Globalisation's retreat?

By Buttonwood

WORRIES about the global economy are not just confined to sluggish growth, deteriorating demographics or the overhang of consumer and government debt. World trade, which used to grow faster than GDP, seems to have turned sluggish. In each of the last three years, growth has been less than 3% in real terms. The World Trade Organisation is hoping for 3.3% this year but it regularly has to cut its forecasts; there have been reports of export declines in recent weeks from Taiwan, Egypt, Indonesia, Jordan, and China, to name but a few.

Some of this year's decline is down to a stronger US currency, of course, which reduces the dollar value of exports. But it is hard to believe that is the only thing going on. A new book from Vox EU covers the subject in great detail. In one chapter, Douglas Irwin looks at the historical record; Angus Maddison's data suggests trade was growing at more than 3% a year in the first great era of globalisation from 1870 to 1913, slowed to less than 1% a year from 1913 to 1950 thanks to two world wars and the Great Depression, and then took off in the "wonder years" from 1950-1973 at more than 7% a year. Figures from the WTO suggest the peak decade was the 1960s. Trade growth slowed after that, until the 1990s when China burst on to the scene. But the current century has seen another slowdown, which worsened once the financial crisis hit.

You won't be surprised to learn that a writer at The Economist thinks trade is a good thing, and to note than it is associated with periods of prosperity (although that says nothing about causation). The plausible explanation for the link is that trade leads to specialisation and specialisation is more efficient.

The explanation for the recent slowdown could be cyclical - linked to sluggish growth in output since 2007 - or structural, ie more long-term in nature. Bernard Hoekman notes in his introduction that

There are different potential explanations of a ‘structural’ nature (that is, nonmacroeconomic) that can result in a decline in the income elasticity of trade. One is that it reflects a change in the composition of global trade towards products that have a lower elasticity. Another is that the slowdown simply reflects the end of the integration processes of China and central/eastern Europe – i.e. the high trade growth was largely a transitional phenomenon. A third is that it reflects the limits having been reached on the ability of (incentives for) firms to engage in the international fragmentation of production that is part and parcel of GVCs. A fourth potential explanation is a rise in government support for domestic industries, reducing the incentives for firms and households to buy goods and services from foreign suppliers.

China plays a big role in many of these explanations. Its great surge of growth was driven by investment, and the building of infrastructure that boosted demand for raw materials. Now it seems to be both slowing down and changing to a more consumption-based model, with big effects on other exporting nations.

Another important point, mentioned in a recent piece, is that trade flows are calculated on a gross basis. So if Taiwan sends electronic components to China, and a Chinese factory then assembles them into an iPhone, then both the component and the phone exports count as trade. For GDP purposes, however, this would be regarded as double-counting; only the value added at each stage would be included. So extended supply chains boosts trade. If China makes the components and assembles them itself, GDP is the same but the volume of trade appears to fall. An essay by three economists from the World Bank and the IMF notes that the slowdown in trade has been focused on manufacturing, not services; which lends weight to the supply chain argument.

Supply chain change may be cyclical, or it may be structural. A recent Standard Chartered research note highlighted some factors that might lengthen supply chains - ease of communication round the world, lower oil prices reducing transport costs - and some that might shorten them - 3D printing allowing local production or geopolitical risk.

All this is significant for three reasons. The first is that some countries may have followed a strategy of being part of the supply chain; if China is cutting them out, that will have an impact on their growth. Secondly, sluggish export markets increase the temptation to devalue currencies to grab market share; many view the fall in the yen in that light. Third, the developed world in particular has a productivity problem; it needs productivity enhancements to offset its deteriorating demographics and boost growth. Export sectors are often the most productive, because competition forces them to be so. Slower trade growth will not help.