Future Outlook and Strategic Cooperation

Why do chancellors focus on pensions? Because it's a really attractive and tempting pot to raid. You've got questions about pensions and we've got the answers you're looking for. Join me, Philip Alam, on the Pension Confident Podcast, where we unpack the Downing Street decisions being made today that might impact your pension tomorrow. So give us a listen, that's the pension confident podcast, and you'll find all four seasons in your podcast app right now . Hi listeners. Today's episode of the Economics Show with Sameya Keynes is a little different. I'm still here, but I'm not the one asking the questions . Hi everybody. I'm Paul Krugman, professor at the City University of New York, and an independent newsletter writer on Substack. You might have noticed that I'm not Sumea Keynes, host of the Economics Show podcast. I'm here with Sumea, as well as her longtime collaborator Chad Baume, who is a senior fellow at the Peterson Institute for International Economics, formerly chief economist at the U.S. State Department. Together, these two have just written a book called How to Win a Trade War. And today we're going to be asking just that. How do you win a trade war? Zumeya Chad? Hi. Hi. Hi Paul . So maybe I can start by asking a slightly funny question, which is who are you? Not who I know you're a cat in some way, but uh but when we talk about how to win a trade war, who is you who's the audience? Presumably not actually Donald Trump, presumably not Xi Jinping. Who should be you know I mean everybody should read it, but who do you think might in some sense read it or at least be briefed on people who've read it? Well look, if Donald Trump wants to read the book, then we uh very willing to sign a copy, we'll hand deliver it however he wants uh a copy. And you know, the the the conceit of the book is that you, the reader, are really interested in fighting a trade war, right? And we are the two nerdy, kind of reluctant guides saying, uh, if you really want to do it, then you know, we'll give you the evidence that you need, we'll tell you everything there is to know. It's not easy to fight and win a trade war. Um, and so you know, at least arm yourself with the evidence of what's happened in the past, what works, what doesn't work. We kind of acknowledge that most readers may come to this not actually wanting to fight a trade war, right? So the point is to help people understand, you know, how to navigate this world of economic conflict. As I feel like, you know, many people have become unwilling participants in these massive, massive geopolitical conflicts. It can be a bit bewildering. And so, you know, the book is really supposed to be for everyone, right? To understand how we got here and where we go next. Let's talk a little bit about how did we get to this point. I think if we were holding this conversation 10 years ago, it mostly would have been, oh well, we're economists. We understand free trade is great. Uh maybe fifteen years ago, even more so. And you know, the answer is yes, don't do this. Free trade. So I think all three of us probably have had some visions on the road to Damascus about why that isn't an adequate approach. So I guess to answer the question, we have to talk about what trade war we could or should be fighting, because there are, I think, arguably multiple trade wars happening right now. You've got President Trump doing a lot of things, but behind that, there's another really big trade war that's happening, and that's the one having to do with China. So let me start there. I would say, and it's not as if I noticed this at the time, but say in 2015, um, when China rolled out its made in China 2025 strategy, uh, industrial policy that said, you know, we're gonna have these market share targets to dominate certain important sectors of the future, that was kind of a sign that China was thinking about things differently than I think the United States and others had been. And then you fast forward a couple of years with um Xi Jinping and his dual circulation strategy, more clearly articulating the idea that China did not want to be interdependent with the rest of the world. It wanted the rest of the world to be dependent on China for their supply chains, so the United States to be dependent on China for sourcing stuff, but China to not have dependencies on the rest of the world. And when you start to think about a functioning trading system as we've lived in for, you know, in the in the post-war period, since the the late 1940s, it requires rules, all those things, but it also fundamentally requires a willingness to be interdependent, right? And to trust that I'm going to export to you, you're going to import to me, and yeah, there'll be sometimes some frictions, but by and large, that will be okay. And China was saying, no, we want to have an asymmetric relationship where we want to do what we want to do, but we're not all that interested in in what you want to do. So for me, it was kind of seeing those things that really made me think that ah the world has changed. We're in some sort of trade war and really China is the part that's that's driving this. So my journey, I think um, you know, there was an important moment for me in the first Trump administration, right? And so, you know, Trump ran onto the scene during his first term and