One of the puzzles about the performance of the world economy since the 2008-09 global financial crisis has been that the slowdown in international trade has exceeded the slowdown in economic growth.
According to the World Trade Organisation, global trade grew at less than 2 per cent last year, whereas from 1985 to the GFC world trade grew twice as fast as world gross domestic product.
In other words, pre-GFC, international trade growth exceeded world GDP growth. Now the opposite is true.
So what has been smothering international trade? Is it mainly due to slower world growth itself? Is it because of higher protectionist measures and/or inaction on trade liberalisation? Has the rebalancing of China's economy from its past heavy reliance on investment and exports to greater focus on domestic consumption and services played a role?
In short, the answer to all of the above questions is yes.
But for policy reasons it is important we know how significant each factor is.
World GDP has slowed dramatically since the GFC, averaging less than 3 per cent a year compared with about 5 per cent in the five years before the GFC. Anaemic investment in advanced economies - notably in the US, the euro area and Japan - as well as China's rebalancing mostly explains this. China, the second biggest contributor to world GDP after the US, has a new normal post-GFC growth rate of almost 7 per cent. Before the GFC it averaged a rate of 10 per cent.
The first thing to note is that the relationship between international trade and economic growth is not straightforward. It is two-way: economic growth causes international trade and international trade causes economic growth. If economies are growing, trade is growing, and this forms a virtuous cycle.
Globalisation was a driver of pre-GFC global growth consistent with the theory that international trade was a powerful economic engine fuelled by the efficiency and productivity gains it generated. With this engine no longer in top gear, unemployment in advanced countries, especially in Europe, remains elevated, and global poverty reduction is less than it could be.
According to empirical work by the International Monetary Fund on this issue, the main cause of the trade slowdown since the GFC has been the slump in economic activity resulting from the investment crash. Three-quarters of the decline in trade growth since 2012 relative to the five-year period before the GFC is attributable to weaker economic activity arising from stagnant investment. This is because a high proportion of international trade is in intermediate and capital goods.
The weak investment driving the trade slowdown reflects poor productivity in advanced economies, still-damaged European and US banking systems, ongoing budget deficits that crowd out investment funding, the China factor and a global debt overhang that has never been higher.
The public debt component of global debt has increased on average by 25 per cent in advanced economies since the GFC and central government balance sheets have worsened accordingly. Australia's public debt and government balance sheet deterioration has paralleled this.
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