The unstoppable force has stopped.
With economies in the United States, Europe and Japan slowing simultaneously, the World Bank says that global trade will shrink next year by more than 2 percent. That will mark the first time in more than a quarter century that the seemingly inexorable tide of globalization will be in retreat.
“Trade tends to be extra responsive to changes in income. When the world economy contracts, trade contracts even more rapidly,” says economic historian Douglas Irwin of Dartmouth College.
The trade slump is both symptom and cause of the current global economic distress. For the U.S. economy, which just a few months ago was getting almost all of its forward momentum from net exports, “Trade will be a substantial drag on … growth,” Ian Shepherdson, chief economist of High Frequency Economics, told clients in a recent research note.
Compounding the recessionary gloom, trade is being choked by the credit crunch, which is drying up routine export financing. Entering 2009, the open trading system that has delivered low-cost goods to American consumers while lifting tens of millions of people in developing countries out of poverty faces the danger of protectionism in countries such as China, Russia, France and, potentially, the U.S.
Trade’s turnaround has been abrupt. As recently as 2006, global trade was surging at an annual rate of nearly 10 percent. This year, the total volume is still expected to grow more than 6 percent to about $14 trillion. But, with the Economist Intelligence Unit forecasting 29 national economies will shrink next year, demand will slump for products worldwide.
“Everything is down significantly, across the board in all sectors,” says Peter Keller, president of the North American operations of NYK Line, a 123-year-old Japanese shipping company. “The trenches are ugly.”
Until recently, trade was virtually the sole bright spot in the U.S. economy, with net exports responsible for most second-quarter growth. But the global slowdown is taking its toll. In October, U.S. goods exports fell for the third consecutive month to $120.8 billion, almost 14 percent below July’s level. And there are signs that new orders are melting amid the economic tumult.
Bright spot no more
After 70 consecutive months of expansion, the Institute for Supply Management export index released Dec. 1 showed falling orders in both November and October. A few weeks ago, Keller’s ships were mostly full, thanks to orders placed months ago. Then, business tanked. Now there are mounting worries about retailers’ plans for post-holiday orders. NYK announced last week that it would defer plans to purchase 60 ships as it seeks to trim capacity.
Trade’s rise and fall can be traced on the Baltic Dry Index, a measure of shipping demand. The index more than quadrupled from the end of 2005 through May of this year, reaching a high of 11,793 on May 20. Since then, as demand for container vessels and cargo ships evaporated, it has dropped an astonishing 94 percent.
It’s not just slumping demand that explains traders’ woes. Exporters are finding it difficult to obtain the letters of credit and insurance needed to ship goods between countries. “The subprime crisis has resulted in a liquidity crunch and, hence, bank finance for trade has decreased,” said an October report from Celent, a financial consultancy.
Latin American exporters were the first to feel the chill, in September. In countries such as Brazil, companies found they couldn’t obtain financing from New York banks that were feverishly reducing their credit exposure amid the worsening crisis.
Some of the affected trade even involved cases in which the International Finance Corp., the private sector arm of the World Bank, had signed contracts to provide the trade financing. The deals fell through because the money wasn’t available from the U.S. banks, according to Hans Timmer, lead economist for the World Bank’s global trends unit.
Since then, the problem has spread to other top emerging markets, such as India, according to the World Bank. Even companies in the U.S. and Europe shipping to customers in emerging markets face difficulties. Today’s more volatile environment has prompted many companies to move away from so-called open-account or pay-on-delivery trade to the use of letters of credit, in which banks guarantee a customer’s payment.
But even as demand for such bank guarantees has surged, the supply has been pinched by the overall credit crunch.
“Now even for corporations with long relationships, trust is not there anymore. … It’s affecting almost everyone,” says Axel Pierron, Paris-based senior vice president at Celent.
Long a financial backwater, trade finance is drawing increased attention from policymakers: The U.S Treasury and the Chinese government agreed earlier this month to jointly make available $20 billion to facilitate their companies’ sales to emerging markets. That move followed a $3 billion initiative announced last month by the International Finance Corp.
“There’s been an aggressive intensification of the crisis over the past five or six weeks. Especially in emerging markets, credit is just drying up,” says Harvard University’s Kenneth Rogoff, former chief economist for the International Monetary Fund.
The frozen trade credit market is attracting new financial players, Pierron says. A handful of hedge funds, seeing prospects for attractive investment returns elsewhere vanishing, are considering getting involved in trade finance, he says.
Last month, at the Washington summit on financial markets and the world economy, leaders of the Group of 20 nations promised to refrain from erecting new barriers to trade or investment for the next 12 months.
Left unsaid was what would happen in the 13th month. The last thing the already enfeebled global economy needs is a trade war.
Many industry representatives are apprehensive about the new year. With unemployment rising, the new Democratic-controlled Congress is expected to be less amenable to new trade agreements than was its predecessor. Public Citizen’s Global Trade Watch says the ranks of trade liberalization opponents had a net gain of 28 votes in the House and six in the Senate, figures business community representatives, such as the National Foreign Trade Council, dispute.
Still, there is little argument over the fact that enthusiasm for further trade expansion along the lines of the agreements pursued by both parties in recent years is at low ebb. A trio of bilateral trade deals with Colombia, Panama and South Korea, continue to idle in Congress. And the Doha Round of global trade talks sputtered to a halt this month when WTO Director General Pascal Lamy opted not to convene a last-ditch negotiating session in Geneva.
The U.S. recession — the economy is shrinking in the fourth quarter by an estimated 4 percent to 6 percent — provides a potentially receptive environment for anti-trade measures. “As time goes on and the jobless rate goes up everywhere, we will see a growing trend toward protectionism,” says Sung Won Sohn, an economist at California State University.
The Doha Round’s failure also means countries will be free to impose tariffs that could shrink global trade volumes by $728 billion to $1.7 trillion, according to a new report by the International Food Policy Research Institute.
Countries typically apply lower tariffs than are permitted by the last global trade agreement, the Uruguay Round. They could legally increase them at any time.
Other arguments will come into play. Already one prominent U.S. economist, Dani Rodrik, has pointed out on his blog that the Obama administration’s planned economic stimulus would pack a greater punch if the U.S. raised import tariffs to make sure the money is spent here and not on goods from abroad.
A $1 trillion shot of economic adrenaline, for example, would boost gross domestic product by $1.8 trillion, assuming consumers spent 20 cents of every dollar on imports. If tariffs, by raising the price of imported goods, encouraged them to buy only made-in-the-USA goods, the economic gains would rise to $2.8 trillion.
But Rodrik also says a coordinated international effort to stimulate spending would be a better option than raising tariffs, which would invite retaliation by other countries and risk a 1930s-style trade war.
What happened in the ’80s
The last time the U.S. faced a severe recession, the early 1980s, it imposed import limits to protect the domestic auto, steel and textiles industries. Will a similar pattern unfold next year?
Not necessarily, Irwin says. The dollar was strong in the early ’80s, so there was more pressure on domestic companies from foreign products. And U.S. manufacturers were not as globalized as they are today, with cross-border ownership stakes and supply chains that span the globe.
“Globalization has really defused a lot of protectionist pressures. Stopping trade at the border won’t help as it did in the ’80s,” he said. “Things might be different this time.”
Or they might not.