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American Diplomacy
Commentary and Analysis

November 2010

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 A Belgian-based Austrian scholar with broad U.S. experience examines the issue of free trade and hegemony. —Ed.

Supporting Political and Economic Pluralism:  A 21st Century Diplomatic Approach

Introduction
Ever since the end of the Second World War and the introduction of the Bretton Woods system, the United States has been seen as a champion of free trade. In part due to its industrial supremacy and the onset of the Cold War, the U.S. government was one of the most consistent proponents of reduced tariff barriers and free trade in the last sixty years and helped to establish the General Agreement on Tariffs and Trade (GATT) and later, the World Trade Organization. Today, with its economic power in relative decline and neo-mercantilist powers such as China on the rise, the question arises whether the US will remain a champion of free trade.

This paper will argue that the United States should continue to be a champion of free trade for two reasons. First, free trade promotes peace and hence, makes it easier for the single hegemonic power to manage the international system. It lessens the cost of the “empire,” so to speak. Second, the argument that the United States will deviate from free trade due its relative decline in relation to neo-mercantilist powers such as China is unsubstantiated. The truth is that a hegemon1, despite the arguments of the hegemonic stability theory, can do very little to influence states’ behavior in the international system. Hegemony is based on tacit consensus among the members of the international system.  Hence, the professed inability of the hegemon to deal with a new emerging power should not be seen as a decline but merely as a natural exposition of the limitations of any state trying to influence the domestic policy of another state in the international arena.

The first part of the paper will attempt to show that free trade indeed promotes peace. The second part will take the historical case study of the British Empire and how it tried unsuccessfully to influence continental economic policy with little consequence for the overall promotion of free trade in the later part of the 19th century.

CREATOR: gd-jpeg v1.0 (using IJG JPEG v62), quality = 100 Peace through Free Trade
The old liberal idea that trade promotes peace is based on four assumptions or models. The first has been labeled the “opportunity cost” or “deterrence model”. Armed conflict or even the threat of confrontation tends to disrupt normal trade pattern and out of that the resulting large economic costs will deter dependent states from using military force to solve political conflict. A case in point would be the large Chinese trade surplus that the Chinese government uses to invest in U.S. treasury notes. Economists have referred to the growing Chinese dollar reserve as a “balance of terror” since both economies would substantially be hurt if China decided to sell U.S. treasury notes as a retaliatory measure, for such instances as U.S. intervention in the Strait of Taiwan on behalf of the island, resulting in a devaluation of the U.S. currency.

The second assumption is an “efficiency argument” in that it compares the relative costs of acquiring productive resources. As trade increases it will become progressively less productive to acquire resources through plunder or conquest in order to promote economic growth. A good illustration for this is that the Soviet Union delivered more raw materials and wheat to Germany in one year prior to 1941 than Germany was able to extrapolate during four years of its occupation of the western parts of the Soviet Union from 1941 to 1944.

The third assumption is a sociological hypothesis and focuses on how trade helps to increase contact and communication across societies. Through those contacts national loyalties and competitive behavior are displaced and hence lead to a more stable international environment. Italy during the Renaissance provides a good example for this hypothesis. Wars were not uncommon during this period of time, but they were relatively bloodless and short mostly due to the economic interests of the parties involved such as the Medici family of Florence.

Fourth and lastly, international commerce, international trade and the resulting human interaction can provide important signaling mechanism that can help a state to achieve a negotiated compromise short of war.

Yet, is trade alone sufficient to explain state behavior? The simple answer is no. A mercantilist trading system, such as that of 18th century Europe, did actually promote conflict.  Most of the mercantilist policies were the outgrowth of the relationship between the governments of the nation-states and their mercantile classes. In exchange for paying levies and taxes to support the armies of the nation-states, the mercantile classes induced governments to enact policies that would protect their business interests against foreign competition, which often meant through either the force of arms or trade barriers, i.e. tariffs. Both conflict and tariffs have the effect of reducing foreign competition.

CREATOR: gd-jpeg v1.0 (using IJG JPEG v62), quality = 100 Also, trade based on David Ricardo’s idea of comparative advantage leads to a redistribution of income within a domestic society as shown by the Heckscher-Ohlin model.  Hence, by definition it can create opposition to further transnational economic integration. It follows as a corollary that groups that see their income decline form international trade namely import-competing sectors (the mercantile class) are unlikely to lobby the state for a pacific foreign policy that promotes expanding transnational ties. Indeed, conflict may create income gains for these sectors by enlarging a protected domestic market through conquest and the integration of another economy as was the case for the French manufacturing industry during the Napoleonic wars.

This is precisely the reason why free trade rather than any other form of trade promotes stability and peace in the international system. Free trade removes an important foundation of domestic privilege- protective barriers to trade- that enhances the domestic power of societal groups likely to support war and thus, is the reason why the United States will continue to support trade liberalization.

