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The economist’s view: A world caught in tradelock

Global trade was high on the agenda of the G20 meeting in Hangzhou, China – and for a good reason, too.

Global trade was high on the agenda of the G20 meeting in Hangzhou, China – and for a good reason, too.

Volume growth trudged along at a limited pace over the past four years, twice slower and twice closer to GDP growth rate when compared to the pre-crisis period. In 2016, it might even dip below the key overall indicator. Trade volume growth is expected to reach +2.1% against GDP growth of +2.4%.

Unsurprisingly, such trends raise worries among the leaders of major economies. Global GDP has been inching up below 3% since 2012 and trade seems to be one of the culprits. In the pre-crisis period, strong expansion in global movement of goods and services was associated with healthy economic growth and a fast catch-up by emerging markets.

Unsurprisingly, such trends raise worries among the leaders of major economies. Global GDP has been inching up below 3% since 2012 and trade seems to be one of the culprits. In the pre-crisis period, strong expansion in global movement of goods and services was associated with healthy economic growth and a fast catch-up by emerging markets.

Against this backdrop, G20 members with China as a frontrunner called for further coordination and action. Their aim, if you will, was to rid the global economy of what I call tradelock. In this situation sluggish trade hinders growth and vice versa.

Solemn pledges to act might suffice for some pundits. Those who want to believe are welcome to. Reality as seen through the economist’s lens is, sadly, a trifle more complex.

There are few reasons to believe in a fast recovery. Real global trade would likely grow below 4% in the medium term, far below the pre-crisis average of 7%.

Stuck in the slow lane

Global trade growth in volume will slow in 2016 to 2.1%, down from 3.0% in 2015. In value terms, it should contract at a slower pace: - 2.9% this year, after -10.4% in 2015. Why is this happening? Look no further than low commodity prices, which push down overall prices.

Currency depreciation and volatility will also remain a drag. These reflect the continued divergence in monetary policy between the US and large economies such as China and the Eurozone. While the former is tightening, the latter is easing. Add to those ongoing concerns over large emerging markets such as Russia, Brazil. When these engines sputter, if not overall choke, the whole machine is stuck in tradelock.

We see a slight improvement next year, with volume trade expanding by a modest 3.1% in 2017. In value terms, USD denominated trade growth would rebound (+5.7%) due to progressive improvement in commodity prices and less currency depreciations.

What’s crucial is that global demand growth would finally improve. Demand from advanced economies could strengthen. Expect firm growth in the Eurozone and gradual improvement in Japan as policymakers intensify their support.

Demand from emerging markets should also expand somewhat as Russia and Brazil will exit recession. China’s imports would see a significant rebound next year as policy stimulus continues. Add to the mix a growing middle class, which translates into services imports such as tourism, and education related expenditures. Higher demand growth would help stabilise global prices. As the same time, better prospects outside the U.S. will translate in lower pressures on currencies.

Small pie, small gains

In this context, countries will find it hard to grow through exports.

Core Eurozone countries and markets related to their value chain such as Romania and Poland would top the league. These economies combine real exports growth which is well above global average with a rise in market share over 2016-17. They will benefit from a heady mixture of cheap currency, eased financing conditions and improved demand growth by main partners (namely European Union members). Next in line will be countries with strong competitive advantages. Vietnam, Philippines, Morocco, and Kenya are all good examples of economies benefiting from cheap labour costs and strategic positioning in regional value chains.

Second, a weaker RMB in China will provide some boost to volume growth. Yet one can expect reduced US dollar exports gains (+$33 billion only from 2015 to 2017) and a loss of market share (-0.15pp). Causes include a deteriorated price competiveness over the ten past years (due to rising wages and strong appreciation of the RMB) and limited demand overseas. For net primary industrial producers, countries with strong market share (e.g. Saudi Arabia, Australia, and South Africa) or more diversified export base (Canada, Mexico) may enjoy strong growth in volume terms. Yet market shares will probably decline with a lack of a price boost. For manufacturing hubs such as Turkey and Thailand, weaker currencies will lead to lower USD denominated exports. Then upside of depreciations is a boost to volume growth.

The main losers would include: (i) countries highly dependent on Chinese demand (primary industrial commodities and Asian trade suppliers), (ii) exporters suffering from monetary tightening or strong currency (United States), (iii) markets that are affected by political deadlocks (Russia).

Low for longer?

In the medium term, there are few reasons to expect a significant upturn. Global trade is hampered by frequent demand shocks, structural adjustments in the global value chains, lack of US dollar financing, competitive depreciations and political hurdles.

Brake #1: demand shocks become more frequent

Global demand is struggling to find a solid footing as cyclical shocks become more frequent. 2015 marked the fourth consecutive year in which GDP growth has been below the +3% threshold. This situation might last until 2017 at least.

The Eurozone crisis and austerity policies were the main culprits in 2012-2013. Since then, headwinds in the emerging markets have been the main drag. Heightened financial volatility, weaknesses in some large emerging markets, increasing signs of a bumpy transition in China, and low commodity prices hit oil producing countries are all to blame.

Brake #2: Structural adjustments are still underway

Structural adjustments in global demand components and value chains are still underway. In particular, lower investment translates into lower import growth while vertical integration of large economies affects global supply chains.

The main protagonist of these changes is China.

Growth pivots from a reliance on investment, exports, and manufacturing, to consumption and services. This also means a shift from the production of low value-added goods to high-tech products. On top of that, there is also a will for a more sustainable growth which is less resource and credit intensive.

