Global Trade on the Mend but Serious Risks Remain

Authors: Uri Dadush, Shimelse Ali
Originally published by the Carnegie Endowment for International Peace

The strong recovery in global trade, which started in the second quarter of 2009, has continued this year, and helped buttress demand across the world. The trade recovery is driven by a reversal of the crisis-induced credit crunch and the rebuilding of inventories. World trade is projected to continue growing robustly in 2010 and 2011, though it will remain well below its pre-crisis trend path and will not return to its pre-crisis peak until 2011. The global trade recovery faces significant downside risks, however, beginning with the risk of spreading financial turmoil in the Euro area. To support the trade recovery, aggressive measures to deal with the European debt crisis are critical.

Strong recovery

World trade has rebounded strongly since the crisis. By March, the volume of world merchandise trade had risen by 21 percent from its trough a year ago, with growth in the last three quarters in the 4–6 percent (q/q) range. Though the trough was deeper, the rebound from the current crisis has also been stronger than the ones following the global slowdowns in 1982 and 2001¹. Nonetheless, the volume of trade remained 4 percent below its April 2008 peak in March and export growth momentum appears to be slowing slightly².

At the same time, the recovery of industrial production (IP) is broadening, further evidencing the strengthening of global activity and the recovery in the real economy³. While it remains about 2 percent below its pre-crisis peak, global industrial production is now about 12 percent above its 2009 trough.

Reflecting the uneven recovery of global demand, the trade rebound has progressed at different speeds across regions. Emerging economies, led by Asia and Latin America, have exhibited the fastest growth⁴. Imports into emerging Asia are—remarkably—already 13 percent above their pre-crisis peak, while those into advanced countries remain 11–13 percent below their pre-crisis peak. GDP jumped by about 8 percent (q/q, annualized) in the first quarter of 2010 in emerging markets, compared to 2.6 percent in developed economies, improving the external demand of advanced economies.

Meanwhile, despite the effects of the Euro crisis—euro depreciation of more than 20 percent against the dollar and the renminbi in the last six months and sluggish domestic demand in Europe—U.S. and Chinese exports to the EU have moved largely in line with their overall exports. Over the last five months, China’s exports to the EU grew by an average of 36 percent (y/y), in line with the 34 percent (y/y) growth of its overall exports. Similarly, U.S. exports to the EU have not decelerated since the outbreak of the Euro crisis.

On the other hand, concerns about the Euro crisis appear to have impacted commodity prices. Metal prices, which rose more than 150 percent since the end of 2008, dropped sharply in May. Similarly, oil prices, which had recovered about 70 percent from a year earlier in March, have dropped 15 percent since then.

Factors behind the recovery

Reversal of the major factors that caused the trade collapse during the crisis—the global credit crunch and sharp drops in the demand for investment and consumer durables—is driving the rebound. Low policy interest rates, liquidity injections, and fiscal stimulus helped engineer the turnaround.

Global output increased by a remarkable 5.5 percent (q/q, annualized) in the first quarter of 2010 and 4.7 percent in the preceding quarter, boosting incomes and demand for imports.

The rebound in demand for credit-sensitive goods, such as motor vehicles and investment goods, is especially strong, following the sharp drop during the crisis, when consumers and businesses postponed purchases and banks refused to lend. Global auto sales surged by 25 percent (y/y) in the first quarter of 2010.

Furthermore, the supply of trade finance, which, according to the World Bank, may have caused 10 to 15 percent of the overall decline in trade during the crisis, is now showing signs of life. The volume of global trade finance grew by 3 percent (y/y) in 2009, reaching $155 billion. Despite this growth, the supply remains constrained; according to the International Chamber of Commerce, 27 percent of 161 banks in 75 countries were unable to meet the demand for trade finance.

Widening imbalances

After narrowing considerably during the crisis, trade imbalances have begun to widen again as global activity has picked up. At -$40.3 billion in May, the U.S. external deficit is now at its highest level in more than a year. The trade balances of surplus countries like Germany and Japan have started to rise in recent months and the contraction in China’s surplus, which fell from 8.2 percent of GDP in 2008 to 5.1 percent in 2009, is continuing but at a slower pace.

While current account imbalances are expected to widen again in 2010 and 2011, they are unlikely to return to previous levels.

Current Account Balance (percent of GDP)*
	2007	2008		2010	2011
United States	-5.2	-4.9	-2.9	-3.5	-3.7
Japan	4.9	3.3	2.8	3.1	3.0
Germany	7.7	6.7	5.0	5.7	6.4
China	10.6	9.4	6.1	4.5	5.0
* 2010 and 2011 numbers are averages of the OECD and IMF forecasts. Sources: OECD, IMF.

