Globalization

Trade, deglobalization and the new mercantilism

Originally appeared on the Hinrich Foundation

By Prof. Razeen Sally

The COVID-19 pandemic is accelerating shifts underway since the last global financial crisis (GFC). It ushers in a new era of deglobalisation and protectionism, indeed a new mercantilist world order.

Three global shifts will shape international trade. They will probably last beyond the immediate crisis to the “post-vaccine” future. The first is an accelerated shift from Market to State: more government interventions will further restrict markets. The second is to national unilateralism – governments acting on their own, often against each other – at the expense of global cooperation. The third is to more contested and unstable geopolitics, centred on US-China rivalry. Taken together, they herald a new mercantilism, whose main precedents are Europe and its colonial expansion in the seventeenth and eighteenth centuries, and the period between the two world wars in the first half of the twentieth century.

Mercantilism – the exercise of state power to control markets domestically and internationally – existed after 1945, but was constrained by the expansion of markets: it was relatively benign. But malign mercantilism governed the preceding decades, shattering domestic economies, shrinking individual freedom, destroying the world economy, and so poisoning international politics as to culminate in global war. Today’s emerging mercantilism is still far from that reality, but it risks heading in that direction.

Another set of historical precedents is also relevant. Increasingly, the US-China conflict today echoes that of the US and the Soviet Union in the “old” cold war. But China today, unlike the former Soviet Union, is an authoritarian (not totalitarian) power with a state-directed and partly globalised market economy (not a sealed-off command economy). China better resembles Germany and Japan as rising powers in the late nineteenth and early twentieth centuries. And US-China rivalry today better resembles that of the UK and Germany before the first world war: a contest between the established power, with a liberal-democratic political system and a free-market economy, and a rising power, with an authoritarian political system and a state-guided market economy.

Three eras of international trade preceded the present pandemic. The first – the quarter-century until the GFC – was an era of unprecedented liberalisation and globalisation. The second – the near-decade after the GFC – saw globalisation stall, though not reverse, and trade growth stagnate alongside “creeping” protectionism. The third, starting in early 2017, was triggered by President Trump, partly to retaliate against increasing Chinese protectionism. It centred on a US-China trade war but rippled out into copycatting protectionism by other countries. Protectionism went from creeping to galloping.

This pandemic has triggered the worst deglobalisation since 1945. International trade may shrink by up to a third, foreign direct investment by up to 40 per cent, and international remittances by 20 per cent, this year. The trade outlook is worse than it was during the GFC in two ways. Now economic contraction is synchronised around the world; during and after the GFC, fast growth in emerging markets, led by China, cushioned the fall in trade and enabled a recovery. Now services trade is suffering even more than goods trade; travel and tourism have collapsed. The GFC, in contrast, hit goods trade hard but services trade was more resilient, especially fast-growing travel and tourism. Now there are signs of a protectionist upsurge, starting with export bans on medical equipment, with new restrictions on foreign ownership in the pipeline.

What is the medium-term – post-vaccine – trade outlook?

First, protectionism is likely to increase as a spillover of domestic state – particularly industrial-policy – interventions that last beyond the present crisis. Crisis-induced subsidies will be difficult to reverse wholesale and will have trade-discriminating effects. New screening requirements might have a chilling effect on foreign investment. These and other interventions to protect domestic sectors and national champions have a home-production bias. The list of “strategic” sectors to protect on “national security” grounds against foreign competition will likely expand. There will probably be more restrictions on migration and the cross-border movement of workers.

Two precedents are relevant: the “new protectionism” of the 1970s and ‘80s, which partly resulted from bigger, more interventionist government in domestic markets; and, more perniciously, the expansion of government after the first world war, which empowered interest groups to lobby effectively for restricted imports, foreign investment and immigration.

Second, national unilateralism – this time “illiberal unilateralism” – will likely expand and make effective regional and global policy cooperation more difficult. It bodes ill for the WTO, APEC and the G20, also for regional organisations such as ASEAN, and will cramp the liberalising effects of stronger preferential trade agreements. This only increases the prospect of tit-for-tat retaliation, starting with the Big Three (the US, EU and China), and copycatting protectionism that will spread around the world.

Third, the reorientation of global value chains will accelerate. Western multinationals will relocate parts of their production from China to other countries on cost grounds, as they have been doing, but increasingly on political-risk and security grounds as well. There will be a combination of onshoring, near-shoring and regionalisation of value chains, which will vary widely by sector. But the overall effect will be to raise costs for producers and consumers.

