No permanent friends, only permanent interests

We do not hear as much these days about the prospect of the UK falling back on WTO rules in the event that a trade deal with the EU cannot be concluded. This is partly because such an outcome is unlikely to happen in the near-term since the UK will enter into a transition agreement with the EU from February. But it also probably reflects the fact that the WTO has been severely damaged by the actions of Donald Trump which in turn has reduced its usefulness as a body overseeing international trade rules.

The problem is that Trump has consistently blocked appointments to the WTO’s Appellate Body – the high court of international trade – as the terms of sitting judges expire. The Appellate Body (AB) was established in 1995 and is comprised of seven judges who rule on trade disputes between WTO member countries. Each judge is appointed for a four year term, which can be renewed only once, and the Body requires a quorum of three in order that its rulings are accepted as valid. Following Trump’s tactic of blocking the reappointment of existing members, the AB was reduced to the minimum number of three in 2019 and with the terms of two of them expiring in December, it can no longer command a quorum. In theory, the AB can continue to hear pending appeals because members are able to rule on existing cases even after their mandate expires, but it is no longer able to hear new cases. As a consequence, a country which loses a dispute can file an appeal knowing that it will not be heard, and as a result can continue to act as before.

How have we got into this position? Quite simply, the Trump administration believes that the WTO is biased against the US. It is true that compared to the pre-1995 period the US is less able to throw its considerable weight around on international trade issues. Under the old GATT system, there was no settlement mechanism in place to hold countries to account for trade violations and in the 1980s and early-1990s the US exploited this to introduce a series of unilateral tariffs, ostensibly to force countries to open up their domestic markets. This policy, dubbed “aggressive unilateralism” by US-based trade economist Jagdish Bhagwati, served only to anger major trading blocs such as the EU and in any case its rate of success was limited. To assuage these concerns, the Uruguay Round of GATT began in 1986 which eventually led to the formation of the WTO in 1995, including the Appellate Body.

On a global basis, the WTO has been a great success in as much it has reduced the extent to which trade disputes spiral out of control. But it does constrain the US to work within the rules. However, the US wins around 85% of the cases that it brings before the AB – hardly evidence of bias against it. As long ago as 2007, the US Council on Foreign Relations suggested that “the dispute settlement system reflects a delicate balance between toughness and respect for sovereignty; rather than criticizing the result, U.S. policymakers and legislators should invest more energy in defending it.” Furthermore, the dispute settlement mechanism “curbs the protectionist instincts of U.S. trade policymakers and so underpins prosperity” by acting as a counterweight to the intense domestic lobbying by politically influential, but inefficient, domestic industries.

Ironically, the US is today reported to have reached out to Japan and the EU for support to introduce tougher WTO regulations on government subsidies in a bid to further increase the pressure on China, where the US believes state support is distorting competition. To the extent that this may be a way to bring the US back into the WTO fold, it has found support from the EU. But it comes just a day before the US and China are supposed to sign their phase one trade agreement, in which China will agree to buy at least $200 bn of US exports over the next two years whilst the US will commit to rolling back some of the tariffs it has levied on China (though by no means all).

One of the concerns ahead of the publication of the deal is the extent to which the phase one agreement will fall foul of WTO rules. If, for example, it requires China to import a specified amount of US produce, this would amount to managed trade and thus violate WTO rules. There is also a concern that China may simply import less from other WTO members whilst raising its imports from the US. All this goes to reinforce the views expressed by nineteenth century British prime minister Lord Palmerston that “nations have no permanent friends or allies, they only have permanent interests.” China is very much in the sights of the US but the EU fears that it, too, could fall foul of the Trump administration’s trade policy. Meanwhile, China may well be prepared to acquiesce to US demands for now but at the expense of trade with other nations. And who is going to do anything about it? Not the WTO, which has been hobbled by the US!

At the current juncture, it does look as though we are going back to an era of power politics on trade issues, with the US and China increasingly operating in their own interests. I did point out last August that this was not the right time for the UK to go it alone on trade policy and I maintain – as I have done for the last three years – that the decision to leave the European single market is a dumb and short-sighted policy. As I noted in my last post, it is imperative that the UK strikes the best possible trade deal with the EU for it cannot rely on the kindness of strangers in what looks to be an increasingly hostile trade environment.

From the sublime to the ridiculous and beyond

Just when you thought that we have reached bottom in the Brexit debate, reality has a habit of showing us that things can always be worse than we thought. The Tory Party anointment of Boris Johnson as Prime Minister a month ago was already a step beyond the surreal, given his past record, but his rhetoric regarding a no-deal Brexit is taking the UK down a dark road from which recovery may be very difficult.

