The Unraveling Economic Order
The world has entered a period of extraordinary turmoil and uncertainty characterized by, among other disruptive developments, the breakdown of the international economic order that has existed since the end of the Cold War. The interval that is now ending has been described as an age of globalization, a period of exceptionally high levels of economic interconnectedness, with relatively unobstructed transnational flows of goods, capital, and data encompassing virtually the entire planet. Now, after falling for several decades, barriers to trade and investment have begun to rise and seem set to spring up markedly in the years immediately ahead. It is not yet clear how far this process of fragmentation will go, how fast it will unfold, or what will take the place of the highly integrated, largely open global system that has now begun to unravel.
In trying to explain recent events there is always a temptation to simplify, personalize, and focus only on the latest developments. While it is tempting to attribute everything to the whims and obsessions of Donald Trump, and especially his affinity for tariffs, this would be superficial and misleading. A deeper understanding of what has been happening lies in the realms of theory and history.
In contrast to economists, who generally prefer to analyze them in isolation, as if they operated solely according to their own, internally consistent rules, political scientists and historians insist that economic systems always rest on political foundations. How an international economic order operates depends on the distribution of power among the states it comprises. As my late Princeton colleague Robert Gilpin pointed out over 50 years ago, open international economic systems are rare because they depend on an unusually lopsided power structure. Their creation requires the presence of a liberal “hegemon,” a single state whose wealth and power vastly exceed those of all the others and whose domestic economy is based on liberal principles. These include private ownership of the means of production, a reliance on freely functioning markets, and limited intervention by the state.
Liberal hegemons are willing and able to pay the costs involved in managing an open international trading system, even at moments of crisis.
Motivated by a mix of ideology and self-interest, liberal hegemons seek to create international economic systems organized around similar principles. Their leaders believe that open, market-based orders will enhance the welfare of all participants. But they are also confident that such systems will serve the interests of their own countries, creating outlets for domestic industries and enabling ready access to the raw materials and other inputs they need in order to grow.
Liberal hegemons are willing and able to pay the costs involved in managing an open international trading system, even at moments of crisis. The size of their domestic market and the relative sophistication of their industries give them the confidence to resist protectionism, their deep capital markets provide the liquidity that eases international trade, the power of their successful example and their diplomatic clout make it easier for them to persuade (or pressure) others to follow their lead, and they have the military capacity needed to keep open the channels of global commerce.
Open systems can create prosperity for all, but thanks to what Vladimir Lenin labeled the law of uneven development, they are also inclined toward instability. This is because wealth is the ultimate source of power and national economies never grow at exactly the same rate. In time, differences in growth rates will change the distribution of national power, and, whether slowly or in a sudden crisis, such changes will eventually alter the character of the international economic order. Ironically (and inadvertently), a liberal hegemon’s preferred policies actually serve to accelerate this process. By promoting the widespread diffusion of goods, technology, and capital, the open systems that liberal hegemons create help spur the rise of other states, eating away at their own margin of advantage.
As its relative power diminishes, so too will the hegemon’s inclination to absorb the costs of preserving an open system. Increasing foreign competition will lead to mounting demands for protection from domestic industries. As its position erodes, the hegemon’s people and their leaders will be more inclined to believe that other countries have been taking advantage of their country’s openness. On the other hand, when the hegemon takes actions to shore up its position, others will see its behavior as self-serving and unfair. Disputes over trade will become more common and more likely to escalate. Open, integrated systems will grow increasingly fragile and prone to break apart, fragmenting into closed trading blocs.
Such an outcome is not inevitable, but it is more likely to be avoided under certain political conditions. Even as the hegemon declines it may be able to preserve openness if it can cooperate with other leading economic powers, creating agreements and institutions that help them to resolve their differences and preserve the system. Such cooperation is far more likely when the core group is made up of like-minded (i.e., liberal) states that share a belief in the virtues of openness and a commitment to preserving it.
This theoretical framework can shed light on recent events and help to explain the history of the past century and a half. During these years, the world has seen what can best be described as two and a half eras of globalization: two periods of full global integration (from the mid-1800s to 1914 and from the end of the Cold War to the present), punctuated by an interval of partial, geographically limited integration (from 1945 to roughly 1990). It is the second era of full globalization that is now drawing to a close.
The first era of full globalization extended from the second half of the 19th century to the outbreak of the First World War. Having led the way in the Industrial Revolution, Great Britain became for a time the world’s biggest, most productive, and most advanced economy, as well as its preponderant naval power. Britannia ruled the waves, abandoned protectionism, promoted free trade, and persuaded many others to follow suit. In time, competitors inevitably arose. Taking advantage of their superior scale, as well as the appropriation of British intellectual property and the use of tariffs to protect their own “infant industries,” Germany and the United States began to surpass Great Britain, challenging it in global markets and even at home. At the turn of the century, although they wavered under pressure from domestic interests, Britain’s leaders held firm to their faith in free trade. Ultimately it was the First World War, triggered by Germany’s growing power and increasing aggression, that brought the first era of globalization to a sudden and catastrophic conclusion.
After the war, under the leadership of Woodrow Wilson, the United States tried to re-create an open international trading system, but Wilson’s plans were soon rejected by both the US Congress and America’s wartime allies. Weakened by war, Britain no longer had the capacity to preserve an open system, while the United States, now the world’s dominant economic power, lacked the willingness to do so. With the onset of the Great Depression, trade collapsed, the world economy fragmented, and international tensions rose—paving the way for another global conflict.
