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Global trade in decline long before the pandemic

The sensitivity of trade to the economic cycle appears to have become larger in recent decades.

The crisis has massively disrupted the international flow in goods and services and may well have long-term consequences to the global trading system. Before the pandemic, global trade was already experiencing a long-term slowdown as a result of protectionism and a changing structure of supply chains. Once the virus is brought under control and economic activity has returned to pre-pandemic levels, these issues are expected to remain. This structural decline is likely to accelerate as governments aim to reduce the vulnerabilities that the pandemic has exposed to the global trading system.

  • Industrial shutdown has caused collapse in global trade and localized breakouts will lead to a volatile recovery
  • Global trade has been in decline for the last two decades due to deep-rooted structural reasons
  • The crisis is likely to lead to an acceleration in onshoring of production and protectionist measures

Trade in goods well placed to recover but there are grave concerns for global tourism

  • Industrial shutdown has caused collapse in global trade and localized breakouts will lead to a volatile recovery
  • The collapse in tourism has created a unique shock to services, with international travel taking until 2023 to fully recover

Industry shutdown stopped global trade with uneven recovery ahead

International trade is widely acknowledged as being the engine of global growth since WWII. Trade in goods and services increases competition, offering consumers a greater variety of goods and lower prices. For firms, it boosts the size of potential markets. Greater competition requires firms to invest and innovate in order to both improve the quality and efficiency of its production process. Ultimately, this boosts productivity, the long-term driver of economic growth. Increased globalization has seen the gains from trade spread, leading to an acceleration in global growth.

Global trade generally falls by more than overall GDP in downturns reflecting the fact that trade tends to be closely linked to the performance of the industrial sector which can exhibit particularly sharp fluctuation over the course of the economic cycle. Indeed, trade was already declining before the virus hit, leading to an 18% y/y slump the movement of goods in May.

The ‘sudden stop’ in trade since March looks quite similar to that seen in late 2008 and early 2009 as a result of the financial crisis – and is dramatically worse than seen in the early 2000s ‘dot-com’ bust. This is consistent with industrial production suffering the sharpest fall in a decade, particularly in consumer-facing industries such as automotive, aerospace, and furniture manufacturing.

World: GDP, trade and industry – worst years

Alternative high frequency indicators suggest trade likely bottomed out in June before picking up again in July. In the second half of 2020, a significant easing of lockdowns will mean global activity will be kicking back into gear. Early indications from Asia show the recovery could be swifter than it was a decade ago, where the level of world trade bumped along the bottom for six months or so before starting to recover. China’s exports in April-May were already back close to the levels seen before the virus hit, and South Korean exports in July are 10% below pre-pandemic levels having hit a low of -23% relative to the start of the year in May. This points to a sharp rebound in demand for final consumer goods. Combined with an unwinding of supply-chain disruption, global trade should initially rebound sharply before decelerating with the wider global economy.

These are all encouraging signs, but do not guarantee a rapid or sustained recovery. While much of the world has now started to emerge from lockdowns, the process may not be a smooth one. The US has already had some setbacks, and localised viral outbreaks may continue to be a disruptive factor in the movement of and demand for goods across the globe, even where national lockdowns have ended.

This will be the first step on the long, uneven road to recovery; the global movement of goods is significantly easier to navigate around new health restrictions than the movement of people and services.

Global collapse in tourism creating a unique shock to services

While a slowdown in the trade of goods is to be expected in global downturns, the restriction in the international movement of people is unique, with the travel and tourism sector in the midst of the largest downturn since World War II. One of the early containment measures used to control the outbreak of COVID-19 were restrictions on international travel. These have had a significant impact on travel with daily flight volumes in April 80% lower than in January. The unusually service-driven nature of the emergent recession means services trade, which accounts for one fifth of total, has plummeted far more sharply than in a normal global recessionary environment.

Usually demand for travel recovers quickly following downturns, and despite the severity of this current crisis, can be expected to eventually recover to pre-pandemic levels in coming years. While economic factors will play a role in the recovery this time too, other factors such as how quickly travel restrictions are lifted and the speed at which people are prepared to resume foreign travel, will be more important.

It is likely that travel restrictions will be a fact of life for some time, weighing on global tourist activity, while residual social distancing may also be a problem for some sectors. Oxford Economics baseline forecast assumes international visitor arrivals decline 55% in 2020 and do not recover to 2019 volumes until 2023.

World air passenger demand

Structural factors have been weighing on trade growth for the last two decades

The sensitivity of trade to the economic cycle appears to have become larger in recent decades. Goods trade is particularly sensitive during crisis periods, for example in the 1930s and 2008/09. The reasons for this include rising trade barriers and costs (in the 1930s), financial dislocations interrupting trade finance (during 2009), and sudden ‘stops’ to economic activity leading firms to run down inventories (happening now).

