Could It Be That The High-Water Mark of Free Trade Has Passed?
As financial disruption reached threatening proportions in 2008, global policymakers were reminded of the 1930s, when troubles in the banking system had led to economic depression. At one international meeting after another they resolved that history would not be allowed to repeat itself. One feature of the 1930s that historians have, ever since, picked out as especially damaging to economic activity and employment at that time was the shift that occurred, across the world, towards protectionist trade policies. This time, policymakers resolved, they would exert themselves to resist protectionist impulses and to maintain progress towards opening channels for international trade. This, they hoped, would contribute to global recovery, if not a return to pre-2007 normality.
It is not obvious why trade protection should be inimical to world economic growth. After all, from a global perspective, the aggregate of national exports must equal aggregated national imports, even though the summation of national export and import data does not, as a matter of fact, bear out that logical identity. Differences in methods of data collection must lie behind the discrepancies in the reported numbers. But if aggregate exports must equal aggregate imports, it follows that the contribution of net trade to world GDP must be zero. Whether there is a large volume of international trade or very little at all, this must be the case. It seems to follow that a reduction in the level of world trade activity can have no effect on the level of world GDP. This purely arithmetical analysis, however, leaves out important dynamic elements that may be present when trade volumes contract. If it is accepted that free trade allows goods and services to be provided worldwide on the most efficient basis, that is, at the least total cost, any impediment to trade must result in inefficiency and hence in higher costs of production. That, in turn, means that, for a given level of global income, the volume of goods and services that purchasers can afford is less than in the free-trade situation. Further, from the point of view of a business operating on an international scale, a fall in sales in foreign markets is likely to have a depressing effect on expectations of future activity. For that business, there will not necessarily be an offset from the reduced sales of foreign competitors in its home market. Indeed, the fact that other companies operating in its market sectors are also having a tough time may well reinforce its own dim view of prospects. In such an industrial climate, capital investment is likely to be cut and employment constrained. With jobs hard to get, consumer spending is also likely to suffer. The multipliers that, in a healthy economy, generate growth are put into reverse. The result may be an intractable depression.
The pledges of 2008, to eschew 1930s-style competitive currency actions, appeared to have been forgottenIn the aftermath of the financial crisis, policymakers were entitled to claim credit for preserving the free trading arrangements that had prevailed prior to 2007. There was no replay of 1930‘s implementation of the notorious Smoot-Hawley Act. In passing, we should note that the Fordney-McCumber Tariff Act of 1922 raised US import duties by more than Smoot-Hawley but this action was accompanied by large US loans to Europe, the chief market for US exports at the time. But Fordney-McCumber did not plunge the world economy into depression. The conclusion must be that protectionist measures do not invariably generate headwinds for the global economy; much depends on the attendant circumstances. However that may be, world trade suffered a severe setback in 2009 before rebounding in 2010. After this hopeful sign, though, the negotiations relating to the Doha trade round, which had begun in 2001, ground to a halt at the end of 2012. The aim had been to liberalise trade in services and agricultural products and to lower non-tariff barriers, but the results were negligible. Also at the end of 2012, Japan adopted a monetary policy that appeared to depend for its effectiveness largely on enhancing the competitiveness of its currency. The other members of the G7 approved Japan’s policy-shift because they did not want to pick a fight with the newly-elected Abe Government, because they hoped that Mr Abe, given a free rein, would at long last adopt policies to drag the Japanese economy out of its malaise and because they could not suggest any other course that might materially improve Japan’s prospects. The risk always was that the weakening yen would trigger a general ‘currency war’ involving Japan and its competitors. In the event, other national authorities showed a degree of forbearance but, by the beginning of this year, their patience began to wear thin. They, too, moved to adopt monetary policies that depreciated their currencies. The pledges of 2008, to eschew 1930s-style competitive currency actions, appeared to have been forgotten.
The problem is that the 2010 upswing in world trade has not been maintained. It is no easy matter to measure world trade volumes but the World Trade Organization (WTO) has compiled consistent series covering the period since 1950. The WTO estimates that world export volume fell by 12% in 2009 but then recovered 14% in 2010. The swings in trade were far more extreme than those in world output, which fell by 2% in 2009 before rising by 4% in 2010. Between 1970 and 2007, world export volume had risen almost seven-fold while global GDP increased slightly more than three-fold. The ratio of export growth to GDP growth was 2.2-to-1. Expansion in both exports and GDP resumed in 2010 but in the period between 2010 and 2013 (the latest year for which the WTO has compiled full data), export volume rose 10.0% while GDP increased 6.3%. The ratio of export growth to GDP growth declined from its pre-crisis level, to only 1.5-to-1. What is more, the WTO estimates world export growth of 2.8% for 2014 and forecasts a similar outcome for 2015. This compares with IMF figures for GDP growth, on which the WTO estimates are founded, of 3.4% in 2014 and 3.3% in 2015. Based on the most recent partial data, the WTO is saying that world trade has most recently been expanding more slowly than world GDP. The ratio of export growth to GDP growth has dipped below 1-to-1.
