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The Future Global Trading System: Remarks to the 2007 Joint Operational Environment Seminar
Date: 6/26/2007

Norfolk, Virginia, June 26, 2007

William A. Reinsch

I'd like to begin with some context on where the global economy is heading, then paint in general terms the future landscape I see, and finally go into some detail about one of the countries that will clearly be the focus of our attention in the coming years.

The factors that will define the global economic system in the future are the rapid and widespread dissemination of technology and the growth of global supply chains and global capital markets. Taken together they will mean the narrowing of the gap between the U.S. and others, primarily Asia.

Advances in technology drive globalization. Technology speeds everything up. Today, communication is virtually instantaneous. Technology milestones pass by more and more quickly. Moore's Law, for example, tells us in essence that semiconductor performance capabilities double every 18 months. Software is out of date in half that time.

Second, globalization and advances in technology bring everything -- commerce, people, conflict -- closer together. In trade, I illustrate this by pointing out that more than half the cut flowers sold in this country every day are imported from overseas, which would have been unthinkable even 30 years ago. There's a company just south of here in North Carolina that catches flounder off the AtlanticCoast and sells it fresh every day ‑‑ in Tokyo. There are banks in Manhattan raising capital in London and investing it there because they have concerns about American capital markets.

Third, technology is a great leveler. As it speeds production and shrinks space, the opportunity for more people – good guys and bad guys -- to operate globally and acquire new technologies grows rapidly. That makes the world a more dangerous place because the same globalization that is bringing the world together for economic growth and prosperity is also making dangerous technologies more accessible. If everything is made everywhere, how do we control it?

Fourth, just as the growth of commerce in the last century brought about the decline of states' rights versus federal authority, globalization will bring about a decline in nations' rights and a growth of supranational and transnational entities and transnational problems – environment, health pandemics, financial crises – that will demand the institutional structures the previous speaker discussed. Ironically, as countries become less important, we're likely to see more of them.

Fifth, technology is enabling new "bottom-up" pressures. Grassroots advocates have tools and organizing capabilities that dwarf the capacity of 20-30 years ago. Call them hypermobilized, hyperempowered agitators. They influence policy in ways that are often unexpected – and for which we are often unprepared. For example, pressure on Darfur that has led to global divestment campaigns, to World Bank policies to doing something about global warming

Sixth, post-Cold War, we are still transitioning to a new era, which in economic terms will be "non-polar." Some states may be preeminent by virtue of size and strength, but their influence over others will be increasingly limited. The gap between the US and everyone else will continue to narrow, not because we are declining, but because others are catching up. That means that the United States, which for years has been the linchpin of the global economic system for strategic as well as economic reasons, will be less able or willing to make sacrifices for the good of the system because our domestic politics will not permit it. For example: [slide 2]

Looking forward

We can't turn back the clock. The world is becoming flatter, faster, and closer together. The winners will be those who run faster. If we want to maintain the capability gap between ourselves and others, outpacing their development is essential. Holding them back no longer works very well.

The global supply chain will expand; trade and cross-border investment will continue to grow even if we never sign another trade agreement. [slides 3 and 4] The Doha Round will eventually succeed at some level – probably in 2009 or 2010 -- and will be followed by another one. The trend of liberalization over time is clear. Anyone who looks at the data can see that countries that are globally engaged grow and countries that are not, stagnate. [Slides 5 and 6] Continued liberalization will help the new drivers of global growth, particularly China and India, and bring both benefits and challenges to us.



The key economic dilemma in the future will be dealing with globalization as a force for both stability and instability as it simultaneously pushes countries to conform to market principles and to Western norms of rule of law yet at the same time rides roughshod over deeply ingrained cultural values, exacerbates growing problems of income inequality, exploitation of workers, women, and children, and contributes to environmental degradation and resource depletion. [Sari story]



By the way, these are not really trade problems, but they end up being treated that way for two reasons. First, it's always easier to blame the foreigners than yourself for your problems, so most bad economic developments are blamed on trade and lead to demands for protection. Second, the WTO is the only multilateral organization that has an effective dispute resolution mechanism, so nations have an incentive to define their problems as trade grievances so they can take them there.



