Since the fall of the Iron Curtain, the volume of global trade has been characterized in part by double-digit growth rates. Yet evidence shows that this growth has declined steeply since 2012. This piece examines the reasons for the decreasing dynamism of global trade.
High growth in the volume of global trade occurred no later than the integration of Eastern Europe into the global economy. Between 1995 and 2007, the volume of global cross-border trade grew on average by 7.3 percent per year. At its peak, the growth rate stood at over twelve percent. Since 2012 however, we have seen much lower annual growth rates (see Fig. 1). Based International Monetary Fund forecasts, the long-term growth rate will halve from 2008 to 2020, reaching only 3.4 percent per year on average. In my opinion, there are five key reasons for this decrease in global trade.
# 1: Decreasing demand for goods in Europe and China
The global financial and economic crisis triggered by the Lehman collapse, weakened economic growth in all developed industrialized nations. The European national debt crisis that erupted in 2011 put an additional damper on growth in Europe. Dynamic of the Chinese economy is also declining: between 1991 and 2014 China’s gross domestic product grew on average by around ten percent per year. However, it is likely that in the future growth will sink to six percent.
In large economies, whenever economic growth decreases, there is a decline in demand for goods and services. This also affects demand for products from abroad. As a consequence, there is a reduction in exports and global trade.
# 2: The growing importance of services
Global structural change means that services account for an ever-increasing share of total net domestic profit. In many instances, this is a matter of the provision of locally supplied services, where cross-border trade is bound to fail due to prohibitive costs. So for example, it makes absolutely no sense for people to go abroad for a hairdresser’s or doctor’s appointment. If, therefore, the share of material goods in proportion to consumer goods is decreasing, the share of exports as part of the total economic demand will also fall. As a result, exports and the volume of global trade grow weaker.
# 3: Rising wages in the newly industrializing countries
Up until now, international division of labor has been characterized by the fact that developed industrialized nations have concentrated on the production of goods whose manufacture requires a considerable amount of capital and technology. By contrast, newly industrializing and developing countries manufacture products that are more labor intensive. The reason for this is the fact that wages in these countries are considerably lower than in industrialized nations, leading industrialized countries to outsource the production of such goods abroad (outsourcing).
With the economic rise of the newly industrializing countries, the cost of living is rising in these countries, and with it, wages as well. China illustrates this neatly: average wage levels in urban areas have increased almost tenfold between 1995 and 2013. This means it is less attractive to outsource the production of goods to China. Instead there is a growing incentive for industrialized countries to once again manufacture goods in their own country. The consequence of this insourcing is a reduction in international trade.
# 4: Increasing protectionism
A frequent economic policy response of a country that finds itself in an economic downturn is the introduction of protectionist measures: in order to prevent a decline in production and employment at home, governments often protect domestic businesses by means of tariffs or other trade restrictions. This reduces exports, thereby weakening global trade.
One indirect form of protectionism is the failure to conclude free trade agreements. By withdrawing both tariff and non-tariff trade restrictions free trade agreements can increase trade between participating countries. At present however, it is becoming more and more difficult to conclude these kinds of agreements. This means that countries miss out on potential export opportunities and in so doing weaken the dynamism of global trade.
# 5: Increasing digitalization
The growing importance of new technologies and information and communication technologies has led to production processes becoming increasingly dependent on capital and technology. Labor is losing its importance as a factor of production. This means that the international competitiveness of low wage countries is disappearing. For industrialized countries it is therefore becoming increasingly more attractive to once again move production sites closer to the domestic market, because this leads to savings in transport costs. As a result, the previous trend towards outsourcing is now being replaced by a trend towards insourcing, which is reducing the volume of global trade. Some economists have also argued that growth effects in the digital and the sharing economy are only partially captured by traditional GDP measurement methods which would lead to an underestimation of economic growth. This view, however, is still subject to debate.
Why is a decrease in global trade problematic?
The weakening of global cross-border trade is problematic for at least two reasons:
- In the first place, cross-border trade has positive effects on economic growth and employment. A decrease in global trade would have a detrimental effect on people’s material prosperity and their employment opportunities.
- In the second place, cross-border trade also has a peace-making effect: countries that trade with each other are less likely to be involved in military conflicts. This effect will also become weaker with a decrease in global trade activity.
Economic policy implications
The development trends described here lead us to expect that in the future the volume of global trade will lessen. In order to make best use of the remaining growth and employment potential that result from a stronger international division of labor, two key measures suggest themselves:
- Attempts at economic isolation in the form of border closures or protectionist measures should be avoided. Such measures are detrimental to the economic prosperity of all citizens.
- Opportunities for economic cooperation, such as those resulting from concluding bi-lateral or regional free trade agreements should be exploited. They strengthen economic growth and at the same time safeguard jobs.
If you are interested in this topic, the anthology The Global Trade Slowdown: A New Normal contains many articles dealing with the determinants of this slowdown, the role of global value chains, regional perspectives and more.