Trade

By Ian Bremmer

The most obvious long-term effect of the financial crisis is a shift in economic decision-making power from capitals of finance to capitals of politics. We see this trend in the United States, where decisions on how best to value assets and allocate capital are now made in Washington on a scale unthinkable until about this time last year. Outside the United States, nowhere is this development more obvious than in the United Arab Emirates, where power and wealth have shifted at startling speed from Dubai (until recently a financial powerhouse) to Abu Dhabi (the seat of political power). But the American trend is temporary; the UAE's might not be.

Remember when newspapers, magazines, and TV business reports produced feature after feature on lavish investment in Dubai's newest architectural marvel and the corporatist management style of its ruler, Sheikh Mohammed al Maktoum? As foreign investment stopped flowing into Dubai, large-scale infrastructure projects ground to a halt. Thousands of foreigners lost work permits in the construction sector. Thousands more saddled with loans they could no longer repay simply abandoned their property and left the country. By January 2009, local police complained that about 3000 cars had been abandoned at the airport. Dubai found itself buried beneath a mountain of IOUs, and for a few days in February 2009, the financial world lost faith. The emirate's credit rating tanked, and foreign investors began to plan for the once unimaginable risk that Dubai would default on its sovereign debt.

Faced with that, Dubai announced a $20 billion bond program to raise the needed cash. In February 2009, Abu Dhabi moved in with $10 billion bailout, underwritten by the UAE's central bank. So far, Dubai has yet to find the other $10 billion, and Abu Dhabi may have to step in again. But the bursting of Dubai's real estate bubble and the sudden collapse of its economy have already allowed Abu Dhabi's ruling al Nahayan family to buy a big share of the al Maktoum's assets.

On a recent visit, I saw the evidence for myself. Abu Dhabi is bustling as the city state prepares for its first Formula One championship this Sunday.  In Dubai, the traffic jams are gone, the hotels are struggling, and everyone's waiting for something to change. What a difference a year makes.

There's plenty of reason to fear that things won't get better soon. Real estate prices are now at about half their peak, but overbuilding on many projects continues because the state controls many of the emirate's largest construction companies. Many of Dubai's biggest construction projects are still underway, because the government wants to minimize further job losses. That's likely to continue through 2010, leaving the emirate with large amounts of unused commercial space.

In many cases, local firms haven't paid their employees in weeks, and there have been some moderately violent protests. The government appears aware of the seriousness of the problem and is working to improve healthcare and living facilities for the laborers. Dangerous levels of unrest are unlikely given that most guest workers can't afford to risk deportation.  

But there's another cloud on the horizon. If the United States moves to intensify sanctions on Iran next year (a good bet given the low likelihood that the current diplomatic optimism will last), Dubai will be vulnerable. Much of Iran's financial flows move through Dubai, and sanctions would hit the emirate especially hard.

Ian Bremmer is president of Eurasia Group.

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By Ian Bremmer and Willis Sparks

To mark 60 years in charge, China's Communist Party threw a lavish party last week, a triumphalist pageant with enough military hardware on parade to fill the nightmares of would-be "dragon slayers" for years to come. It was a reminder that China has developed advanced fighter aircraft, military satellites, the Dong Feng 21 missile (also known as the "aircraft carrier killer"), and has been working toward production of a first aircraft carrier of its own -- an asset that would enable China to project naval power further from its shores than ever before. As if the visuals weren't enough, the celebration included a 2,000-member military marching band.

So will China one day pose the 21st century equivalent of a Soviet-scale military challenge to America's geopolitical dominance? That's unlikely. China wants to extend its influence throughout East Asia, protect the commercial traffic that provides the oil, gas, metals, and minerals that feed China's growing economic appetite, and project national pride. It will one day pose a broader military threat than it does now, but its economy has grown so quickly and its living standards have improved so dramatically over the past two decades that it's hard to imagine the kind of catastrophic, game-changing event that would push its leadership to upend a profitable status quo and confront American leadership outside Asia. China's leaders know their government won't be ready anytime soon to bear a superpower's burdens. Their primary goal is to bolster their political control by generating prosperity for the Chinese people. Why would it allow anything short of the most dire and immediate threat to its territorial integrity to ignite a military conflict that would sever its web of commercial ties with countries all over the world -- and, in particular, with its three largest trading partners: the European Union, the United States, and Japan?

