The 12-day exchange of missiles between Iran and Israel made the world forget all about President Trump’s trade policy. This is understandable, though unfortunate: when two presumed nuclear powers enter into an armed conflict, the world is reminded of the devastation that would follow, should the conflict escalate and proliferate.
At the same time, the fundamental shift in U.S. trade policy that came with Trump’s new tariffs also offered the world in general, and the so-called industrialized world in particular, a chance to rethink its adherence to conventional economic wisdom.
Contrary to said wisdom, free trade has not been to the benefit of mature industrialized countries, at least not generally. There are exceptions, but the expansion of free trade in the last century came with an almost eerily proportionate slowdown in economic growth. This is not something that free-trade fundamentalists will ever acknowledge, but it is nevertheless a fact. From the infamous Japanese stagnation to the “Great Moderation”—a period of stagnation masquerading as economic stability—the world’s wealthiest nations gradually lost the force of economic progress that was so characteristic of them through most of the 1900s.
Today, the American economy can barely break 3% real annual economic growth. Europe is experiencing a painful, protracted economic standstill. Rather than assigning this economic sluggishness to some fancy metaphysical economic trend, we need to acknowledge that it coincides conspicuously with the expansion of free—or freer—trade around the world.
This expansion of trade opened economic connections between under-developed economies, primarily in eastern Asia, and industrialized economies in Europe and America. The former thrived from booming exports and massive foreign direct investment, while the latter found themselves struggling with trade imbalances, lower growth numbers, and higher long-term unemployment.
As industrial capacity, primarily in manufacturing, migrated from the mature economies to the developing ones, it became clear that the economic fate of the industrialized world was in the hands of its own trade policy. By opening themselves up to trade liberalization in the 1970s through the 1990s, and by exposing their economies to the forces of global trade, Europe and America lost large swaths of their economic capacity to fierce competition from aggressive overseas newcomers to the global market.
It is important to note that none of this was unexpected. The economic theory of comparative advantages predicts that when two countries begin to trade with one another, their economies will specialize in the industries where they are stronger and more competitive. Correspondingly, they will lose jobs and production in industries where their trading partner holds the edge.
This theory thus foresees a migration of industrial capacity, both between the countries and within them. In practice, this would mean that the cheaper, leaner, and more profit-hungry developing nations would be on the receiving end of investments in manufacturing from Europe and America.
So far, so good—the theory has worked just as its proponents claimed it would. But from hereon, history took a different turn than economic theory said it would.
In addition to the migration of industrial capacity from ‘rich’ to ‘poor’ countries, the theory of comparative advantages also suggests that the ‘rich’ countries would experience a surge in investments, production, and employment in industries where they have a global advantage, such as high-skill services that require a thoroughly trained and educated workforce.
The services in question are of a kind that is tradable internationally: engineering, medicine, finance, corporate management. Therefore, according to the theory of comparative advantages Europe and America would see a surge in investments, jobs, and exports of those services; this surge would more than make up for the fact that the loss of manufacturing capacity left massive economic resources idling.
To a large degree, this creative transformation of the workforce and productive capital took place in America. An entirely new industry, centered around computer technology and Silicon Valley, emerged with millions of new jobs. Nothing of the kind happened in Europe, where in formerly thriving industrialized economies large segments of the workforce have become permanently unemployed. The capital that was otherwise used for direct investment in the economy has instead poured into increasingly speculative stock and real estate markets.
Economic theory did not predict this. As proponents of free trade sold their political leaders on the ideas of ending protectionism and exposing their economies to the world, the European continent was left with lower workforce participation and higher dependency on the welfare states.
What was once a continent where industrial workers could support a family is now a continent where governments are struggling to feed the many with tax revenue from the few. Public finances are plagued by seemingly endless budget deficits; taxes have crept upward and made life for the remaining taxpayers increasingly unaffordable. The private sector has become passive, acting more like a caretaker of what is left of Europe’s economic success and less like an engine for economic growth and prosperity.
Bluntly speaking, this is not where Europe was supposed to end up as a result of free trade. America has fared better, but it has still suffered from the loss of manufacturing capacity to other countries. President Trump has recognized this and laid out a plan to re-industrialize the American economy. His trade policy is part of this plan—and it is not even a plan for protectionism, just fair trade deals to replace those that have favored other nations.
Europe needs the same kind of visionary economic leadership. That leadership may emanate from Brussels, and it may steal a cue from the Trump administration, but it could just as well emerge at the national level. Some countries in Europe have shown what such visionary leadership can accomplish.
Regardless of whether the EU or its member states take the lead, it is high time for Europe to re-industrialize itself. That requires throwing out old conventional economic wisdom and replacing it with new, creative, and forward-looking ideas.
One of Europe’s biggest problems is that government rules the business sector. Government is almost by definition non-visionary. Maybe it is time to flip that coin? Maybe Europe’s business sector should rule the government for a change?