The First World War is often cited as the main example to counter the free trade peace hypothesis. Scholars such as Kenneth Waltz and John Mearsheimer have characterized the global economy prior as an open trading system fostering the independence among states. In fact, starting in 1879, the great European powers became increasingly more protective. Next to wide-ranging tariffs, both France and Germany possessed capital controls that allowed them to funnel domestic savings toward their political allies and away from potential enemies.

CREATOR: gd-jpeg v1.0 (using IJG JPEG v62), quality = 100 Industries that rely on protection to remain profitable are in many senses “captured” by the state and more likely to support its entire range of domestic and foreign policies. For example, the French government used its influence on the private sector to build coalitions in support of a more aggressive foreign policy before World War I. In France, the need for the approval from the foreign and finance ministries before floating the loans of foreign governments in the Paris money market allowed the government to use the economy’s financial reserves to shape balance-of-power diplomacy in Europe. It pressured the Russian government into building strategic railways in 1913 in Poland for it was hoped that a quicker Russian mobilization would slow a German offensive into France.  The imposition of agricultural tariffs in Germany created an opportunity for the state to wed agricultural and industrial interests behind Weltpolitik. Those tariffs, however, produced a strong anti-German within Russia pressuring the government for a more aggressive foreign policy against German interests. Thus, the pre- World War I global economy can hardly be described as an archetypical liberal economic order and one can easily see the possibilities of conflicts arising out of the various protective measures.

For the United States in the 21st century, a return to a system such as the pre-World War I global economy would be detrimental to economic growth and the stability of the international system. Free trade rather than any other form of trade is the key ingredient to promoting peace. This fact can be easily proven by the relative absence of conflict between countries engaging in free trade in the last sixty years.  Free trade also makes the management of the international system less costly since it promotes economic efficiency and reduces the cost of policing the international system due the decrease of international tensions. Consequently, the United States has no alternative but to promote free trade.

CREATOR: gd-jpeg v1.0 (using IJG JPEG v62), quality = 100

The Limitation of Hegemony
Scholars from the realist tradition such as Robert Gilpin have identified the distribution of power among states as a central factor in explaining the openness and stability of the international economy. The “Hegemonic Stability Theory” first coined by Charles Kindleberger in the 1970s focuses on the role of leading states- for example, Great Britain in the 19th century- and how changes in the distribution of power affect the world economy. The theory argued that the preponderance of power of one state was the precondition for an open and stable world economy. Such a hegemon served to coordinate and discipline other countries so that each feels secure enough to open its markets and to avoid beggar-thy-neighbor policies.

In the 19th century, Britain enjoyed this role as a global economic hegemon over most of the world. After the end of the Napoleonic Wars in 1815, the British Empire was by far the wealthiest and strongest power in the world. The British Royal Navy ruled the waves, guaranteed the free flow of capital, the globalization of markets and enforced the openness of international trade.

In the 20th century the United States of America took on the role of economic hegemon and it was the U.S. Navy that guaranteed international commerce and the integration of world markets. Just like the British Empire at the end of the French Revolutionary Wars, the U.S., after the end of the Second World War, assumed the leadership role and moved forward to create an open international trade system based on the General Agreement on Tariffs and Trade (GATT)  and a stable monetary system founded on the Bretton Woods system. The United States also actively promoted the completion of various multilateral trade negotiations, such as the Tokyo, Uruguay and Doha rounds, aimed at reducing barriers to trade and reducing tariffs.

In the 21st century, the U.S. is by far still the most economically powerful country in the world and continues to be the main proponent of free trade. Free trade, despite the U.S.’s long history of opposition, is intrinsically connected to the spirit of enlightenment of which the country’s political institutions are a direct product.  Various scholars and commentators, however, have assessed that this is changing and that the U.S. is rapidly declining in relative terms to neo-mercantilist powers such as China with its gigantic trade surplus and its market entry barriers.

CREATOR: gd-jpeg v1.0 (using IJG JPEG v62), quality = 100 According to the hegemonic stability theory, the hegemonic state is able to offer both bribes and threats in exerting its influence. The unprecedented U.S. current account deficit and U.S. consumption behavior financed by abroad (mostly China), however, has substantially limited the United States’ policy options in that regard. It just cannot threaten to, for example, cut off China’s access to the U.S. domestic market.

It is increasingly argued that the United States cannot manage the rise of a new economic superpower and that according to the hegemonic stability theory this decline will result in reduced economic activity and reduced trade flows among states. In short, the emergence of a new power that only on paper abides to the rules of free trade will result in an abandonment of free trade and loss of U.S. influence on the international economic system.

A case in point for some observers is the impossibility to force the Chinese to revalue their currency although the U.S. Congress drafted legislation in 2007 to "boost pressure on China to let its currency rise in value." Beijing's currency manipulation imposes severe economic costs on the United States, Europe and many developing countries that compete with China. The U.S. threatened various retaliatory measures such as trade sanction, yet so far to no avail.

In reality, there is very little a hegemon can do when it comes to promoting free trade in the international system or influencing other powers to comply when they are not willing. A state that opposes an open system of trade, such as Japan in the 1980s, faced very little consequences from the hegemonic power, i.e. the Unites States.

