Hefty risk perception was a key feature of 2019, as the White House’s trade war and systematic reprisals from China fueled the prospect of a watershed moment and a long-lasting shock on economic activity right throughout the year. This scenario was borne out as world growth did take a downward turn, and manufacturing output dipped in most large countries (US, euroarea, Japan) or even suffered a serious slowdown (China).
However, this new situation does not fully reveal the US President’s intentions. Looking across the pond, Donald Trump sees the economy as a zero-sum game, so if we look at matters from this standpoint, then his choices are entirely rational: goods that are produced in the US are not being manufactured in China or elsewhere, so this is good news for US companies and workers. This is the reasoning thatunderpins Trump’s border tariff policy, which sent import duties soaring – especially on goods from China – while also triggering a manufacturing recession.
I would also like to include the idea of risk in this situation. As Frank Knight suggested in 1921, the probability of risk materializing can be measured objectively. In this respect then, the dip in economic activity resulting from US policy could be foreseen. Trade is fettered by higher duties, with a swift and serious impact on manufacturing output as trade primarily involves manufactured goods.
An agreement with China will probably be signed in early 2020, easing the risk of the whole situation escalating further and therefore reassuring investors: this is the explanation behind the recent rise in interest rates, which I discuss here.
However, the situation worldwide could become more complex and trigger further uncertainty
According to Frank Knight’s reasoning, this uncertainty involves subjective probability i.e. it cannot be assessed systematically using a model and clearly defined laws.
This added uncertainty comes from the fact that the US has taken a unilateral position, which jars with the growing globalization that we have seen since the end of the Second World War, so the overall framework for growth we have witnessed for the past 70 years could be jeopardized.
Trade has grown since the 1950s, especially from the end of that decade, as institutions were developed – ranging from the IMF to the GATT – with the aim of setting a framework to organize trade as efficiently as possible.
Each country had an objective incentive to play by these rules,as each had something to gain. Trade drove up manufacturing output, and both jobs and income were buoyed considerably. Developed countries enjoyed this virtuous trend, with emerging markets then later following in their wake.
Looking to a more recent past, we highlight the very clearimpact for China when it joined the World Trade Organization (WTO) in December 2001, or looking further back, we notethe advantages for the UK when it joined the European Union in 1973.
This period of growing trade also involved implementation ofa series of rules that have facilitated financial globalizationsince the start of the 1980s. The capital markets’ seamless functioning provided for cheaper access to funding, which in turn promoted trade: the world trade crisis after the collapse of Lehman Brothers in late 2008 was due to the decline in available financing after the banking crisis.
At the start of the 1980s, the central banks stepped in to manage the economy and set out rules to drive trade and promote financing for this sector. They developed policies for increasingly direct intervention methods, which in turn further drove globalization.
These rules in place at the time set out a multilateral approach, where each country was treated fairly, scaling backuncertainty and thereby driving development and growth.
Globalization is a crucial outcome of the implementation of these international organizations, which set out the rules for multilateralism.
Each country was able to find its place in the world economy and draw the benefits of multilateralism as rules were similar and consistent for all countries, even if implementation of this set-up sometimes took a while.
Globalization drew on these international institutions and led to a drastic reduction in poverty worldwide, and this is the vital point to bear in mind here. The poverty headcount of individuals living below the $1.90 a day point (at constantprices) fell from more than 42% in 1981 to 10% in 2015 according to the World Bank. This situation was facilitated by the development of institutions and the rules they then applied, in a direct result of globalization.
This system is now under threat
US policy took a more unilateral turn when Donald Trump arrived at the White House. The US wants to conduct its policy outside the multilateral framework, as the country feels that it bears most of the cost of this set-up: this impression has been further amplified since Trump was elected President. TheWhite House wants to set the rules for its own economy, without having to abide by any pre-existing framework.
The WTO is unable to work properly as the US is blocking the appointment of appeal judges, which means that the WTO is losing its main institution to settle disputes between countries and is ultimately failing its main purpose. Globalization can no longer work in the same way by promoting bilateral arbitrage.
This all makes for a transformation in the way world trade operates. Under the WTO’s framework, the various countriescould work in a way that suited everyone, promoting development worldwide. The US stand-off will lead to uncertainty and hamper the globalization process.
This is the real irony of the situation. The US is denting trade by taking this approach and impeding the globalizationprocess that had considerably reduced poverty. But there would be heavy costs involved in changing the manufacturing industry’s specializations – it is hard to see how textile production could swiftly be relocated to industrialized countries or how mobile phones could be sold so cheaplywithout globalization.
I would like to highlight here that US unilateralism is challenging rules and institutions, reflecting the country’s perception that any non-US goods are not successful and/or the feeling that they compete unfairly with US goods. We have seen this situation since Bush was at the helm, and the trend has now taken on much greater proportions under Trump. The WTO is under threat and NATO is on shaky ground, but other institutions could also be at risk, with the danger of creating further uncertainty on the trade of goods and capital e.g. the Federal Reserve’s independence could be jeopardized.
This systemic change would set the stage for an inward-looking approach, which is not advisable.
World growth was initially driven by the ability to produce goods in one place and sell them in another as a result of decreased transportation costs. This momentum gathered paceand institutions were set up, with the trend then heightenedfurther and triggering a period of robust growth for economicactivity, jobs and income, as well as a strong surge in tradethat affected an increasing number of countries.
So we have cause to be concerned if the most powerful economy – the founder of several institutions that are currently in the hot seat to boot – can challenge the world’s trade capabilities. The period of sluggish growth could last longer than expected.