Photo: Bloomberg
Photo: Bloomberg

The great global trade slowdown

The sharp decline in trade elasticity suggests that there are structural challenges that are deeper than the usual reasons

Has the golden era of global trade that began with the collapse of communism finally come to an end? And what does this mean for Indian economic strategy?

The latest trade statistics from around the world do not make for happy reading. Economists at the World Trade Organization have recently cut their forecast of global trade in 2015 by 50 basis points, to 2.8%. Trade volumes are falling in many countries such as China. The Indian trade numbers too have been weak. The immediate news on the trade front should not be a surprise for most people who follow economic trends. But there could be more structural damage as well that is not captured in the headlines.

The trouble began a few years ago. Annual global trade growth averaged a splendid 6% between 1990 and 2008, or broadly twice the growth rate of global output. Then trade between nations collapsed in the aftermath of the North Atlantic financial crisis.

The recovery since then has been weak. A simple extrapolation shows that global trade is even now around a fifth less than what it would have been if the trend of the 18 years after 1990 had been maintained.

Trade growth has averaged an anaemic 2.5% over the past four years. That is just a little less than the growth in global output in that period. In other words, a comparison of the data between 1990 and 2008 on the one hand, and between 2011 to 2015 on the other, shows that trade elasticity has nearly halved between the two periods. The most immediate causes for the sluggish growth in global trade are well known, but the sharp decline in trade elasticity suggests that there are structural challenges that are deeper than the usual reasons such as the slowdown in China or weak demand in the developed countries.

What does this mean for policymakers? Here are three issues that deserve attention.

First, countries that faced weak domestic demand have traditionally tried to export their way out of trouble. What has been happening in recent years may mean that net exports will be of less importance as an engine of economic recovery. Many countries are still trying the old strategy by pushing down their currencies. In fact, the current debates about currency wars need to be looked at against the backdrop of sluggish global trade. The inability to depend on net exports could mean that the classic Keynesian strategy—higher public spending—will become more important when countries are battling weak demand from the private sector.

Second, most Asian countries that raced out of poverty over the past five decades have depended heavily on export growth. China is the latest example. This strategy worked with countries such as India that chose autarky because of export pessimism and languished in the growth race. The technology revolutions as well as the fall in transaction costs after 1990 also made it possible for large firms to splinter their production processes. Integrated companies were replaced by global value chains. Trade in intermediate goods grew in importance. It is not at all clear what is happening, but yet worth asking whether ambitious programmes such as Make In India will struggle when there are such important structural changes in the global economy.

Third, will onshoring become enough of a threat to offshoring as energy costs decline and the use of robotics on a large scale reduces the importance of wage differentials between different countries? Of course, one must not forget the basic Ricardian insight that trade can be beneficial even if one country produces all goods cheaper than another country, or that comparative advantage is more important than absolute advantage.

This is what Paul Krugman wrote in September 2013: “The point is that it’s entirely reasonable to believe that the big factors driving globalization were one-time changes that are receding in the rear-view mirror, so that we should expect the share of trade in GDP to plateau—and that this doesn’t represent any kind of problem. In fact, it’s conceivable that things like rising fuel costs and automation (which makes labour costs less central) will lead to some ‘reshoring’ of manufacturing to advanced countries, and a corresponding decline in trade share."

Most economists agree that trade lowers costs, promotes specialization and helps in the transfer of knowledge. That is why the recent trends in global trade deserve more attention. Unlike the 1930s, when global trade collapsed because of myopic protectionism unleashed by governments across the world, what is happening now could be more endogenous changes.

Global trade may stage a spectacular recovery in the coming years, but what is happening right now cannot be ignored. It needs to be understood. It needs to be debated.

Finally, take a look at trade intensity. China’s trade-to-GDP ratio was 32.2% in 1990, peaked at 61.8% in 2007, and was down 41.5% in 2014. That perhaps tells us something.

Niranjan Rajadhyaksha is executive editor of Mint.

Comments are welcome at cafeeconomics@livemint.com.To read Niranjan Rajadhyaksha’s previous columns, go to www.livemint.com/cafeeconomics-

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