When Theory and Reality Diverge

One of the difficult things in economics is to match theory with reality. Anybody who has taken a basic economics course has learned the theory of comparative advantage and been taught the advantages of free trade. On a macro level, trade produces gains for everybody. Occasionally acknowledged is the reality that on a micro level, it is not that simple. Trade accelerates the pace of change in an economy by introducing new, more competitive elements and encouraging the creation of more of them. That creates winners, but it also creates losers who find themselves on the wrong side of technology change, productivity improvement, and the unfair trade practices of foreign producers.

Unpacking that a bit, the first two—technology change and productivity improvement—are predicted by and consistent with economic theory, although theory historically has not had much to say on what to do about their victims. The third one—unfair trade practices—has been more controversial, with some economists arguing that if other nations want to dump or subsidize their products, that is to the advantage of the buyers, who get cheaper goods. Others point out that the bigger consequence is that domestic producers get pushed out of business. That is why we have trade rules and the World Trade Organization (WTO) to enforce them, at least in theory.

We are now in an era where economists have begun to recognize that these are market flaws not fully contemplated by David Ricardo and his intellectual successors, and, more important, not fully addressed by existing rules. The most cited culprit these days is China, although many of its policies have precedent in the actions of Japan, South Korea, and Taiwan, all of which used various combinations of industrial policy, subsidies, protection, and (legally or illegally obtained) intellectual property from the West to produce rapid economic growth and the development of globally leading companies in a variety of sectors.

In the case of China, countries are grappling with Chinese actions with varying degrees of success, largely through traditional tools that are WTO-approved, like the U.S. laws on dumping, subsidization, and patent/trademark infringement. Work is also underway to develop new tools. Numerous U.S. officials and politicians have called for them (without offering concrete suggestions as to what they might be), and the European Commission is in the process of polishing its new “economic coercion” tool. That is important because the existing tools have limited effectiveness. They provide relief that is too little too late. Investigating and judging a complaint takes a long time, and the complainant is often in dire straits by the time the matter is settled, and the relief provided, by design, is compensatory rather than punitive so the deterrent effect can be minimal.

While I do not recommend abandoning the old tools, and there are some proposals pending in Congress to enhance them which deserve support, there is another way of looking at the problem that is worth consideration. (I am indebted to Clete Willems at Akin Gump Strauss Hauer & Feld for giving me this thought.) It is based on the idea that it might be more effective to help the victims—the companies having to deal with unfair competition—than punish the perpetrators. Clete’s suggestion was in a different context (how can the U.S. government help companies that it has harmed through restrictive export controls) but the principle is the same: government can help companies find new markets to compensate for the ones they have lost, either due to export controls or unfair trade practices.

In the case of export controls, from the U.S. companies’ perspective, the U.S. government is the villain because it has imposed limits on their exports, but the government is also able to open new ones for them through trade agreements. This is an opportunity we are clearly missing in the current Indo-Pacific Economic Framework negotiations, both because the United States made an initial decision not to negotiate on market access generally and because it now appears that we are seeking little progress on digital trade commitments specifically. The result is that some U.S. high-tech companies will take a revenue hit due to export controls, and we are passing up an opportunity to create alternatives for them.

In the case of unfair trade practices, the villain is the foreigner, but there is much the U.S. government could do to help U.S. companies find alternative markets through trade agreements and by providing more effective export financing and support from the Department of Commerce and the Export-Import Bank. The administration’s aversion to exports remains a mystery.

Both cases also illustrate a larger point. The economic battleground of the future will be with China, but it will not be in China, where the risks of doing business continue to grow. Instead, the battleground will be everywhere else—Africa, Latin America, Europe, the Middle East, and India—where we will find ourselves competing head-to-head with highly competent Chinese companies. The Biden administration appears to understand that and has taken steps, including the CHIPS and Science Act and the Inflation Reduction Act, to help get our companies in better shape to compete. Assisting them in finding new markets through trade agreements should also be an important element of our strategy. We are missing that opportunity and with it a chance to align market realities more closely, though still not perfectly, with theory.

William Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies in Washington, D.C.