Fourth, international trade will be hit harder by a more fractured and conflictual geopolitical environment, especially US-China rivalry, but not helped either by an inward-looking and divided EU. It will be squeezed between more unstable geopolitics and the recalibration of states and markets – more “state” and less “market” – domestically.

All the above points to a new mercantilist trade order that might be more malign than benign, echoing the “new protectionism” of the 1970s and early ‘80s, or, even more worryingly, the 1920s and ‘30s.

My ideal world is a classical-liberal one: limited government, free markets and free trade, underpinned by appropriate domestic and international rules. I would add political liberalism and legally protected individual freedoms. The post-1945 global order was some distance from this classical-liberal ideal, but it was liberal enough to deliver unprecedented freedom and prosperity. From this vantage point, the new mercantilist order, with emerging malign characteristics, is alarming – bad economics, politics and international relations; bad for individual freedoms and global prosperity. As a realist, however, I must take the world “as it is” rather than indulge in wishful thinking. To improve the world, principled liberalism must be combined with practical realism.

I believe the two biggest threats to global order are rising illiberal populism in the West, endangering the West’s adherence to its own liberal values, and the increasingly aggressive illiberalism of the Chinese party-state. Both have mercantilist features that spill over the border into protectionism and restricted globalisation. Both feed off each other in a global negative-sum game. Hence both must be resisted: naivety and complacency should apply to neither.

China under Xi Jinping, with its mix of authoritarianism, a state-directed market economy and external assertiveness, is becoming a classic mercantilist power, like Germany and Japan in the late nineteenth century and early twentieth century. Its external power projection, especially in the last decade, looks quite different to that of the US in the Pax Americana. Of course, at times, here and there, the US threw its weight about unilaterally and arbitrarily. But the essence of US leadership was to provide public goods for a stable, open and prosperous world order. It did so by organising concerts of international and regional cooperation. In international trade, that took the form of the GATT, later the WTO, and the multilateral rules it administers.

China, in contrast, prioritises a combination of unilateral and bilateral action to expand and entrench its power. That subsumes the expansion of the PLA Navy in the East China Sea, South China Sea and Indian Ocean; and tight, asymmetric bilateral relations with smaller, weaker states in a twenty-first-century recreation of the ancient tributary system. The Belt and Road Initiative should be seen in this frame: a network of hub-and-spoke bilateral relationships in which China wields power over-dependent states. This is classic mercantilism. It privileges discretionary power, exercised unilaterally and bilaterally, over plurilateral and multilateral rules that constrain such power.

China – meaning the Chinese Communist party-state – presents a pressing challenge to the liberal world order. Dealing with this challenge will require some trade, technological and investment restrictions, and limited supply-chain decoupling. But that could easily descend into an all-round mercantilist and deglobalisation spiral. Hence China must be engaged at the same time, not least to preserve existing links that are mutually beneficial. Engagement and strategic decoupling need not be mutually exclusive. Still, this will prove an incredibly difficult, perhaps elusive, balancing act.

Liberal or semi-liberal small states and middle powers in Asia, the West and elsewhere have a crucial role to combat malign mercantilism. In Asia, this group includes Japan, South Korea, Taiwan, Singapore, Australia and New Zealand. They need to keep their economies and societies open; demonstrate best policy and institutional practice (as they have done in this pandemic crisis); build coalitions of the willing on trade and other issues; strengthen alliances with the US and EU to nudge them to be more outward-looking and globally constructive, and finesse a mix of strategic decoupling and engagement on China. But doing all that in a global mercantilist environment will be an uphill struggle.

Prof. Razeen Sally is a visiting associate professor at the Lee Kuan Yew School of Public Policy at the National University of Singapore. He is also the author of "Return to Sri Lanka: Travels in a Paradoxical Island."

Sri Lanka's Rajapaksa restoration is complete. What comes next?

Originally appeared on Nikkei Asia

By Prof. Razeen Sally

Government may have to rely on new Chinese loans to avert a macroeconomic crisis

Sri Lanka's parliamentary election on August 5 delivered a thumping victory for President Gotabaya Rajapaksa and his older brother Prime Minister Mahinda Rajapaksa's Sri Lanka Podujana Peramuna, or SLPP, party. Following Gotabaya Rajapaksa's decisive victory in the presidential election last November, what does the Rajapaksa family's unlimited rule portend for Sri Lanka and its external relations?

