Tsunami: protectionism spreads
Protectionism has been one of the main factors weighing down global activity over the past 18 months. Last summer, we argued that trade tensions were the biggest risk for the world economy. We still believe this and we continue to perceive the tariff war as one of the greatest risks going forward.
The US-China spat remains at the centre of this protectionist surge and the route to achieving a trade deal between the two is no clearer now than it was when the trade war erupted last year. Treasury Secretary Steven Mnuchin said that 90% of issues were resolved before talks collapsed in the Spring, including the trade imbalance and intellectual property. The remaining issues, however, have proved hard to crack – notably the enforcement mechanism.
Meanwhile, trade protectionism has spread. The European Union (EU) has one of the largest current-account surpluses in the world, which has attracted Washington’s attention. Recently, the US threatened to impose higher tariffs on $4bn-worth of imports, blaming Airbus subsidies. While this move was largely symbolic, the US and the EU are set to resume negotiations on auto tariffs later this year and a more critical confrontation looms.
Trump: aggressor or accelerator
Beyond current rising tensions however, there are also several longer-term trends that explain the ongoing reconfiguration of global trade patterns.
In a sense, the protectionist wave we now observe is simply bolstering anti-trade sentiment that has been underway for decades. While the net effect of greater trade openness is positive, globalisation has created winners and losers. Since the mid-1980s, the gap between developed and emerging markets has shrunk significantly, but inequality within countries – particularly in advanced economies – has widened. The low-skilled workers that typically fall in the upper-middle section of the global income distribution have suffered from more exposure to international competition.
The retreat of cross-border trade predates the recent protectionist wave, suggesting that there are other factors at play. Growth in trade volumes has slowed sharply since 2012, relative both to historical performance and overall economic expansion. Weaker structural growth and the decline of trade-intensive components of economic growth (such as investment) help explain this.
Technology key to brave new world
Technology has also played a crucial role, with automation enabling the re-shoring of manufacturing activity and the contraction of global value chains. The availability of cheap, automated technology and rising foreign labour costs have encouraged firms in the US and other western countries to start to repatriate manufacturing activity. One study found that one extra robot for every 1,000 workers is associated with a 3.5% rise in re-shoring.
Subsequently, the long-term prospects for global trade are not clear cut. Is the US-China spat a disruptive force for global trade, or is it simply a catalyst hastening the reversal of globalisation and bringing about the birth of a new and unavoidable equilibrium?
A fragmented future
It has become increasingly apparent that we are moving from an integrated, international model to one that is based around two or three regional trade blocs, each with its own regulatory system, shorter supply chains and limited cross-border activity.
The emergence of a bifurcated global economy looks increasingly likely, given that US-China tensions spread far beyond trade. Indeed, tariffs look secondary to technological tensions, security concerns and diverging cultural values.
It is unclear whether there will be room for a third player: Europe’s lack of cohesion means it risks being squeezed by the two behemoths surrounding it. The continent’s divided response to China’s ‘Belt and Road’ initiative is testament to its lack of direction at this stage.
There are many downsides to a more fragmented world. The re-shoring of manufacturing is unlikely to increase wages for lower-skilled workers. Instead, it will probably boost the incomes of professionals who are not affected by automation, leading to even greater income inequality.
Regions and countries will also be excluded or disrupted from a globe split in two. Africa and Latin America might fall between the trading blocs, while economies that export to both China and the US will have to make difficult choices. Moreover, multilateral cooperation will probably become harder. A lack of international coordination could impair the effectiveness of efforts to tackle climate change and sustainability issues. The chance of a military conflict could also increase.
The transition period will inevitably come with challenges. Yet we think it could also throw up opportunities. Should an alternative economic order emerge, investors will need to be savvy when navigating the new system and identifying emerging opportunities. The new order will not be built overnight: it is a long-term story that is likely to develop over decades but the trade war has exacerbated forces already in motion and change is certainly on the horizon.