Why more trade, not less will save the world

Multilateral trade pacts, and not restrictive ones, are best hope for avoiding another global recession

The impact of the crisis has been so severe on market demand that all G20 leaders are turning to overcapacity, following the example of China. Until current overcapacity is absorbed, the recovery will be slow.

Fear of and misunderstanding about free trade and globalisation brought us a turbulent 2016. And the last few months have been a wake-up call about the dramatic slowdown in international trade, presaging a major change in global policies.

The World Trade Organization (WTO) has warned that world trade would only grow by 1.7 per cent (in volume) in 2016. This is its lowest growth since 2009, the year of the global financial crisis, when international trade started retreating. Worse still is the phenomenon of international trade growing at a slightly slower pace than global production. The ratio of international trade-to-GDP, which indicates the relative importance of international trade in the economy of a country, has been falling sharply since 2009 except a slight recovery in 2010-2011.

According to the October 2016 IMF World Economic Outlook, international trade in goods and services has grown at the mediocre rate of around 3 per cent a year since 2012, less than half of the growth of the previous three decades. Between 1985 and 2007, world trade increased, on average, twice as fast as world production, whereas for the past four years it has just kept pace.

This is an historic change. If the WTO forecast for 2016 were to be confirmed, world trade would have risen less rapidly than world GDP, which grew between 2.2 per cent and 2.9 per cent in the first half of 2016.

This could indeed be evidence for the beginning of globalisation going in reverse. The globalisation of trade means that countries trade more with each other, and that trade between them increases faster than their national production. Has globalisation, which is the modern form of the international division of labour, reached its peak? Those good old times when companies, mainly multinationals, achieve production efficiency and generated more revenue through outsourcing work abroad than manufacturing at home.

The IMF suggests three explanations for the decline in trade regimes: the slowdown in global economic growth; halt in trade and investment liberalisation agreements (which started long before the freezing of the Trans Pacific Partnership or the Trans Atlantic Trade and Partnership agreements); and maturity of international production chains that have exhausted their advantages.

Geopolitical competition in global trade agenda-setting among the US, the European Union and emerging powers, such as China and India, and increasingly popular protectionism rhetoric in national trade debates also explain the failure or lack of cooperation in the multilateral trading system.

IMF experts estimate that the slowdown in economic growth since 2012 explains by itself “about three-quarters of the dramatic slowdown trade”. Proof of this, it argues, is that investment products, and durable household goods, such as cars, whose trade has slowed down the most. They note that slowdown of goods consumption affects 143 countries out of 171 under review, including China, Brazil and the nations in the Euro area, among others.

In this respect, the period between 2012 and 2016 will have been particularly volatile in terms of world trade, resulting from the collapse of oil and commodity prices. The IMF notes that this fall itself resulted in a 10.5 per cent contraction of all international trade in 2015, when looking at all products.

The second explanation for shrinking international trade stems from the general global climate, which has become more protectionist. The IMF notes that, in the 1990s, an average of 30 trade liberalisation agreements were signed annually between countries. But barely ten such agreements have been signed each year since 2011.

Free trade agreements include deeper provisions that go beyond trade barriers and more partners can significantly reduce the cost of trade, which, in turn, helps boost trade flows.

The third reason for the brake on trade is the decline in the growth of global value chains, which is the idea that the process of production consists of many stages and occurs across borders. But this phenomenon, which developed at a very high rate after China’s accession to the WTO in 2001 as the country emerged as a global supplier, has now reached cruising pace.

Similarly, the fall in the cost of crossborder transportation and international cost of telecommunications, which had contributed so much to trade, would also have met its limit. But even as worries about the disappointing numbers surface, countries remain very divided on what to do next. In fact, we may witness the return of economic nationalism that threatens withdrawal from global market.

It seems, then, that the only diagnosis is that the global economy is slowing down and the risks to recovery are picking up. Challenges range from Brexit to the slowdown in emerging markets, from the collapse of commodity prices to rising geopolitical tensions.

Part of the problem is that the level of public debt of countries is too high. And countries that have the means, such as Germany, refuse to spend more. At least, in the last months of 2016 the G20 leaders’ communique recognised the impact excess capacity has had and there’s now a chance of focusing on this problem. Excess global capacity in steel and other industries is mainly a result of falling demand, rising production and excessive government subsidies.

The impact of the crisis has been so severe on market demand that all G20 leaders are turning to overcapacity, following the example of China. Until current overcapacity is absorbed, the recovery will be slow. But the remedy has the social cost of job loss, and that could fuel the risk of fragmented national politics such as in the US and Europe.

On the bright side is the noteworthy G20 Guiding Principle for Global Investment Policymaking lays out a roadmap for future investment policy. It seems that, at best, 2017 will be another difficult year. The most we may be able to hope for is that national trade-restriction measures will be compatible with WTO rules. If history is any indication, trade deals are the world’s best hope for avoiding another global recession.