Posted on January 10, 2015

Over the last three years, world trade growth has been significantly lower than prior to the global financial crisis. This raises questions about why world trade is in the doldrums and whether it is likely to recover to pre-crisis levels. On the demand side, weaker global growth has contributed to lower world trade activity and is likely to depress trade growth going forward. However, this is not the full story. Other factors, such as the changing structure of supply chains and rising protectionism, have also contributed to lower world trade activity. It is likely that these long-term structural trends will keep world trade growth depressed below pre-crisis levels for years to come.

World trade volumes grew by an average 5.9% a year during 1980-2008, collapsed during the 2009 recession that followed the financial crisis to -10.6%, and bounced back in 2010-11 to 9.6% on average. However, in 2012-14, annual growth in world trade volumes has been relatively weak at 2.8%. Part of this slowdown is attributable to weak global demand. World GDP growth was 3.3% in 2012-14 on a purchasing power parity (PPP) basis, compared with 3.6% in 1980-2008. Additionally, world trade has typically been 1.6x global GDP growth. This suggests that world trade should have grown by 5.3% in 2012-14, whereas its growth rate has been even slower than global GDP growth. Therefore, lower demand is insufficient to fully account for the slowdown in world trade, begging the question, what else is holding back global trade?

Why is world trade in the [].jpgFirst, the evolution of China and the US as the world’s largest trading nations is changing the structure of global supply chains. During the last two decades, China has become the world’s manufacturing hub. At the same time, China has reduced its reliance on other countries for inputs to its supply chain. As a result, the share of imported inputs in China’s exports has fallen from 50% in 2000 to 35% currently. This has had a negative impact on world trade growth. Since the 1980s, the US relied on off-shored production, mainly to China, to reduce its production costs. As a result, US manufacturing imports doubled from an average of 4% of US GDP in the 1980s to 8% in the 2000s. Since then, the US has slowed the rate at which it offshores production—manufacturing imports have been broadly constant at around 8% of GDP. This has also had a negative impact on world trade growth. A recent IMF study, “Slow Trade”, highlights these structural changes as the main factor holding back world trade.

Second, rising protectionism may be holding back trade growth. In late 2008, in the aftermath of the global financial crisis, G20 leaders pledged a standstill on trade protectionism to avoid a repeat of the trade protectionist spiral of the 1930s. However, numerous measures have been introduced since then in contradiction to this pledge. In 2012, the EU released a report that identified a “staggering increase in protectionism around the world”. According to the Global Trade Alert website, over 70% of new trade rules are protectionist and almost 3,870 such measures have been introduced since 2008. Last but not least, tariff barriers have been falling steadily over recent decades, but at a slowing rate. Since the 1980s, the fall in tariff barriers has been most dramatic in developing countries—average tariffs were about 30% of trade in 1980, 15% in 2000 and are currently under 10%, but are now only falling slightly each year. The boost to trade from lower tariffs has therefore been gradually declining over time.

Going forward, world trade is unlikely to recover to pre-crisis levels in the short term for three main reasons. First, demand is unlikely to recover. Europe, which accounts for almost one third of world trade, is expected to be economically stagnant in 2015. In China (11% of world trade), growth is slowing and any pickup in growth in the US (10% of world trade) is unlikely to be enough to compensate. Second, the trends driving the structural slowdown in trade between China and the US are likely to persist. China is likely to continue to reduce its reliance on external inputs in its supply chain in order to capture a higher share of value added. At the same time, the US is unlikely to accelerate the rate at which it offshores domestic manufacturing, especially given lower US energy costs and flat domestic wages.

Third, the lack of success for multilateral trade negotiations means that minimal progress in the reduction of trade protectionism can be expected. The Doha Round of trade negotiations was initiated in 2001, but few of its ambitious objectives to lower global trade barriers have been realised. The latest agreement on implementation of the Doha Round—finalised in Bali at the end of 2013—faced setback when India reneged on the deal in July 2014. A recent agreement between the US and India could help salvage the situation but negotiations remain fraught. Therefore, we expect world trade to grow at roughly the same rate as world GDP growth in 2015-16 (forecast to average 3.9% by the IMF), well below pre-crisis levels. The next question is, does it matter? History suggests that if world trade does not pick up significantly, the recovery of the world economy is likely to be subdued.