This was highlighted at the weekend by the leaked details of the government’s Operation Yellowhammer (chart – zoom in to see the details) which highlights the extent of the planning required to combat “a catastrophic collapse in the nation’s infrastructure.” Amongst the contingencies for which the government may be forced to prepare are the imposition of hard borders with the Republic of Ireland and at Channel ports, which will lead to significant disruptions in trade flows and which could severely disrupt the imports of food and medicine. None of this should come as a surprise. The government and Bank of England produced analysis last November which looked at the impact of a no-deal Brexit on GDP, and my own contribution was to sketch out some back-of-the-envelope calculations for the impact on cross-channel traffic which look close to those outlined in the Yellowhammer documents.

Whilst the true believers in Brexit dismiss this as Project Fear, an inside source with knowledge of the planning categorically stated, “this is not Project Fear – this is the most realistic assessment of what the public will face with no deal. These are likely, basic, reasonable scenarios – not the worst case.” Indeed, this is coming from inside government: from a civil service which is charged with implementing the policies of the government it serves, not from those who are diametrically opposed to Brexit and have an incentive to derail it. If a modern day Rip Van Winkle were to awaken after a four year nap and see the extent of the government’s preparations, he could be forgiven for thinking that the UK was preparing for war. 

In a way, it is – it’s just not clear who the enemy is. Half the population seems to believe that the plucky UK is facing off against the bullying EU whilst the other half believe the government is visiting a catastrophe on its own people. The United Kingdom has never been more disunited and its own government is stirring the pot. Irrespective of how people voted in June 2016 they certainly did not vote for this. They were sold a vista of sunny uplands in which the UK would benefit from tapping into the more rapidly growing regions of the world rather than being shackled to the moribund EU. Gerard Lyons, who has reportedly been interviewed for the post of Bank of England Governor, is one of the few respectable economists who believes that breaking trade relations with the UK’s most important trading partner will improve its prosperity.

But the view is total and utter rubbish and is based on the sort of analysis which gives economics a bad name. It is founded on a textbook idea of how free marketeers believe international trade is conducted, rather than the realpolitik on which it is actually based. The majority of the economics profession understands that the bigger partner in trade negotiations holds the balance of power. The only way that the UK will be able to close trade deals that the EU has somehow failed to achieve is to roll over and sell out its interests in favour of the more powerful partner – something the EU has refused to do. Anyone who believes differently is urged to sign up today as a trade negotiator – your country needs you! 

A bigger obstacle to the Brexiteers dream of a Britain driven by fantastic new trade deals is that the world has changed significantly in the past three years. Globalisation is in retreat as economic nationalism moves to centre stage, thus removing the central plank upon which their model depends. Donald Trump has torn up NAFTA and is engaged in a trade war with China from which nobody will emerge unscathed, as the basis of the global trading system over the last seven decades is slowly pulled apart. This is the very worst time in the post-1945 period for a country to throw itself on the mercy of the international trading rules. 

Brexiteers believe that the UK can perform well under WTO arrangements. But this is not a strategy – it is a default. So good are these arrangements that the only country in the world that trades solely on WTO rules is Mauritania – everyone else has made supplementary trade deals. Nor is it clear that the WTO will be in any position to enforce its own rules in future. The WTO’s Appellate Body is composed of seven members who serve for four-year terms. But as the terms of serving judges have expired, new appointments have been blocked by the Trump administration and it is currently down to three – the minimum required for a quorum. With two of them set to leave at end-2019, further blocking by the US means the WTO will be in no position to hear any disputes brought before the court. That is not a basis for the new trading relationships that the UK hopes to forge in a post-Brexit world.

Doubtless, those who continue to believe in the purity of Brexit will accept nothing less than departure at any cost. Unfortunately, those who continue to point out the pitfalls in the argument are labelled Remoaners (or worse). But this is not just about Leave or Remain – delivering a Brexit which does great economic harm will permanently damage the credibility of the Brexit case. If influential Leave politicians have any interest in remaining relevant beyond Brexit, they need a plan of how to deliver without crashing the car and the vexed issue of the Irish backstop is not the ditch they should be prepared to die in. I believe they know this, which is why I don’t take their rhetoric at face value. But if I am wrong, and the government really is intent on jumping over the cliff on 31 October, they will almost certainly be pursued by a vengeful electorate armed with ballot papers.