Lower investment growth and economic servitization will translate into weaker demand for basic materials and capital goods.

The upgrade of the economy is associated with substitution effects where domestic companies rely more on local suppliers than foreign ones. Asian economies will bear some of the brunt. Old trade hubs partners (e.g. Hong Kong, Taiwan, Singapore) and industrial commodities suppliers (Malaysia, Indonesia, Australia) are the most affected.

Brake #3: US dollar shortage renders external payments difficult

Limited access to US dollars makes it more difficult to pay for imported goods. For some countries, the problem could persist. Further monetary policy tightening by the Fed means that worldwide liquidity would continue to decrease. And when the world’s currency runs low so do external payments and trade flows.

Second round effects may take place and capital outflows are a particular worry. Lower FX reserves translate into a more prudent monetary policy stance from Central Banks as governors become reluctant to share with the private sector. This is a typical problem in small emerging markets such as Papua New Guinea and Mongolia but also for larger markets such as Venezuela and Nigeria.

Brake #4: Unproductive currency depreciations

In theory, a decrease in the value of currency can be supportive for exports. Once more, reality bites – and crawls. Simultaneous competitive depreciation is a hurdle for trade, and even more so when global demand growth is low.

The past two years showed that depreciation works best when implemented in markets with improved financing conditions and little reliance on industrial commodities. For such economies, cheaper currencies may translate into better price competitiveness. This should lead to an increase in export volumes.

In contrast, countries suffering from forced depreciation due to capital outflows and weaker domestic financing condition (tightened monetary policy) may suffer. This is especially true for those which rely on primary commodities. In this case, the main effect of currency depreciation is a contraction of imports. This is the case for Latin American, African, primary industrial commodities exporters in Asia.

Brake #5: Political hotspots and protectionism

Political hotspots continue to weigh on traders’ confidence, driving countries and multinationals to take a wait and see position. Soured relations between the West and Russia, risks of conflict in the Middle East with the collapse of Yemen's government, and political instability in Syria are all clear examples. In Brazil and South Africa discontent is on the rise as a result of deteriorating economic prospects and rampant unemployment.

The rise of protectionism is also a major obstacle. This is true for explicit trade barriers such as high tariffs (e.g. India or Brazil) as well as less direct measures such as subsidies (e.g. France with its public bank). A top 10 list of protectionist countries since 2014, is dominated by emerging markets with the BRICS leading the wat. However, the US, Japan and the UK have also been quite aggressive in restoring protectionist measures.

External growth alternatives: meet EDI

With global trade of goods growing below trend, companies need to find alternative strategies to internationalise. Recent trends offer a few ways forward.

First, businesses can leverage Foreign Direct Investment (FDI) to get closer to consumers and then repatriate investment revenues. The nature of current economic growth calls for further proximity as consumer demand and services are becoming the main growth drivers globally. Households’ consumption accounted for 61% of GDP in 2015, up from 58.3% GDP in 2014.

Moreover, a currency valuation effect is still in play. Countries where there was little depreciation since 2014 lost price competitiveness but gained purchasing power (e.g. USD, JPY). Cash rich companies can venture abroad and buy assets on the cheap.

Finally, countries with large current account surplus and mild economic prospects (e.g. Taiwan, South Korea) can use foreign investment as a way to recycle savings.

A second way forward is, well, to really move forward. Companies must adapt to new drivers such as digital flows and services. Trade in the latter has been less disrupted compared to goods trade. In 2015, services exports accounted for 6.7% of global GDP (stable from 2014), while exports of goods decreased to 22% (from 24%).

Looking ahead, there are signs of further improvement. A gradual recovery in oil prices would be associated with an improvement in marine transports services and a modest pickup in global demand. Structurally, this will be underpinned by the servitisation of large emerging markets like China.

Another type of cross-border movement is growing rapidly: data flows. Digitalisation of business activities contributes up to 9.4% of the annual global economic output, according to estimates by Euler Hermes. This figure is set to reach 16.6% in 2020.

However, only affluent countries and advanced markets benefit from the transition to knowledge-intensive economy. These typically have the necessary infrastructure to enable fast access to the internet and other technological networks.

To asses readiness for change Euler Hermes developed a proprietary Enabling Digitalization Index (EDI). It grades 135 countries on a scale based on the quality of connectivity, logistic performance and ease of doing business.

EDI’s scores show a clear discrepancy between advanced economies and emerging markets. Germany, the Netherlands and Sweden lead the ranking. None of the BRICS rank in the top 40 and China ranks 44th. While it performs relatively well on logistics sub-indicator (24th out of 135 countries), the Asian giant still lags in connectivity quality and ease of doing business.

EDI’s scores show a clear discrepancy between advanced economies and emerging markets. Germany, the Netherlands and Sweden lead the ranking. None of the BRICS rank in the top 40 and China ranks 44th. While it performs relatively well on logistics sub-indicator (24th out of 135 countries), the Asian giant still lags in connectivity quality and ease of doing business.

Third, companies can take advantage of mega trade agreements. Despite political resistance and protracted haggling international deals are potential game changers. So where do things stand? The adoption of the Transatlantic Trade and Investment Partnership is blocked since France and Germany have threatened to withdraw from negotiations. The US elections could also be pivotal for the Trans Pacific Partnership. The One Belt One Road designed by China seems to be on more solid ground. However, implementation would take time. So far, no formal treaty has been negotiated between the 65 participant countries.

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