Welcome to Trade Secrets: Crunch Points in Trade and Global Trade Woes

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Welcome to Trade Secrets. Like many trade folk, I keep a special cynical facial expression (one of the many I possess, to be honest) for when I hear the terms “crunch point” or “make-or-break” in trade negotiations. The latest talks to receive this treatment are between the EU and Mercosur, whose chief negotiators are meeting this week in Brasília.

Self-imposed deadlines rarely achieve much in negotiations, but with the upcoming presidential election in Mercosur member Argentina, the leading candidate of which has threatened to dissolve the four-nation bloc altogether, minds are focused. Paraguay’s president Santiago Peña has even threatened to kill the talks if the environmental and public procurement issues aren’t addressed before he takes over the chair of Mercosur on December 6. This deal goes beyond just cars and beef: it’s a major test of whether agreements can still be achieved between big rich-world trading powers and assertive middle-income countries, both of whom have the ability to walk away.

In today’s newsletter, I discuss rich-world subsidies leaking to China and the decline of global goods trade. Charted Waters explores Germany’s dependence on Russian gas before the Ukraine war.

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Keeping the Handouts at Home

My last column touched on the issue of green subsidies in the context of Europe’s slow progress in building an EV industry. As mentioned, the delays have more to do with inertia and incompetence in the German automaker-government complex than China distributing trade-distorting subsidies. However, there is no denying that EU demand-side subsidies to consumers for purchasing electric vehicles (or installing solar panels) have given Chinese businesses an advantage in the European market.

Typically, trade economists argue that allowing consumer subsidies to be used on products from any company is the most efficient and non-distorting approach to going green, though they may concede the case for limited protection of domestic companies in order to establish a foothold in a rapidly expanding industry, especially if there are national or economic security concerns.

Regardless of the economics, the politics surrounding Chinese companies benefiting from rich-country subsidies to dominate global markets are delicate. The US tackled this issue in a convoluted manner, first restricting EV tax credits in Joe Biden’s Inflation Reduction Act to American companies, and then begrudgingly including those of various allies and trade partners such as Canada, Mexico, Japan, South Korea, and the EU.

Assuming the aim is to limit subsidy recipients to prevent Chinese companies from taking them all, is there a better approach? One idea being discussed is the creation of a “subsidy club” where wealthy democracies restrict their handouts to companies from countries that adhere to agreed-upon standards regarding labor and the environment, such as forced labor, carbon emissions, and waste disposal. This might help them avoid being undercut by Chinese producers, if not excluding them entirely.

Other sectors beyond EVs that may benefit from the “subsidy club” are semiconductors and critical minerals. Hosuk Lee-Makiyama, from the think-tank ECIPE, who proposed this idea, suggests that “a subsidy club, where there are already similar standards on labor or environmental protections, would be a way to address political concerns about unintended exploitation of buyer subsidies while complying with WTO law.” WTO rules do allow for trade restrictions to protect human health and the environment. However, an obvious challenge lies with the US, where Congressional approval may be required, and members may resist losing discretionary control over subsidy allocation. Senator Joe Manchin of West Virginia, a swing vote on the Inflation Reduction Act, has already criticized the provisions created for European and Japanese companies. Nevertheless, proposing a “subsidy club” might be a way to defuse a politically charged issue without completely disregarding WTO rules.

Don’t Panic Over the Decline in Trade

Global goods trade has experienced its fastest decline since the start of the Covid crisis, falling 3.2% in July compared to the same period last year. Should we be seriously concerned about the state of the world goods trading system?

The short answer is no. I hope that reassures you.

Now, if you are interested in a more detailed explanation, here it is. Goods trade, which by the way is not the most important aspect of globalization, is cyclical and usually follows the patterns of GDP and industrial production, albeit with greater amplitude. Given the global economy’s slowdown due to the impact of the Ukraine energy shock and central bank interest rate hikes, it is not surprising that trade is also slowing down. Take a look at this chart based on data from the Dutch CPB think-tank (known for its outstanding contributions to the world, including Total Football and hydroponic tomatoes), where I’ve smoothed the data into a three-month average and compared the annual changes. The relationship between industrial production and global goods trade is not unusual at this point, although the decline in trade is slightly steeper (and has even turned negative). It’s worth monitoring, but there’s no immediate need to panic.

Charted Waters

Rejoice when sinners turn away from their wickedness. Lars-Hendrik Röller, Angela Merkel’s chief economic adviser during her tenure as Chancellor, has admitted that Germany had become too reliant on Russian gas. The surprising thing, as shown in the chart, is how Germany increased its reliance on Russian gas even after Vladimir Putin’s annexation of Crimea in 2014. It was truly a disastrous bet.

Trade Links

A paper from the Brussels think-tank Bruegel explores ways to reduce carbon emissions from aviation and shipping.

My FT colleague Gideon Rachman conducts an excellent regular podcast interview with WTO director-general Ngozi Okonjo-Iweala, who highlights the threats to the global trading system and advocates for the WTO as the solution.

Two more Brexit-related successes to mention: with the UK’s carbon emissions scheme decoupled from the EU’s, the declining cost of carbon credits in the UK market could result in tariffs for British exporters to the EU under Brussels’ new carbon border levy. Additionally, if the UK government starts inspecting animal and plant imports, British businesses may face new costs of £330mn annually.

A thoughtful article on Bloomberg notes that the US no longer possesses the same geopolitical power it once enjoyed by disposing of agricultural surpluses.

Joe Biden’s EV tax credits have sparked a dispute between Ford and GM over the role of Chinese technology in the US car industry, reports the Wall Street Journal.

Trade Secrets is edited by Jonathan Moules

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