Anxious to avoid the mistakes of the past, in the immediate aftermath of the Second World War the United States sought once again to build a fully integrated international economic system. This effort, too, was quickly abandoned because, once again, the political preconditions were lacking. The United States was comparatively wealthier and more powerful than it had ever been, but it was now one of two opposing superpowers. In ideological and geopolitical terms, the structure of the international system was bipolar, and much of the international economy also became divided into opposing camps. To the West lay a capitalist bloc, comprising the nations of North America, Western Europe, and Northeast Asia. In the East, a socialist bloc extended across Eurasia and included the Soviet Union, its East European satellites, and, initially, the newly formed People’s Republic of China.
Over time, the Western bloc came to be characterized by increasingly free flows of goods, capital, and people among its members and significant barriers to exchange with those outside its boundaries. This was a partial, as opposed to an all-encompassing, global liberal order. Meanwhile the Eastern Bloc (from which China eventually broke away) comprised a hierarchical, quasi-imperial system centered on Moscow and walled itself off deliberately from the West.
Starting from a posture of overwhelming postwar preponderance, the United States experienced a degree of relative decline as its allies and former enemies recovered and began to challenge its economic dominance. This led to episodes of friction and occasional calls for protection in the United States, but these were fended off, and the overall openness of the partial liberal order was preserved. United by their shared commitment to liberal economic principles and political values and facing a common external threat, the democracies were able to resolve their differences. America’s essential role in providing security also gave it added leverage that it used at times to try to bolster its own position, as in the 1980s when Washington sought to shield American manufacturers from Japanese imports by pressuring Tokyo to revalue its currency. In the end, the Western bloc was able to hang together and outproduce, out-innovate, and outlast its Eastern rival.
Following the collapse of the Soviet empire, the United States tried for a third time to build a fully integrated global economic system, in effect extending the perimeter of the partial liberal order that had grown up in the West until it encompassed the entire world. Circumstances appeared at last to be auspicious. America was now a true global hegemon, basking in its “unipolar moment.” The “end of history” seemed to portend an end to ideological rivalry and the triumph of political and economic liberalism. The “IT revolution” and other advances in communications and transportation were propelling economic integration. “Globalization” was the watchword of the day.
By the late 1980s this process was already well underway. With the death of Chairman Mao Zedong and the rise of Deng Xiaoping, China had begun to emerge from its self-imposed isolation and was pursuing a market-friendly policy of “reform and opening up.” Many Western observers believed that this would lead inevitably to the liberalization of China’s domestic economic and political systems. These trends would be further accelerated by China’s incorporation into the World Trade Organization in 2001 and the resulting convergence in values and interests would enable the successful management of a unified global economy.
Today the preconditions for preserving such a system no longer exist. The United States is first among equals, but it is no longer as dominant as it once was. China’s share of total world gross domestic product has grown from 3.5 percent in 2000 to just under 17 percent today, while the US has gone from 30 percent to 26 percent. During this same period, China has gone from 6 percent to over 30 percent of total world manufacturing output, while the US has fallen from 25 percent to 17 percent. By some estimates, within a few years China could account for an astonishing 45 percent of global manufacturing, an agglomeration of industrial power unmatched by any nation since the United States in 1945.
In addition to differences over economic issues, there is a deep divergence in values and strategic interests between the United States and China.
Since the turn of the century, there has been growing dissatisfaction in America and other advanced industrial countries with the way in which the global economic system is working. This is due partly to pressure from a large, fast-growing competitor, but it also reflects an increasingly widespread recognition that, despite its promises, China has not been playing by the rules of a liberal trading system. Beijing has persisted in its use of market-distorting trade and industrial policies and its theft or forced extraction of others’ intellectual property. The most recent outpouring of subsidized, underpriced Chinese exports now threatens the viability of industries in advanced and developing countries alike. Washington’s attempts first to coax and then to coerce Beijing into changing its way have failed, and the mechanisms meant to resolve disputes in mutually satisfactory ways have effectively ceased to function.
In addition to differences over economic issues, there is a deep divergence in values and strategic interests between the United States and China. Each sees the other as posing a threat not only to its future prosperity but to its security and even survival. To varying degrees and in different ways, both have been trying to alter the terms of their economic relationship so as to reduce the dangers from “weaponized interdependence” and gain an advantage over its rival. An escalatory, interactive process has been set in motion, and a significant restructuring and at least a partial segmentation of the global economy is now underway.
In certain respects, America’s options in this struggle resemble those it faced in the years that followed the First and Second World Wars. Having failed once again to create a fully integrated global trading system, the United States can abandon any pretense of belief in the virtues of free trade, draw back behind tariff walls and try to nurture its own economy. Or it can attempt to rebuild a partial open system, made up of states committed to liberal principles, along roughly the same lines as the one that waged and won the Cold War.
Given the sheer scale of the challenge from China, the second of these would clearly be the preferable course of action. Pursuing it will not be easy. Washington will have to abandon its recent flirtation with protectionism, at least in so far as its friends and allies are concerned, instead working with them to preserve the freest possible flows of goods, capital, and information among a core group of like-minded states.
In contrast to the 1940s, when the Soviet Union practiced a form of self-isolation, China has embedded itself deeply in the open system that the United States and its partners have sought to create. Even as it has grown wealthier and stronger, instead of being transformed, China has continued to pursue policies that now threaten to distort and damage the economies and societies of those countries. In order to defend themselves and preserve a partial international economic order based on liberal principles, the democracies must therefore also work actively to extrude this profoundly illiberal power from their midst.