Negotiating better rules to deal with these problems, though, is beyond the WTO's capacity. Don't look for its death, -- old organizations rarely die -- but look instead for growing interest in a "dual-speed" system, where countries prepared to take more globalization risks in the interest of more rapid growth will get together and liberalize faster on their own terms. Others will be left behind in the expectation that when they see their neighbors growing faster, they'll climb aboard the train.



Even so, there are constraints that all countries will face:



1) Growing demand for resources, particularly energy, will lead to sustained price increases and periodic shortages, which in turn could slow growth, contribute to price pressures in the economy, and become the source of future conflicts.



2) Continued sparring over environmental degradation. The rich countries show signs of getting religion on the subject; the poor ones will continue to view it as a plot to hold back their industrial growth. All of us continue to cling to the fantasy that we can clean up the environment and solve global warming without compromising economic growth or significantly changing our lifestyles. Learning to live with limits promises to be one of the important but painful lessons of the 21st century.



3) Global capital markets will grow in size and volatility. When money moves around the world at the click of a mouse, financial panics in one country can spread quickly, and current institutions are ill-equipped to prevent them. As a result, more than ever before the Golden Rule will apply – he who has the gold makes the rules. On the plus side, Western financial institutions' rules will focus on rule of law, transparency, and anti-corruption, all essential elements of a global trading system. On the minus side, the rules will do little for income inequality and the other social issues I mentioned.




To be a bit more specific, let me show you some demography slides. I have come to the conclusion that demography rules. It determines the fundamentals of geoeconomics and geopolitics.

1. The populations of emerging markets are growing faster than more developed countries. [Slide 7]



2. In Europe, Russia, and Japan, birth rates are declining, and their birth rates are (or soon will be) lower than what is needed to sustain the population. Their long term fate is either to accept significantly more immigrants or resign themselves to slow decline. Regardless, their share of global GDP will decline. [Slide 8]



3. In the United States our historic openness to immigration will permit a continued slow increase in population, even as our birth rate levels off, leaving us perhaps in the best position of developed countries. [Slide 9]



4. High proportions of young males in poor countries are a good proxy for instability. A snapshot right now shows that is a big problem in Africa and the Middle East, but it will get better over time. Currently, 33% of the Mideast population is males under 29. That will decline to 27% in 2025 and 23% in 2050. There will be a similar, albeit smaller, decline in sub-Saharan Africa, where 36% of the population is currently males under age 29. By comparison, young males in the US currently constitute 22% of the population, declining to 20%, while in Western Europe the number is 19% declining to 16% and then 15%. This suggests that while this will be a problem for the near term future, over the longer term, it will recede somewhat.



This data suggests five areas of interest, only one of which I have time to discuss in detail:



1. Rich countries – Aside from the United States, major developed countries, particularly in Europe, will increasingly face the challenge of relevance in a world where they are declining in importance numerically, economically and politically. One of the challenges of our multilateral institutions will be to recognize that and rebalance political weight in favor of the rising countries.



2. The United States – will be in a better position but must cope with the psychological and economic impact of waning preeminence. That will mean continued policy battles over trade policy and protection, some of them fought in the name of "national security" like the Dubai Ports World investment case last year, and over immigration. We will increasingly need to rely on imported workers to maintain growth and competitiveness, but we will continue to face divisions in our population over this, as we have for the past 200 years.



3. The Middle East and Africa – Both face continued volatility for many reasons, currently including the explosive nature of their young populations. Rapid economic growth would help, but it has historically been trumped by other factors. In the Middle East, it is politics, religion, and the determination of elites to hang on to what they have. In Africa, it is debilitating disease, corrupt governments and egocentric leaders that resist the disciplines of globalization even though it can save their economies and their people. These problems cannot be solved in the time frame we're looking at, and probably not in our life times, but can certainly be managed better, but I'm smart enough not to say any more about that.



4. Asia – There's a lot to watch for in Asia, including how the Asian tigers, who have been true success stories over the past 50 years, will adapt to the emergence of India and China as economic and political powers. It is the China story, along with India, that I want to conclude with.



