The Radio, the Submarine and the Tariffs

This is one of a series of posts providing a little background to my forthcoming book, Trade World. If it whets your appetite, please do pre-order a copy. And if you do so between now and Sept 2 you can even get exclusive access to a free bonus essay!

On 1 July 1987, Republican members of Congress invited photographers and journalists to the lawn in front of the US Capitol building and did something rather unusual. Waiting for them on a metal bin strategically in front of the building’s iconic dome was a Toshiba radio cassette player. After a few words, and after checking the ranks of photographers were ready, the politicians took it in turns to smash the radio to pieces with a sledgehammer.

For many economists, this press conference has established itself as a sort of parable: an iconic moment that defined an era. And the way the story is mostly told these days is that this was all about America being paranoid about the rise of Japan. Every so often an economic commentator writing about the rise of China will refer to the Toshiba boombox being obliterated and sagely note that this is not the first time we’ve seen something like this happening before. I think I have trotted this one out before.

The problem with this version of history is: it’s not quite right. For it turns out the main reason the politicians were smashing up the Toshiba music player on that particular day was because of something else entirely. The previous day, the Senate had voted in favour of imposing sanctions on Toshiba, because of something one of its subsidiaries, Toshiba Machine Company, had done.

Toshiba Machine Company specialised in making machine tools, the sort of enormous rigs you need to make complex pieces of hardware. Machine tools are an often ignored but incredibly important part of the industrial underbelly of the modern world (here is a useful primer on why they matter and why it matters that Britain has so few of them). In short, if you want to be able to make anything and, even more importantly, to make it to a high degree of accuracy so it actually works well, you need decent machine tools. Much of the story of the modern world, our ability to produce excellent technology that changes lives, might better be described as the story of machine tools - all the way from the ones that enabled countries to make steel machines through to the 21st century AI/tech age, where a single company that makes the machine tools for all the world’s most advanced semiconductors is one of the most important firms anywhere.

Anyway, Toshiba Machine Company was one of those businesses, making machine tools that enabled other manufacturers to make high precision parts for their machinery. And the reason it had just been sanctioned was that it had emerged that it had sold some of its machines to the Soviets, allowing the communist country to make better submarine propellers, which in turn meant it would have better, harder to detect submarines. The story is an intricate and complex one (as trade stories often are) but the long and short of it is that TMC broke the rules then in place banning exports of sophisticated western technology beyond the iron curtain.1

As far as anyone could work out, there was no political or ideological reason Toshiba sold the machine to Russia. It was simply a question of commerce. Russian propeller manufacturers were willing to pay and Toshiba rather needed the business. And anyway, it was hardly as if other companies hadn’t done similar deals. One of the fascinating stories of the Cold War concerns the sheer quantity and variety of stuff that was traded between the supposed enemies. One of the stories I cover in Trade World was the “Great Grain Robbery” of the 1970s, whereby Russia bought a staggering amount of wheat from American grain traders.

So Toshiba (actually strictly speaking Toshiba and Kongsberg, a Norwegian company that supplied some of the computer controllers for the machine) did what many of their counterparts had been doing for years, lying in their customs declaration about how sophisticated were the particular machine they were exporting, and to whom they were being sold (they said civilian buyers rather than a military end customer). They assumed the authorities would not spot the contravention. And, it so happens, they didn’t. Years passed. What really went wrong for Toshiba was that a disaffected colleague later ratted them out to the authorities.

All of which brings us back to the Toshiba radio being smashed up outside Congress in 1987. Sure, the moment came against a backdrop of paranoia about the economic strength of Japan, about the inroads the Japanese car industry was making into the American market (much more on that to come in Trade World). But actually, this was about something deeper: about the fact that a company had been selling stuff to the Soviets, and that they very nearly got away with it.

