Globalization's Demise in Seven Stories

The reasons for the disruptions roiling the international trading system

Big week for trade policy, and seeing as you’re no doubt tired of hearing from me on the issue, I thought we’d try something a bit different, in keeping with the old adage of “show-don’t-tell.” What follows are excerpts from seven stories published in the last week. (Well, technically, six from the past week, one from back in May when the US-UK trade deal was announced.)

Taken together, they explain what is happening in the international economy right now and why.

They reality that they depict bears no resemblance to the models of free markets and free trade you learned in economics class, heard about from political and business leaders, and read about in prominent publications over the past 25 years. In the real world:

1. China’s economic strategy grievously harms American security and prosperity. There is no “trade deal” to be had with a country pursuing the Chinese model.

2. Simply decoupling from China is not enough; if the U.S. is to remain engaged in an international trading system at all, it must have partners who themselves decouple from China, and it must use the leverage of access to the American market to accomplish that.

3. That leverage is in fact powerful and using it benefits the United States, even when an Economics 101 model shows “deadweight loss.” Tariffs induce domestic investment, even when those tariffs raise input costs, because more work done in the United States equals less of the end-product’s value subject to the tariffs.

Note, whereas I usually italicize quotes from other sources, in what follows the excerpts are presented in a regular style and anything from me is in italics.

So, let’s begin. Has “access to the Chinese market” ever really been on the table for American firms in a way that would provide long-run benefits to the American people, or were they merely multinational corporations selling out to capture short-term profits while handing over the future?

Long Before Musk, Beijing Had a Playbook | Lingling Wei, Wall Street Journal

For decades, American companies saw China as the ultimate prize: a massive market and a peerless factory floor. For a while, their foray into the Chinese market boosted their bottom line and strengthened their competitiveness.

But fundamentally, they appear to have misunderstood the transaction. They thought they were hiring a contractor; Beijing knew it was running an apprenticeship.

First Motorola, then Apple, and now Tesla have served as invaluable, if sometimes unwilling, teachers. They taught China how to make phones and cars and build the supply chains that feed them. Now, the lesson is over.

For Musk, the chilling reality is that in China, the student has become the new master, and the old master is being shown the door.

Bonus link: Here’s the longer WSJ story on Tesla’s current plight, Elon Musk Is Running Out of Road in China.

Bonus bonus link: As usual, today’s news was available yesterday at American Compass, where we published an in-depth analysis last year of Elon Musk’s pants-ing by the Chinese Communist Party.

And now, after American policymakers allowed the charade of free trade to proceed for more than a decade beyond when it was obvious what was happening, we have reached the point where continued integration of our markets spells doom for American industry.

Why Americans Can’t Buy the World’s Best Electric Car | Michael Dunne, New York Times

How did BYD pull this off? “Government subsidies!” Western critics will cry, and that’s of course part of the story. Chinese automakers such as BYD are believed to have received billions of dollars worth of state support over the years. This is state capitalism at work. Americans can complain about it all they want, but China isn’t going to scrap this model just because we don’t like it.

It’s also not the only reason for BYD’s success. It can build cars so inexpensively thanks to what’s known as vertical integration. While most major carmakers source many important parts from outside suppliers, BYD makes almost all of its key components in-house, including batteries, semiconductors, motors and tablet screens, which saves costs and enhances quality control. It developed its cars’ operating software, has stakes in mines and mining companies that produce the minerals for its batteries and transports its vehicles around the world aboard its fleet of specially designed car-carrier ships.

BYD is also rapidly innovating. Earlier this year it unveiled an autonomous driving system that may be as good as Tesla’s, if not better, as well as technology that BYD says can charge cars in just five minutes — as quickly as filling a gas tank. Its top-end models include the YangWang U8, a luxury S.U.V. that can rotate 360 degrees in place and operate in water like a boat over short distances.

There’s an argument to be made that we should just let BYD into the U.S. market. It would give American consumers more bang for their buck and U.S. manufacturers a chance to learn from the company.

But BYD now has such overwhelming advantages in costs and battery technologies that it could end up destroying its U.S. competitors, endangering a critical American industry and hundreds of thousands of jobs.

OK, the economists will now concede, so perhaps we need to confront China. But that’s no reason to go after other countries. Unsurprisingly, they are wrong again, conceding only that which they would look foolish to deny, while still preferring their abstract principles to any consideration of reality.

If the U.S. wants to have any zone of free trade at all, from which it can import products not dependent on Chinese supply chains, and to which it can export products without getting undercut by Chinese competitors, it has to have partners that decouple too. This means tariffs on other countries—either as leverage to force their hands, or as permanent measures if they choose to continue doing business with China.

“Why is the Trump administration going after Mexico and Canada?” That’s why. And it works.

Caught Between Tariffs and China, Mexico Adapts to an Unpredictable U.S. | Emiliano Rodríguez Mega, New York Times

The factory in northern Mexico was built to supply Americans. Just a few hours from Texas, about 80 percent of its air-conditioners and refrigeration units are sent to the United States.

President Trump’s tariffs threatened to upend its whole business — at least until the company devised a plan.

Before the tariffs took effect in March, only about 40 percent of its exports traded under the rules of a pact Mr. Trump signed in his first term. But when Mr. Trump agreed to suspend tariffs on any Mexican goods that fell under the agreement, the company’s leaders saw ways to adapt.

They sought out Mexican suppliers for products bound for the United States. They analyzed which products already complied with the pact’s rules but had not yet been certified as such. And they reconsidered projects that involved bringing in imports from outside North America.