Before the COVID-19 pandemic forced a sudden and sharp drop in global activity, world trade was already in an ongoing structural slowdown. Between 1992 and 2007, world trade growth averaged 7.7% per year, roughly double the average pace global GDP growth of 3.4%.

In the latter part of the 20th century factors such as technological development, reduced barriers to trade and China’s membership of the World Trade Organisation encouraged the creation of complex supply chains that led to multiple crisscrossing of borders by components and the rapid growth in global trade. Increased fragmentation of the production process across the globe went hand in hand with declining transport costs and easing of trade barriers.

It seems that these trends have lost momentum or even gone into reverse since the early 2000s. Since 2011, world trade growth has slowed significantly to 3% while global GDP growth has moderated slightly from before the global financial crisis to 2.9%. The key structural drags on world trade have been changes to the global supply chain network and the erosion of the multilateral trading system.

Growth of import

Nature of supply chains is changing

During the 1990s and 2000s, the production process became truly global as the imported content of production rose, with the components of manufactured goods crossing international borders several times, leading to a surge in the value of global trade.

This expansion has now stalled. To some extent, this reflects the “natural” development of developing and emerging economies moving up the value chain. Some key factors here are:

  • Rather than predominantly assembling foreign components, China now produces a substantial share of these intermediates on its own.
  • Europe’s declining share of global GDP and the corresponding rise in the share of emerging markets that are less open to trade. This means that while global trade has continued to expand, it has slowed relative to growth of the overall global economy and therefore trade is becoming a less vital cog in the global growth.
  • Technological changes (eg, 3D printing and automation); higher wages in emerging markets; and firms prioritising flexibility, quality, or proximity to customers have also reduced the incentive for firms to move production to low-cost centres abroad.

Physical goods are highly tradable and make up the vast majority of international trade between economies. Services, such as travel and tourism on the other hand, are much less tradable between economies since these generally require individuals to be physically present in the country of origin. Therefore, trends in international services trade are much less susceptible to change from forces such as supply chains and protectionism.

Rising protectionism has accelerated these trends

Shifting international supply chains and its consequences are somewhat inevitable and are not necessarily malevolent. However, a rise in protectionism and inward-looking trade policies is something else to be concerned about.

The most damaging recent trade dispute has, of course, been between the US and China. Even with the “phase one” trade deal signed; the trade war has left bilateral tariffs very high. The average US tariff on Chinese imports is still 19.3% – over seven times the average rate in 2017. Each round of increased levies on Chinese imports has had a direct negative impact on the demand for these goods. Collectively in annual terms, overall US imports from China have been contracting steadily since the start of 2019. The prospect of further sharp rises in tariffs and other restrictions may have further discouraged bilateral trade.

On top of this, the imposition of trade tariffs by the US on Mexico and Europe contributed to global goods trade slowing from 6.5% growth in 2017 to just 0.3% in 2019.

Estimates of the strength of these structural factors vary, but some studies suggest that it accounts for between half and two-thirds of the recent decline in world trade as a share of global growth, with little evidence that the trends are likely to reverse anytime soon. Overall, the rise in protectionism globally has contributed to countries trading less and focusing on domestic industries, something which is expected to continue accelerating after the pandemic.

Pandemic could intensify already fragmented trading relationships

  • The crisis is likely to lead to an acceleration in onshoring of production and protectionist measures
  • Coronavirus crisis could intensify existing trading hostilities and lead to the further breaking up of the global trading system

There is likely to be interest from governments in shortening of supply chains or “reshoring” of production; some of which (eg, the US) were already pushing for before the crisis hit. But given that reworking (or duplicating) supply chains can be an expensive business, much will depend on how long the virus threat lingers. If it dissipates fairly quickly, the impact on supply chains will probably be small.

There is likely to be particular interest in building strategic domestic capacities to generate certain kinds of medical goods, given recent acute supply problems. The impact of that shouldn’t be exaggerated, though; imports of drugs and medical devices amount to only around 4%-5% of total imports for the major economies.

Oxford Economics latest forecasts show world goods trade rising by just 3.5% per year from 2020-2029, roughly equal to the decade just gone. However, more concerning is the ratio of trade growth to GDP growth (the trade-multiplier) for the next decade is at just 1.1, which will be by far the lowest seen in any decade since the 1950s. This is a concern because a lower trade multiplier implies that resources are being allocated less efficiently across economies and therefore there are significant losses to productivity – essentially the gains from trade are being reduced.

