With global economic output projected to decline by 3 percent in 2020 (and over 6 percent in advanced economies) according to the IMF, we are looking at a downright plummeting of global trade volume in 2020: between 13 and 32 per cent, according to the World Trade Organization.
It is worth comparing this situation with the 2008-2009 financial crisis, among trade economists known as the Great Trade Collapse. Trade volume fell by 15%, around four times as fast as the drop in output. One of the reasons why the WTO projects global trade to fall by a much bigger factor (up to 10 times the fall in global output) is because the economic contraction is greater, much more synchronized and effectively impacting all countries. The effects of the 2008-2009 crisis were more limited, and much more concentrated.
Protectionism will not create a recession, but it will deepen it
This synchronized, global lockdown caused by Covid-19 has struck at the core of global value chains hub regions including China, Europe and the U.S. Over the past four decades, the creation of global value chains has demonstrated how to produce and market products in a cost-efficient manner around the world. The current pandemic has had a big impact on these global value chains, perhaps in none so much as in medical supplies, but certainly in sectors with complex supply chains, such as electronics and car manufacturing. As the immediate public health crisis slowly but surely recedes, policymakers try to look beyond the horizon as they see a very high risk for an extraordinary economic downturn.
Trade barriers have gone up remarkably easily in the last few weeks. In fact, the WTO has reported that so far 80 countries have introduced export prohibitions or restrictions as a result of the Covid-19 pandemic. These new export prohibitions or restrictions mostly cover medical supplies such as face masks, pharmaceuticals, ventilators and other medical equipment. But the WTO also reports on the current lack of transparency at the multilateral level and the long-term risks that export restrictions pose to global supply chains and public welfare.
In response to shortages of personal protective equipment (PPE) in Europe, for example, the European Union introduced an export authorization measure in late March. This required companies wishing to export PPE to notify their national government. The EU has changed tack in the meantime and introduced exemptions. It soon realized its measure had unintended side-effects for developing countries that heavily rely on EU exports of medical supplies.
However, history teaches us that trade restrictions have a remarkable ability to survive over time (some of the tariffs introduced in the wake of the 1973 oil crisis remain in place to date). In the meantime, new restrictions that will impede global trade loom large.
The current trade conflict between the U.S. and China is now fully focused on the future of 5G technology. Last month, the White House issued proposals that require both domestic and foreign firms using American chipmaking equipment or intellectual property to obtain an export license to supply products to China. U.S. industry groups are pushing back on the proposed changes to U.S. export controls, highlighting the role chips play in addressing the Covid-19 pandemic and the harm it would cause to US exports of chipmaking equipment (which bring in over $20 bn a year). The trade war with China happened over a period of economic prosperity. With the U.S. economy contracting by nearly 5 percent this year and a Presidential election upcoming, the current pandemic provides a useful pretext to impose new restrictions in the form of tariffs.
Diversify or Re-shore?
More generally, there is a strong political will around the world to strengthen resilience in supply chains and to reduce trade dependencies that have been laid bare by this crisis. Policymakers differ on the correct approach to achieve such resilience and can be broadly divided into two camps: the free trade supporters call for a diversification of supplies, whereas the more interventionists believe the right remedy is to repatriate (parts of) the supply chains.
The U.S. already embarked on a strategy to increase the number of stronger integrated U.S. based supply chains. The European Union proposed to achieve more strategic autonomy in several “critical” sectors, both through a “dynamic industrial policy” and re-shoring of supply chains to Europe. Usually, this means greater market intervention: more flexibility with regards to state aid and subsidies, and possibly higher tariffs to encourage production to move into the EU Single Market. Because the EU is made up of 27 different Member States with a variety of economic interests, the list of “critical” sectors is potentially significant. Unlike in 2008, the UK won’t be around this time to prevent the EU from giving in to more protectionist tendencies.
The crisis confronts policymakers around the world with tough choices. Advocating for free trade is not inherently left or right wing. Indeed, several countries have called for an international agreement to remove tariffs and quota on medical supplies. Some politicians are leading the charge for continued openness. European Commissioner for Trade Phil Hogan wants to increase the pace of bi-lateral free trade agreements. This week’s conclusion of the modernization of the EU trade agreement with Mexico is an example that trade diplomacy continues apace.
Nevertheless, some of this ‘de-globalisation’, will happen whether policymakers like it or not. Some businesses will look to reduce their exposure to trade tensions. As businesses start developing better plans to accommodate different supply chain scenarios, it looks likely that many will seek to ramp up investments in automation, to bring home – and thus shorten – their supply chains. There will be pressure on the just-in-time manufacturing model in which components and products from across the world are delivered right on time. Some will seek to increase their inventories to build resilience to shocks in international supply chains – what some have dubbed the just-in-case model.
Choices of policymakers matter
This doesn’t mean that policymakers’ choices in the coming years do not matter. Export protectionism is notoriously contagious and can quickly spill over into other sectors and to other countries, whether they are generally free trade minded or not. It is politically hard to continue playing by the rules if others refuse to do so.
International coordination will be key to prevent the global trade system from fraying. At the inaugural G20 summit in 2008, a strong, joint commitment helped to keep barriers to trade and investment largely at bay, speeding up global recovery from the financial crisis.
The world has changed since 2008. China is much more dominant in global supply chains and sees a unique opportunity to bring more countries into its economic orbit. U.S. leadership is already focused on an all-consuming election campaign. Other major economies shouldn’t wait around to let trade protectionism create a deeper recession than necessary.