A Trump adviser on how the international economic system should change

The United States must play a more active role in reshaping the international economic order. Completely abandoning the international trading system would be a disaster for the American people and our allies. However, the status quo creates security vulnerabilities, and the aggregate economic benefits for the United States are unclear. The next generation of America’s international economic policy must more closely link security and economic relations to deliver the benefits that truly free trade can bring. Adjustments are needed, but they must be carefully calibrated and deliberately paced.

The experience of globalisation has demonstrated shortfalls in the two principal theories that motivated its supporters. The first was that by opening its markets to the world, and thus promoting economic co-operation, the United States would strengthen its national security. This security theory of integration produced mixed results. Opening American markets to European countries and to Japan after the second world war helped those countries rebuild their economies and transformed them into crucial security allies. However, integration with rivals, such as China, has created vulnerabilities. Increased Chinese prosperity has in many ways consolidated the power of the Chinese Communist Party (CCP) rather than tempering it. Global supply chains also handed the CCP a geopolitical tool in the form of the ability to disrupt other countries’ economies by withholding critical inputs.

Additionally, international economic integration altered the underlying structure of the American economy, changing the balance of power in relation to our adversaries. The shift of industrial production abroad and the corresponding reallocation of American resources into the service sector arguably provided aggregate benefits in periods of geopolitical calm. But ultimately the strength of the defence-industrial base is closely tied to the health of the broader industrial base.

The second theory of globalisation was that it would lead to economic benefits. This argument relied on the classic Ricardian comparative-advantage paradigm. Even if economic integration led to short-term disruptions, like the loss of manufacturing jobs because of the gap between American wages and cheaper foreign labour, these disruptions would balance out over time. Foreign markets would open up to American producers, and relative foreign competitiveness would decrease via foreign wage increases and currency effects, preventing persistent imbalances in the global economy.

The results of this experiment were similarly mixed. The short-term efficiency of the global economy improved. The cost of goods fell dramatically, helping curb inflation. But the distributional implications of trade liberalisation were overlooked, exacerbating American inequality.

Furthermore, the adjustment process that was necessary to achieve Ricardian comparative advantage has largely not materialised, resulting in persistent imbalances in the global economy. The wished-for equilibrium has been prevented by the deliberate policy choices of foreign governments, particularly China, but also Japan, South Korea and other export-dependent economies. Such overt policies include tariff and non-tariff barriers to market access, currency manipulation, subsidies for preferred industries, forced technology transfers and outright theft of intellectual property.

On a more subtle level, governments’ choices about the structure of their economies have also created the imbalances. For example, many countries suppress the household share of national income, which artificially raises the international competitiveness of their export sectors. China’s size and its extremely low consumption share make it the most glaring example, but Germany, Vietnam and other surplus countries need to boost domestic demand. Indeed, overall economic imbalances are actually increasing, suggesting the United States’s bilateral focus on China is insufficient to rebalance the international system. The United States’s monthly trade deficit in July reached a post-pandemic high of $79bn, and the annual deficit in goods is on track to exceed $1trn for the fourth year in a row.

The lesson of global economic integration is that free trade is to some degree in tension with free markets. Ricardian comparative advantage only works to the extent that economic systems are compatible, and therefore trade between the two does not result in imbalances over time. If a country with a free market trades with a managed economy, it in effect imports the industrial-policy choices of the managed economy. And because trade clears on a global basis, countries that run significant imbalances affect all participants in the global trading system, not just their bilateral counterparties.

Despite its many flaws, abandoning the international trading system would be a major economic and strategic mistake. Instead, the United States must adopt policies aimed at correcting the sources of imbalances in the international economy. Critically, these measures must act on a global basis, as bilateral actions largely shift imbalances around rather than address their underlying source. Interventions at the macroeconomic level, like broad-based tariffs, will be more effective than microeconomic interventions like industrial policy that generally rely on the government to pick winners and losers.

These interventions must be well telegraphed in the form of forward guidance to provide negotiating leverage and time for markets to adjust. The United States also needs to tackle its own contribution to global imbalances by reducing its unprecedented budget deficits. Given that federal spending is both anomalously high and inefficient, whereas tax revenues are consistent with historical levels, spending cuts are the appropriate mechanism.

Additionally, the United States must link its security and economic relations more closely. Security allies are much more likely to have economies with which trade will benefit America’s own welfare. American security assurances and market access should be linked with commitments from allies to spend more on our collective security and to structure their economies in ways that reduce imbalances over time. Such a linked system of security and economic alliances should be dynamic to incentivise behaviour that aligns with American interests. Countries could move closer to or further from the centre of this system of relationships based on their revealed preferences.

Clearer segmentation of the international economy would provide more effective levers to confront the underlying sources of imbalances than the currently dominant bilateral approach. Additionally, the cost to remaining outside the perimeter would be high. Without access to US markets, Chinese overcapacity would instead threaten the viability of other countries’ domestic output. And would-be hegemons outside the US-led zone are unlikely to prove as benevolent as the United States in the post-war era.

The current global economic system is in an unsustainable disequilibrium. Western middle- and working-class populations are growing increasingly wary of globalisation. The only way to preserve the benefits of the international trading system is to question some of its mistaken assumptions and update them for the current moment. ■