World trade multiplier

The economic development of the 1990s and 2000s was helped significantly by the expansion of global trade. This globalisation resulted in production shifting to the cheapest locations, cutting costs but at the cost of greater supply chain complexity. While it is not clear whether less complex supply chains would have resulted in less disruption to firms during the Covid-19 crisis, recent events have shown that many firms’ production processes are at risk of huge disruption if one small part of the supply chain is forced to cease production. In this respect, post-pandemic firms may increase efforts to improve the resilience of their supply chains. Nonetheless, wholesale changes to firms’ supply chains seems unlikely.

While supply chains can be reconfigured, shifting from one supplier to another will merely swap one form of risk for another. To improve resilience, firms could source all inputs from multiple suppliers. But this would be expensive and time consuming to find, monitor, and integrate multiple producers into a supply chain. For most management teams, particularly those that are incentivised to maximise short-term profits, ramping up costs significantly by reshoring or switching to multiple suppliers is unlikely to be seen as a sensible strategy.

Pre-pandemic trading hostilities still a threat to world trade order

  • The crisis is likely to lead to an acceleration in onshoring of production and protectionist measures
  • Coronavirus crisis could intensify existing trading hostilities and lead to the further breaking up of the global trading system

The crisis likely is to lead to an acceleration in onshoring and protectionism

There is likely to be interest from governments in shortening of supply chains or “reshoring” of production; some of which (eg, the US) were already pushing for before the crisis hit. But given that reworking (or duplicating) supply chains can be an expensive business, much will depend on how long the virus threat lingers. If it dissipates fairly quickly, the impact on supply chains will probably be small.

There is likely to be particular interest in building strategic domestic capacities to generate certain kinds of medical goods, given recent acute supply problems. The impact of that shouldn’t be exaggerated, though; imports of drugs and medical devices amount to only around 4%-5% of total imports for the major economies.

Oxford Economics latest forecasts show world goods trade rising by just 3.5% per year from 2020-2029, roughly equal to the decade just gone. However, more concerning is the ratio of trade growth to GDP growth (the trade-multiplier) for the next decade is at just 1.1, which will be by far the lowest seen in any decade since the 1950s. This is a concern because a lower trade multiplier implies that resources are being allocated less efficiently across economies and therefore there are significant losses to productivity – essentially the gains from trade are being reduced.

World trade multiplier

The economic development of the 1990s and 2000s was helped significantly by the expansion of global trade. This globalisation resulted in production shifting to the cheapest locations, cutting costs but at the cost of greater supply chain complexity. While it is not clear whether less complex supply chains would have resulted in less disruption to firms during the Covid-19 crisis, recent events have shown that many firms’ production processes are at risk of huge disruption if one small part of the supply chain is forced to cease production. In this respect, post-pandemic firms may increase efforts to improve the resilience of their supply chains. Nonetheless, wholesale changes to firms’ supply chains seems unlikely.

While supply chains can be reconfigured, shifting from one supplier to another will merely swap one form of risk for another. To improve resilience, firms could source all inputs from multiple suppliers. But this would be expensive and time consuming to find, monitor, and integrate multiple producers into a supply chain. For most management teams, particularly those that are incentivised to maximise short-term profits, ramping up costs significantly by reshoring or switching to multiple suppliers is unlikely to be seen as a sensible strategy.

Pre-pandemic trading hostilities still a threat to world trade order

There is a risk that tensions between the US and China could be reignited by the coronavirus crisis and even broadened to involve other actors. Weak global growth and high unemployment may also encourage governments more broadly to try to protect domestic firms.

The coronavirus crisis could hasten the decline of the multilateral world trade system and increase tendencies towards regionalism. Regional trade integration isn’t necessarily a bad thing for world trade. Indeed, it has in the past been an important push for faster global trade, with recent rises in intraregional trade (e.g. in Asia and Africa) having almost certainly been positive for world trade.

But if regional groupings become more closed to the outside world, this is potentially negative for world trade. In this regard, some straws are already in the wind, such as tighter rules of origin agreed in United States-Mexico-Canada trade agreement (USMCA and successor to NAFTA) and proposed environmental border taxes in the EU.

In a worst-case scenario, the economic impact of the virus could inflame existing trade tensions and accelerate inward-looking trends. The world trade system could fracture into a multipolar system based more on the bullying power of large economies than on global rules. In such a scenario, the growth rate of world trade could fall below that of GDP for an extended period – something last seen in the interwar years.

This is not to suggest that less trade is taking place, it simply means that it is slowing down relative to the rate of growth of the overall economy. Global trade has been growing at twice the rate of GDP in the 1990s, which highlights the rapid rise of globalization that allowed goods to be traded efficiently between countries that could produce such goods at the cheapest costs. A slower pace of trade implies that goods are not being traded as efficiently and is therefore hampering productivity growth and the capacity of global output.