World trade hasn’t been back to its former vivacious state ever since the Great Recession. Before the crisis, world trade volume used to grow at around double the rate of world GDP growth, supported by a movement to liberalise trade and build international supply chains, which spread production and assembly of goods across borders. But this all changed since 2008, which is somewhat surprising given that improved technology and, more recently, falling fuel prices have caused the cost of trade to fall.
After years of charging forward, the ratio of merchandise trade to world GDP came to an abrupt halt in recent years, and the shortfall against what we might have expected, had the trend of earlier good times continued, is increasingly widening (see chart below).
So is this something that we should worry about? Some economists fret that slower trade will have broader detrimental impact on the world economy. For example, if world trade had stayed on its pre-crisis upward trend (depicted above), applying analysis conducted by Hufbauer and Scott at the Peterson Institute implies that we would have seen a long term increase in world GDP of around 5 per cent. Other economists, notably Dani Rodrik and Paul Krugman, raise doubts over the methodologies used to arrive at such high impact numbers, and think that globalisation on its own has had a much lower impact on world economic growth. The truth is likely to be somewhere in the middle, with our own analysis showing how openness to trade is an important factor in facilitating technology and best practice catch-up, helping countries improve their productivity.
Beyond the impact on world GDP, slowing trade can inflict serious pain on a host of industries, from transport and logistics, to a wide array of support services. How bad is the outlook for them? Trade is highly cyclical and world trade is particularly influenced by the economic environment in the Eurozone, given that the region accounts for about a third of the total trade volumes measured. Poor economic performance in the Eurozone can therefore explain a good deal of the wobble in world trade (see chart below), while also providing hope that as the region continues to recover, so will world trade.
Other factors may put more permanent pressure on trade. Trade protectionism has been on the rise since 2008 according to some measures, while other measures point to a flat environment after earlier gains in liberalising trade. Either way, a rise in protectionism may be part of governments’ (misguided) attempts to protect their economies in the face of a cyclical downturn, which could be reversed once the recovery is on a stronger footing. It seems that trade policies are playing a minor role in the current drama.
Perhaps a more meaty explanation why trade growth may never rise as high again is the possible shift is global supply chains. Countries like China may be at the forefront of this new trend. The share of the country’s imports of parts and components in total exports fell from a peak of 60 percent in the mid-1990s to around 35 per cent more recently, thanks perhaps to greater integration of some of the interior Chinese regions into the country’s supply chain. Data is too patchy to corroborate, but if correct, it would have significant implications for a host of industries.
So where does it leave us? World trade growth of around 4% in the medium term seems like a reasonable performance to expect, representing an improvement on recent years but a much more muted performance than pre-crisis years. Exchange rate volatility could make even this small feat difficult to achieve in the short term.
Those closely affected by trade may wish to embrace these new realities. The collapse in the Baltic Dry Index provides a lesson in ultra-exuberance. The index, which tracks the cost of shipping dry bulk commodities such as wheat and metal, fell from 1200 in August last year to a paltry 303 yesterday. Weaker demand for commodities may have something to bear but the main cause seems to emanate from the supply side, with too many new ships joining the fray and creating massive excess capacity. It is likely that these were not the only companies to get ahead of themselves during the good days of cheap credit, with more companies likely to be put out of business for misjudging future demand.