At the time, those in power in the US fell broadly into two camps when considering the Toshiba–Kongsberg scandal. For many, the answer was to tighten up the rules on trading with the USSR, to make them even harder to avoid. But others took from this that it was simply very hard to prevent “technology diversion”, as it was known. Sure, if there were a single American company making these machines, you could probably stop them getting into the Soviet Union. But as it happens there were numerous companies making them, and if they weren’t going to go directly to Russia (as in this case they did) then how could one stop them going there indirectly, through a third country?

If there is one prevailing lesson that infuses Trade World it is that if someone on one side of the planet wants something enough and someone on the other side wants to sell it to them, then it is very, very hard, even with the most sophisticated rules, sanctions or tariffs, to prevent that trade happening.

I was reminded of this episode this week when the White House published a rather unusual paper, entitled “The Great Transshipment Scam”. The paper, which was mostly written by White House advisor and famous China hawk Peter Navarro, is remarkable in part because one interpretation of it is that in one key respect the entire second Trump era’s tariff policy has been a total failure.

Recall that the main objective of tariffs on China was twofold: to reduce American dependence on Chinese imports and to rebuild the manufacturing sector domestically. Well, for all that the President might repeatedly point to the fact that Chinese exports to the US have fallen precipitously since he began imposing tariffs on the world’s second-biggest economy, this is to miss the bigger picture, which is that many of those items are still going to America, only via “third countries” instead. Instead of stopping cheap Chinese products and trinkets from getting into America, the trade barriers on China had mostly served to slightly lengthen the journey they take instead. That, at least, is the gist of the paper, which accuses a host of other places, from Vietnam and Cambodia to Canada and the European Union, of essentially acting as a conduit through which Chinese goods can be sent.

As the paper puts it, “Products that previously moved directly from China to the United States were shipped through jurisdictions where limited assembly, finishing, repackaging, relabeling, or documentation changes could create the appearance of a different national origin. Over time, these practices contributed to the development of a global network of production hubs, logistics platforms, free- trade zones, bonded warehouses, processing corridors, and re-export centers.”

The strangest thing about this paper, published nearly two years after Donald Trump’s second election victory, is that any of this should have taken the White House by surprise. Because the more time you spend observing trade - not in theory but in practice, from ground level, observing the way people do business with each other - the more you realise that it this is just the way trade works. Tempting as it is to believe that when you impose trade barriers, be they tariffs or the trade bans during the Cold War era, that the movement of goods between particular countries stop, or that domestic producers of a given product suddenly sprout up out of nowhere, it’s rarely that simple.

None of this is to say that trade rules cannot have an impact. But you underestimate the ingenuity and ambition of the millions of merchants and middlemen whose purpose is to help connect supply and demand at your peril. I first learnt this not in a textbook or indeed by observing American economics, but on the border between Russia and Georgia some years ago, where I watched supposedly sanctioned European-made cars being transported across into the very country they were supposed to be banned from. Sanctions hadn’t stopped the goods crossing the border; they had simply made the journey they took from the factory to Russia that bit more complicated.

And when I saw that, it struck me that this was a far more plausible model for how a world of greater trade barriers (the world we seem to be sliding towards today) would actually look. Trade would not miraculously stop. It would mostly just become more complex. Products wanted by country A and sold in country B would end up taking a more circuitous route via countries C and D on the way there.

And, in a sense, that is precisely what “The Great Transshipment Scam” is talking about. It contends that a whole network of shady factories and warehouses have been erected across much of the world outside America, devoted to ingesting products made in China, changing the label to “Made in Cambodia” or something else and then selling it to America, at a lower tariff rate. Now, I’m not entirely sure this is exactly what’s going on but here’s the most remarkable thing about this. The main takeaway from this paper is that even now, having imposed the biggest set of trade barriers in nearly a century, the White House doesn’t have a clue either!

