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Global trade cycle sends a terse warning

By Stephen S. Roach | China Daily | Updated: 2019-02-11 07:56

As the trade cycle turns, so goes the global economy. But there is a new twist. With growth in global trade sharply diminished since the 2008-09 global financial crisis, an upsurge of protectionism and disrupted global supply chains has become all the more problematic. There is a distinct possibility that a turn in an already weakened trade cycle could spark a surprisingly swift deterioration in the global economy.

Early hints of just such an outcome are evident in the January update of the International Monetary Fund's World Economic Outlook. While the IMF has revised downward its 2019 forecast of world GDP growth by 0.2 percentage points (from 3.7 percent to 3.5 percent), it has made just a fractional reduction to its projection of 4 percent global trade growth. This is certainly puzzling. In a climate of increased tariffs between the United States and China, with threats of more to come, and given Brexit-related risks to eurozone trade, there is good reason to look for more significant downward revisions to the global trade outlook.

Global trade outlook gloomy

This would be especially problematic, given that the world economy's support from global trade is already on shaky ground. Following a crisis-induced plunge of 10.4 percent in the volume of global trade in 2009-a modern-day record-recovery has been muted. After a brief two-year rebound in 2010-11, world trade growth averaged just 3.6 percent from 2012 to 2018-about half the 7.1 percent average annual pace in the 20 years before the crisis.

The slowdown in world trade may be traceable to the global economy's relatively weak post-crisis recovery. But the ratio of growth in global trade relative to growth in world output-an indicator that normalizes for different recovery trajectories-says otherwise. In the two previous expansions-1985-90 and 2002-07-this ratio averaged 1.6; in other words, once the cyclical noise of post-recession rebounds subsided, growth of global trade was about 60 percent faster than growth in world GDP.

By contrast, in the current expansion, that ratio has averaged just 1.0 over the comparable 2012-18 period, with global trade having slowed to a pace only equal to the growth of world output.

Debate rages about why growth in global trade has slowed so sharply in recent years. Extensive research published by the IMF in late 2016 attributed the slowdown largely to subdued business capital spending, finding only small effects from protectionism. Yet the world has changed a lot in the subsequent two years.

While the capital spending shortfall persists-despite a temporary increase from large corporate tax cuts in countries like the US-there has been a marked increase in protectionism, with attendant pressures on global supply chains. As a result, a rethinking of the IMF findings is in order.

Rhetoric quickly gave way to action and was followed in short order by US disengagement from the Trans-Pacific Partnership agreement, replacement of the North American Free Trade Agreement with a higher-cost United States-Mexico-Canada Agreement, and, of course, a succession of tariff hikes against China. Withdrawal from the Paris climate agreement, threats to pull out of the World Trade Organization, and complaints about NATO participation round out US disengagement from multilateralism and the global trading system that it has long supported.

Against this backdrop, a rapidly unfolding China slowdown is all the more problematic. While recent GDP data point to only a slight deceleration in late 2018-6.4 percent annual growth in the fourth quarter versus 6.5 percent in the third quarter-monthly data revealed sharp declines in December retail sales of key discretionary consumption items such as automobiles and mobile phones.

Reflecting this deterioration in domestic demand, Chinese imports plunged by 7.6 percent in the 12 months ending December, a worrisome about-face after a 16.1 percent gain in 2017. At the same time, China's exports fell 4.4 percent in December as tariff-related weakness in US markets finally appears to be taking a toll.

No winner in trade war

Needless to say, depending on the outcome of US-China trade negotiations, there could be more bad news for Chinese exports to the US.

Moreover, while China is moving aggressively to counter the cyclical shortfall in domestic activity, it could be several months before its policy moves start to take hold. In the meantime, risks remain very much on the downside for Chinese import demand. That underscores a key risk to the IMF's latest forecast: China is the world's largest exporter and second-largest importer. Its negative impact on an already weakened global trade cycle is only just starting to become apparent.

The disruptive effects of Brexit can only exacerbate this problem. The eurozone, as a whole, ranks right behind China among global exporters and slightly above China as the world's second-largest importer. With exports to the United Kingdom accounting for about 3 percent of the European Union's GDP-considerably higher for Belgium, Ireland, and the Netherlands-Brexit-induced frictions to global trade can hardly be taken lightly.

All in all, the global trade cycle is facing major stress in 2019, and markdowns have only just begun. This underscores the risks of a major shortfall in world GDP growth. In a still tightly connected world, no major economy will be an oasis.

The author, a faculty member at Yale University and former chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China.

Project Syndicate.

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