The Trade Factor

As the world economy edges away from the precipice, we can see the enormity of the catastrophe we averted. In the first 12 months of the financial crisis, world industrial output fell at nearly the same rate as during the first year of the Great Depression. Trade declined at an even faster pace than in 1929. But a year later, growth, albeit anaemic, is back and the stockmarket is rising again — so much so that experts are now warning against a new bubble. How was it possible? The short answer is globalisation. The globalised economy transferred the shock of Wall Street to all. But, grasping the common danger, major countries launched an unprecedented rescue operation. The task now is to collectively remedy the trade and financial imbalances that brought the world economy to the brink.

Fortunately, our darkest fears did not materialise. With the world economy shrinking fast and trade collapsing, the fear was of a trade war. In this column (‘Made in America’, BW, 9 february 2009) I was worried that government interventions were “beginning to slip into a protectionist groove that could, if unchecked, sink the world into a 1930s-style ‘depression’”. Indeed, the World Bank’s Global Antidumping Database shows that industry requests for trade barriers globally are up 30 per cent over the same period last year. Yet, governments have been circumspect about erecting trade barriers after investigating dumping complaints. The bank has found a declining trend across all imposing countries, only 50 per cent of whose investigations completed in the third quarter of 2009 resulted in the imposition of new trade barriers. Despite pressure from domestic industry, governments seem anxious not to fall foul of WTO rules. With a supply chain economy intertwining the economic fates of so many countries, there is also concern about hurting a partner in the production network.

In fact, the supply chain’s growing role in trade turned out to be a decisive factor in the dramatic synchronised trade collapse last year. When the US financial crisis struck, trade dropped sharply not so much because trade credit was tight, but because anxious shoppers decided to postpone their purchases. With demand for durable goods plunging in the world’s largest market (the US), the shock was transmitted rapidly to all the links in the supply chain. A synchronised collapse of trade ensued. But why did trade fall more sharply than countries’ gross domestic product? The answer to that question lies in the globalised economy of the supply chain.

The vertically integrated production of durable goods, spread over several countries, has been a key factor in the falling price of manufactured items and rising trade. From running shoes and iPods to refrigerator and automobiles, most durable goods cross many borders — thus boosting trade figures — before reaching the consumer. When demand for such goods dropped, the impact was felt across the supply chain. New research has shown that a closely interconnected supply chain has been the main reason for precipitous and synchronous collapse of trade. As the value of trade fell by more than ultimate demand did, global trade dropped more than five times as fast as GDP.

The conclusion that trade did not collapse because of protectionism or a credit shortage is surely good news, but it also promises new troubles. In a recent study, two Swiss economists Richard Baldwin and Daria Taglioni note, “Since the trade shut-down was not due to supply-side shocks that might hinder a rapid recovery, it is a good bet that trade flows — both imports and exports — will regain their pre-crisis growth rates as the world’s economy is nursed back to health.” But the bad news is that in the absence of measures to end the causes of trade imbalances, growing trade may again create unsustainable trade deficits and generate protectionist pressures.

While the US has been working to reform its financial system to avoid future subprime mortgage crisis, trade remains a worrisome area. After falling for a period, the US trade deficit is rising again (not to mention its trillion-dollar budget deficit), and its main trading partner China’s surplus is growing. The imbalance between a spender US and saver China — one motivating factor for the crisis — may again reignite protectionist cries in the US Congress. Beijing’s refusal to revalue its currency and its industrial overcapacity may combine to undermine the stabilisation that collective action by governments, including China’s, has achieved.