It is, essentially, guessing what’s going on here beneath the surface of the world’s trading system. And if that weren’t already clear enough from the bulk of the paper, it becomes clearer still when it proposes the creation of “a new AI-enabled Detective Border. The U.S. needs a system capable of ingesting and analyzing global trade data with lightning speed, identifying anomalous routing patterns, validating production capacity, and directing enforcement toward the highest-probability offenders.”

To me, this gets to the most extraordinary thing about the modern world. Even now, with our years of experience and the enormous might of technology we have at our disposal, still no-one is entirely sure where a product is actually made. As you will see in Trade World invariably what appears on the label of an item you buy in the shops tells you next to nothing about its real backstory- about the journey it has taken to get to you, about the transformations it has undergone along the way and the people who have transported it. The 21st century world’s marvellous, confounding economic underbelly remains, for the most part a total mystery. And not just to the White House... in many cases even the company selling you something will have little firm clue of how it actually got made!

Where is something made? How was it made? By whom? These questions sound so self-evidently simple, you might find it utterly bizarre to hear that even the company selling you the item often doesn’t know the answer. But this isn’t even the most surprising thing you will find as you delve deeper into the Trade World. Indeed, sometimes you find that the item you’re being sold isn’t even what the documentation says it is.

There are, in short, two prisms through which you can look at the world: the version of the world depicted by the official labels, by the customs documents handled by officialdom. In this world, the machine tool sold by Toshiba to the Soviets was nowhere near capable enough to help them make a superior submarine propeller. In this world the items being imported into America in the Trump era are increasingly made in countries like Vietnam and Cambodia.

Then there is the perspective from ground-level, where it transpires that those Toshiba machines were far more capable than the paperwork suggested and the items coming from Vietnam and Cambodia were still mostly made in China, albeit with the components assembled somewhere else altogether. The lesson the Trump administration failed to learn from decades of experience, including from their predecessors wrestling with the Soviet Union in the 1980s, is that trade barriers don’t stop trade. Sometimes they encourage domestic production, but just as if not more often, they give businesses even more incentive to come up with ingenious ways around the barriers.

That was the case at the time of the Toshiba scandal, but it is even more so today, thanks in part to a structural shift in the way the modern global economy worked. Where, once upon a time, manufacturers actually made a finished product, including many (albeit not all) of the components inside, these days most prominent manufacturers, including by the way most car companies, are better thought of as assemblers of other peoples’ components. This is an enormous topic, one I deal with at length in the book, but is still only barely understood in policy circles. The corollary is that the majority of stuff being shipped around the world is not finished products but components that will later get assembled into those finished products. The upshot of this is to make it even harder to stop a company from shifting the production of a given product from one country to another in the face of trade barriers.

Look back through history and you see that whenever trade barriers or customs charges rose, it sparked a sharp and proportionate rise in smuggling. For many periods of history, there was almost certainly more illicit trade than legal trade. Or, to put it another way, one of the unsung benefits of a world of lower trade barriers was that - for all the flaws of the global economic system in recent decades - it was also a world with far less smuggling and criminality around trade. Now, in a world with more trade barriers, we are beginning to see the consequences: more stuff being quietly smuggled around, more stuff being mislabeled, more stuff being falsely declared to customs authorities. And those agencies seem about as powerless to deal with it as their predecessors decades ago (arguably even more powerless, since they are mostly set up for a world of free trade).

Yet trade goes on - either on the surface or in the world’s underbelly. On the one hand, this is quite depressing (when it comes, for instance, to sanctions on nations that want to import components to go into weapons to help them kill people) and marvellous. It speaks of something deep in the human condition: a deeply-held desire to interact economically with each other. Trade, after all, is what we have been doing with each other since the very earliest days of humanity. The remarkable thing is that even now, hundreds of thousands of years later, there are still so many mysteries about how it actually works. I can’t wait for you to hear more about them.

A reminder that if you pre-order Trade World between now and Sept 2 and email me at preorder@edmundconway.com attaching a proof of purchase, I will send you an exclusive essay containing bonus material that didn’t make it into the final edition of the book.