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Advice on strategic issues for governments

On the art of the deal

David Skilling
19 February 2017

The causes and consequences of the outbreak of World War I in 1914 were the subject of several very good books a few years ago. But judging by recent events, perhaps the more relevant centenary to mark is the Treaty of Versailles in 1919 (or for the more historically minded, the Concert of Vienna in 1815). In these conferences, the great powers of the day divided up the world.

In contrast, the post-1945 period has been governed by a relatively liberal, rules-based international order. Of course, power has not been completely absent. The US has played an influential role at the centre: John Maynard Keynes, representing Britain, was outgunned by Harry Dexter White in the initial design of the system at Bretton Woods; the US walked away from the fixed exchange rate system in 1971; and the ‘committee to save the world’ – as Time Magazine called Alan Greenspan, Bob Rubin and Larry Summers in 1999 – was based in Washington DC. Being the reserve currency issuer may not be an exorbitant privilege for the US, but it has conferred benefits.

Overall, though, the liberal, rules-based global system has helped to separate international commerce from the projection of political power. This provided a stable environment in which globalisation could take off. However, the demarcation between international economics and politics is becoming less clear. Big power deal-making is returning.

The new US Administration seems to prefer bilateral deals to working through multilateral institutions or country groupings. President Trump has withdrawn the US from the TPP in favour of bilateral agreements with selected individual TPP members, presumably calculating that the negotiating power of the US will allow them to strike better terms. Mr Trump and his team have also made supportive comments on Brexit, and have come close to endorsing the further break-up of the EU. US accusations of currency manipulation are becoming more common, from China to Germany. And US complaints about the trade deficit with Mexico and threats of a wall (who will pay?) are apparently a prelude to NAFTA renegotiation.

This approach to international affairs is perhaps one reason why there is a stream of Chinese commentary that is positive on Mr Trump, despite his statements on Taiwan, the South China Sea, and currency manipulation. China also has a bilateral approach to international affairs, and perhaps senses an Administration that sees the world in a similar way.

As former Chinese Foreign Minister Yang Jiechi delightfully noted a few years ago, “China is a big country and other countries are small countries, and that’s just a fact”. China is inclined to do deals with individual countries, and does not like to be bound by external rules and institutions. On South China Sea issues, China deals with countries individually rather than as a group. And China frequently uses its large market size as a way to secure changes in behaviour. The ‘new model of great power relations’ suggested by President Xi in 2013 (predictably dubbed ‘the G2’) went nowhere under President Obama; perhaps it will now be revived.

This changing approach to international affairs will have substantial economic and market implication. I expect more pronounced mercantilist behaviour from large countries, as international commerce becomes an expression of geopolitics to a greater extent. There are several dimensions on which this big power behaviour will be seen, which will create exposures for specific countries.

First, and most obviously, countries will find it more difficult to secure trade deals with big powers on decent terms. Even Australia’s FTA with the US – signed in 2004 under the Bush Administration when Australia was seen as the ‘deputy sheriff’ in the region – is estimated to deliver negligible benefits at best to Australia. And many small economies will struggle to independently secure meaningful trade deals at all, which is why the TPP was important for small countries like New Zealand.

And outside of formal trade negotiations, countries run the risk of being squeezed by big powers. There are many examples: China ostracised the UK after David Cameron met with the Dalai Lama, and has acted to discourage tourism to Japan and South Korea after periods of geopolitical tension. Similarly, Norwegian salmon exports to China collapsed after the Nobel Peace Prize was awarded to a Chinese dissident in 2010. And the US tendency towards extra-territorial jurisdiction on tax and financial sector issues has impacted countries such as Switzerland.

The warning of the Athenians in the Peloponnesian Wars is instructive today: “the strong do what they can and the weak suffer what they must”. These exposures are one reason why, despite the political noise, regional integration is not going away. As former European Commission President Barroso noted in 2013, “in a world of giants, size matters”.

In addition, deal-making between big powers is increasingly likely on international economic policy. The G20 and the IMF have not been effective on international policy coordination. But there is now a much increased likelihood of big power deals on exchange rates (similar to the Plaza and Louvre Accords) and on trade (perhaps like the various US/Japan deals in the 1980s). The higher risk of disruptive shifts in asset prices as a result of such political deal-making should be priced in.

After decades of a relatively market-driven, rules-based global economy, we are moving rapidly into a new regime in which big powers more explicitly call the shots. From trade agreements to currency arrangements (and beyond), the art of the deal will reshape many aspects of the global system. My assessment is that this will be much more like the 1970s and 1980s than the 1990s and 2000s. And if it goes badly, we could end up with conflictual relationships like the 1930s – which, of course, was contributed to by poor big power decision-making at Versailles.