Positive outlook

Leading trade indicators, such as new exports orders, have been growing recently⁵ and world trade is expected to remain robust. According to the WTO and OECD, trade volumes will grow by close to 10 percent in 2010, again led by developing economies⁶. Reflecting its rise as a source of global demand, China will account for about 30 percent of global GDP growth in 2010 (in PPP terms), twice the contribution from the United States.

However, the impressive rebound will not be enough to return world trade to its pre-crisis peak this year. If trade continues to grow as projected by the OECD—10.6 percent in 2010 and 8.4 percent in 2011—it will only reach its pre-crisis level in 2011, three years or so after the global recession began. Moreover, world trade volume will be 10–15 percent below its pre-crisis, twenty-year trend path in both 2010 and 2011⁷, underscoring the persistent effects of the financial crisis.

Substantial risks remain

Prospects for a sustained trade recovery driven by a private sector recovery are good but remain subject to substantial downside risks.

• Euro crisis: If the recovery falters in the European Union (EU), which accounts for nearly 40 percent of global imports (15 percent, excluding intra-EU imports), and the euro weakens further, exporters across the world will suffer. The United States will be affected, and the Obama administration’s target to double exports in five years will become hopelessly unrealistic.
• Financial uncertainties: Even more worrisome, financial contagion from the Euro crisis and banks in Europe to other regions could cause a second global credit crunch, stifle the already-constrained supply of trade finance, and plunge world trade into recession again. Already, stock markets are down about 10 percent in both emerging and industrial countries from the start of the year, with Euro area stock markets especially badly hit. Concerns are rising, as indicated by the widening of the TED spread and the spreads at which corporations and government borrow in emerging markets⁸; the spreads facing European banks are highest. So far, the financial turmoil remains modest compared to the post-Lehman period, and there is little evidence of spillover onto the real economy, but this could change quickly if the news from Europe worsens.
• Inventory Effects: With capacity utilization continuing to increase and inventory restocking slowing in most economies, this catalyst for trade will weaken.
• Stimulus: As most countries—beginning with the troubled countries in Europe—withdraw fiscal stimulus measures due to rising concerns about government debt, import demand may decline, though policy interest rates are expected to remain low well into 2011. China, where activity is already slowing⁹, is of special concern. Monetary and fiscal stimulus withdrawal and overheating may further limit growth there.
• Protectionist Pressure: According to the WTO, trade-restricting measures have declined in recent months; however, international frictions and protectionist pressure are likely to rise as the euro weakens, unemployment remains high, and global imbalances widen again.

Policy

With the Euro crisis representing the largest risk for world trade, Euro area countries need to take aggressive steps to reassure the markets, forestall a credit crunch, and prevent the crisis from spreading further. For the troubled countries, these steps include fiscal consolidation and structural reforms; at the European core, more expansionary fiscal and monetary policies are needed.

Access to trade finance must also be enhanced. Improving the credit access of small- and medium-sized enterprises, which are playing an increasing role in world trade, is an important step.

Finally, an early conclusion to the stalled Doha negotiations will strengthen the WTO and reduce the risk of protectionist pressures, even if the new liberalization measures incorporated in current Doha drafts are modest. Speeding up the negotiations is not a technical issue—rather, it requires political will from the major economies.

---

1. Four quarters after the trough, the volume of world trade of goods and services grew by 9.7 percent in the 1982 downturn, 8.4 percent in 2001, and 10.2 percent in 2009.
2. World exports rose 24.3 percent at a three-month annualized rate in March, slightly down from the 27–29 percent growth of each of the preceding three months. The three-month annualized growth rate of imports to developed economies slowed from about 15 percent at the end of last year to 8 percent in March.
3. World IP grew by 2.8 percent in the first quarter (q/q) of 2010, following similar increases in each of the previous two quarters. JP Morgan’s Global PMI, which expanded for a twelfth consecutive month in May, also reflects the strength of industrial production.
4. Imports to emerging markets rose by 8.4 percent (q/q) in the first quarter of 2010.
5. JP Morgan’s global index of new export orders has been rising rapidly and, in the United States, the Institute of Supply Management’s (ISM) new exports order index registered its eleventh consecutive month of growth in May.
6. Exports from developing economies are projected to grow by 8–11 percent in 2010, compared to 6–7.5 percent in developed countries.
7. Using the twenty-year trend path before the financial crisis, world trade in 2010 and 2011 will be 16 percent below trend. However, using the trend path before the start of the current business cycle (2000), world trade will be 10 percent below trend.
8. The TED spread, the rate at which banks lend to each other minus the Treasury bill rate, has risen from 15 basis points in the first months of the year to 45 basis points currently.
9. Industrial production growth decelerated from more than 20 percent (m/m, annualized) at the beginning of the year to a single-digit in the last two months.