started throwing tariffs at China predominantly. And, you know, Chad and I had this podcast about trade, and we were the loudest voices saying, you know, what are you doing? You've got to you've got to play by the rules. Um, why not try to use the rule book to solve these underlying structural problems that we have with China? And you know, I was covering trade full-time at that time, and you know, something that was happening behind the scenes was that there were efforts to try and get some kind of coordinated plan to save the rules-based system to try and solve some of the structural problems between China and the US by writing new rules. So you had this these trilateral discussions between the US, Japan and the EU. And the idea was, okay, well, why don't we just write out the way in which we want China to behave, limits on subsidies, new ways of protecting ourselves against China's subsidies? And the idea was, you know, they would agree on that common plan, then they might go to China and say, hey, look , we've got some new rules, you sign up to these, and look, President Trump will drop his tariffs. That was the hope of some involved in that process. It certainly wasn't Donald Trump's plan. And I think a very fundamental way in which I have moved on from that is I I just don't believe that the solution to these problems lies in a new set of common rules that everyone is going to sign up to. Right. In fact, the Trump administration did go to the the Chinese government with a list of requirements or requests in terms of, you know, China's subsidy behaviour. And the Chinese, you know, shredded it, right? Um they weren't they weren't going to change their system . Um and so you know that's that's really the backdrop to where we are today, which is the Trump administration, I think pretty much most everyone else has given up on the idea that that the rules are gonna save us. And that is kind of scary. It's a bit, you know, it means that we can't rely on the rule book to predict what's going to happen next. It's a much more chaotic, power-based world. And we're kind of feeling our way through. Yeah. For what it's worth, I've had sort of two moments of revelation about trade. And one of them, which seemed terribly relevant, but maybe a little less so now, was the work uh early uh 2010s on the China shock, where we started to realize that hey, you know, the the problems of adjustment and dislocation that come from rapid globalization are a lot bigger than, you know, economists have always understood that there were distributional issues but they're a lot bigger and that that was revelatory and a bit of a shock but I think it's actually not the core of the story now and and for me the the revelation was actually when Russia invaded Ukraine. When we s realized, hey, this rules-based order, not just about trade, but everything, is not the future. We we sort of had to take it for granted that all of the old stuff, all of the old demons were had been banished. We weren't going to have countries just plain exploiting their powers over trade for geopolitical gain. And um we now realize I think I realize that hey, all of that all the things that we thought were fundamentals about the twenty first century economy were actually basically dependent upon a benevolent hegemon. Not totally benevolent, not totally hegemonic, but still a lot of it depended upon basically the United States, which enforced the rules and obeyed its own rules for the most part. And well, we're not in that world anymore. Not in Kansas uh anymore, among other places. So it's now it's a much tougher world out there. Can I just add that I think economists have been on a sort of journey as well, right? The starting point being your theory, right? So, you know, one of the we thought that one of the benefits of trade was, you know, agglomeration, right? You know, huge efficiencies, huge economies of scale, and that, you know, created these gains from trade. Uh and what we've seen now I think is that those agglomeration benefits are real, but in a world where we're not friends with everyone and we don't trust everything. They come with risk. Where do you feel like economics has has gone? Well, yeah. I mean that's a in some ways the models were already there, and we we understood that there are big advantages to agglomeration, although I think they've turned out to be even bigger than we realized. If we talk about Chinese manufacturing, it's not just that China is good at a lot of stuff. China has a whole industrial ecosystem that gives them tremendous amount of leverage in the world. I mean, China isn't the only place that has rare earth deposits, but it's the only place that has the industrial ecosystem that can process them at this point. And so I thought if you'd asked me 15 years ago, I would have said, well, all this national security stuff, that's just an excuse. National security is the last refuge of the scoundrel. But actually, not. Yeah. Um, so okay. Any further thought? Any other sort of revelations beyond the fact that that it it's a scary world with nasty people in it? So I have one which is, you know, you mentioned the the China shock literature, right? Um and so, you know, this is this collection of papers showing the effects of of of imports from China. Um and you know one paper that I thought was super interesting that came up as