What the heck is happening to global trade? This is a question G7 finance ministers and central bankers might have asked as they met in Chantilly in France this week.
At the start of the previous decade, global trade was growing at almost 8 per cent a year, twice the pace of growth in gross domestic product. This year, however, the World Trade Organization expects trade to rise by a mere 2.6 per cent — the same as projected global GDP growth.
Unsurprisingly, this turnround has sparked hand-wringing about the cost of the current trade wars. Indeed, G7 ministers have pointed to this as evidence that protectionism could spark a wider global economic downturn.
But amid this entirely understandable concern, there is one crucial detail that is overlooked: the slowdown in trade started well before the recent eruption of protectionism. That suggests we cannot blame our current woes on the trade wars alone — although protectionism is, of course, worth fighting against.
The issue at stake was set out on Tuesday by Hyun Song Shin, chief economist of the Bank for International Settlements, at a meeting of senior finance officials organised by the Banque de France in Paris.
Shin started by noting that there are several ways to track trade. The metric commonly used is absolute real or nominal trade. There is, however, another: the ratio of gross exports to net GDP.
And the latter metric is particularly revealing right now, since it indicates the activity of cross-border global supply chains, or "global value chains", as economists prefer to say. Complex GVCs generate multiple export "sales" — and the more extensive these chains are, the higher is that gross export number relative to GDP.
This gross exports series shows that between 2000 and 2008 there was a frenzy of activity in global supply chains. Indeed, as Shin explained, gross exports relative to GDP exploded by a cumulative 16 per cent, due to intense supply chain activity between China and the west.
However, when the 2008 financial crisis hit, gross exports crumbled. No surprise there, perhaps. But what is more remarkable is that, while gross exports recovered in 2009, they have never returned to anything like the pre-2007 figure. More striking still, since 2011 gross exports have steadily declined relative to GDP — meaning, Shin noted, that "the slowdown in trade predates the retreat into protectionism and trade conflicts in the last couple of years".
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Why? One explanation might be that services are becoming more important in the global economy than manufacturing. Another might be technological innovation: automation has cut the cost of western manufacturing, reducing the need to outsource production to low-wage locations such as China.
However, Shin thinks another crucial — and overlooked — factor is finance. Companies need hefty amounts of working capital to run their supply chains, and about two-thirds of this typically comes from their own resources, with the other third coming from bank and non-bank finance.
During the pre-2007 credit boom it was easy for companies to find working capital and trade finance. But, since then, the crisis banks have reined this in. This is partly because post-crisis regulations have made it more costly for western banks to supply such funding, but also because banks' resources have been hit by the debilitating impact of ultra-low interest rates and the flattening yield curve.
Currency swings also hurt. About 80 per cent of trade finance is supplied in dollars, and trade invoicing tends to be dollar-based, too. This means that dollar strength tends to affect the ability of companies in emerging markets to finance supply chains.
Now, it is highly unlikely that this subtle message about the role of finance will gain much attention from politicians, let alone voters. However, if Shin's analysis is correct (as I think it is), it has at least three important implications.
First, it underscores the importance of studying financial channels in tandem with "real" economic trends if you want to understand the global economy.
Second, the research suggests that the pre-2007 credit bubble not only created a house price boom, but also helped create a trade and GVC bubble, too.
Third, insofar as this bubble has now burst, it seems unrealistic to expect that the world will recreate that global trade surge anytime soon — even if, by some miracle, the US and China suddenly end the trade war. This is not a comforting message. But it is the new reality to which the G7 has to adapt.
Written by: Gillian Tett
© Financial Times