In recent weeks, and particularly after the bloody stand-off between Indian and Chinese troops in the Ladakh frontier, there has been an outcry in India over the $50-billion-a-year trade deficit it runs against its neighbour. There have been calls for a consumer boycott of Chinese goods and services, ostensibly to hurt that economy, although the prospects of such an initiative succeeding are open to question. The Indian government, too, is looking to reduce the country’s dependence on Chinese products and screen investments from there into India, evidently to signal that if China wishes to profit from the Indian market, it must respect India’s strategic sensibilities.

The tendency to ‘weaponise’ trade (and investments) is more common than is acknowledged, and much of the angst is focussed on the ‘trade deficits’ that countries run up, primarily against China, Germany and other manufacturing economies. The US, arguably one the world’s freest economies, has been waging a multi-pronged ‘trade war’, by imposing tariffs on imports from China and the Eurozone, and by playing hardball with India by trying to get it to lower tariffs on US imports. President Donald Trump has ratcheted up the anti-China trade rhetoric.

Many of the arguments that underlie such ‘trade war’ bluster rest on a flawed understanding of global trade dynamics, argue economics commentator Matthew C Klein and Peking University Finance Professor Michael Pettis, in this magisterial book. What heightens trade conflicts between countries is, in fact, rising inequality within countries, they reason. And despite what it may seem like from the sidelines, “there is no economic conflict between America and China as countries. The Chinese people are not the enemy,” they write. “Rather, there is a conflict between economic classes within China that has spilled over into the United States.” In other words, “class wars” within countries translate into “trade wars” between countries. And just as the flapping of a butterfly’s wings in the Amazon jungle may whip up a tornado in Texas, problems of wealth distribution in one country — caused by massive transfers of income to the rich — tend to get “exported” as economic distortions around the world.

This isn’t just a polemical point: the authors back up their arguments with (occasionally wonk-ish) academic rationale. Illustratively, the Chinese government persecutes labour organisers and offers cheap bank loans to real estate developers — and, as a consequence, American manufacturing workers lose their jobs.

The complexity in analysing global trade data, and in establishing who is running up egregious ‘trade surpluses’, is complicated by the spaghetti bowl of trade flows and the invidious corporate practice of ‘profit shifting’ to low-tax jurisdictions.

Klein and Pettis flag the risks that lie ahead — to the global economy, and to international peace — if these problems are not addressed. The danger, they fear, is of “a repetition of the 1930s”, when a breakdown of the international economic and financial order “undermined democracy” and “encouraged virulent nationalism”. And although we are not quite in the same dire straits today, there is no room for complacency.

Roots of imperialism

Just as fascinating as the ‘class-based theory of trade wars’ is the authors’ deconstruction of the likely economic foundations of imperialism. In the late-19th century, as a consequence of the unequal income distribution in the rich European countries, workers could not afford to consume all that they produced. The rich, however, had plenty of money to invest, but building more factories at home would have been pointless since impoverished local consumers could not have consumed more. Their solution: to shift their excess output to captive markets abroad. Indicatively, British colonialists debased Indian manufacturing capability, and created a captive market for British imports. This understanding provides a fresh perspective on China’s Belt and Road Initiative, which is motivated by a search for new export markets for Chinese goods.

As British economist John A Hobson noted in the early 20th century, “the fight for foreign markets… the greater eagerness of producers to sell than of consumers to buy, is the crowning proof of a false economy of distribution.” And imperialism, he said, “is the fruit of this false economy.”

Given the risks inherent in trade frictions, Klein and Pettis conclude that doing nothing is not an option: China is too big an economy for the rest of the world to passively accept the consequences of its internal distortions. The pushback today in Trump’s America against “open” trade systems is evidence of this. And although tariffs are ineffective, the surprise, they note, is that Americans have tolerated the open system for so long. Given the reality of the open trading system in which it operates, the US has fairly limited options: it will remain the “dumping ground for the world’s excess savings and the surplus production that comes with it.” But if trade wars are to end, the twin problems of income inequality and the world’s unhealthy dependence on the US financial system must end. In fact, the authors reason, the US must take the lead to reform the “broken” system of global trade and global capital flows — by forcing the elites in the surplus countries to internalise the cost of their behaviour, through income equality measures.

The subject of trade economics doesn’t make for light reading. But marshalling their storytelling and professorial techniques, and making delightful excursions into the contributions of, say, container ships in the expansion of global trade, the authors make it accessible. At a time when the powder is being readied around the world for all-out trade war, this book is a cautionary tale that points the way to a de-escalation, and eventual reform, of the flawed global trade architecture.

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