we were researching this book was was about what happened in Canada, right, when when there was liberalization as part of was it NAFTA or was it ? Um so the predecessor to to NAFTA. And actually, you know, this this research found that that the effects were n were really quite dissimilar from those China shock effects. Um people were able to adjust. There were export opportunities created by that trade deal. People moved into those other industries. There's also research looking at trade liberalisation and populism in in Europe, right? And there seems to be this relationship between places that have stronger social safety nets and the switch to right wing parties. Um, and so one point that that I would want to make is you know it's important not to go to over interpret what's going on now and to kind of see it as this as this idea that, you know, all trade liberalization, you know, has losers and and there's just nothing we can do to address those, right? There are cases where actually import liberalization, you know, we So I think it's you know it's important not to kind of overcorrect after some of those uh you know instances where there was you know real pain in the past. Trevor Burrus I'm trying to remember how much in the book you really talk about the political economy of the protectionist backlash. Because that is actually it's not as you know, there was a simple story, oh trade produces lots of losers, and now the the the public won't have it. And that's not actually the story as far as I can make out. What did you say? I'm trying to remember the actual way you put it. No, yeah. I mean I well I mean the the story is that it's complicated, right? And voters don't, you know, kind of respond as cleanly as you know one might expect to what the economic implications are for them. Right. And so one of the more recent China Shock papers, in fact, has looked at the longer run impacts of the China shock and the reapplication of the tariffs in the first Trump administration and has found that they didn't really do the job of, you know, helping workers in those regions, right? Didn't improve employment or anything like that. But But it did help President Trump's party in subsequent elections, right? So there is maybe something to the idea that, well, okay, he may not be helping me uh, you know, get a better job or or my employment process. But at least he's fighting on my behalf, right? And so what that means is it's really messy to draw these links between all of this stuff in the political economy context. There wasn't that much of, I think in the end, protection ism in the US and I think in Europe is not really a mass public groundswell. There are parties who exploit it, but it's not really, you know, the this this sort of simple deterministic, you know, losers fight back, and this is why we have a problem. It a lot more has to do with again the the complexities of the political process. Yeah, and so you can see this in, you know, both what's going on in the US and and also the EU. So if you think about what Trump did, right? He he had to do this by using and arguably abusing, you know, arcane bits of US law because he didn't have the support of Congress to apply these tariffs, right? And so he kind of ran roughshot over the democratic process there. Obviously in the case of AIPA, that turned out to be overturned by the Supreme Court. And you know, during the first Trump administration, companies were complaining quite a lot. I think during the second, those complaints were a little quieter. That's probably some combination of you know worrying about retribution. But also maybe in some cases they adapted, right? And so I think one lesson of that episode could be that you may not have the constituents for protection at the beginning, but you could you could develop those constituents if that protection is there for long enough. And then the contrast is with what's going on in in Europe right now, right? There's a huge discussion about whether the EU should essentially do more of what the US is doing and protect itself. And it's just extraordinarily difficult, even though you've got these really acute problems, right? German exporters being, you know, crushed in third markets the car industry really struggling to cope with that Chinese competition. And even then, right, even in the face of these really extreme Chinese export trends, even then it's really, really difficult to get a consensus, right? And so it's a question of: you know, can Europe ever act as decisively as the Trump administration? Um, you know, that there maybe there's a middle ground between kind of hopeless inaction and kind of maybe overaction. But yeah, that that just speaks to that issue. The importance of pesky institutional details, including the details of legislation that people wrote decades ago that were not intended for the purposes to which it's being applied is it's amazing. I mean the fact that section 122 is written the way it it is and that AIPA is written the way it is is suddenly turning out to be, you know, the the the fate of the world is hinging on more or less accidental wording of of decades old legislation. It's kind of amazing. I was outraged when I, you know, I an economist, uh you know, the economics correspondent of the Economist magazine . I started, you know, covering trade. I thought this was gonna be