Beijing's primary military concern is the risk of a direct or proxy conflict with the United States over Taiwan. But the Chinese leadership knows that no U.S. government will support a Taiwanese bid for independence, and why should China invade the island when it can co-opt most of Taiwan's business elite with privileged access to investment opportunities on the mainland? Globalization has been good to China's Communist Party, and wars are bad for business.

Certainly, China has ambitious military modernization plans. With 2.3 million soldiers under arms, the People's Liberation Army (PLA) is already by far the world's largest. It has reportedly invested considerable time, effort, and money in cyber-warfare technology. Its total military budget probably doubled between 2003 and 2009 to about $70 billion. But that's still only about 12 percent of what the United States now spends on its military each year -- and an even smaller percentage if supplementary U.S. spending on the wars in Iraq and Afghanistan is included.

The problem for U.S. policymakers over the next several years is not that the unipolar world order will give way to a multipolar but to a non-polar system. In other words, it's not that America has company on the global stage but that it must continue to carry so much weight on its own-and at a time when pressing problems at home will limit the American public's appetite for ambitious foreign-policy commitments.

Over the past 20 years, U.S. analysts have scanned the horizon in expectation of potential challengers to America's great power advantages. The European Union was already struggling to manage the latest round of expansion before the financial crisis gave EU leaders another reason to avoid potentially onerous new commitments abroad. Russia's leaders may be unhappy with the geopolitical status quo, particularly when it comes to the balance of power within several former Soviet republics. But they're far too preoccupied at the moment with the protection of domestic markets, banks, and companies from the worst effects of the financial crisis to embark on any long-term plan to build a threat to U.S. power outside its immediate neighborhood. India has market reform issues to manage and security worries flowing across the border from Pakistan. Within the Western hemisphere, Brazil appears to have no grander near-term aspirations than to promote stability in Latin America, jumpstart an economic recovery, find new ways to profit from its recent oil discovery, and to play a broader leadership role among developing states.

It's not a challenge for dominance, but a growing vacuum of power that should worry Washington. The more important questions for the next decade are: Who will take the lead on building a new global financial architecture that reflects 21st century realities? Who will take the lead on multilateral efforts to address climate change? Who will create a new (and more credible) nonproliferation regime? Who will provide momentum behind Middle East Peace talks? Who will provide the leadership to ensure that G20 summits don't simply turn into G8-style photo opportunities with a wider angle lens?

A decade from now, who will carry that weight?

Ian Bremmer is president and Willis Sparks is a Global Macro analyst at Eurasia Group.

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By Eurasia Group analysts Damien Ma and Sean West
    
After the Obama administration slapped 35 percent tariffs on Chinese tires over the weekend, China responded with hyper-charged rhetoric and its own investigation into U.S. chicken and auto parts exports. When the news broke, the world woke up to a scary possibility: What if these actions were the opening shots that would trigger a trade war?

Despite some serious media hype, we don't think a trade war is likely. But we also don't think it's outside the realm of possibility. If such a scenario occurred, it would have serious implications for global recovery, financing the U.S. debt, and even the stability of the Chinese regime. Therefore, it's clearly worth considering how this situation could occur, while also examining why it's unlikely that events will evolve in that direction.

The United States implemented tariffs on Chinese tires under section 421 of U.S. trade law, which was agreed to by the Chinese when U.S.-China trade relations were normalized and China joined the WTO. Until 2013, it allows the United States to tariff Chinese goods simply by showing that there has been a surge in imports from China with damaging effects for U.S. domestic producers. To put tariffs in place, the U.S. International Trade Commission makes an assessment of the import surge and recommends to the president whether and how large a tariff should be put in place. The president then determines what tariff to apply.

Until now, the U.S. president never put such tariffs in place; the Bush administration declined four ITC recommendations to do so during its tenure. The interesting twist about President Obama's decision to apply tariffs was that the case was filed by a U.S. labor union without the support of tire manufacturers. Thus, section 421 became a direct path from labor grievances about imports to domestic protection. It's hard to imagine labor groups not trying to push forward similar cases in the future.

Rampant enforcement of section 421 is the type of thing that could seriously anger the Chinese to respond outside of the global trade regime. This is because section 421 can be implemented even if China does nothing wrong -- other than becoming very efficient at exporting a particular good to the United States. Moreover, when 421 is invoked, there is little China can do to appeal or counter the action because the determination is not based on China doing anything forbidden, so China cannot undo any action. Challenging whether the United States is implementing the provision properly -- as China has recently announced it will do -- can take as longer than the life of the tariffs.

