Trade Truths for Trumpians and Brexiteers

LONDON – Here’s a reality check for British and American policymakers, and for the many pundits who frequently comment on world trade without understanding its realities: data on Germany’s total exports and imports in 2016 indicate that its largest trading partner is now China. France and the United States have been pushed into second and third place.

This news should not come as a surprise. I have often mused that, by 2020, German companies (and policymakers) might prefer a monetary union with China to one with France, given that German-Chinese trade would likely continue to grow.

And so it has, driven primarily by Chinese exports to Germany. But German exports to China have also been increasing. Notwithstanding a recent slowdown, Germany could soon export more to China than to its crucial neighbor and partner France, and it already exports more to China than it does to Italy. For German exporters, France and the UK are the only European national markets larger than China.

Seasoned observers of international trade tend to follow two general rules. First, the level of trade between two countries often decreases as the geographic distance between them increases. And, second, a country is likely to conduct more trade with big countries that have strong domestic demand, rather than with smaller countries that have weak demand.

The latest German trade data confirm both rules, but especially the second one. A big but geographically distant country is different not only in size, but also in kind from a smaller one. This is too often forgotten in discussions about trade agreements, especially in such charged political atmospheres as currently prevail in the United Kingdom and the US.

In the UK, the House of Commons has already adopted a bill to establish a process for withdrawing from the European Union; but the House of Lords is now demanding that the bill be amended to protect EU nationals living in the UK. In my own brief contribution to the marathon House of Lords debate last month, I argued that, even if Brexit is not the UK’s biggest economic-policy challenge today, it will likely exacerbate other problems, including persistently low productivity growth, weak education and skills-training programs, and geographic inequalities.

Moreover, I warned that the UK will need to adopt a far more focused and ambitious approach to trade, not unlike that of China or India, if it is to fare well after Brexit. Sadly, the UK’s post-Brexit trade strategy is being determined by internal politics, such that it is “patriotic” to focus on new trade deals with Australia, Canada, New Zealand, and others in the Commonwealth, while ignoring harsh economic realities.

New Zealand may be a beautiful country, but it does not have an especially large economy, and it is a very long way from the UK. In fact, despite its massive problems, Greece’s economy is still larger than New Zealand’s.

Many UK policymakers – and all members of the “Leave” campaign – are ignoring the likely costs of exiting the EU single market. But this factor alone demands serious attention, given the single market’s size and close geographic proximity. It is very important that the UK maintain strong trade ties with many EU member states after Brexit. To that end, Britain should be shoring up its exports of services, a sector where it arguably still has a real net natural advantage.

At the same time, the UK should urgently be trying to take its relationship with China – or what former British Prime Minister David Cameron called the “golden relationship” – to a new level. If there is any country with which the UK should want to strike a new trade agreement, surely it is China. During my brief spell in the British government, I helped then-Chancellor George Osborne persuade Cameron that we should aspire to make China our third-largest export market within a decade. Does the new government still consider this a priority?

Beyond China, Britain also needs to be far more focused on its trade ties with India, Indonesia, and Nigeria, all of which will have significant influence in the world economy and global trading patterns in the coming decades.

In the US, President Donald Trump and his economic-policy advisers need to return to reality, especially on trade. They can start by studying Germany’s trade patterns, especially vis-à-vis China. To be sure, China has a large bilateral trade surplus with the US; but it also constitutes an expanding export market for US companies. And if trends from the last 10-15 years continue, China could soon supplant Canada and Mexico as America’s most important export market.

As Chinese household income continues to rise, demand for some of the US’s most competitive goods and services will only increase. Trump, rather than spewing nonsense about China manipulating its currency, should be encouraging market forces to rebalance bilateral trade.

The same can be said for the US’s overall external deficit. Unless the US can boost its savings rate relative to its internal investment needs, it will continue to need foreign capital inflows. And this, in turn, will require it to maintain a trade and current-account imbalance.

Finally, by pushing for a renegotiation of the North American Free Trade Agreement, Trump is taking a risk similar to that of the Brexiteers. Despite China’s recent gains, Canada and Mexico are still close neighbors and crucial trade partners. By potentially disrupting import patterns with all three countries, Trump’s policies are more likely to push up import prices, while jeopardizing US export growth.

Jim O’Neill, a former chairman of Goldman Sachs Asset Management and former Commercial Secretary to the UK Treasury, is Honorary Professor of Economics at Manchester University and former Chairman of the British government’s Review on Antimicrobial Resistance.

By Jim O’Neill