all about, you know, big intellectual battles of of you know which model worked best. And actually I essentially became a lawyer um working out, you know, what what does the section 301 statute mean? What's 232? How is this compatible with the World Trade Organization rules? You know, it's you get stuck in the legalese quite quickly. But as you say, these these details really, really matter. Yeah, I knew somebody who uh taught a trade policy course y long ago, but uh she would return term papers with uh just right at the top, a Y H T M A A A I Y P , which was you have too many acronyms and abbreviations in your paper. So anyway, we're talking about Europe responding. And you're going to tell the European Commission here's here's what you should do in response to. I think you called the America's a pirate and China is a warship. But anyway, they, you know, they to these two quite different, but also but very seriously threatening aggressive trade policy partners. The two of the world's three economic superpowers apart not behaving the way they used to. And you're, you know, t the most obvious case is okay, you're the you're sort of running the third power. What what should you be doing Well, engaging, right? And I think, you know, as some may indicated, Europe has been a little bit slow to engage in the can we fight a trade war question, but they do seem to be there now. One of the really interesting front lines for Europe at the moment is this issue of electric vehicles and the automotive sector? And what's fascinating is is the following. They're essentially trying to see if they can learn from the Chinese model to encourage Chinese firms to build cars in Europe, right? So what was the Chinese model? The Chinese model was forced technology transfer. What made them successful at the time, or partly what made them successful, was back in the early 2000s , there were a lot of Western automakers in the United States, Japan, Korea, Europe that all wanted access to China's 1.4 billion potential drivers, right? And China had high tariffs at the time. So exporting into China was really hard. China said, we want you to build those cars here. Um, and not only do we want you to build those cars here, but we want you to form joint ventures with local Chinese firms and then teach them effectively uh how to make cars themselves, right? And they were successful. And part of the reason why they were successful, you know, we think is there were lots and lots of these Western automakers competing against each other, all seeking to get access to that Chinese market. So you fast forward today and you say, well, okay, can Europe do the same thing with respect to the you know the Chinese technological leaders today in in battery electric vehicles? And while there may be at the moment lots and lots and lots of EV manufacturers in China, BYD is the dominant one. Um, and behind that is the battery makers, which are BYD and CATL, right? And to sort of thwart that possibility, right, the idea that, well, maybe Europe could exploit divisions amongst Chinese firms and negotiate to get them to come into Europe, partner with German automakers, teach them how to make battery electric vehicles better, locate production here, create lots of jobs. The Chinese government has already set up a system of licensing for its technology and saying no, BYD, C A T L, you know, these companies, you're not allowed to just go out and negotiate with the Europeans. We're gonna be the one. The Chinese government is gonna be the one controlling access to that technology from foreigners, right? So on one hand, you have the Europeans maybe seeking to learn from the Chinese model. And the other hand, you know, the the Chinese are already going a step beyond and saying, yeah, we're not going to let you learn from our from our model and get those jobs there in Europe. Here's how we're going to thwart those kinds of things. Wow. And that's uh that's really instructive because I guess all of us you know spent years learning uh about why government intervention and trade is almost always a bad thing and how letting people buy where they want and not not certainly not blocking possi ble profitable opportunities is is clearly going to hurt your country. And then we're sort of saying, oh , you know, this deer resist uh overall control. And in this case, it's not just geopolitical. It's well, you know, China can preserve its uh effectively its technology advantage, even though it's not fancy technology, because they can uh can close off uh the technology transfer. So but you're you're saying that basically, as as I understand it, that at least the EU, presumably uh Mark Kearney's middle powers need to be at least a little bit more like the Chinese, have uh have more of a sort of let's let's think about this from a a national interest uh point of view. I think that's right. I mean I think you know one of the lessons that we took away from the book is we all need to learn a lot from each other, from the other players. But especially, you know, I think in the Western system, we need to learn from China. That does not mean we need to adopt the Chinese model, right? And so please don't get me wrong. But there are elements of what China does when it does industrial policy, when it does in that earlier example, the the transfer of technology, that if you want to