It's reasonable, then, that politicians in Beijing are worried that the decision on tires will lead to China being singled out as the target of future trade actions. What's more, the simmering nationalism of the Chinese public forces the leadership to be more aggressive in its responses. A poll on a state-run news site found that 90 percent of Chinese citizens believe that China can go toe-to-toe with the United States in a trade war. Thus, every time Section 421 is used, it will engender fiery retaliation from the Chinese. If the door the administration has cracked open is thrown fully ajar, trade tension could theoretically spill over into WTO-incompliant responses or responses that have nothing to do with trade. Thus, there is a chance -- though not a likelihood -- that section 421 could lead to a trade war if the United States repeatedly uses it and China responds through escalation.

The administration's recent demonstration that it is willing to apply section 421 and China's aggressive reaction moved the US-China relationship one step closer to that scenario. But it was a small step in a robust trading relationship with two sides that understand what's at stake. Top Chinese leaders have little interest in engaging in a trade war with the United States because they know it would hurt their heavily export-dependent economy. Washington is trying hard to make China a willing partner on a host of global issues, and China has been receptive to the idea if only for the recognition of its increased international stature.

During the first Strategic and Economic Dialogue in July, the two countries pledged to move toward a more mature relationship. In Washington, Obama -- despite how he appeared on the campaign trail -- remains committed to open markets and the national economic benefits the United States gets from trade. While a potential trade war is scary stuff, there is little reason to believe it is forthcoming.

By Eurasia Group analyst Courtney Rickert

Amid headlines that the global economic crisis has stabilized, an important question arises: Which countries' economies will recover most quickly, and which recoveries will be the most sustainable? The key to finding an answer lies in understanding how countries were exposed to the global downturn and assessing their policy responses. Countries that choose to adjust to the changed global economic environment will come out on top in the long term.

While all internationally integrated economies have suffered growth declines, some economies entered the recession in a better position than others. Part of this divergence is a result of the quality of government policies, such as balanced fiscal positions and low inflation. Other key factors in determining a country's exposure to the crisis are trade imbalances and overinvestment in select sectors, such as real estate, in the period leading up to the global financial crisis.

Countries that had persistent trade deficits -- such as the US-financed them by borrowing heavily from abroad. Frequently, international borrowing fed domestic consumption far more than investment. This excess consumption contributed to bubbles during the boom years -- notably in financial assets and real estate-that have since popped. These economies have been slower to stabilize, but the housing and retail markets are naturally adjusting as home prices fall, banks become more prudent, and consumers buy less. In these cases, there is little need for long-term adjustments to macroeconomic policies.

On the other hand, government policy choices will play an important role in countries that sustained trade surpluses, such as China, Germany, and Japan, because these surpluses were a result of government policies that promoted exports. Their economies have been hard hit by declining global demand-particularly in the US. Although government stimulus spending has propped up their economies in the short term, China, Germany, and Japan will face a fundamentally different global market in the long term -- one that is unlikely to revert to the pre-crisis status quo levels of global demand. Governments in these countries will have to choose whether to reorient their economies away from export dependence or try to muddle through and hope for a return of foreign demand.

Effective policy responses in all countries have required crisis stabilization, the cleanup of sectors that experienced overinvestment, and adjustment to the rapidly shifting global flow of funds and goods. Even the best-run governments will face difficulty managing these activities smoothly, but many are demonstrating the ability and willingness to do so. Below are snapshots of policy responses in the four largest economies: the United States., Japan, China, and Germany.

United States
The United States had a large trade deficit during the expansionary period, allowing it to adjust relatively easily to declining global demand. However, as a result of international capital inflows, it also had significant overinvestment in financial assets and real estate. The Obama administration responded relatively aggressively to the crisis by taking action to clean up the financial sector and implementing a $787 billion fiscal stimulus plan, but spending has been slow to materialize. The US economy is forecast to contract by 2.6% in 2009 and show only minimal growth in 2010, as individuals and firms paying down their debts remain a drag on economic growth. But compared to the major trade surplus countries, the United States' relatively fluid economy will likely to adjust to the new global environment more smoothly and rapidly.

