How—and Why—to Save the World Trade Organization

The new global trading system demands a new type of governing.

The World Trade Organization’s meeting earlier this year in Yaoundé, Cameroon, confirmed what has long been obvious: the organization is under increasing pressure—especially, albeit in very different ways, from its two largest members, the United States and China—to the point where it risks becoming merely a bystander in the emerging global reorganization of trade.

This should not come as a surprise. The WTO was organized in 1995 to enforce a set of global trade rules, but investors, businesses, and policymakers in recent years have become increasingly skeptical of them and of the wider organization. This is not because rules are unimportant, but because the rules themselves have become disconnected from the economic realities they were meant to govern.

The economic purpose of trade is to enhance global welfare. In a well-managed trading regime, countries should expand the value of their exports mainly to maximize the value of their imports. The former means shifting production to where it is most efficient, while the latter means converting higher domestic production into greater global demand.

This, however, is not the world we live in. For decades, a number of large economies have used rising exports primarily as a way of externalizing weak domestic demand, which itself resulted from industrial policies designed to expand domestic manufacturing, usually by shifting the associated costs onto the household sector. Because more production is incompatible with less demand, these countries balance the two by running trade surpluses and acquiring foreign assets in exchange for exports.

While this is the textbook definition of mercantilism, it has also been perfectly acceptable under WTO rules governing trade. It is not only direct trade policies that affect trade—any industrial or financial policy that shifts income from the household sector to subsidize the manufacturing sector can do so. Whether financial regulators control the direction of credit allocation in the banking system, or repress deposit and lending rates; or when labor officials impose restrictions on the ability of workers to unionize or migrate; or when policymakers subsidize production, research and land sales; or when local government officials overspend on logistical infrastructure—these actions might not seem like forms of trade intervention, but all of them can boost production relative to consumption, creating domestic imbalances which in turn result in trade imbalances. There is, after all, no meaningful distinction between trade policies and industrial policies, and the latter are often far more effective in distorting trade than the former.

But WTO rules address mostly the former—with rules on most-favored-nation dealing and national treatment, and limits on tariffs and quantitative import restrictions—while largely sidestepping the latter. That is why the organization risks becoming irrelevant as the global economy loses its tolerance for mercantilist surpluses. When the rules restrict some trade-distorting policies but allow others that result in even more serious trade distortions, it is hard to see what purpose the rules serve.

While these trade distortions have been in place for decades, they were largely ignored by the WTO and rest of the world so long as countries like the U.S., the United Kingdom, and Canada—driven by misguided economic theory and the interests of their financial sectors—were willing to accommodate the surpluses of economies like Japan, Germany, China, and South Korea. The three anglophone economies absorbed most of the imbalances in the form of rising household and fiscal debt, stagnant wage growth, and deindustrialization.

For a time, this arrangement appeared stable, but only because the costs were concentrated and politically underappreciated. But the wider system was always unsustainable. This is the point British economist Joan Robinson made all the way back in 1937, when she warned that at some point major deficit countries would become unable and unwilling to continue accommodating what she was the first to call “beggar-thy-neighbor” trade surpluses.

When that happens, she wrote, the system must adjust, usually in disruptive ways. If surplus countries refuse to boost domestic demand, “the burden of unemployment upon any country which refuses to join in the game will become intolerable, and the demand for some form of retaliation irresistible”. In that case the deficit countries will intervene in their own trade and capital accounts to reduce the extent to which their domestic demand leaks abroad.

It should be noted that in Robinson’s day credit expansion was still constrained by the gold standard, which is why she described beggar-thy-neighbor surpluses as a way of exporting domestic unemployment. Since the breakdown of Bretton Woods, however, deficit countries can replace demand exported to trade surplus countries with demand generated by rising debt. Thus, the cost of these deficits no longer comes mainly through rising unemployment but instead through rising household and fiscal debt and a shift in production out of manufacturing and into services.

Our current global trading system seems to have arrived at the point Robinson predicted. The breakdown of consensus around globalization is not primarily due to a recent rise in protectionism, as is often claimed, but rather the consequence of a system that has failed for decades to contain destabilizing imbalances, and whose harmful effects are increasingly becoming recognized.

The WTO, in other words, has presided over a global trading system in which some major economies have gamed its rules by implementing aggressive—but nonetheless WTO-compliant—industrial and financial policies that boost domestic manufacturing competitiveness at the expense of domestic consumption. These countries then externalized their weak domestic demand by exporting excess production to the rest of the world. The rules have been followed, but the outcomes are increasingly problematic.

For the WTO to remain relevant in a world where deficit economies no longer want to absorb global imbalances, it must radically rethink its purpose. This means recognizing that trade imbalances matter, and that rather than regulating a limited number of trade practices, the WTO should work to constrain the imbalances themselves. Put differently, the objective should shift from implementing regulations to ensuring that outcomes are consistent with a stable and sustainable global system.

The WTO can begin by recognizing which imbalances are benign or even beneficial, and which are harmful to the global economy. In the former case, when saving in advanced economies is directed toward productive investment in developing economies, the former’s trade surplus can lead to a welcome rise in global output and welfare. These are the kinds of imbalances that reflect efficient capital allocation and genuine development needs.

But other forms of imbalance do the opposite. When surplus economies recycle excess savings into economies like the U.S., where investment is constrained by weak demand rather than scarce saving, the result is not higher global growth but rising debt, asset bubbles, and/or higher unemployment. These are not coincidental, they are central features of a beggar-thy-neighbor trading system.

That is why the WTO must shift its focus. Rather than enforce an arbitrary set of rules, it should prioritize welfare-enhancing outcomes. This means greater scrutiny of persistent trade surpluses, coordination on exchange rate policies, and more consideration of the distributional effects of domestic trade policies.

It also means acknowledging that domestic imbalances in one country often reflect opposite imbalances in other countries. Put another way, it means recognizing that industrial policy in a country that controls its external accounts becomes industrial policy in reverse among its trade partners that don’t, whether or not the latter approve of those policies.

Why not abolish the WTO altogether, as many skeptics propose? The reason is because an optimal global trading system is not a fragmented market in which large economies hide within their borders and smaller economies look to find protective shoals. It is one in which global productivity is maximized through the expansion of global trade, but within a regime in which individual economies cannot use trade to externalize the cost of their domestic policy distortions.

This is what John Maynard Keynes proposed at Bretton Woods in 1944. He argued that instead of trying to identify and prohibit the wide variety of trade and industrial policies that create beggar-thy-neighbor surpluses—an impossible task—we should contain the surpluses themselves, because these are the mechanisms by which countries force the costs of their distorted policies onto their trade partners.

The WTO, in other words, must become an institution focused on results rather than processes. It must concern itself with the overall health of the global trading system rather than a limited set of rules. If it fails to do so, it risks becoming little more than a bureaucratic relic—one that endlessly debates procedures even as the system it was meant to govern fragments around it. In a world increasingly defined by strategic competition and persistent imbalances, WTO’s relevance will depend not on its adherence to rules for their own sake, but on its ability to ensure that global trade actually delivers broadly shared economic benefits.