5. India will be the biggest country in the world by 2030 and has the potential to be a significant global force.



· Its middle class is projected to grow from 50 million currently to 583 million in 2025. India's GDP per capita will quadruple from 2007 to 2020, while average annual growth will be 8.4% (Goldman Sachs report)



· There are already signs – in the last election – of growing strains between rich and poor, urban and rural that, unlike China, will be worked out in a democratic framework. Their challenges are poor infrastructure – China spends seven times more on it than India does – which will be tested by increasing urbanization, a still omnipresent and inefficient bureaucracy despite government policy changes, and cultural taboos that restrict economic progress.



· The conclusion: Their rule of law and democratic traditions will matter, but the political path to implementing needed economic reforms will continue to be rocky and their nuclear program and the unsettled state of Kashmir makes them a source of global instability in the future regardless of their economic growth or their democracy.



China -- I'm going to spend more time on China than on other countries because it's the emerging power of the 21st century.

  • Economically, China is growing – fast. It is improving its agricultural capabilities, developing its infrastructure, and expanding its manufacturing, moving up the value-added chain as fast as it can. [Slide 10]

  • It is doing what Japan did in the 50s and 60s, what Korea and Taiwan did subsequently, and what Malaysia, the Philippines, Indonesia, Thailand, and a host of others are trying to do right now.

  • But China is different because of its size and its politics. With 1.3 billion people, there are few limits on its capacity. It will become a true economic rival -- not the proverbial 800-pound gorilla but the 800,000-pound gorilla. 

  • While we had many of these same worries about Japan 20 years ago, at the end of the day it was still an ally and friend. China is not, which means its growth has strategic as well as economic implications. 

  • This is not a new condition. It has characterized debate in Washington for 30 years, and the debate won't be settled in 30 more.


China's future

For the next 5-10 years we will see more of the same. No one expects any dramatic near term developments because of the upcoming Party Congress and then the Olympics, and because its leaders are essentially conservatives determined to hold onto power. Also, many Chinese believe in stability more than they believe in democracy and are not inclined to rock the boat. That may change as the older generation dies off, but we cannot realistically expect any scenario that will lead to Western-style democracy


One thing the Chinese have done with some success is institutionalize retirement. High government officials are expected to step aside as they approach 70, and there is a growing record of that actually happening, which is unusual in an authoritarian state. 


That will help the government sustain itself, but it also guarantees policy change as new leaders come and go, generally every 5 or 10 years. Right now, as Hu Jintao approaches the mid-point of his tenure, analysts are anticipating the decline of the engineers, which has been the educational background of virtually all the recent leaders, and the rise of lawyers and others with a "soft" educational background. Will that change China's ability to manage its economy and/or will it lead to a leadership more sensitive to rule of law and local grievances? At this point it is hard to say, but it is unlikely to make things worse.



· The debate is likely to be over accountability rather than democracy – a government that is reasonably transparent, does not act arbitrarily, particularly on local matters like seizing farm land to build shopping centers or closing down internet cafes, and which provides an effective means of redress of individual or group grievances. China's dilemma is how to build accountability into a system that depends on its absence for its survival.

· As far as the economy is concerned, initial skepticism may be giving way to optimism that they can successfully deal with their internal economic problems and transition to a modern economy. Unprofitable state-owned enterprises that employ millions of people, overwhelming bank debts, largely to those companies, regional and urban-rural income disparities, and growing inflationary pressures, are the symptoms. The real medicine is financial reform so that the cost of capital is determined by the market, and there are fewer subsidies and economic constraints that skew investment and lead to bubbles, panics, and inflation.



· Interestingly, the Chinese know that – for Communists, they have become very good capitalists – but so far their implementation has been too conservative, as exemplified by their exchange rate policy. The reason is that truly opening up their economy to deal with its contradictions will address their economic problems, but it will inevitably undermine their political system and challenge the Party's control. And that is the dilemma they cannot yet solve.



Even if they succeed, other challenges remain, enhanced by globalization:



· Perhaps the greatest is clean air and water. Experts estimate that at least one-third of China's water is not fit for human use, and anybody who has been there can testify to their air pollution problems. Addressing these problems without significantly retarding their manufacturing growth will be expensive, difficult, and time-consuming, and it will require substantial public cooperation.