Japan
Japan's exposure to the current crisis has been exacerbated by its efforts to sustain trade surpluses, but its economy had already been adjusting before the crisis began, with production increasingly moving overseas. Moreover, when the global decline in demand hit, Japanese firms decreased production and rapidly leveled off at much lower output. In addition, the 30 August elections are expected to displace the long-ruling Liberal Democratic Party (LDP), bringing to power a government that is more interested in protecting the interests of consumers rather than producers. This situation is reducing Japan's dependence on exports, providing a more stable base for growth.

China
The global slowdown has hurt demand for Chinese goods and threatened the vitality of China's export-oriented economic growth. While exports are unlikely to return to their previous levels in the near to medium term, Beijing's massive stimulus spending, relaxed monetary policy, and export promotion will partially counter the collapse in demand. If China is to secure long-term growth, however, efforts to rebalance the economy toward greater domestic consumption -- by putting more income in workers' pockets-must be considered.

Germany
The export orientation of the German economy and tight integration with the wider European economy limits the government's ability to stimulate domestic demand. Moreover, liabilities in the banking sector are worrying. While the government has fiscal room to maneuver, focus on the upcoming election and fears about the cost of potential interventions in both the real and financial sector have constrained Berlin. Most importantly, the government is averse to policies that would lead to a structural change in the country's export orientation. While this could begin to erode after the 27 September elections, any shift in German policy will be limited by concerns about government debt levels.

YOSHIKAZU TSUNO/AFP/Getty Images

By Ian Bremmer

Sometimes there's less to a story than meets the eye. Take Venezuelan President Hugo Chávez's announcement last week that he would freeze diplomatic and commercial relations with Colombia. There's nothing new about tensions between these two governments, but markets responded badly to what sounded like a drastic step. This story is much ado about almost nothing.

Chávez is angry that Colombia has invited a few hundred additional US troops into the country, granting them access to three Colombian military bases. (There are currently about 300 American soldiers in the country. Colombia's government insists it will not amend an existing bilateral agreement that caps the total of US troops at no more than 800.) Colombian President Alvaro Uribe insists the troops are there to help target narcotics trafficking, but Chávez has warned his people of an impending Yanqui invasion. Meanwhile, Uribe accuses the Venezuelan government of selling military materiel to FARC guerillas inside Colombia.

There's nothing new about any of this tension. Trade between Venezuela and Colombia briefly shut down in 2005 after Colombia captured a FARC spokesman in Caracas. It happened again in 2008 after a Colombian bombing raid killed FARC's second in command inside neighboring Ecuador, a Venezuelan ally. In both cases, trade between Colombia and Venezuela briefly halted but was quickly restored.

That will happen again this time, because the two governments need the commerce more than they need the conflict. About 14 percent of Venezuela's imports come from Colombia. Venezuela needs these products, particularly processed food, because the tight price controls Chávez has ordered and his ongoing threats to nationalize companies and entire industries have depressed production levels inside his country. Closing the door to inexpensive and easily accessible Colombian imports would worsen already significant shortages and put extra pressure on inflation and fiscal accounts.

The dependence works both ways. About 18 percent of Colombia's exports go to Venezuela. President Uribe has fewer political vulnerabilities than Chávez, and with an election next year, some fear he might take a tougher than usual line -- rallying core supporters, riding out protests from the export sector, and boosting his chances of securing a third presidential term.

But Uribe will probably abandon hopes for a third term, since he's unlikely to win support from lawmakers to launch the referendum he would need to remove constitutional term limits. Uribe already faces criticism that he hasn't done enough to refloat the country's floundering economy. It makes little sense for him to make economic matters worse, just as he's moving into retirement.

It's one thing for Chávez and Uribe to stir up nationalist fury in a bid to change the subject from tough economic times. It's quite another to launch a mutually damaging trade war that can only make matters worse.

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By Eurasia Group analyst Sean West

Earlier this month, the G8+5, the world's leading industrial states plus some other important developing states, committed to finishing the Doha Round of trade talks by the end of 2010. U.S. and Chinese officials paid lip service to finishing Doha this week during the inaugural bilateral "Strategic and Economic Dialogue." World Trade Organization chief Pascal Lamy will likely cite both announcements as cause for celebration. Healthy skepticism is in order.