There could well be prolonged disruption to trade flows within the euro zonEThis would be a dramatic development, if confirmed in more complete data. In fact, national trade figures released over the past few months suggest the WTO’s forecast for this year is, if anything, too optimistic. There appears to have been a particularly sharp dip in trade volumes in the Asian region, widely attributed to slower growth in China’s industrial output. There could well be prolonged disruption to trade flows within the euro zone resulting from the spread of border restrictions related to the refugee crisis. For policymakers, the outlook for world trade is likely to become increasingly a matter of concern in the months ahead.
There are factors that might explain the slowdown in world trade in the post-crisis era that are not at all cyclical in nature. The globalisation of economic activity proceeded apace up to 2007. Since the creation of cross-border supply-chains was a central element in the globalisation process, it was only to be expected that, while the process was ongoing, international trade should grow rapidly. It is not unreasonable to suppose that globalisation had already reached a mature phase before the financial markets erupted in turmoil. The ratio of world export growth to GDP growth would, then, in any case have fallen. But there are other influences at work that may have led to some erosion of the gains in trade volumes that had been related to the pre-2007 globalisation of economic activity. The crisis was accompanied by temporary strain on supply-chains that may have prompted some producers to reduce their reliance on their ability to source components from foreign sites. In view of the extremely severe disruption of international trade during the crisis, it might have seemed prudent to integrate production at specific centres. This would have resulted in smaller export volumes being associated with any given level of output.
Then again, the regulatory measures the authorities have taken to minimise the chances of another financial crisis may well be hurting world trade. The flow of goods and services around the globe depends even more than domestic sales on external finance being available to companies. Banks have traditionally been the chief source of this finance. A substantial increase in the capital requirements that regulators impose on banks is likely to have dampened the banks’ general willingness to lend, including for purposes of supporting international trade. Since world trade is in any case slowing, the risks in this line of lending business probably appear larger than they did a few years ago. The resulting constraint on world trade growth is one of several unintended consequences of the G20’s resolve to tackle prudential issues in the banking sector largely through measures to strengthen the banks’ capital.
the rate of expansion in the emerging sector has turned decisively downwardsThe factors we have considered so far do not explain why the trend in world trade growth should have taken so sharp an adverse turn this year. The strongest element in world trade prior to this year had been that which involved emerging countries, either as suppliers of raw materials or as purchasers of capital and consumer goods. The fact that world exports were able to grow faster than world GDP for so long during the recovery from the global crisis was a reflection of the buoyancy of economic activity in the emerging sector. This year, however, the rate of expansion in the emerging sector has turned decisively downwards as many of the economies concerned have become sensitive to their levels of indebtedness. At the same time, China’s attempt to reduce reliance for growth on manufacturing and construction has left global demand for raw materials running below expectations based on previous trends. The downward adjustment in world demand for commodities and for energy products is reflected in the overall trade statistics. Whether this will turn out to be a one-off development or will lead to a longer-lasting drag on international trade will depend primarily on how successfully the Beijing authorities deal with the challenges facing their economic strategy.
This has been the background for the multilateral discussions on regional trade pacts under way this year. At the time of writing, the future of the Trans-Pacific Partnership (TPP) has still to be decided. If the TPP is agreed, it would reduce barriers to trade between twelve nations on both sides of the Pacific, together representing 40% of world trade. In the circumstances, a successful outcome would be a significant achievement. If a deal is reached, President Obama will have ninety days to sign it and send it to Congress for a vote which, under legislation passed this year, could not be subject to a filibuster. If the TPP currently hangs in the balance, the chances of the proposed Transatlantic Trade and Investment Partnership (TTIP) being concluded look even more tenuous. Such an agreement would liberalise trade between the USA and the EU. But, under the most favourable conditions, negotiations on this deal are not expected to conclude until next year, when the US presidential election could well complicate the process. In some respects, the TTIP is a more ambitious project than the TPP since it would go far beyond removing conventional barriers to trade, venturing into areas that are usually regarded as matters of sovereignty, in the interests of fostering business. Further, a long-term consequence of the VW affair could be to increase the suspicions that the USA and the EU harbour over the trading practices they each adopt. If either of these regional initiatives to free up trade fails, following the stalling of the Doha Round, the widespread assumption will be that the high-water mark of free trade has passed. That, in turn, could have a long-lasting negative effect on business confidence around the world, with adverse implications for growth in activity.
About the author
Stephen’s career spanning five decades has made him one of the most respected and unique voices in the City of London. Disclaimer regularly publishes a selection of his elegant and thoughtful essays on the global economy, which he has been writing regularly since he founded Fifth Horseman Publications in the late 1980s. As well as an economist, Stephen serves as Treasurer of the Forum for European Philosophy and was elected to the Royal Institute of Philosophy.
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