…

Today, virtually all Danfoss products shipped from Mexico to the United States comply with the trade deal, called the U.S.-Mexico-Canada Agreement, or U.S.M.C.A. Efforts are underway, Mr. Casas said, to make some components in Apodaca, where the Danfoss factory is, instead of in China — another way to mitigate the impact of punishing U.S. tariffs.

“Until now, Mexico’s trade strategy was still closely tied to Asia. Bringing in supplies from there was financially viable because of the low costs: Instead of thinking how to manufacture things here, I’d import them,” Mr. Casas said. “But the current situation is pushing us to think, ‘Hey, why not?’”

Likewise, you’ll see treatment of China play a central role in the agreements that the Trump administration is pursuing with other countries as well, as it has in both the UK and Vietnam deals that have been announced. China is loudly displeased.

China Criticises UK Trade Deal with U.S. | Joe Leahy and Ryan McMorrow, Financial Times

China has criticised a trade deal between the UK and US that could be used to squeeze Chinese products out of British supply chains, complicating London’s efforts to rebuild relations with Beijing.

The trade deal the US sealed with the UK last week, which includes strict security requirements for Britain’s steel and pharmaceuticals industries, was the Trump administration’s first since it announced sweeping “reciprocal tariffs” last month.

Asked about the deal, Beijing said it was a “basic principle” that agreements between countries should not target other nations.

“Co-operation between states should not be conducted against or to the detriment of the interests of third parties,” China’s foreign ministry told the Financial Times.

Transshipment Clause in US-Vietnam Trade Deal Cause for Concern | Editorial, South China Morning Post

The word “transshipment” is causing many to lose sleep in Asia, not least in China. The problem is that a term that Washington has been using as a blunt instrument in trade negotiations with Asean countries, among others, is vague enough to be open to interpretation but harsh enough to penalise China’s trading partners in the region.

The most extreme form of transshipment refers to exporters evading tariffs by diverting goods through a third country. But what about foreign components that have gone into another country’s domestic production or assembling?

“Transshipment” is embedded in a clause in the new trade deal that Washington announced has been struck with Vietnam. As it may well become a test case, the reported trade pact has everyone’s attention, though its official terms have yet to be released.

China – a top supplier of goods and products to Association of Southeast Asian Nations economies – has already warned against trade deals that could undermine its interests.

But if you tariff imports to the United States, manufacturers won’t want to build here, the argument goes. Once again, it is an argument generated from an abstract model that fails to engage with reality. Yes, if you are trying to export goods into a global market dominated by China and firms that rely on Chinese supply chains, you will be at a huge disadvantage if your own supply chains exclude China and have higher-priced inputs. But that market has no future anyway.

As I explained in back in April, in “Don't Cry for Me, Argentinian Import Substitution,” If you have a trillion-dollar trade deficit and want domestic investment to serve the domestic market, tariffs make domestic investment attractive, and create incentives to move as much of a supply chain as possible into the U.S. (and to friendly countries that might themselves be inside the tariff fence).

Again, this is what’s happening.

TSMC to Delay Japan Chip Plant and Prioritize U.S. to Avoid Trump Tariffs | Yang Jie, Wall Street Journal

Taiwan Semiconductor Manufacturing is delaying construction of a second plant in Japan partly because it is pouring funds more quickly into U.S. expansion ahead of potential Trump administration tariffs, people familiar with the plans said.

The revised schedule is the latest example of how President Trump’s aggressive stance on trade is pulling some investment toward the U.S. at the expense of allies. Major technology companies have committed to expand U.S. production of artificial-intelligence servers that are currently made in places such as Mexico and Taiwan.

…

TSMC’s Arizona factories are the only ones outside Taiwan that are designed to produce leading-edge chips for American tech giants such as Apple, Nvidia and AMD. That aligns with the push by both the Biden and Trump administrations for greater domestic semiconductor manufacturing.

Trump has called for semiconductors to be made in America, and his administration has opened a probe that could result in semiconductor tariffs.

When the U.S. declares its market open regardless of how other countries behave, other countries will quite rationally behave in ways that benefit themselves at our expense. When we declare that era over, and countries take it seriously, their behavior changes.

Quick Take on Canada and EU Caving on Digital Service Tax | Anna Wong, Bloomberg

• The first Trump administration was very much against DST as early as 2019. Diplomatic measures went nowhere.

• My recollection was that overwhelmingly the world/international institutions like OECD was in favor of DST and US has always been outnumbered in its opposition.

• For both Canada and EU to cave in this greatly exceed my expectations of what concessions the tariff threat and 899 was about going to get. It moved the dial in something that I thought was not going to move.

• This is a BIG win to Trump administration, and the result likely is a sign of confirmation that the “crazy man” negotiation tactic is working.

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OK, me again. I hope you’ve enjoyed this tour through the world economy as it is operating in practice, which looks so different from how economics predicted it would operate and how we’ve been told it was operating for so long. And I hope it helped to shed light on the Trump administration’s strategy which, while far from perfect, is also far from crazy. Ultimately, a serious remaking of the international trading system is necessary.

Some parts will work better than others. There will be setbacks, lessons learned, and course corrections. There will be costs, too—“winners and losers,” as the economists like to say, when insisting that their own preferred set of tradeoffs is the one we should choose. But those tradeoffs were the wrong ones, and with new tradeoffs we stand a better chance of restoring a trading system in which the United States and its allies among the market democracies can benefit from the kind of free trade that delivers real benefits, just like we learned about in economics class.

- Oren