Overblown fears of oncoming protectionism were all the rage just weeks ago. But as Ian Bremmer wrote in this space back in March, the financial crisis need not trigger as many new trade barriers as some feared. Still, the global liberalization envisioned by a completed Doha Round by the end of next year is likely a bridge too far.

Pledges aside, there's not much reason to be optimistic that a deal can be concluded in the near future. Personality conflicts may have receded, as both Susan Schwab and Kamal Nath -- who banged heads last year -- no longer represent the United States and India respectively. But domestic conditions in the wake of the financial crisis won't help much with trade liberalization. While there's ample reason to be skeptical that neither China nor the EU are any more ready conclude an agreement than in the past, all other countries can play wait-and-see unless and until the United States shows serious leadership.

Obama has yet to lay out a clear strategy for the Doha Round. U.S. Trade Representative Ron Kirk has said several times that the United States considers Doha completion as critical, but there's no evidence yet that he'll have the political support he needs to set policy and to bargain. Comments from Obama himself on Doha have been ambiguous at best, warning of an "imbalance" in potential trade-offs on the table in current negotiations. It's also not yet clear how much political capital Obama will put at risk at a moment when he needs the support of organized labor for a host of other domestic priorities. And in a nod to agricultural interests, he allowed his budget proposal to cut farm subsidies -- a critical sticking point in the Doha negotiations -- to die on arrival.

Real movement on trade policy remains on hold until the president explains publicly how trade policy fits into his administration's broader agenda -- a speech he might give in advance of the September G20 meeting in Pittsburgh. But he'll have to use that speech to persuade an anxious American public -- and many trade skeptical US lawmakers -- that trade deals can spur growth without killing jobs. Obama has an advantage. His history suggests that he believes in the benefits of trade, and in a Nixon-goes-to-China way, he can spend political capital earned on the campaign trail to bring trade-wary Democrats along with his initiatives. But he has so far provided no indication that he's ready to accept the political risks that come with the push needed to get Doha done within 18 months.

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By Ian Bremmer

Believe it or not, there is an emerging bit of good news from Washington's efforts to address the financial crisis: The Obama administration and Congress are unlikely to stumble into the global trade war that some continue to fear.

The swing toward large Democratic majorities in Congress of the past two election cycles, some of Obama's campaign-trail rhetoric, and the financial spiral of recent months have stoked fear of a trend toward a level of protectionism that might trigger a belligerent international reaction.

It's not that we haven't seen U.S. lawmakers surrendering to a few protectionist temptations. In fact, the financial crisis has pushed governments all over the world to bolster their political capital by throwing up barriers meant to protect local industries and companies. In fact, the World Bank has noted about 50 trade restrictive actions and only a dozen liberalizing ones taken by G20 countries since they promised to avoid protectionism last November. Several countries have doled out low-cost (or no-cost) cash to domestic automakers; the United States has restricted stimulus procurement to a subset of countries under a "Buy American" provision; Mexico has slapped more than $2 billion in tariffs on trade with the United States in response to U.S. cancellation of a Mexican trucking program.

But thinking about the (limited) magnitude rather than the (large) quantity of these actions reveals that this is more a predictable, populist response to tough times than the opening salvos of a trade war. In the United States, the highest stakes for protectionism are around the automotive sector. That's not surprising, given that the loss of millions of jobs that would follow a total industry collapse would undo the Obama administration's job protection plans at one fell swoop. But there has been no serious suggestion in Washington of raising tariffs on foreign autos. And both nationwide polling and congressional votes have made clear that there is no large-scale public pr political demand for keeping the industry alive through massive subsidy. If the crisis in the auto sector, where both unionized labor and management could easily point to foreign competition as a cause of its problems, is not enough to merit nuclear protectionism, what is?

Nothing, probably. The silver lining to the economic and financial crisis in the United States is that it has very little to do with globalization. To date, there has been virtually no scapegoating of foreigners. Instead, polling suggests that Americans view the recession as the price that must be paid for domestic greed and lousy oversight. Certainly, as Americans feel poorer, the risk of redistribution from the have-lots to the have-littles increases. But that's not a backlash against international economic interconnectedness, trade, or global supply chains.

Some risk of a global trade war will remain for as long as the recession continues. And we certainly see more tit-for-tat protectionism internationally (especially out of Beijing, where economic nationalism is on the rise) as an unintended consequence of U.S. policy. But absent a depression scenario, the near-term likelihood of an all-out trade war remains small.

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