I just finished Trade Wars Are Class Wars by Matthew Klein and Michael Pettis, a book about the history of global trade that I think deserves your attention.
Below, I will provide a brief summary of the book along with some themes that I took away from it. If you are more interested, I will post more detailed notes next week and would also suggest picking up the book.
Brief Summary
The central theme of the book is that inequalities within countries are being misinterpreted as trade disputes between countries via “trade wars”. The current open system of global trade with the US dollar at its center was fine when the United States was large share of the global economy. However, the US economy is now a much smaller proportion of the world economy and the system is showing strains.
The book begins with a history of global trade starting with Adam Smith’s theory of specialization and ending with illustrating the complexity of Apple’s global supply chain. Next, the books goes into trade basics such as understanding that financial flows drive trade flows and how savings, investment, and trade imbalances occur. Next, the book provides historical context for two surplus countries (China and Germany) and a deficit country (United States). Finally, it makes some recommendations on how fix the problems of the imbalances that have occurred.
Next, I share some themes I came away with.
Global Trade Today
Before reading this book, I naively assumed low trade barriers were good for all. Unfortunately, that doesn’t seem to be the case. Open systems have benefits as well as costs. The open system of global trade today is subject to imbalances and bad incentives. These imbalances cause tensions between countries that really reflect inequality within countries that most can’t seem to square. Said another way, we like our cheap stuff, but it may be cheap because workers in other countries are not getting a fair shake.
For example, consider China and Germany, two economies that are export driven. They export more because their goods are cheaper. However, the authors argue this is not because they are more efficient, but rather the reflection of inequality within their countries. This inequality is a result of a domestic policy that subsidizes production at the expense of consumption. These countries suppress consumption of their workers to keep goods cheap. The value that doesn’t flow to workers instead flows to business owners who do not consume but rather save the capital they accumulate.
To compound matters, the wealthy people in these countries do not invest it domestically but abroad accumulating foreign exchange reserves. In effect, those countries overproduce for domestic needs, and export the difference to the global market. Even now, the two countries I mentioned above are now at odds ($) as they compete for export market dominance.
Unfortunately, these actions affect other countries as well. For example, from 2000-2010, the United States closed 66,000 manufacturing facilities as they are no longer competitive with global imports. Countries who force workers to under consume deindustrialize the countries that absorb the excess production.
Advances in technology have made global supply chains more efficient and complex, increasing profits, but also compromising both resilience and optionality. Make no mistake, optionality has value as we have seen during the COVID-19 pandemic. In an ironic twist this pursuit for efficiency has come at the cost of global supply chains being “weaponzied“, creating a modern day hold-up problem. Advanced economies always move up the chain into higher “value added” activities, but that doesn’t mean value chain activities such as manufacturing aren’t important, and in fact may be matters of national security.
Finally, this book pointed out that analyzing trade data and bilateral trade imbalances are not effective. Trade data is not useful because the country exporting the finished goods gets credit, but often raw materials and components originate in other countries. Bilateral trade data is also not useful given all the differences balance out on a global level. This means the imbalance between two countries is reflected somewhere else. Stated simply, viewing the US / China trade imbalance does not give you the whole story. Only global relations matter. This makes policy such as tariffs a tool that either has no impact, or the cause of additional harm.
Infrastructure & Innovation Drive Development
Initially, global trade was simple, consisting of raw materials and finished goods. There was really no infrastructure or ability to trade intermediate goods. The development of infrastructure, better communications technology, and the shipping container changed all of that. These advances spawned strong growth in global trade and led to complex global supply chains.
I thought I heard this story before, and I was right. The opening chapter of Economics of Strategy analyzes the business environments of the United States in 1840, 1910, and today to show that advances in infrastructure and technology reduced coordination costs. This allowed firms to develop from small businesses with a local presence to become large corporations who sought to expand markets and exploit scale and scope economies. The same thing has happened with global trade, but the markets are not going from local to national, but from national to global.
Capital Allocation
Capital allocation is a topic I often think about, but usually at a firm or even individual level. This book helped me realize capital allocation also occurs at the national level, which is really a sum of the individuals, business, and governments decisions.
At the national level, capital allocation is influenced by a country’s economic development priorities expressed through its monetary and fiscal policy choices. This book also highlights, much like people, nations are not always rational capital allocators. This of course makes perfect sense given countries are made up of people who make the decisions.
The authors point out that many countries accumulate US reserves not because they represent the best investments, but as a form of self-insurance against catastrophe. This is not to say it doesn’t make sense within the current system, but it is certainly not the most rational use of capital.
In other cases, ideology can trump logic and cause countries to misallocate capital. The authors point out that Germany likes a balanced budget and abhors public debt. They also contend Germany should have taken on public debt to improve its infrastructure instead of investing its excess savings abroad. This idea may have some merit.
Capital flows from other countries seeking safety have to go somewhere. If the government chooses not to issue debt, that capital makes its way to businesses or even individuals and this has been the cause of many recent bubbles, both historical and present day as the book explains.
Scarcity vs. Abundance
A theme I run into a lot is that of scarcity versus abundance. Ben Thompson argues in a world of scarcity, distribution power served as a moat for many companies that the internet has decimated. Now, value in the value chain has accrued toward the ends which he aptly explains how the internet is best defined by the smiling curve.
The authors make a similar point, but in terms of an age old tradeoff between savings and consumption. Delaying consumption to fund investment and increase production is not as important as it once was now that resources are abundant.
The takeaway here is more value will come from increasing consumption (demand) than by saving money that ultimately goes to find safety. The authors posit that consumption and production can push one another forward in the form of a positive feedback loop. Greater production, if transformed into higher wages for workers, would encourage them to consume more, which would help expand production. We often hear global growth is slow which makes this idea interesting to me. Is it because there is not demand, or that we are artificially suppressing demand through policy?
Conclusion
This book was an excellent primer on the system of global trade and provided great historical context that has led us up to today.
It also gave me a better understanding of how interconnected our world is and how choices made in one place can affect others far away. I am glad I read it as I feel we will hear a lot about global supply chains going forward.
Update: I posted my book notes here.
