April 28, 2016

It's Getting Hard to Write Free Trade Scenarios

Peter Kennedy
Partner

Free trade is headed downslope.  It’s tough to make the case otherwise, in an election year in which four of the remaining five US presidential candidates have taken strong, protectionist stands against the ambitious Trans-Pacific Partnership (TPP) trade agreement. (In case you’re wondering, John Kasich is the exception.) But rejection of TPP, while perhaps regrettable from the standpoint of lost US exports and less transparent commerce with the US’s Pacific trade partners, may be just the start of a much broader – and scarier – spiraling downward of trade and globalization. This is what really keeps scenario planners awake at night.

The issue of trade is playing out quite differently in the current US election cycle. In recent elections, Republican candidates embraced predictably orthodox free-trade positions (even while making exceptions for politically-influential industries under threat).  For their part, Democratic candidates, including the current president, criticized unfair trade practices but without essentially questioning the underlying belief that free trade – and open borders in general – was generally a good thing for the US and the world.

That consensus is coming apart. It’s not just Bernie Sanders’s and Donald Trump’s  protectionist positions, either.  If one listens carefully, many formerly free trade-leaning economists (including the New York Times’s Paul Krugman) are taking more skeptical stances on practical, short-term benefits of more free trade agreements. Moreover, the academic world is bringing real data to the discussion about exactly what has happened to US manufacturing jobs in recent years. The Economist magazine cites recent research data estimating that nearly six million manufacturing jobs were lost between 1999 and 2011, and a fifth of those job losses can be traced to Chinese competition. 

What’s making this a particularly sensitive political issue in the US is the fact that the last two decades or so laid off factory workers have had few or no options for rejoining the workforce at equivalent pay and benefit levels. Relocation to more promising job markets is difficult, as many are burdened with mortgages on homes they are unable to sell in hard-pressed real estate markets.  While the post-2009 job recovery shows that the US economy is still a dynamic job-producing machine, there’s a large and growing mismatch reported between available jobs (e.g., industrial mechanics, computer controlled machine operators, etc.) and the skills of the people searching for them. All of this is feeding the current anger and discontent – on both the left and the right – over an increasingly elusive middle class American lifestyle.

Given all this, it’s certainly hard to make the US case for yet freer trade. And no matter who wins the 2016 election will have to deal with protectionist pressures that have been unleashed during the current campaign. They are not apt to go away anytime soon.

Beyond the June 23rd Brexit Vote

Looking ahead, the scenario-planning question is whether the current anti-trade sentiment is mere populist crankiness or the start of a rising tide of not just protectionism, but isolationism.  Clearly it’s not just a US question, either.  Continental Europe is engulfed in a refugee crisis that has sparked understandably emotional debates over intra-EU open borders.  The UK is debating whether to stay in or leave the European Union.  The so-called Brexit referendum will be held on June 23rd.  President Barack Obama’s vigorous support for the “Stay” cause in his recent UK visit underlines the strategic value the US places on an economically and politically unified and strong EU.

Events could work out well enough for the pro-trade cause. Britain may opt to stay in the EU and Hillary Clinton, who is considerate trade moderate, is likely to be the next US president. And if the global economy stays on at least a moderate growth track, radical isolationist positions are not apt to gain traction.  Those are big but reasonable qualifiers.

Yet there are a number of alternative scenarios that while not necessarily disastrous to free trade and open markets could seriously alter the operating environment for multinational companies and global financiers.  For one, the Panama Papers revelations have once again spotlighted the privileges enjoyed by elite investors, at a time of rising sensitivity over economic inequality and class advantages. Offshore tax rules – including mandatory public registers – stand to be tightened in the future.  Along this line, there’s the related issue of tax inversion – foreign M&A deals in deals that significantly reduce tax liabilities of US corporations.  Just recently, the Treasury Department issued new rules to limit tax inversion benefits.  The action reportedly killed the $160 billion merger of New York-based Pfizer and Dublin-based Allergan.

A Fluid Global Situation

No doubt, there are many other weighty variables that could push the free trade debate in different directions:  China’s recovery, the dollar and global currency relationships, corporate lobbying pressure on lawmakers, and the mood of the US electorate after the election, among other factors.

Here in the US, the conventional wisdom holds that extreme protectionist pressures can be kept at bay if employment is strong and wages are rising. But putting more money in workers’ pockets has proved particularly elusive not just during the current recovery but truthfully over the last couple of decades. It’s a massive, structural challenge that is as much about technological change and the automation of production as it is about Chinese competition and the offshoring of production. But that’s a tough argument to make during an election year, when voters are looking for concrete solutions and near-term results.

Trade is, in the abstract, a positive sum game for the global economy. But as the US political dynamics have revealed, there are winners and losers along the way. The challenge for the next US president will be preserving the the essential benefits of globalization while meeting increasingly urgent material demands of the middle and working classes. This suggests nothing less than a massively different US economic model and the neccessary political accomodations to make this all happen.  It's hard to see this all coming together, but at some point the US may simply have no other choice. 

Thoughts?