnerability impacts relationships with friendly and less friendly partners, from the viewpoint of economists. I would suggest using this analysis to launch interdisciplinary discussions among economists, lawyers and maybe political scientists, with the aim of reviving an international trade order with restored mutual trust.

Chair’s Summary

URATA:
I would like to highlight three key points from our insightful presentations. Dr. Schott emphasized regional trade agreements as a potential solution, focusing on the U.S., EU, Japan, Indonesia, and China. Mr. Tamura emphasized the importance of mutual trust, prompting the question of whether such trust can be fostered among these nations as proposed by Dr. Schott .

Professor Evenett spoke about intelligent unilateralism as especially vital for smaller nations, yet the challenge lies in its application to larger countries. While unilateral action is crucial for domestic preparation, convincing larger nations may pose difficulties.

Mr. Tamura's emphasis on rebuilding trust through resilient supply chains raises questions about the feasibility of achieving mutual trust. Is an RTA-style arrangement, as suggested by Dr. Schott the path forward for supply chain resilience?

These points are not only intriguing but also crucial for discussion. The presentations today have offered valuable insights into the global trade order, inviting us to consider these key messages.

Session 2: Multilateral Rule-based Liberal Trading Order and Supply Chains

Chair:Simon J. EVENETT (Research Fellow, CEPR / Professor of International Trade and Economic Development, St. Gallen University / Founder of the St. Gallen Endowment for Prosperity Through Trade)

Presentation

KAWASE Tsuyoshi (Faculty Fellow, RIETI / Professor, Faculty of Law, Sophia University)

The past seven years have seen a number of supply chain crises, including U.S.-China trade conflicts, the Ukrainian war, and the impact of the COVID-19 pandemic. As a result, countries are currently discussing supply chain risks from a national security perspective. A shortage of dual-use technologies, in particular semiconductors, could have a negative impact on the production of civilian and military goods. Furthermore, countries have been aware of the risk of facing economic coercion from China and Russia. This has led to discussions about developing supply chain resilience strategies, including diversification (e.g., the China + 1 strategy), increased supply chain transparency, and the creation of early warning systems for disruptions.

In 2021, for example, the Biden administration ordered the U.S. agencies to research supply chain vulnerability, focusing on 10 sectors, such as semiconductors and critical minerals. The agencies' report proposed improvements, including diversifying supply chains, upgrading domestic manufacturing and research capabilities, increasing government procurement and investment.

In this context, the Biden Administration has been promoting "friend-shoring," which aims to build supply chains among nations that share a set of norms and values, thereby minimizing geopolitical risks. Domestic legislation, such as the Inflation Reduction Act (IRA) and the Chips and Science Act, as well as initiatives to establish supply chain-focused international frameworks, such as the Indo-Pacific Economic Framework (IPEF), the U.S.-EU Trade and Technology Council (TTC), and other bilateral agreements including the U.S.-Japan Economic 2+2, are designed to enhance supply chain resilience and facilitate friend-shoring.

Trade agreements play a pivotal role in facilitating and encouraging the development of supply chains by reducing costs and risks and increasing predictability. In the Indo-Pacific, the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) has made a significant contribution to this goal by eliminating almost all tariffs in the region, liberalizing and protecting foreign direct investment, achieving free flow of data and movement of business persons, and including innovative provisions to ensure a level playing field. Unfortunately, the absence of the United States from the CPTPP prevents the agreement from serving as a basis for friend-shoring in the region.

Currently, the United States is more focused on supply chain-oriented trade frameworks for friend-shoring, such as the IPEF and the TTC, instead of traditional trade agreements with market access commitments. In the IPEF, the parties have successfully concluded the IPEF Supply Chain Agreement under Pillar II. As Ambassador Katherine Tai of the USTR explained, the Pillar II Agreement provides stability to an existing global supply chain, while Pillar I (trade) provides incentives for supply chain formation by reducing costs and increasing predictability. This implies that these two pillars are complementary in the establishment of friend-shoring. Unfortunately, the parties were unable to reach an agreement in the Pillar I negotiations last November. Furthermore, the prospective Pillar I agreement is insufficient for the establishment of friend-shoring as it is supposed to lacks market access commitments, robust rules and enforcement mechanisms.

