The World Trade Organization (WTO) has said escalating trade tensions and tighter credit market conditions in important markets would moderate the growth of global merchandise trade to 3.7% in 2019 from 3.9% in 2018. This may just be the beginning as the tariff war initiated by the US intensifies. Indeed, some believe the future of the WTO and the multilateral trading system itself is at stake. What is driving the actions of US President Donald Trump?
A 2017 National Bureau of Economic Research working paper by Fatih Guvenen et al shows that the lifetime income of the American worker has been in decline since the 1970s. The increasing participation of women in the workforce and their growing incomes served to shore up household earnings but this effect ceased to operate in the 1990s. The extensive outsourcing of jobs to China and the emerging economies is believed to be the principle cause of the decline of the American middle class.
However, attacking global trade was not the only option open to Trump. US corporations have fared extraordinarily well in the global world order. Data released by the US Bureau of Economic Analysis, shows that the share of profits after tax of US firms increased from 6% of gross domestic product (GDP) in 1995 to 10% in 2015. US firms earn close to 25% of global corporate profits. Taxes on US corporations could have been used to re-skill American workers left out of jobs in the wake of outsourcing and automation. However, far from acting against US firms, Trump has chosen to reduce corporate taxes and turn a blind eye to tax havens to which US corporations siphon profits.
Within the US corporate sector, firms in the financial services industry have done especially well. The US finance, insurance and real estate sectors now account for 20% of GDP, up from 10% in 1980. The pre-eminent position occupied by finance endures despite financial capital being widely regarded as responsible for the 2008 financial crisis that resulted in the loss of 8.4 million jobs, or 6.1% of all payroll employment, in the US alone.
The operation of the US financial services sector disabled the feedback loop that exists in a democracy between economic outcomes and political success. It did so by facilitating a decoupling of household incomes and consumption through the rapid growth of household debt. This allowed US households to buy homes, consume cheap imports from China, and enjoy free services from internet companies, even as their own job prospects and earning potential steadily worsened. Opiated by the worldly goods at their command, the middle class were unable to press for politics that would serve their long term interests.
We should have seen measures to empower the American worker, a traditional stakeholder of the Democratic Party during the Bill Clinton presidency that came after 12 years of Republican rule. However, Clinton fought for presidency as a ‘New Democrat’ which meant that he espoused economic policies similar to those of the Republicans while remaining more liberal on social policies like abortion. In 1995, he loosened housing rules by rewriting the Community Reinvestment Act, which put added pressure on institutions like Freddie Mac and Fannie Mae to lend in low-income neighbourhoods a year after signing the North American Free Trade Agreement (NAFTA). One would recall, Freddie Mac and Fannie Mae received a bailout of $187 billion of US taxpayer money after the 2008 financial crisis.
One of the mechanisms which encouraged the financial services sector was the development of complex financial instruments called derivatives that seemed to diversify risk and allow loans to be given to previously un-bankable households. The notional amount of total derivatives held by the 25 largest US bank holding companies grew 18 times from $16.6 trillion in 1995 to $308 trillion in 2012, while US GDP merely doubled over the same period. The growth of financial derivatives was aided by the passage of a slew of legislation including the Gramm-Leach-Bliley Act of 1999 which significantly weakened regulatory oversight of financial services firms. The result of such policies was that household debt increased from around 40% of GDP in 1980 to close to 80%, reaching a high of 98% in 2008.
Had the financial services sector not masked the iniquitous impact of globalization of supply chains from the US worker, the safety valve of democratic politics may well have gotten triggered far sooner than 2016. The pent-up fury led to the victory of a demagogue like Trump.
Today, from a systemic point of view, it is more important to regulate finance than to initiate a trade war that may well fail to benefit the American household. But the US is moving in the opposite direction. The regulations of the Dodd-Frank Financial Regulatory Reform Bill, designed to avert future financial crises, are being relaxed, the value of derivatives contracts are 13% higher than their pre-crisis levels, and compensation schemes on Wall Street still reward traders and executives for taking big risks with other people’s money, while being protected from the downside risk by the perception of being ‘too big to fail’.
Recognizing China as a strategic adversary is a sensible move. But that battle should principally be fought on the geopolitics front, as opposed to the trade front. However, Trump seems to be oblivious to China’s increasing stranglehold in the South China Sea and ignores the role India could play in this region. It’s a classic case of missing the wood for the trees.
Rohit Prasad is a professor at MDI, Gurgaon. Game Sutra is a fortnightly column based on game theory. Read Rohit’s previous Mint columns at www.livemint/gamesutra