China's recent decision to allow a very slight devaluation of the yuan caused a momentary panic in stock markets around the world. Behind the extreme reaction were concerns about China's slowing growth and the effect it will have on exports by the rest of the world to China. But these trade concerns are not limited to trade with China. In fact, world trade, the sum of exports and imports of goods and services, which used to grow at nearly twice the rate of world gross domestic product (GDP), has barely matched it over the last four years. Based on historical relationships, world trade should be growing about 1.5 percent to 2 percent faster than it actually is.
Struggling with sluggish exports as well as slow growth at home and the prospect of higher U.S. interest rates, most countries, advanced and developing, have allowed their currencies to slide against the U.S. dollar. Until recently, China stood out in resisting this trend, and indeed had seen a large appreciation against the U.S. dollar over several years. So, not surprisingly, many saw its abrupt change of course not only as signaling deep trouble in China, but also as opening the door to a bout of destabilizing currency competition.
These troubling developments raise an important question: Does the trade slowdown call for specific steps by policymakers over and beyond their continuing efforts to reignite economic growth at home? The answer is "no," but to arrive at that conclusion, we need to understand what caused the great world export slowdown in the first place.
There is a broad agreement among economists that cyclical factors have played a very important role in the trade slowdown. More specifically, the global financial crisis has had a disproportionately severe effect on regions and industries that trade a lot. The European Union, which is struggling to recover from a chronic sovereign debt crisis, accounts for roughly one-fifth of world output but about one-third of world trade. Furthermore, faced with sluggish demand, firms across the advanced countries have delayed replacing machinery, while nervous consumers have delayed buying houses, furniture and washing machines. The production of these investment goods requires a lot of back-and-forth of raw materials, parts and components across nations, as they are often at the core of so-called global value chains. The import content of investment goods, for example, is estimated to be twice that of consumer goods, and investment goods are heavily traded, so that a fall in investment has a large disproportionate effect on trade. The slowdown in investment — which more recently has spread to developing countries — together with the European recession could easily have accounted for more than half of the slowdown of world trade relative to GDP.
If this interpretation of the trade slowdown as a cyclical phenomenon is correct, then trade growth is likely to resume to something much nearer its customary rapid pace once the world economy returns to its trend growth path. There is nothing new, additional or specific that is required of policymakers beyond the mandate to reignite economic growth, which of course is a tall enough order. What must be avoided, however, is policymakers misinterpreting slow exports as being caused by currency manipulation or protectionism by their trading partners, which could easily trigger a race to the bottom. This leads us to the next important reason for the trade slowdown.
With the fall of the Berlin Wall and against the background of stable economic growth, trade grew extremely rapidly by historical standards throughout most of the 1990s and early 2000s. As the Soviet Union dissolved, and Eastern Europe and Vietnam moved to the market, India also engaged in substantial trade liberalization, and, most important, China became rapidly integrated into world markets. In this process, production patterns were recast along new lines of comparative advantage and large new trade and foreign investment opportunities arose. In the 1990s, world trade grew almost 3 percent faster than GDP, a difference about 1.5 percent a year larger than from 1950 to 1990. However, the transition from central planning is largely done, and such a one-time boost to world trade growth is unlikely to be repeated in the foreseeable future. Policymakers cannot change this fact and can only moderate their export expectations accordingly.
Yet another argument put forward to explain the trade slowdown is that there is a declining need to operate global value chains. China, the argument goes, is refocusing its economy away from exports and manufacturing and toward consumption and services and domestic markets, and is also learning rapidly to produce sophisticated components at home instead of importing them. At the same time, American firms have become more aware of the cost of coordinating global production chains, and are bringing production back home to take advantage of low domestic energy costs and advancing automation. Although these arguments contain a kernel of truth, the empirical evidence in support of them is mixed and open to different interpretations. For example, China's decelerating exports and increased reliance on domestic demand — which have contributed to reduced imports of components — is at least in part due to the end of its transition and to the cyclical demand effects outlined above. And, despite America's much-heralded manufacturing renaissance, new jobs created are overwhelmingly in services and manufacturing employment remains well below its pre-crisis peak. The high dollar is, if anything, likely to reinforce these trends.
But even supposing the argument that firms are durably retreating from global value chains is correct, which I doubt, such a trend would only mean that firms have found a more efficient way to produce and market. Policymakers should be aware of this trend, but there is no need for them to interfere with it.
The remaining possible explanation for the world trade slowdown is a resurgence of protectionism. However, the evidence that protectionism has played a significant role in the slowdown remains unconvincing, in my view. Several experts have scrutinized the indicators of new protectionism, such as those made available by the World Trade Organization's (WTO) secretariat, the World Bank and by Global Trade Alert, a nongovernmental organization. They have found no evidence of an across-the-board deterioration, though some countries, such as Brazil and Indonesia, have enacted a number of egregious measures that significantly affect specific sectors. In fact, taking a longer view, there are important reasons to believe that trade is freer today: according to a recent paper by WTO and Organisation for Economic Co-operation and Development economists, over the last 20 years, the tariffs of WTO members have declined by 15 percent and transport costs have declined continuously from 7 percent to 5 percent of the value of trade. Moreover, 80 percent of exports from developing countries enter advanced countries duty-free today, compared to 55 percent 20 years ago. Nor can one ignore the fact that the spread of the internet and of electronic commerce has spawned a multitude of "micro-multinationals," small firms that export (and buy) all over the world, a trend that is bound to be reinforced in the future.
Finally, in determining how policy should react to the great trade slowdown, it is important to dispel a common misconception. This is the view that rising exports play an essential role in stimulating aggregate demand. Seen from an individual country at any point in time, that is true, but since the world does not export to Mars, in the aggregate world exports must equal world imports, so the effect of world trade on world aggregate demand is exactly zero. The vital benefit of world trade is not that it stimulates global aggregate demand, but that it expands global supply by raising productivity. It does so by improving the allocation of capital and labor, allowing firms to exploit huge global markets and by boosting competition.
That is why policymakers must, above all, continue to guard against protectionism, and also to deepen their country's connections to the world through better transport, communications and Internet links. As for reigniting the rapid growth of trade over the next year or two, nothing is more important than measures to accelerate the pace of domestic recovery from the financial crisis.