Anyone who has sat through a basic economics class would know the notion that a trade between two or more separate entities is beneficial for both parties. This notion of Adam Smith takes cue from the fact that two or more entities regardless of the absolute or comparative advantage should trade together.
This notion is best pictured in the simple expose of Robinson Crusoe and Man Friday, two castaways on an island that needed meat and crops to survive. Crusoe, being a skilled hunter-gatherer, was able to catch more meat and gather more crops than his pal Friday ever could, on any single day. This means that the best arrangement for these two castaways would be one where Crusoe spent his time to carry out what he is best skilled at, say hunting, while Friday would carry on gathering crops.
By trading, this will allow both men to be able to consume more meat and crops than they would have been able to consume, had they decided to do it on their own. This gave rise to the common shared belief that trade is beneficial.
On the contrary, an earlier theory called mercantilism, which was predominant from the 16th to the 18th century, believed that the world’s wealth was static and that countries should strive to increase their wealth by seeking to maximise exports and limiting imports by trade barriers, to ensure that wealth entered the economy but did not leave, as much as possible.
This theory is based on controls over free trade in order to assure control of resources and capital. As we can all witness, mercantilism is no longer the credo of global economics, despite it being re-considered in periods of depression and war, and ever since we have moved towards an integrated world economy, with trade volumes increasing year over year.
Recently you may have noticed the increase in column inches for trade war. We are told that the US, through increased rhetoric and threats, is entering into a trade war with China. This rhetoric has started turning into action, which has been characterised by a tit-for-tat announcement of tariffs on goods traded between these two countries. The real effect of these tariffs is that they increase the flat cost of the imported goods making these less attractive, and increase the cost for exporters on the other hand. This is meant to discourage such trade and entice those creating the demand and supply to seek local options.
In order to understand why these two countries are having goes against one another, we need to understand the history. Trade between the two largest economies in the world, for the year 2017, exceeded $600 billion. The overall trend confirms a gradual increase in the level of trade between the two countries over the years. The trouble with this trade lies in the fact that it is a rather one-way street, with the US importing much more than it exports to China, resulting in a trade deficit.
It is clear that global governments are playing catch up
The current US administration deems this situation to be detrimental to its interests. Their belief is that China is taking an unfair advantage over the US through cheap labour dumping (the practice of an export by a country or company of a product at a price that is significantly lower in the foreign importing market than that charged domestically) and currency manipulation (keeping the Renminbi at an artificially lower value through monetary policy).
The objective of the US administration is to tackle these matters to create a more fair-trading relationship. Also, in the process it hopes to attract ‘stolen jobs’ in the form of US corporations relocating their manufacturing operations back to the US mainland.
The notion of wanting to eradicate the trade deficit the US has in respect of China goes beyond the notion of the Chinese stealing US jobs. Some of what the US claims may be true, but that would only be describing the symptoms and not the disease. The deeper reality is that as a society the US in general spends more than it earns, and generally the Chinese spend less than they earn. This is a reflection of an extremely capital-driven economy where consumerism through spending is dominant, against one where sharing and saving are dominant. The narrative that China steals US jobs could be changed to any other country that provides access to global corporations, to cheaper human capital and resources.
Multinational corporations will seek to exploit these cost-saving opportunities of cheaper human capital, access to highly skilled labour, jurisdictions with favourable tax regimes and government subsidies, amongst others, in the name of maximising profits for their shareholders, and expanding their grip in becoming as globally significant as possible. It is clear that global governments are playing catch up, in their efforts to control these mammoths of globalisation. Unless a global common framework for regulating multinationals exists, these corporations will continue to seek to maximise these inefficiencies to their gain.
Despite the carnage we have witnessed in the Chinese markets as stock indices record double-digit declines, I take this to be a positive awakening for them. The realisation that relying heavily on foreign exports could be an Achilles’ heel for the Chinese economy has led its leaders to focus more on internal consumption. The process to increase internal consumption involves improving standards for the population of over 1.3 billion Chinese so that they are able to consume further. Slowly but surely conditions for the average Chinese have been improving, paving the way for the emergence of the largest population of middle-class in the world. As their affluence increases, so will their spending.
Another positive takeaway of the US abdicating from its international role as promoter of democratic values, trade champion and protector of the free world, has led to a flurry of unlikely bilateral talks and trade forums. This is occurring as different countries and blocks try to reduce their reliance on the US, be it for trade purposes or protection purposes, and they create new relationships from which they may benefit in the long-term.
From the current standpoint as a neutral observer, it is clear that we are still in the early stages of this escalation. It is clear that both the US and China intend to hold firm to their positions, which is signalled through the unwillingness to hold talks at a high level regarding this topic. At some point, both countries will run out of goods and services on which to slap tariffs, which could result in a stalemate. Over the long-term, possibly when an Economic crisis hits the global markets, the two countries will make concessions to each other in order to revive trade. Both countries can afford to do so due to their internal strength, however at one point we can hope that both countries draw from the lessons of Adam Smith and realise that by collaborating on trade they can be both better off, rather than working in opposite directions.
This article was prepared by Daniel Gauci HnD Management, CeFa Investments, an investment advisor at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The Company is licensed to conduct investment services by the MFSA and is a Member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For more information contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on 2122 4410, or e-mail daniel.gauci@jesmondmizzi.com.
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