· Solving their environmental problems is also directly related to their energy consumption. In 2004 they used 40% less energy than the US; by 2030, they will use 11% more. In contrast to the US, the most rapidly growing energy use is industrial production. Much of the increase comes from coal. They will build a new coal power plant every week for the next 2 or 3 years. Cleaning their air will require a shift toward other fuel sources, including oil and gas, which will significantly increase global demand for petroleum and nuclear power, and it will also require a shift away from industrial production and towards services on a much faster schedule than it took the U.S. to do the same thing. The fact that India will go through the same transition will make the global problem even worse.



· The rise of India and China means increasing global competition for natural resources, particularly energy. The current Chinese tactic of buying sources of production rather than barrels, if continued, will add to paranoia about both prices and availability in a tightening market.



· There is also a political dimension to this, as China's and India's need for energy will lead them to sources that are not already taken. That means Iran, Venezuela, Sudan, and other African countries where American companies either cannot do business or will find it more difficult in the future, like Nigeria. China's behavior here is not likely to change except at the margin, despite multilateral pressure. That will increase the possibility of tension not only over resources but over their foreign policy that effectively supports our adversaries, as in Sudan.



· At the same time, while the Chinese economic model will be attractive to others, there are likely limits to China's "soft power" because its authoritarian government, its obsession with control and its lack of transparency, not to mention its historic treatment of its neighbors do not present an attractive political model.



What does this mean for us?

Will their likely economic powerhouse overwhelm Western economies, hollow out our manufacturing base and cost us millions of jobs?



I see three scenarios:



1. China and India address their problems and become engines of growth for the global economy. The challenge for us in that case will be to adapt to an economic system where power is more diffuse and to ensure that economic rivals do not also become political or military rivals. The challenge for India and China will be to accept the increased responsibility for maintaining the trading system that comes with leadership. Unfortunately, there is no sign of that yet. If we collectively fail to meet those challenges, we will likely see a new bi-polar global system involving a United States- China/India rivalry.



2. One or both of them fail, either economically or politically in which case they will be preoccupied with their internal problems for a long time to come. Depending on the severity of those problems and the extent to which they spill over into the international system, the United States might be drawn into them as well.



3. They muddle through just like us – continuing to grow but continuing to face the same challenges they have now, which, if nothing else, will significantly constrain the international role each of them can play. This is the least interesting outcome, but the most likely.



Regardless of which scenario is correct, however, the economic consequences for us are not that different because they are an inevitable consequence of globalization and growth elsewhere, not just in those countries:



· U.S. manufacturing will continue to lose jobs while improving productivity. We have been losing manufacturing jobs for 40 years, but mostly to technology – not China. The Chinese have actually lost millions more manufacturing jobs than we have.



· Like everyone else, the United States must deal with the psychological and economic consequences of globalization in terms of lost jobs and devastated communities. The economic gap between the top and bottom in our society is getting worse [slide 11], and our adjustment programs to deal with it do not work well. A study just released this morning by the Financial Services Forum has some innovative ideas in this area that deserve attention.



· We should be wary of our increasingly precarious global financial position. [slide 12] We are deeply in debt to the Chinese, which increases their potential leverage over us, even though they could not exercise it without taking an enormous financial hit. For all of our economic might, I doubt that we can ignore economic fundamentals forever, and markets will one day decide one day that a declining dollar, massive debts and deficits, and low returns on T-bills are reason enough to flee the U.S. economy. The issue will be hard landing or soft landing, and the longer we do nothing, the more likely it will be the former.



In spite of all these challenges, the good news is that doing something about many of them is under our control, not anyone else's. We can choose the right tax, trade and immigration policies that encourage foreign investment and make the United States a welcoming place to visit, live and work. We can choose to improve our educational system and can create a 21st Century workforce. We can choose to address the massive imbalances in our trade and current accounts. 


The one thing we know for sure is that the rest of the world, particularly China and India, will continue to run faster, so it falls to us to pick up the pace if we want to retain our global position.