have those similar kind of outcomes be successful, you really do need to see what it was about the Chinese system that allowed them to be successful in those instances, you may not be able to replicate it, right? So you need to you need to learn those kinds of lessons as well. But yes, important lessons from China. Aaron Powell So I mean the European EVs in Europe, I mean the United States has decided that we're going to have coal burning cars or something. But um EVs in Europe, there is a question, should they even be trying? You know, why not okay, if the Chinese are gonna sell you cheap electric vehicles, why not just drive cheap electric vehicles and uh work on on your European comparative advantage, whatever that may be. I mean this is actually a a debate in the US, right? You've got some saying, you know, why won't you let me buy a cheap EV? These these things are, you know, karaoke bars on wheels. I want a I want a piece of that uh equipment. And the arguments against, you know, include one, this is actually an area where Chad and I had quite a heated debate as we were writing the book, as Chad was much more in favor of banning things than than I was. And you know, that relates to some of the security risks around you know having Chinese software around some of these vehicles, the risks of surveillance, even being able to turn off the car remotely. Chad was more , you know, gung-ho about banning banning vehicles because of that concern than than I was. I wanted surely it's possible to come up with some kind of technical test. Because you know if we're if we start banning cars on that basis, then you know, what about smartphones? Right, last time I checked, there was quite a lot of electronic equipment that was made in China that could, in theory, carry the same risks. So are we really going to be inconsistent? So there's the security piece of that. There's also just the political economy piece of that, right? Which is that, you know, the the car industry is massively important in Europe. The the political consequences of letting all of those smaller companies just shut down would be potentially devastating. And then third, there's a kind of bigger argument about industrial capacity uh and you know when we don't trust each other, is it really wise to be you know cutting cutting manufacturing um or accepting the loss of manufacturing? Could there be some connection to innovation? The evidence on this isn't you know something that we we explore, but it isn't you know as concrete as we'd like. But do the folks who worry about manufacturing having some kind of national security advantage do, they have a point right in some kind of heated conflict? Do you actually need the capacity to scale up quickly? Um, and so actually having that industrial might is important now. That doesn't mean manufacturing jobs, but you know I'm talking about overall manufacturing. Some ETFs simply take you further. Am und's solutions are built with your needs in mind. Empower your investments with the number one European ETF provider. ETF says they should be. Find out more at omundetf.co.uk Amundi Trust must be earned. Source ETFGI March 2025 for professional clients only. Capital at risk. Marketing communication issued by Amundi UK Limited. FCA authorized under 114503 . You wrote the book, obviously, before the Iran War, but you do talk about supply chains and the the threat of cutoffs, and that's now seems immensely more real. How does that change the way we think about trade wars? So I think Iran and Strait of Hormuz, rightight. From Iran's perspective, the war, the physical war, the military aspects of it are have to be absolutely devastating, right? But at the same time, they have been able to weaponize through their export restrictions, you know, imposed on not allowing things through the Strait of Hormuz in a way that is, you know, orders of magnitude bigger than the size of their economy would otherwise suggest, right? And so that's part of the new world in which we live. Sometimes you have those kinds of supply chain disruptions that can come up by, you know, not recognizing just how serious those choke points are I think there were a lot of folks that probably did recognize how how serious those potential choke points were. But as we have seen, you know, through what's happened since February, the world is now, you know, facing the consequences of of those actions. So just building on on that, you know, I think what we've seen so far with the straightforward moves is that some of those disruptions haven't hit yet. And that's because companies have been doing, you know, one of the policies we we discussed in the book, which is stockpiling, right? So we've had inventories and they've been running them down. Um so you know when the crisis first started, uh you know, folks were asking how bad could this get? And the response was, well, as long as it doesn't last for very long, it'll be okay, right? Because there are those buffers. And so, you know, the crisis I think highlights the importance of having those buffers. But also I think that, you know, there is a point about substitution. So if you think about the drop in oil flowing out of the the Strait of Hormuz, a third of that has been made up with oil flowing out through other ports. Right. And so one of one of the lessons here is that you know, when thinking