As the annual gathering of US Federal Reserve policymakers takes place in Jackson Hole in Wyoming this weekend there might be rather a few worried looks. Market instability in China has been ricocheting from bourse to bourse from the Dax to the Nikkei, despite rallies at the end of the week.
New data shows world goods trade contracting at its fastest rate since the global financial crisis. Prior to the crash in 2007 increases in global trade outstripped GDP growth. Not any more. The key question is whether this is here to last. The answer to that question depends on your view of why global trade has slowed.
An excellent Bank of Canada working paper earlier this year said: ‘There are a variety of factors beyond slow economic growth that explain the post-crisis slowdown in global trade. The most notable include diminished incentives to expand trade, the changing composition of global demand and increased protectionism.’ Some think it is a short term blip – they argue that the problem is cyclical. There are some strong reasons for doing so. As leading economists Cristina Constantinescu, Aaditya Mattoo, and Michele Ruta argue in a paper The Global Trade Slowdown: Cyclical or Structural? weak global demand and the relatively poor performance of investment (especially in the Eurozone) are major drivers of global trade’s doldrums. However, econometric models suggest that this explains about half of the decline in global trade.
Why else has global trade slowed so dramatically? The alternative explanation is that the plateauing of the global propensity to trade reflects a long-term trend, with trade now growing at a slower pace relative to GDP than it had in the past. According to this view, trade reforms and technological innovations that lowered trade costs during the 1990s had a substantial effect on global trade. Encouraging emerging markets to integrate into the global economy and by making global value chains economically viable meant that global trade rose relative to GDP. However, since this process is largely complete, the underlying incentives to expand trade are likely weaker now than they were in previous decades, leaving the world in a state where trade is neither rising nor, relatively speaking, falling relative to GDP.
Yet, this explanation, in turn does not explain the full picture. Protectionism has risen too. Often when we think of protectionism we think of tariffs. However, tariffs have not on average risen across the G-20 since the crash. Non-tariff barriers to trade, on the other hand, have been introduced at an alarming rate. Since 2008 G-20 members have introduced nearly 1000 such measures by the end of 2014 as notified to the World Trade Organisation (WTO). Some economists are assuming that if the introduction of these barriers does not continue to rise then this decline in global trade will prove to be cyclical. What happens if those economists are wrong? An increasingly held view is that they are. The argument being that the decline in trade is attributable to a shift in the pattern of trade. The last decades of the twentieth century saw large growth in two types of activity. First, inter-industry trade. This involves trade between countries in goods that are produced by different industries. Inter-industry trade is driven by comparative advantage ie. one country can produce a good at a lower cost, relative to other goods, than another country could. This is normally determined by differences in productivity, labour, natural resources and cost of finance and was a concept first put forward by the Manchester school economists, Cobden and Ricardo et al.
The second type of trade is called ‘horizontal intra-industry trade’ or HIIT. This involves a country importing different varieties of the same type of good. For example, a country like Germany may export Audi A8s and VW Polos whilst at the same time importing Range Rovers. Although the share of HIIT in total trade was rising during this time, incentives related to comparative advantage strengthened as well and therefore explain at least part of the increase in the global propensity to trade over this period. Driven by the rapid integration of labour-abundant emerging markets, such as China and India, into the global economy at the time, this is not surprising. Starting in the early 2000s, however, specialization began to fall, indicating that countries’ trading patterns were becoming more homogeneous: comparative advantage began to fade. As the underlying incentives to expand trade (falling transportation costs, lower tariffs, etc.) strengthened during the 1990s, they helped redefine the way global production takes place. In particular, what is known as the ‘global value chain’ emerged.
China is a great example of how this has ultimately led to a change in how trade happens and why trade has diminished. In 1995, parts and accessories of capital goods as a share of China’s total imports were about the same as in other countries but grew rapidly. As exports of final capital goods rose in China so imports of parts and accessories flooded into China. By 2002, this import share was about twice that of other countries. Starting as early as 2003, however, the relationship between the relative importance of exports of final capital goods and imports of parts began to weaken. Nevertheless, the process largely continued until 2007, at which point China started to reduce its dependence on imported parts and increasingly used domestic sources. It could be that global trade growth has been dependent on an immature global value chain. That is why some economists now question whether globalisation has reached its nadir.
This summer HM Government has launched its centrepiece on productivity. One of the major planks of this paper was to increase exports through a number of innovative means – further globalisation implicitly being at the heart of it. Yet, the political opposition to globalisation has also reached a crescendo. Campaigns against TTIP and Britain’s membership of the EU are in part reflections of antipathy to ‘globalisation’. While clearly campaigners have legitimate questions they could win a pyrrhic victory. Lower global trade growth could see Britain trying to expand its exports into a fierce headwind.