Authors: Uri Dadush, William Shaw
Originally published by AmCham EU Quarterly
We are living in special moment in history, when the benefits of industrial revolution are finally spreading rapidly to the mass of humanity. In populous, fast-growing countries like China, India and Brazil, poverty rates are falling and rapidly-expanding trade is helping to forge modern industrial sectors. In Juggernaut: how emerging markets are reshaping globalization, we anticipate that the growth rates of major emerging markets will slow dramatically as their incomes rise but they will continue to grow more rapidly than the advanced countries, due to expanding labour forces, higher rates of savings and investment, gradually appreciating real exchange rates and, most importantly, more rapid technological progress. Emerging markets will continue to benefit from opportunities to import more advanced technology, while technology in the already rich countries can only grow through innovation at the frontier, which is inherently a much slower process.
China’s growth will be about half as fast in the next forty years as in the last thirty. Even so, within little more than a generation, not only will China be the largest economy in the world, but also the top seven global economies will all be emerging markets, with the exception of the United States. The rise of emerging markets with political institutions, social values and income levels that are very different from the advanced countries that have dominated the global economy over the past century has immense implications for international economic cooperation, the environment, political relationships and world trade.
One positive aspect of this coming change is the growth of demand for high-quality goods and services. What we call the Global Middle and Rich Class, or the people who are able to purchase modern goods such as automobiles, refrigerators and air conditioners, will increase from some 1.5 billion people today in G20 countries to about 3.3 billion in 2050, and the majority will live in emerging markets. This presents an enormous opportunity for expanded trade and for the advanced-country firms that dominate these markets.
The forecasts in Juggernaut envision huge shifts in global trade. Emerging markets will dominate the world trading system, with their share of trade rising from less than a third today to approach 70 percent by 2050. China will account for a quarter of global trade, or more than three times the US share. India’s share will be more than double that of Japan’s. The locus of world trade will also shift: trade among developing countries will rise from just 10 percent of world trade today to 40 percent in 2050. The precision is misleading, and the numbers projected are bound to be wrong, but the story they tell has a high probability of being correct, barring a cataclysm.
The increased importance of emerging markets in global trade in 2050 can be illustrated by looking at the shares of China and the United States in other countries’ trade. China’s share of US trade will rise from less than 10 percent in 2006 to 30 percent in 2050. Similarly, China’s share of EU trade will jump from about 3 percent in 2006 to almost 20 percent in 2050. At the same time, the US’s share of trade in major countries and regions will decline, falling slightly in the EU but by about half in most other countries. This forecast of rapidly expanding growth in global income and trade is subject to major risks. Such an enormous shift in trade shares could generate protectionist responses from some trading partners. However, the greatest threat to the forecasts comes from forces that are essentially exogenous to the trade system, including geopolitical tensions, financial crises and reactions to climate change.
The next 40 years will see one of the greatest shifts in economic and military power in history. Such transitions are not always managed peacefully, or at least without big political tensions that could spill over into trade. The potential for conflict can be illustrated by the relationships among three Asian powers: China, India and Japan. Both Japan and India have a history of rivalry and ongoing territorial issues with China. Twenty years ago Japan’s economy was larger than the two others combined, and few believed that either country could challenge Japan’s leadership role in Asia. Now China’s economy is approaching the size of Japan’s and in 40 years both China and India will dwarf Japan. Whether this dramatic change in power can be accomplished without conflict is a major question.
The next 40 years may also see a rise in the size and frequency of financial crises. While the recent crisis was generated in advanced countries, developing countries remain more prone to financial instability because they lack strong regulatory institutions and market mechanisms to ensure transparency. The risk of financial crisis will be particularly acute for emerging markets attempting to make the transition from repressed and government-controlled to open financial systems. Moreover, the cost of crisis in emerging markets tends to be greater because they lack social safety nets and (often) fiscal space to undertake countercyclical policies. Thus, as emerging markets become larger, more numerous and costly financial crises could impinge on the trade system, as crisis-hit governments grasp any available instrument to protect incomes in the short term. The fact that protectionism did not rise significantly during the recent financial crisis is no guarantee of the same experience in the future.
Climate change is perhaps the greatest threat to long-term prosperity, if the majority view among scientists is remotely accurate. Absent substantial changes in energy policies, the growth rates we forecast would result in an average rise in global temperatures of 5°C in the second half of the century, which would be catastrophic for the global economy and human welfare. The failure to take steps to control climate change could increase calls for taxes on imports from countries where emissions standards are seen as lax. Such taxes would be viewed as profoundly inequitable, particularly if directed at emerging markets that account for only a small proportion of the stock of carbon emissions now in the atmosphere. Moreover, carbon taxes on imports would be complicated to administer, difficult to distinguish from protectionism, and therefore extremely dangerous for countries’ commitment to a multilateral trading system.