about your vulnerabilities, actually, there's always some slack in the system. There are always some opportunities for substitution. It may not be fast, it may not be easy, but actually, one of the lessons from history in extreme situations is that we tend to be a bit more adaptable than we sometimes fear. That said, obviously, you know, if this disruption goes on, there's real pain being felt, right? We shouldn't, we shouldn't then swing too far in the other direction and say, oh well, there's no point in applying export controls because we can always adapt away. That's not true. As we are seeing now in in you know some of the the poorer countries who are on the front end of this and as we will be seeing later, um, you know, these these weapons are pretty are pretty impactful and pretty dangerous. Aaron Powell What struck me though is I mean the straight up or moves is a physical choke point which is helpful for illustrating the concept but it turns out there are all of these de facto choke points like rare earths like well, semiconductors . I mean, uh, it's not that so much stuff passes through the straight of Taiwan. It's uh the fact that that basically everything runs on chips made in in this island. So yeah. And you it you do you do talk about this. I mean, right there there is definitely a case for policies that even at some cost make sure the critical stuff is made in some quantity in places that are are less subject to this kind of wow. Uh for for many years I was co-author of the the best selling international economics textbook. I don't think we mentioned supply chains, export controls, any of that. I think I probably haven't yet. It it is something. Last question, then we I'll let you go. Um how does this pan out? You're giving some some good advice to people who are not Donald Trump. I mean, maybe Trump would benefit from it, but he's not going to read it. Um, and probably not Xi Jinping, but um what how does do you think this shakes out? It's you know it's possible that Markoni and his middle powers or Ursula Fon Belea and then the U EU leadership will in fact think about these issues and and quite possibly read your book, if that's they should. Uh what does the world look like in five years? Okay, well look, I'm gonna be real. I don't think there's gonna be some grand bargain um in the next five years, right? Which goes back to my point earlier about the rules aren't going to save us. Um, and that's you know, those underpinned the stability that we had for so long, right? That's that's really the only outcome that would would would reduce the chaos, right? And so without that, we're kind of in this messy world where everyone is gonna be following this rule book that we've laid out, everyone's gonna be trying to stockpile, to subsidize, to to look to see what everyone else is doing, to see what lessons they can learn. That's gonna be, you know, pretty chaotic, I think, because, you know the chances are that there's going to be um you know misinterpretation of what's happening. So just you know take an example, stockpiling is one of the main tools that that countries are now deploying to try to protect themselves against you know weaponized shor tages. But you know there was a hearing not too long ago where one of the US committee was quizzing experts on on whether stockpiling was a sign that a country was about to attack , right? You've got China building up massive stockpiles. What if that breeds suspicion that there's some kind of military preparation? And what if Western stockpiling breeds that suspicion on the other side? Right? So you have this real risk of these awful self-fulfilling dynamics. So, you know, do all the nice things, right? Communicate. Try to coordinate with your friends. Engage. Be as transparent as you can. Put in the effort, spend the money, subsidize stockpile, do all of the things that are hard, but you know, you're gonna have to put in the effort and be consistent about it. Because, you know, the the dynamics are such that in a trade war, your adversary is gonna be , you know, taking advantage of any any moment of weakness to to try to strengthen their position. And I would say for me, the only things I would add to that is please work with your partners and allies, right? It doesn't make a whole lot of sense to be fighting with them and distracting them away from the really hard task at hand of fighting the real trade war that needs to be fought, which is dealing with these challenges of with China. And you know, every ounce of time that Europe or Canada or Japan or Korea has to deal with American tariffs, demands for, you know, invest here in my energy sector or something like that, instead of focusing on how do we most quickly at lowest cost possible to deal with the affordability concerns, diversify some of these supply chains away from China, while China is actively trying to prevent us from diversifying those supply chains away from us. We need to do that kind of thing together. So focus on the trade wars that need to be fought and let's put the other trade wars to the side. Okay. That's actually interesting because you're basically saying that the if not full-on conflict, their trade war with China is basically is gonna happen, at least a cold trade war. And uh and that if only the United States would stop doing what it's doing, that we could actually