As discussed in the WTO's World Trade Report 2023, the open and multilateral trading system also builds resilience into supply chains. This is because countries have successfully found alternative sources of supply and alternative markets in the face of recent emergencies or external shocks. This was particularly evident in the case of China's economic coercion against Australia, where Australia effectively utilized the system to circumvent China's pressure.

Therefore, free trade is by no means at odds with national security. Conversely, the open and multilateral trading system provides the foundation for resilient supply chains and contributes significantly to economic security, as previously argued. It is therefore evident that our policy option remains to strengthen the system. This includes updating and expanding the CPTPP, accelerating the IPEF Pillar I negotiations and taking forward WTO negotiations, including Appellate Body reform. It is also important to remember that we must adhere to the "small yard, high fence" approach to prevent the introduction of protectionist measures in the name of security that would undermine the rules-based system of free trade.

Discussant Presentation 1

INOMATA Satoshi (Chief Senior Researcher, Institute of Developing Economies, JETRO)

In discussing the global governance of international trade, Professor Richard Baldwin highlights a structural shift from the 20th-century approach based on traditional trade modes to the 21st-century approach based on global value chains. In the 20th century approach, international trade was envisaged within the framework of "made here, sold there", with free trade agreements (tariff reduction, etc.) as a principal governance instrument. For the 21st century approach, by contrast, the basic landscape of trade is "made everywhere, sold there", with multinational corporations as key players of the game. Accordingly, its governance strategy emphasizes regulatory convergence among countries to secure a level-playing field for global flows of goods, money, people, and information.

Here, the implementation of the 21st-century governance presumes the presence of a huge economic power gap between rule-setters (= advanced economies) and rule-followers (= developing economies). This is because the former maneuvers capital/technological transfer as bargaining chips against the latter for demanding its domestic reform in the direction of regulatory convergence.

The problem is that, while this negotiation card of “my factory for your own reform” may still work for least developing economies with minimal capital and technology endowments, it is no longer effective for fast-developing economies, especially emerging powers, because the prerequisite power gap in rule-setter/follower relations has eroded for them to the date. The rebels may soon start to build up global governance schemes of their own design, as preceded by China’s Belt and Road Initiative.

Currently, the Build Back Better World (B3W) initiative by the United States, later reformulated into Partnership for Global Infrastructure and Investment (PGII), aims to promote infrastructure development and technological cooperation in the Indo-Pacific region, which forms a core ingredient of the US Indo-Pacific (“friend-shoring”) Strategy alongside the Indo-Pacific Economic Framework (IPEF). From the viewpoint of developing economies, this is a clear manifestation of the 21st-century governance since, if seen as a single negotiating package, it provides for infrastructural/technological assistance by the B3W in exchange for the compliance to high-level international rules and standards set out by the IPEF (i.e., “my factory for your own reform”).

So, as the race for the 21st-century “friend-shoring” governance intensifies over time among economic superpowers, there is a danger of perpetually institutionalizing de-coupling of the global economy. Is this what we want for the future of the multi-lateral trading systems?

Discussant Presentation 2

Beatrice WEDER di MAURO (President, CEPR / Professor, the Graduate Institute of Geneva)

Japan and Europe find themselves in a similar position – neither is directly engaged in the U.S.-China power struggle but both need to navigate a middle ground. In 1992, Francis Fukuyama’s “The End of History” was a shared sentiment that we had reached a point where ideologies no longer divide the world, where geography was increasingly unimportant, and the potential for the end of poverty and deep economic divisions seemed real. Thomas Friedman's "The World is Flat" symbolized the era of Great Moderation, falling inflation, and rising globalization through global value chains. These hopes now seem diminished.

Recent years have brought a series of crises - populism, pandemics, trade wars, China's ascent, and for Europe, the conflict in Ukraine. CEPR's recent publications highlight these challenges and the need to rethink our international financial and trade order. Amidst these shifts, we must reconsider economic security. Our upcoming Paris report delves into this, examining what economic security means, especially considering recent crises.

