East Asian Economic Strategies

Restoring the Global Trading System with Collective Action

Visiting Fellow, RIETI

If truth is the first casualty of war, international trade may be the first casualty of geopolitics.

The return of Great Power rivalry and geopolitics has turned international trade and economic exchange into a tool in the pursuit of geopolitical advantage. With China and the United States locked into strategic rivalry, geoeconomic carrots and sticks are seen as a way to gain advantage, align friends and punish those that are not on-side.

At stake is not just the efficient international division of labour but escape from poverty through the growth potential of the global economy. There’s no country anywhere that should understand this better than Japan. Global prosperity has been built from communities and countries specialising in their comparative advantage and benefiting from economies of scale in trade with the rest of the world. That has resulted in high trade shares and concentrated markets internationally which are now seen as a risk because international interdependence is being weaponized. A retreat from specialisation and trade will slow and potentially reverse economic growth and harm prosperity.

The use of economic tools for geopolitical ends will make the world poorer and less safe. Economic interdependence has brought prosperity and security to much of the world. East Asia and the European Union in particular have enjoyed the pacifying effects of trade and economic integration. Economic cooperation that has deepened integration raises the costs of war and market forces constrain the behaviour of states and political actors everywhere.

The unravelling of economic interdependence in East Asia risks relaxing constraints on countries and feeding conflict. Northeast Asia has managed high trade shares and interdependence despite the political ups and downs that come from regional rivalry, unresolved history and political system differences.

Efforts to diversify trade and de-risk interdependence have thus far largely failed outside of the China–US relationship. Mexico this year overtook China as the largest source of US imports and China’s share of US imports fell to its lowest since 2006, thanks to the US tariffs on imports from China. Chinese parts and components are now being shipped to Vietnam, Mexico, Thailand and other countries before finding their way to the United States as inputs in manufactures produced in those countries. Imports into the United States continue to grow. And China’s trade with the rest of the world continues to grow as its value-add in global value chains continues to increase as it sheds lower cost manufacturing to other developing countries. The trade data shows that many supply chains have become longer and not necessarily more resilient.

Trade in goods as a share of GDP may have plateaued, leading many to think that globalisation is in retreat, but the world is becoming more globalised in areas outside of simple goods trade. The digital economy and cross border data flows continue to grow rapidly, for example, and that is a new source of much needed productivity growth. That new source of growth is at risk of fragmentation with different approaches to data localisation, artificial intelligence governance and protecting privacy.

Foreign investment, trade in services and cross border data flows are not separate from trade in goods. The economic reality is that supply chains are becoming more complex between countries and in their composition. Global governance of supply chains is still lacking despite the policy focus on supply chain resilience.

The bigger challenge for managing the reality of global economic interdependence today is that many governments now view concentrated markets and high trade shares as a risk. The policy efforts to diversify and de-risk will likely accelerate given the attempts to weaponize interdependence.

A more assertive China has added to the uncertainty many countries feel around its economic and political rise. Its use of economic coercion has resulted in a breakdown of trust between China and many countries, and shaken confidence in China as a reliable trading partner.

The United States has gone from enforcer to spoiler of the global trading system with its focus on domestic challenges and rivalry with China for primacy. Former president Donald Trump’s America First protectionist policies, with its tariffs against China, and steel and aluminium tariffs against the rest of the world, have been escalated under the Biden administration with extra-territorial unilateral sanctions on China’s high-end semiconductor industry.

Multilateral trade rules have been unenforceable since late 2019 due to a US-veto of judges to the WTO’s dispute settlement system’s appellate body. Shortly after the dispute resolution body became dysfunctional, the European Union and Canada spearheaded the creation of the Multi-Party Interim Appeal Arbitration Arrangement (MPIA). This plurilateral framework mirrors the defunct body, allowing signatories to settle WTO disputes amongst themselves. Notably, Australia, New Zealand, Singapore, and China are included in the current 53 MPIA participants. Japan joined in March 2023 but there are many other major economies, and most of the WTO membership, that have yet to join.

Appeal to the WTO rules, backed by MPIA contributed to Australia’s succeeding in having trade sanctions from China lifted. Membership of MPIA and adherence to its rulings demonstrates a stake in the existing rules-based order and is more than pure symbolism.

With the existing problems in the dispute settlement system and the rules being unenforceable within the WTO, groups like the G7 are considering the development of an anti-coercion instrument. The European Union has implemented an anti-coercion instrument in response to one of its members being on the receiving end of Chinese economic coercion. An anti-coercion instrument might act as a deterrent against attempted economic coercion but at the same time it would significantly weaken the multilateral rules-based order. Having a group of countries take international law into their own hands is akin to mob-justice or vigilante rule, instead of the rule of law.

An approach that would strengthen the rules-based economic order, instead of weakening it, would be to expand MPIA while continuing the reform of the dispute settlement system in the WTO. A second-best solution might be to strengthen dispute settlement mechanisms in regional or plurilateral agreements among members willing to sign up to them.

The multilateral trading system faces two other major challenges. The answer to both lies in collective action mobilised through groups of like-minded countries, just as MPIA is a group of like-minded countries.

The first problem is outdated rules in the WTO that need bottom-up reform and plurilateral rulemaking. Much of this is being tried in regional agreements and through existing initiatives in the WTO but they need to follow certain principles — openness to new members that meet transparent criteria — if they are to avoid fragmentation of the system.

The other challenge is plugging the security exception loophole in the WTO. While Article XXI of the GATT permits countries to implement restrictive measures for legitimate national security concerns, it was never intended to be carte blanche. There was an unspoken understanding in place to prevent blatant misuse of this exemption, safeguarding the integrity of GATT and later, of WTO regulations. Unfortunately, this norm can no longer be relied upon.

In her response to the December 2022 negative WTO ruling against the US steel and aluminium tariffs imposed under the guise of national security, US Trade Representative Katherine Tai unequivocally signalled the Biden administration's disregard for the Article XXI security exception norm. Tai declared that the WTO “should not get into the business of second-guessing the national-security decisions that are made by sovereign governments”.

That leaves a significant loophole in the multilateral trade rules that needs to be plugged. Any country can restrict trade in the name of national security, as self-judged. Invoking dispute settlement procedures will only be effective among MPIA members, and that risks eroding the MPIA by unfairly limiting policy space among a subset of the WTO membership.

Again, progress can be made in plurilateral groups that have the incentive to codify what are legitimate national security interests and under what conditions Article XXI in the GATT can be invoked. Another proposal is to invoke the ‘specific trade concern’ process instead of the dispute settlement process that would allow peer-to-peer engagement as opposed to delegation-to-adjudicators.

At a time of geopolitical uncertainty and huge transition in the global order, it is the multilateral system that will protect the interests of small and medium powers. Time and again the Great Powers have shown they will act capriciously in their own interest with disregard for others, whether they are allies or not. That challenges the rest of the world to proactively and strategically protect multilateralism and the rules-based order, and to keep reminding China and the United States that their prosperity and influence are enduringly embedded in functional multilateral institutions.

December 20, 2023

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