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The impact of Covid-19 on Trade Liberalisation, Globalisation and Geopolitics

The current Covid-19 emergency has caught everyone unprepared and it has shown us that Western countries are too dependent on China and other emerging countries for the production of many goods, especially drugs and medical supplies. Fortunately, this is changing. Governments have already taken measures to ensure greater self-sufficiency on the production of essential items, such as ventilators, testing kits and personal protection equipment. This is key to guarantee national security and to save lives during and after this pandemic.

Globalisation, increased trade liberalisation and free movement of goods and capital have characterised the last decades, especially the period between the 1990’s and the 2008 Financial Crisis. This has been a driver of economic growth, but it has also generated several problems, such as extended global value chains, high dependence of foreign production of many goods, increased domestic inequality and deterioration of the environment.

I believe that global production value chains are too extended across the world. The car industry is an example of that. To build a car you need parts that come from many countries in different continents. This is economically efficient, but it is too exposed to shocks, such as pandemics, wars and many potential economic, political and natural risks. The Covid-19 pandemic should be an eye-opener event that changes global value chains and approaches to trade. International trade and trade liberalisation policies should follow the principles of economic efficiency and utility maximisation, but also of national security, public health, human rights and environmental sustainability.

Since the formation of the Washington Consensus in the 1980’s that much of the world’s economic growth has been based on international trade, free movement of capital, labour market flexibility and outsourcing of labour intensive industries and services from developed to developing countries. Its results have been disparate.

On the one side, international trade and economic output grew at substantial rates during the period called the “Great Moderation”, millions were elevated from extreme poverty mostly in Asian countries and standards of living have improved for a substantial part of the world’s population. At the same time, global trade patterns and geopolitical power have shifted towards East Asia as China has asserted itself as the “world’s factory”.

On the other side, international trade can have significant impacts on income distribution as we can observe from a widespread increase in within-country inequalities. The Heckscher-Ohlin model, one of the most important models that explain international trade patterns, tells us that countries will specialise in the production of goods that use the factors of production which are abundant in that country. Thus, trade liberalisation has led to a shift of the production of labour-intensive goods from developed to developing countries, which are relatively more abundant in low-skilled labour. Empirical data seems to be in line with the Stolper-Samuelson theorem of the Heckscher-Ohlin model which predicts that low-skilled workers in developed countries lose from increased globalisation, while capital owners and high-skilled workers gain from it.

These increased inequalities have led to a feeling of disfranchisement from lower and middle classes in developed countries which have suffered the most from globalisation. The hope that future generations will do better than the previous ones seems to be a key premise of modern societies and the failure to accomplish this is a significant threat to the stability of democracies, fuelling discontent towards institutions and the rise of the far-right and of several populist movements all around the world.

These discontented voters should not be cast aside as “deplorables”. In contrast, they should see some of their concerns dealt with by mainstream politicians. If these fail to do so, extremist parties will flourish and democratic institutions will suffer. The actions of policymakers will be particularly important during and in the immediate aftermath of the Coronavirus crisis. If jobs and incomes are not sufficiently protected, we might see a new wave of political discontent in the next years that might easily surpass the one that followed the 2008-2009 Great Recession.

Therefore, I think that policymakers should try to find a new “compromise” between economic liberalism and economic protectionism that manages to promote economic growth and other values. Economists frequently point out the overall utility gains from international trade and that free trade is usually a first-best measure. They also admit that there will be winners and losers from free trade and that those losers can be compensated by the winners so that the welfare gains are more evenly distributed across society.

Let’s be honest- when does this kind of welfare redistribution happen? Very rarely. The same people that defend the clear benefits of liberalisation are usually the ones that reject greater welfare redistribution for fears that markets will be distorted and that the wrong economic incentives are created. This seems like intellectual dishonesty to me and one that has significant impacts in peoples’ lives.

So, economists and politicians should be much more careful in their approach to trade and financial markets liberalisation. It’s not enough that welfare gains are positive. The impact on income distribution and employment should be weighed and specific channels to support the losers of such policies should be evaluated and subsequently put in place. In addition, significant dependence from foreign countries in the supply of certain goods should be avoided, in particular when those goods or services are crucial for national security and public health, and if those trade partners are more exposed to certain shocks and do not have the same environmental standards, democratic principles and support for human rights.

This is where China enters the discussion. China is not only the world’s greatest producer of manufactures and the world’s second biggest economy; it is also a political and systemic rival to Europe and to the US. This has become clear since China’s presentation of its “Belt and Road Initiative”. Unlike what Francis Fukuyama defended in his 1992 book “The End of History and the Last Man”, influenced by the fall of the Berlin Wall and the end of the USSR, Western liberal democracy is not the necessary end to history and to humanity’s ideological journey. China is on its way to become the West’s ideological and economic rival by offering an alternative regime to the weakened and divided liberal democracies of Europe and North America, characterised by (partially) free markets, state ownership of main companies, and an all-controlling one-party “Big Brother” government. This ideology is particularly attractive to the elites of emerging countries which hope to foster economic growth, maintain a firm grip on political power and be the main winners of their countries’ development.

The United States is particularly important in this context: it is the main Western liberal democracy, the biggest symbol of the neoliberalism of the last 30 years, China’s main competitor and one of the developed countries that has felt the effects of globalisation more heavily, be those positive and negative, economic and political. The Democratic Party has to be especially careful in November if it wants to win the presidential elections. They have to understand that it is not wrong or populistic to criticise China and to strive for a better approach to trade, and so make void Trump’s claim to be defending the “Rust Belt” workers from China’s unfair competition. Biden and his team have to reach out to those voters who are losers of globalisation, that want change and that voted for Obama in 2008 and 2012 and for Trump in 2016. They have to propose measures that improve peoples’ lives, that bring them safe jobs and better healthcare, and greater fair-play in trade with China. However, given the Democratic Party’s ideological trajectory during the last decades from economic progressivism to “tokenist” progressivism, I do not find this likely.

In this context, Europe sits between two economic and political giants: the USA and China. The European Union has to find its place in the world order and to stand out as the defender of a social market economy with a strong welfare system. It has to reform its industrial and trade policies, to implement a “European Green Deal”, to empower the European Commission’s powers in taxation and international affairs, to ensure that democracy and the rule of law is followed in all member states, and to privilege relations with the United States and other liberal democracies in detriment to authoritarian regimes.

In conclusion, I am not asking for a return to a protectionist and autarkic world. I am arguing the case for a more careful and less naïve trade approach that makes countries less exposed to exogenous shocks and to the influence of a political and economic rival that is China. The Covid-19 pandemic has exposed many of the fragilities of the current economic order, in particular of global value chains. Policy-makers should not only deal with the direct economic fallout of this emergency but also take it as an opportunity to make international trade, value chains and the economic system as a whole more self-sufficient, sustainable, humanitarian and just.

Thus, I hope that the tragic health and economic crisis we are experiencing ends up leading to the creation of a new political and economic “Consensus” and not to greater chaos, inequalities and threats to liberal democracies. Let us see if our leaders have the necessary vision and ability to understand the challenges we are facing and the direction to which we should advance.

In the 70th birthday of Robert Schuman’s 9th May 1950 declaration, which is known as the founding text of European integration, I end this text with a quote: “World peace cannot be safeguarded without the making of creative efforts proportionate to the dangers which threaten it. The contribution which an organised and living Europe can bring to civilisation is indispensable to the maintenance of peaceful relations.”


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