To aid in our effort to address economic security, we classify shocks into three types: domestic economic crises, external shocks such as COVID-19, and deliberate actions or aggression by other nations, like Russia's actions in Ukraine. Economic security must encompass these external shocks and deliberate coercions. Our analysis, led by Isabelle Méjean, refines methodologies to identify critical import dependencies, considering both static and dynamic factors. It is critical to account for substitution possibilities when defining import dependencies.

Moreover, where substitution can occur matters. We conducted an analysis on what would happen if the EU suddenly decoupled from China - the impact on output would be significant. Gradual decoupling and diversification of markets reduce these costs. This points to the importance of understanding not only import dependence but also export dependence and the necessity of making like-minded friends for potential substitutions.

Our report also highlights the tools the EU has developed in response to these challenges: the European Chips Act, Critical Raw Materials Act, and Net Zero Industry Act, among others. These aim to reduce import dependency for critical products. However, there is a need to consider export dependencies as well. For instance, how would the EU respond to economic coercion? The EU's anti-coercion instrument, though powerful, has high activation hurdles. There is also the question of whether the EU should gradually reduce dependency on the Chinese market. Our analysis shows that slow reduction is less costly than sudden changes.

In summary, the era of the Great Moderation is likely gone, and not coming back. Geography is coming back. It matters where you are, and who your friends are. Political and economic fragmentation, along with revived ideologies, are on the rise. Our advice is be prepared, buy insurance. Yes, it is costly, and therefore has to be weighed against the size and possibility of the risks, but it is definitely not enough to look at just import dependence. Concentrated exports and coercion risks have to be within the scope of risk assessment.

Finally, for the EU, it is very important to strengthen the single market and speak with one voice. Europe is not as one, and some of these instruments or aggressions might serve to try and divide and conquer Europe. Joint action, and speaking with one voice, is extremely important. We must also avoid protectionism and capture by special interests, because of the risk they pose in terms of supporting inefficient producers and creating subsidy races with other countries, but also within Europe itself.

Chair’s Summary

EVENETT:
I would like to share some questions we have received for reflection. Firstly, there is the question of how global private companies can navigate geopolitical risks without appearing to favor any particular country. Can they truly remain nationality-blind multinationals?

Secondly, how does managing economic security risks differ from standard risk management procedures? Is the distinction driven by the potential for malicious actors to weaponize trade flows? This leads to the broader question: can a rules-based consensus effectively deter such malicious acts, assuming we can define what constitutes such behavior?

In a broader context, the presentations highlighted how plurilateral and regional solutions could enhance economic security, was a common theme throughout. This was discussed in the context of the Asia-Pacific region, Richard Baldwin's unbundling concept, and European perspectives.

A critical question arises: how do we measure the success of these initiatives? It is not just about expanding supply chains but also minimizing disruptions to them. Understanding the value of these efforts, akin to buying insurance, requires clarity on the returns and effectiveness of such measures. These are important questions upon which we must ponder.

Final Remarks

Beatrice WEDER di MAURO (President, CEPR / Professor, the Graduate Institute of Geneva)

I want to once again extend my gratitude for this session. This discussion has been truly enlightening. While we may not have all the solutions, we are certainly honing in on the right questions. Precision in our definitions is paramount moving forward.

In response to your remarks, Simon, I would emphasize the fear of economic coercion, aggression, and weaponization as new challenges. The uncertainty surrounding alliances and who shares our values is a pressing concern, additionally regarding the U.S. and its stance.

Regarding the cost of buying insurance versus investing in deterrents, it is crucial to have strong instruments in place to deter aggression. While this is costly, the effectiveness can often be measured by their use being avoided.

I hold onto hope that we can arrange our world in a way that renders the most aggressive defensive instruments unnecessary.

Finally, I must commend RIETI for their gracious hospitality and flawless organization of this symposium. Thank you to everyone for their contributions and engagement.