Illiberal democracy, a state-led economy, Sinhala-Buddhist supremacy -- Sinhala Buddhists are about 70% of the population, and a China-centric foreign policy were the hallmarks of Mahinda Rajapaksa's rule when he served as president until 2015. His surprise election defeat opened a window for liberal democracy, a more internationally open, private sector-led economy, reconciliation with ethno-religious minorities, and a more balanced foreign policy to reengage with the West and India.

But the coalition government that followed was a total disaster, crippled by no reform strategy, venomous internal warfare, corruption scandals and rank incompetence. The Rajapaksa restoration last November revived the core features of the previous Rajapaksa rule. But now Gotabaya Rajapaksa is in the driving seat, and Sri Lanka faces a COVID-19 plagued world.

With a handful of allies, the SLPP will have a two-thirds parliamentary majority, which will allow it to change the constitution at will. First will come the repeal of the Nineteenth Amendment, which limits presidential powers and strengthens parliament and the judiciary.

Optimists argue that Sri Lanka now has the political stability and decisive governance it lacked under the previous government. President Rajapaksa has centralized power in his small circle, crowded with retired senior military officers. Even more than his brother Mahinda, he favours Big Man rule, exercising untrammelled power, issuing orders and expecting them to be executed without dissent or delay. That has worked, so far, to limit the spread of COVID-19 in Sri Lanka. But will it work to tackle more complex and long-standing problems concerning the economy, interethnic relations, public administration and much else besides?

Countries become stable and prosperous by nurturing effective institutions and social trust over time, not with Big Man politics with its never-ending command-and-control, short-term, ad hoc fixes. That is something the Rajapaksas -- and all but a tiny minority of Sri Lankans -- don't seem to understand. Sri Lanka is now hurtling back to illiberal democracy. It may provide short-term political stability, but I doubt it will lead to better governance.

This Rajapaksa government, like the last one, espouses a collectivist economic ideology. Its first budget was full of tax cuts and expenditure entitlements, guaranteed to increase the fiscal deficit and public debt. The policy consists of diktats and constantly changing regulations on taxes, monetary expansion and import controls.

Sri Lanka was already in a debt trap when this government came to power. Total public debt is about 90% of gross domestic product, and total external debt, at over $50 billion, is about 60% of GDP. Then COVID-19 struck. The budget deficit may go up to 10% of GDP this year, and the economy may shrink by up to 5%. There is no fiscal space for tax cuts and extra public expenditure. The government desperately needs to negotiate debt moratoria, extra loans and possible debt restructuring with the International Monetary Fund and others. But, for now, it has no plan.

The Rajapaksas are unapologetic Sinhala-Buddhist nationalists. President Rajapaksa and the SLPP were elected with a huge majority of Sinhala votes but only a tiny percentage of ethnic-minority votes.

The Sinhala-Tamil cleavage is long-standing. The Easter Sunday blasts last year, perpetrated by Islamic radicals, opened a new cleavage between Sinhala Buddhists and Christians, on the one hand, and Muslims, on the other. The Rajapaksa Sinhala-Buddhist supremacist agenda is guaranteed to keep ethnic tensions on the boil. Muslims will be most at risk if that gets out of control.

President Rajapaksa has largely ignored the West, the IMF and other international organizations, but he is friendly with Narendra Modi, a fellow strongman and ethno-religious nationalist. China, however, remains "first friend." Money talks: Chinese state-backed investment is the only big game in town. There is a real possibility that Sri Lanka will rely on new Chinese loans to avert a macroeconomic crisis, especially if it does not come to a new agreement with the IMF.

Sri Lanka increasingly resembles a Chinese tributary state -- rather like a brief interlude in the fifteenth century, when Admiral Zheng He abducted a local king and took him to Beijing to pay obeisance to the emperor, after which an annual tribute was sent to China.

Sri Lanka is a bewitchingly beautiful country. Since ancient times, it has won the hearts of many a visitor. I would know since I grew up there -- I am half Sri Lankan, half British -- and have spent the past decade travelling all over the island to write a travel memoir.

But Sri Lanka is a little country with layer upon layer of complexity and paradox, and a dark side that has benighted its post-independence politics and institutions. As an adviser to the last government, I saw up close its shambolic disintegration. Understandably, Sri Lankans voted for the only realistic alternative: the Rajapaksas. The prospect of another decade of Rajapaksa hegemony does not fill me with optimism.

Prof. Razeen Sally is a visiting associate professor at the Lee Kuan Yew School of Public Policy at the National University of Singapore. He is also the author of "Return to Sri Lanka: Travels in a Paradoxical Island."