Sputtering Trade Fuels Fears of a Fractured Global Economy

Date: Friday, August 11th, 2023
Source: Wall Street Journal

The downturn in world trade, exemplified by slumping Chinese exports and a decline in U.S. imports, mainly reflects a phase of weak global economic growth.

It also raises questions about whether deeper changes are under way, with decades of deepening global economic integration giving way to a new era in which the West and China do more business with their political friends and less with each other.

Geopolitical tensions, heightened by Russia’s invasion of Ukraine, are leading to more curbs in the U.S. and Europe on doing business with China. The sheer scale and complexity of global trade and investment links, however, mean any process of disentangling the world economy into blocks of like-minded countries is likely to be gradual and incomplete.

Global trade is currently weak mostly because demand for goods is weak, economists say. Higher interest rates in the U.S., Europe and other economies battling with inflation have led to a broad global slowdown.

In addition, consumers who spent heavily on goods during and after the Covid-19 pandemic are now spending more of their disposable income on services, which—with exceptions such as tourism—are more likely to be locally produced. Manufacturing-heavy economies in Asia are feeling the fallout.

Trade in services is livelier than shipments of goods, thanks not least to the rebound in international travel and tourism, which is expected to recover this year to nearly its prepandemic level.

Inflation itself is also weighing on trade. Food and energy prices remain higher than before Russia launched its full-scale invasion of Ukraine in early 2022, cutting into people’s disposable income around the world, even though commodity prices such as grain and natural gas have fallen from their peaks last year.

“The main story is probably related to the global slowdown in manufacturing, after the big surge in manufacturing that followed the pandemic,” said Lorenzo Codogno, chief economist at LC Macro Advisors and a visiting professor at the London School of Economics. “Fragmentation, deglobalization, de-risking will play a bigger role in the coming years and could be very significant. But I’m skeptical that it can happen overnight,” Codogno said.

Resilient U.S. consumer demand, helped by strong wage growth, has been a bright spot for the world economy. But the Federal Reserve’s interest-rate increases are weighing on business investment, including spending on capital goods.

Trade data is beginning to reflect that. In the first half of this year, overall U.S. imports declined 4% from a year earlier, while exports grew 2.6%, the Commerce Department said Tuesday. Imports fell 1% in June from May to $313 billion, the lowest level since December 2021.

“Though the holiday season may bring some improvement to trade flows, we expect strong headwinds in the form of elevated interest rates, softening consumer demand, and a mild recession to prevent a sustained recovery until 2024,” Matthew Martin, U.S. economist for Oxford Economics said in a research note on Tuesday.

The International Monetary Fund expects growth in global trade to slow to 2% this year from 5.2% last year. The World Bank and the World Trade Organization both forecast trade will grow by just 1.7% this year.

Even a partial recovery in 2024 is predicted to fall well short of trade’s average yearly growth of 4.9% during the two decades before the pandemic.

Economists at the IMF and other multilateral organizations mainly blame sluggish overall growth, especially in advanced economies. But they have also expressed concern about the long-term effect of geopolitical rivalries on global trade, with possible emergence of a trading bloc surrounding China and Russia, and another around the U.S. and its allies.

“We see the increase in trade restrictions that have been imposed by countries on one another,” IMF chief economist Pierre-Olivier Gourinchas said in late July, pointing to a spread of tariffs and restrictive regulations. “There is an impact in terms of direct investment also and that is quite important.”

The U.S. is expected to announce fresh curbs on investment in some Chinese technology companies, a further move to restrict Chinese access to American know-how following last year’s restrictions on the export of advanced semiconductors and chip-manufacturing equipment.

The Biden administration has also kept in place most of the tariffs on goods from China and other countries implemented by the Trump administration.

Many European countries are clamping down on Chinese investments in the region, and the continent’s leaders are looking for ways to reduce their dependence on China for critical raw materials and other inputs. But companies from Germany and other countries that have built up a heavy reliance on the Chinese market are resisting political calls to scale back.

The West’s efforts to isolate Russia show how difficult it can be to untangle globalization. Despite sanctions on Moscow and calls for businesses to pull out, many European and U.S. companies continue to operate in Russia. Spikes in German exports to countries neighboring Russia, such as Georgia and Kazakhstan, are fueling suspicions that Russia is still importing many Western products via roundabout routes.

On the other hand, European countries have replaced the bulk of Russian oil and natural gas with other sources, while Russia is redirecting its energy exports to China and other customers, showing how war can lead to rapid shifts.

Other recent geographical shifts include the U.S. and Europe trading more with each other, even as Western trade with China slows; Mexico supplanting China as the U.S.’s largest trade partner; and developing countries shifting their exports to China rather than the West.

The pace and patterns of globalization have shifted before. The world economy rapidly became more interconnected after the end of the Cold War and the collapse of Communism, and particularly after China joined the WTO in 2001. For years, cross-border trade and investment rose as a share of global economic activity.

But globalization began to stagnate after the 2008 global financial crisis. Trade no longer grew faster than the overall world economy, but it didn’t sharply decline either.

Most economists agree that the rise of trade has been enormously beneficial overall, helping to lift hundreds of millions of people out of poverty and boosting overall output in both advanced and developing economies. But the gains haven’t been spread evenly, with middle-to-lower-income workers in rich countries often feeling left behind, fueling a political backlash.

A return to higher tariffs and other forms of trade protection followed, notably under the Trump administration. Now, the war in Ukraine has brought back the specter of “great power” conflicts, including between China and the U.S., and with it a push for more economic barriers.

In the early 20th century, it was great power wars that ended the first era of deeply interconnected global trade, with a revival coming only after the fall of the Berlin Wall.

Many economists worry that a reversal of this century’s boom in trade would carry a heavy economic cost, bringing higher prices and lower efficiency if production moves to politically allied shores. “Economically, a real division of the world into two blocs would be a big loss,” said Codogno.

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