The reason is that the capabilities of a hegemon required to maintain an open system are much bigger (often too big for the hegemon to cope with) if members are opposed to the open system, i.e. free trade, rather than when they are willing to tacitly comply with the existing order. Thus, hegemony is only possible with the tacit cooperation of most of the states in the international system. It follows that if one or two countries oppose policies of the hegemon, it does not necessarily mean a decline of hegemonic power, but the overall limitations of hegemony in the international system.

This can be illustrated with the following case study of the British Empire in the 19th century. The pax Britannica was at its height in the period 1849 to 1880; thereafter, other states began to challenge British naval superiority, colonization became widespread and British economic superiority began to fall as well.  Thus, one can hypothesize that during the period from 1849 to 1880, British hegemony translated into firm British control of the international economic and financial system.

The truth was far from that. For example, the series of treaties that began with the Anglo-French treaty of commerce in 1860 are generally recognized as supplying the building blocks of a low-tariff regime that persisted until the late 1870s and hence, should be seen a sign of British hegemonic influence on the European continent.

Nevertheless, three points should be noted.  First, the British government did not initiate the negotiations. They were essentially triggered by the transnational collusion of Richard Cobden and Michel Chevalier two businessmen. Second, British Prime minister Palmerston, had rebuffed an earlier French overture on commercial negotiations because he was unwilling to tolerate the possible loss of customs revenue from the wine duty, which the French wanted to get rid off in order to have access to the British domestic market.  Third, in 1860 a primary British motivation for seeking a treaty was not to gain lower tariffs and a greater market for exports, but rather to head off a serious deterioration in Anglo-French relations. The British were simply worried about the possibility of a French invasion. At the end, Britain did not succeed in gaining substantial concessions from the French despite its hegemonic position in the world.

The British experience with most of the other states of Europe during the period 1848-1880 roughly corresponds to their experience with the French—scattered British successes, but no clear evidence that Britain was making a major impact on the tariff policies of the European states.

Another case in point would be Prussia. After 1848, it was not Britain but Austria that dominated Prussian calculations on tariffs. The Prussians were ready to use a low tariff policy to block Austrian entry into the Zollverein. The Prussians desired low Zollverein tariffs in order to maximize the economic and domestic political costs to the Austrian government of joining the organization. Although the Austrians mounted two serious challenges to Prussian dominance in the Zollverein in 1852-3 and 1862-4, the British played no active role in either case. Thus, although Britain was assessed to be most powerful country in the world at that time it still could not influence the behavior of a second rate power such as Prussia.

Yet, when Queen Victoria opened the Great World Exhibition in 1851, her country was the world's leading industrial power producing more than half its iron, coal and cotton cloth. Britain was called the “workshop of the world”. The Royal Navy was the biggest fleet of its time and soon the British Empire would rule a quarter of the world. London became the leading financial center.  This pax Britannica would last until 1914 and the beginning of the First World War. Throughout that time Britain continued to advocate free trade.

As with China in the 21st century, the fear that the rise of a new economic power and the decline of U.S. preponderance may inhibit free trade due to the impossibility of the hegemon to influence the economic policy of other countries is unsubstantiated. As illustrated with the example of Great Britain, the hegemon can rarely influence economic policies when a state’s government or electorate is opposed to the policy since hegemony is built on some form of tacit consensus and economic interdependence between nations.

Conclusion
The United States was and will continue to remain the champions of free trade. First, this paper tried to illustrate that it is in the United States’ interest to promote free trade because it leads to a more stable international system by promoting peace. Second, the argument that the United States will not alter from its free trade policy despite the emergence of neo-mercantilists power challenging U.S. hegemony has been put forward. Although observers might detect a decline in U.S. hegemony due to the U.S.’s impossibility to enforce its will on China in reality, this is just an exposition of the natural limitation of hegemony that is always dependent on some form of consensus among states. It will not, as the hegemonic stability theory suggests, lead to a decline in trade openness of states. Consequently, as illustrated with the British example of the 19th century, the lack of influence on other states behavior will not alter the U.S.’s policy on free trade.bluestar

Note:
1. A hegemonic state in this paper is defined as a country or nation that exercises predominant influence, short of direct imperial rule, in a certain period of time over other states in the international system. It cannot directly influence domestic activities of other states but nevertheless can exert subtle pressure on domestic institutions of states who oppose its policy. The hegemonic state is powerful enough to defeat any other power or combination of powers with which it might be at war.

Franz-Stefan Gady is an associate at the East West Institute. He has previously worked as an adjunct research assistance at the Institute for National Strategies Studies of the National Defense University in Washington DC, working on regional security issues. He was also an analyst for the Project on National Security Reform, a congressionally funded non-profit organization founded to reform the national security structure of the United States. He holds an M.A. in Strategic Studies/International Economics from SAIS, Johns Hopkins University and has served in the Austrian Army and the Austrian Foreign Ministry working on various security issues. He can be contacted at fgady@ewi.info.



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