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|Great trade and investment collapse|
|Tuesday, 18 January 2011 12:55|
Global trade and investment contributed so much to our economies over the past decade. But when the global financial crisis erupted, we were hit by the trade and investment whiplash.
Countries most dependent on trade and investment suffered the most.
Economic development based on open markets seems to mean more volatility and vulnerabilities. Are financial crises undermining the viability of open-market development strategies?
Free trade is one of the things that most economists agree on. We can exploit our comparative advantage. We can reap economies of scale. Trade is also a learning experience. By having to meet world market product standards, we raise our own production standards. Foreign buyers are fussy. And we learn even more as we import foreign technology and knowledge-rich products. International trade is key to industrial upgrading.
Foreign direct investment (FDI) has been a big driver of trade as it has created lengthy supply chains, especially in East Asia, but also North America and in Europe. Multinational enterprises choose their factory sites and suppliers based on each country’s comparative advantage for different components and processes. China is the choice location for assemblers.
So when a multinational enterprise establishes an overseas factory, machinery and other supplies are exported to equip it. Components are then flown in from all over the place. A (usually small) production process is carried out, and the output is then shipped off elsewhere for further processing. In other words, measured trade is exploding as it is being fragmented by trade in parts and components.
This trade and investment also creates linkages with the local economy. Foreign investors do business with local suppliers and hire local employees. This creates business, but it also contributes to upgrading through knowledge transfers.
International trade and investment seemed like a great development strategy while the good times were rolling.
Then came the global financial crisis. World trade and investment which had been growing at a much higher clip than GDP suddenly crashed after the Lehman shock of September 2008. Overall, trade fell by 11 per cent in 2009, after barely growing in 2008. And trade fell everywhere. It was synchronized. World trade has since bounced back, almost recovering all the lost ground. FDI fell by about 50 per cent. While FDI to emerging economies picked up in 2010, FDI to the developed world continued to fall, especially for Europe and Japan. These were the sharpest and deepest crashes in trade and investment since the Great Depression.
Much has been written of the causes of the trade crash, and we will never be able to apportion the blame between different causes. A drying up of trade finance may only have been a minor factor. The main factor was the rapid fall in the demand for “postponeable” expenditure like consumer durables and investment goods. And as investment fell, so did FDI.
To some extent, the real effect of the export crash is amplified by double counting through supply chains. Trade is estimated statistically by the total value of the exported or imported product, not the value added. Now that there is much trade in parts, components and semi-finished goods, the same items can be counted several times, as they move through different nations supply chains. This inflates the statistical measure of trade. And similarly, when trade moves into reverse, the fall in trade is also overstated. (The value of China's exports seems enormous, but for very many items Chinese value added might only be 5 per cent, representing the assembly phase.)
All these debates aside, it is clear that the great trade and investment collapse had a dramatic effect on export-oriented economies. The following Asian dynamos experienced GDP falls in 2009 – Japan (-5.2%), Taiwan (-1.9%), Hong Kong (-2.8%), Singapore (-1.3%), Thailand (-2.2%) and Malaysia (-1.7%). While Emerging Asia grew by 5.8 per cent in 2009, this was substantially due to China’s 9.1 per cent growth, propelled by a massive government stimulus package. Export industries suffered major job losses. Even in China, more than 20 million people lost their jobs in the coastal provinces.
G20 leaders have celebrated their determination to resist protectionism, but it is mainly nice words. As the Global Trade Alert has highlighted, governments have struggled to contain protectionism which has taken on many murky forms. Most government stimulus packages, like the motor vehicle assistance in the US, have involved protectionism.
Between 100 and 120 new discriminatory measures have been implemented in every quarter since 2009, and there was no evidence of any slowdown in 2010, even though world trade began to recover. And the G20 is responsible for the lion's share of protectionism. Over the past 12-18 months, many large trading nations have implemented export promotion schemes like subsidies, cheap access to credit and tax rebates and exemptions which have boosted trade, despite their protectionist nature.
There is much talk now about a new burst of political energy for completing the Doha trade talks. The Republican dominated US Congress may provide a window of opportunity. We can only hope. Winding back the crisis-induced murky protectionism will also be necessary. But holding the fort against protectionist pressures will be necessary, while unemployment remains high, and Europe's economy is still rocky.
The IMF and the Asian Development Bank have recommended that export-dependent economies try to increase the role of domestic demand in their economies. This could reduce their exposure to export demand volatility.
However, this is perhaps not very realistic for small, open economies like most of the emerging Asian economies mentioned above. It is also not easy for economies whose production facilities are geared up for exporting.
The key problem is that while ever the root causes of the global financial crisis are not properly addressed, we can be sure that there will be another financial crisis around the corner. And once again many innocent economies will be victims as their trade and investment gets hit by the effects of financial crisis.
Some may even turn away from open-market development policies and towards protectionism. The good globalization of trade and investment could thus be threatened by the effects of badly managed financial globalization. This highlights the self-destructive potential of globalization.
Hold on tight!
The great trade collapse by Richard Baldwin, 27 November 2009
Global and Regional FDI Trends in 2010, Global Investment Trends Monitor
World Economic Outlook (WEO), Recovery, Risk, and Rebalancing, October 2010
Country and Regional Perspectives, Chapter 2,
Do Financial Crises Have Lasting Effects on Trade, Chapter 4,
8th Global Trade Alert Report
The G20 Seoul Summit Leaders' Declaration, Seoul, November 12, 2010