The Future of International Trade Relations

In October, our colleague Thieß Petersen took part in the final discussion of the seminar Free Trade with the Global South – Challenge in times of geopolitical crisis. This discussion focused on the future of global trade relations. He shares some of his key thoughts.

Five trends in global trade

The starting point for these considerations are five central developments in world trade relations.

1. Growing protectionism in advanced economies

Historically, advanced economies have driven international division of labour. But in recent years, protectionism has risen in these economies. This is because international trade increases production and, as a result, the GDP of all economies involved in international trade. But this does not mean that all individuals in all economies profit form cross-border trade.

In advanced economies, such as Germany or the US, people who might suffer from international division of labour are mainly low-skilled workers. They can lose their jobs if labour-intensive goods are imported from low-wage countries. In particular, this pressure on the labour market has increased since China joined the WTO in 2001.

2. Rising relevance of geopolitical goals in foreign trade policy

Initially, governments used international trade to increase material prosperity for their people. But in recent years, more countries are utilising foreign trade policy to promote their geopolitical interests. They want to put pressure on overseas governments to make decisions that help push these agendas.

This helps explain why using trade-restricting instruments is on the rise. If a government wants to increase the prosperity of its population, export bans make no sense. Why should the economy give up employment and income opportunities? However, if political interventions aim to pressurise the government of another country, it makes sense to forbid exports to that country.

3. Increasing capital intensity in global production processes

Technological progress has made production processes increasingly capital-intensive. Robots, machines – particularly digital technologies – are replacing more human workers. This is especially prevalent in advanced economies, but not limited to these countries.

If labour becomes less important in overall production processes, emerging and developing countries lose their main competitive advantage – cheap labour.

This changes the international division of labour – and therefore cross-border trade. In the past, industrialised economies relocated labour-intensive production activities to countries with large workforces and low wages. But this era of offshoring could be rolled back. Now it is worthwhile – at least in part – to relocate some production processes back to industrialised countries. Offshoring is turning into reshoring.

4. Growing disruptions in global supply chains

During the past few years, we saw an increasing number of disruptions to global supply chains. There are many reasons for this, such as the outbreak of a pandemic, military conflicts, social unrest and the obstruction of the Suez Canal by a container ship.

The negative experiences associated with these disruptions increase the attractiveness of reshoring. Additionally, the desire to reduce critical import dependencies speaks in favour of moving away from heavy reliance on offshore labour. It can be assumed that global supply chain disruptions will continue to affect the international division of labour in the future.

5. Increasing subsidies influencing international trade

Public financial aid, selective tax relief, state loan guarantees and similar government assistance for domestic companies are increasingly shaping economic policy. For a long time, China was at the centre of criticism regarding excessive use of subsidies.

However, President Biden is using subsidy packages worth billions of dollars, mainly to decarbonise the US economy and reduce import dependencies, especially in the semiconductor sector. The US economy suffered from shortages of semiconductors during the Covid-19 pandemic. For example, it is estimated that the lack of semiconductors in automotive production in the US meant that around four million vehicles could not be built.

Moreover, the US economy is heavily dependent on semiconductor imports from Taiwan. Should an escalating conflict between China and Taiwan lead to a collapse in these imports, the consequences would be severe.

The EU and its member states are working on their own subsidy packages in response to financial aid and tax reliefs abroad. At the time of writing, there is no indication that this international subsidy race will slow down.

Three main challenges for global trade

More tariff and non-tariff trade barriers, growing geopolitical tensions, digital transformation, increased use of state subsidies – all this creates many challenges for the global economy. In my view, three aspects play special roles in this often-difficult scenario.

1. Rule-based global trade is turning into power-based trade

For a long time, we had a rule-based system of international trade. But now a power-based system of cross-border trade is becoming more established. It is no longer just about increasing material prosperity, but about power and geopolitical influence.

The competition between the US and China is a particular problem in this context. This struggle is mainly about international technology leadership. Technological strength is the basis of economic strength. And economic strength is the basis for military and political strength.

The EU must decide if it is willing to use financial resources to take part in this competition.

2. Geopolitical tensions reduce real economic prosperity

Geopolitical tensions are reducing the extent of the international division of labour. As a result, we are losing some of the benefits of this division.

The most important advantage of international trade concerns consumers. The import of cheaper final products and intermediate goods means that consumers can consume more goods and they pay a lower price.

If there is a decline in the extent of the international labour division – and therefore a drop in trade – consumers won’t buy as much and they will pay a higher price when they do make purchases. For consumers in advanced economies, such as Germany, this is unpleasant, but not much more. But for those with low disposable income, rising prices for food, clothing and energy can cause such a severe loss of purchasing power that they are no longer able to finance their Subsistence Minimum.

3. Dividing the global economy into two rival blocs would further reduce global welfare

The strategic rivalry between the US and China will continue and probably intensify, according to the latest indicators. This increases the risk of a split of the global economy into two large blocs: Democratic market economies in Europe, America and Asia on one hand, and autocratic economies such as China, Russia and Iran, on the other.

This would reduce economic prosperity even further. Western industrialised nations would have to build production capacities for goods that are still imported. This would cause worldwide duplicate manufacturing infrastructure, which is unnecessary from a purely economic point of view.

What are economic policy options?

If trade restrictions increase globally, the World Trade Organization would be the institution that could counteract these developments. Its aim is to shape international trade in such a way that the living conditions of people worldwide are improved. However, the WTO’s ability to act is considerably limited – as are my expectations regarding the WTO’s ability to improve trade relations at a global level. Therefore, it makes more sense to rely on regional regulations.

Two EU trade policy suggestions

1. The EU, should sign more bilateral free trade agreements. As the costs of transportation depend on the geographical distance between the trading partners, the European neighbourhood countries, such as those in North Africa, are particularly attractive for the EU. But countries further away, such as India, with which the EU is seeking such an agreement, provide options too.
2. The EU could foster international trade by reducing their own trade barriers. In addition to a general tariff reduction, specific tariff reductions could be considered. Emerging and developing countries are particularly worthy of consideration for a special treatment.

This could even mean that the EU unilaterally opens its internal market for products from emerging and developing countries without demanding that the emerging and developing countries do the same for European products immediately. As a result, emerging and developing countries would be able to build up efficient companies.

Such a foreign trade policy is in the EU’s long-term interest. If production increases in the emerging and developing countries, incomes will rise – and their people will be able to afford more expensive EU products.

About the authors

Thieß Petersen is Senior Advisor at the Bertelsmann Stiftung, specialising in macro-economic studies and economics. His focus lies on the causes and effects of financial and economic crises as well as the chances and risks of globalisation. Most recently, he worked on the effects of carbon pricing and the benefits of a potential global climate club.