These risks will be difficult to confront, in part because the differences that have confounded multilateral trade negotiations are expected to persist. Most importantly, while emerging markets will become the largest global economies, they will remain significantly poorer than the advanced countries. While incomes will rise more rapidly in emerging economies than in advanced countries, by 2050 the per capita income of developing countries that are members of the G20 will remain less than one half of the advanced countries’. Countries at lower incomes are likely to have different perspectives on key global issues, such as the sacrifices that are feasible to prevent climate change, or the appropriate level of labour, environmental and product standards. Such different perspectives will make reaching trade agreements, or even calming trade tensions, more difficult.
The difference in incomes is only one aspect of a general difference in capacity. Institutions tend to be weaker in emerging markets than in advanced countries, meaning that public administration is less effective, corruption is more prevalent and infrastructure is less reliable and efficient. Weak institutions in emerging markets have many implications, but an important point for the trade system is that countries with weaker institutions are going to be less able to implement agreements that call for complex policy reforms, for example to facilitate trade in services. While institutions are likely to improve over time, this process is slow, as evidenced by the marginal improvement in institutions in emerging markets on average over past two decades despite their rapid growth.
In addition to these inherent differences, multilateral negotiations will be beset by other challenges. The WTO approach of consensus and single undertaking agreements will continue to be slow, particularly as more of the major countries are unlikely to push hard for either completion of Doha or a new trade round. Advanced countries will be dealing with their severe debt and macroeconomic problems following the financial crisis, and are unlikely to take the lead in forging a new multilateral trade deal. Meanwhile, the increasingly important developing countries are more focused on development priorities and high levels of poverty than on spearheading a new trade offensive. The growth of developing countries as significant commercial rivals to the advanced countries is likely to make reaching agreements on trade liberalisation even more difficult. The toughest issues remain to be addressed, including agricultural subsidies, services, investment and the high levels of protectionism against manufactured imports in many emerging markets.
Even absent a dramatically new approach to multilateral trade negotiations, we anticipate that global trade will continue to grow rapidly and that some progress in trade reform will be made. Autonomous liberalisation will remain the main driver of trade reform. Regional agreements will continue to proliferate and perhaps engage the major trading nations (perhaps an EU-US deal is possible). Such agreements will increasingly involve deeper integration in services where regulatory coordination is critical. Selected plurilateral agreements involving a subset of the major traders may be negotiated, for example a broadening of the government procurement agreement or provision of duty free and quota free access to the least developed countries. Russia, the only G20 member outside the WTO, may be brought into the fold. The WTO dispute settlement process may become less important, as more trade is encompassed by regional agreements with their own dispute settlement procedures.
Overall, this is not a calamitous view of the future, and indeed the multilateral trading system is in phenomenally better shape than the international frameworks for finance, migration, and global public goods, the other channels of integration that we consider in Juggernaut. However, this scenario does involve forfeiting significant opportunities for advancing more broadly on trade reforms because of the dysfunctional nature of a multilateral forum where everyone must agree on everything, a goal which will become even more illusory as global diversity increases.
The WTO needs to play a more proactive and substantive role to have an impact on further trade reform in this more difficult negotiating environment. It must move from a focus on universal multilateral concessions based on consensus to making a contribution to arenas where trade reform is actually occurring. The WTO should ramp up its support for autonomous reform, for example by providing technical expertise to support trade facilitation and exploiting the Trade Policy Review Mechanism as a basis for ongoing dialogue with member governments on trade reform. It should encourage and support well-designed (deep, broad, and minimally trade-diverting) regional agreements. It should help sponsor plurilateral deals where a critical mass of members agree on trade liberalisation, working to ensure that such agreements provide for extending membership on reasonable terms and include favourable treatment for the poorer countries. At the same time, the WTO should devote energy to determining how the complex web of bilateral, regional, and plurilateral agreements can selectively and gradually be multilateralised, that is, translated into a set of enforceable rules that can gain more general acceptance. This should be done piecemeal, not by another comprehensive trade round, but rather by urging universal adoption of reform measures that require only modest steps (for example eliminating all tariffs under 3 percent and adopting a uniform code for rules of origin, or at least a voluntary one). All of this would require a strengthening of the WTO secretariat to vigorously pursue a reform agenda.
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