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Was 2016 the year the world turned its back on free trade?

Edgar Su/Reuters

Was 2016 the year the world turned its back on free trade?

Fear of and misunderstanding about free trade and globalisation brought us a turbulent 2016. And the last few months have been a wake-up call about the dramatic slowdown in international trade, presaging a major change in global policies.

In its September forecast, the World Trade Organization (WTO) warned that it was worried world trade would only grow by 1.7% (in volume) in 2016. This is its lowest growth since 2009, the year of the global financial crisis, when international trade started retreating.

Worse still is the phenomenon of international trade growing at a slightly slower pace than global production. The ratio of international trade-to-GDP, which indicates the relative importance of international trade in the economy of a country, has been falling sharply since 2009 except a gradual recover in 2010-2011.

According to the October 2016 IMF World Economic Outlook, international trade in goods and services has grown at the mediocre rate of around 3% a year since 2012, less than half of the growth of the previous three decades. Between 1985 and 2007, world trade increased, on average, twice as fast as world production, whereas for the past four years it has just kept pace.

This is an historic change. If the WTO forecast for 2016 were to be confirmed, world trade would have risen less rapidly than world GDP, which grew between 2.2% and 2.9% in the first half of 2016.

The end of globalisation?

This could indeed be evidence for the beginning of globalisation going in reverse. The globalisation of trade means that countries trade more and more with each other, and that trade between them increases faster than their national production.

Has globalisation, which is the modern form of the international division of labour, reached its peak? Those good old times when companies, mainly multinationals, achieve production efficiency and generated more revenue through outsourcing their labour-intensive work abroad than manufacturing at home.

The IMF suggests three explanations for the decline in trade regimes: the slowdown in global economic growth; the halt in trade and investment liberalisation agreements (which started long before the freezing of the Trans Pacific Partnership or the Trans Atlantic Trade and Partnership agreements); and the maturity of international production chains that would have exhausted their advantages.

Geopolitical competition in global trade agenda-setting among the US, the European Union and emerging powers, such as China and India, and increasingly popular protectionism rhetoric in national trade debates also explain the failure or lack of cooperation in the multilateral trading system.

Three types of explanations

IMF experts estimate that the slowdown in economic growth since 2012, after the temporary catch up in 2010 and 2011, explains by itself “about three-quarters of the dramatic slowdown trade”.

There’s been a dramatic slowdown in international trade. Shu Zhang/Reuters

Proof of this, they argue, is that it’s investment products, and secondarily, durable household goods, such as cars, whose trade has slowed down the most. They note that slowdown of goods consumption affects 143 countries out of 171 under review, including China, Brazil and the nations in the Euro area, among others.

In this respect, the period between 2012 and 2016 will have been particularly volatile in terms of world trade, resulting from the collapse of oil and commodity prices. The IMF notes that this fall itself resulted in a 10.5% contraction of all international trade in 2015, when looking at all products.

This has resulted in considerable loss of purchasing power for many countries and billions of consumers, and thus a reorientation of demand at the expense of durable goods, which have become inaccessible to many. Added to this are national trade imbalances – the surpluses of some countries and the deficits of others – that have also acted as a brake on trade.

The second explanation for shrinking international trade stems from the general global climate, which has become more protectionist. The IMF notes that, in the 1990s, an average of 30 trade liberalisation agreements were signed annually between countries. But barely ten such agreements have been signed each year since 2011.

Free trade agreements include deeper provisions that go beyond trade barriers and more partners can significantly reduce the cost of trade, which, in turn, helps boost trade flows.

The third reason for the brake on trade is the decline in the growth of global value chains, which is the idea that the process of production consists of many stages and occurs across borders. But this phenomenon, which developed at a very high rate after China’s accession to the WTO in 2001 as the country emerged as a global supplier, has now reached cruising pace.

Similarly, the fall in the cost of cross-border transportation and international cost of telecommunications, which had contributed so much to trade, would also have met its limit. And they probably contribute modestly to the decline of global trade.

But even as they worry about the disappointing numbers, countries remain very divided on what to do next. In fact, we may be witnessing the return of an economic nationalism that threatens withdrawal from the global market.

Prospects for 2017

It seems, then, that the only diagnosis is that the global economy is slowing down and the risks to recovery are picking up. Challenges range from Brexit to the slowdown in emerging markets, from the collapse of commodity prices to rising geopolitical tensions.

Part of the problem is that the level of public debt of countries is too high for them to have significant room for manoeuvre. And countries that have the means, such as Germany, refuse to spend more.

Excess capacity in steel and other industries has had a negative impact. Pichi Chuang/Reuters

At least, in the last months of 2016 the G20 leaders’ communique recognised the impact excess capacity has had on the global economy and there’s now a chance of focusing on this problem. Excess global capacity in steel and other industries is mainly a result of falling demand, rising production and excessive government subsidies.

The impact of the crisis has been so severe on market demand that all G20 leaders are turning to overcapacity, following the example of China. Until current overcapacity is absorbed, the recovery will be slow.

But the remedy has the social cost of job loss, and that could fuel the already high risk in the United States and Europe of fragmented national politics.

On the bright side is the noteworthy G20 Guiding Principle for Global Investment Policymaking reached under Chinese presidency and endorsed by G20 heads of state. It lays out a roadmap for future investment policy and the correlation between investment and sustainable development.

In the 19th century, debates over drivers of economic growth – tariffs or free trade – dominated the political scene. Mercifully, the idea of free trade has persisted but it now faces serious challenges.

It seems that, at best, 2017 will be another difficult year. The most we may be able to hope for is that national trade-restriction measures will be compatible with WTO rules.

In any event, we have not finished paying for the consequences of the financial crisis. If history is any indication, trade deals, which are always better in the multilateral format (such as under the WTO), are the world’s best hope for avoiding another global recession.