Yes! US-China Trade War is slowing down the world economy

The global economy is not doing well, and trade tensions between the United States and China have a role to play. Even as the rift continues, another conflict I wrote about yesterday also needs early resolution before it snowballs into something big.

IMF’s World Economic Output Update released earlier this week underlines the fallout of the trade war between US and China. According to its latest forecast, real global economic growth will drop to 3.2% this year, 0.1 percentage point slower than the forecast made in April. These are worrying figures given that the growth figures stood at 3.6% last year and 3.8% in 2017.

The impact of the deterioration of the US-China trade talks can be seen from the slowing growth rate of global trade during the conflict period, the report underlines. IMF’s forecast for growth in global trade by 2.5% now is 1 percent lower than the forecast made in April. Here is another clear and concise analysis of the trade slowdown on Mishtalk. This is especially worrying because global trade since 2017 has seen robust periods of growth. On tariffs, the IMF has also said that attempts to address trade imbalances by taxing imports are hurting the world economy without fixing the problem.

Trade was also a main concern in the IMF’s annual External Sector Report released last week, with Chief Economist Gita Gopinath warning that such conflicts are shaking the global economy. Another important finding of the report underlined the big shift in global economies: China, which had the world’s biggest current-account surplus a decade ago, is now close to balanced trade with developed countries like Germany and the U.S. dealing with largest surpluses and deficits.

To get back to the ripple effect trade wars have been having on world economies in recent months, Gopinath, in her note on the report, says:

Trade actions and tensions have so far not significantly affected global current account imbalances, as trade has been diverted to other countries with lower or no tariffs. Instead, as highlighted in an earlier blog, these trade tensions and related uncertainties are weighing on global investment and growth, especially in sectors most integrated into global supply chains (where production is carried out across multiple countries).

Slowing growth mostly was found in emerging markets, with India forecast lower by 0.3 percent compared to earlier forecasts, followed by Russia, Brazil, and Mexico. Besides the US-China trade tensions continuing to impact growth across the world, the report also cited policy uncertainty as another impediment to growth. The solutions to mitigate the slowing growth, according to Gopinath, also hinge on policy decisions of governments across the world, policies that are pro-trade and contribute towards strengthening the rules governing international trade:

Many countries are now near full employment and have limited room to maneuver in their public budgets. So, governments need to carefully calibrate their policies to achieve domestic and external objectives. Countries with excess current account deficits, like the United Kingdom and the United States, should adopt or continue with growth-friendly fiscal consolidation, while those with excess current account surpluses, like Germany and Korea, should use fiscal space to boost public infrastructure investment and potential growth.

Moreover, carefully tailored and sequenced structural policies should play a more prominent role in tackling external imbalances, while boosting domestic potential growth. Reforms that encourage investment and discourage excessive saving—for example through the removal of entry barriers or stronger social safety nets—would support external rebalancing in excess current account surplus countries. Reforms that improve productivity and workers’ skill base are appropriate to promote exports in countries with excess current account deficits. Even economies with external positions that we assess to be broadly in line with fundamentals, like China and Japan, need to adopt policies that address domestic imbalances and prevent a resurgence of external imbalances; this requires structural reforms that facilitate competition in sectors like services.

Exchange rate flexibility remains key to facilitating external adjustment. As highlighted in this year’s analytical chapter, varying features of international trade, including the extent of integration into global value chains and trade invoicing in a dominant currency like the US dollar, can weaken some mechanisms of external adjustment and limit the benefits of exchange rate flexibility in the short term. So, exchange rate flexibility may need to be supported with other policies that bolster the export response, including through improved access to credit and transportation infrastructure. Allowing exchange rates to play their role, however, remains key to deliver durable medium-term rebalancing. 

Another report from the World Trade Organization, released this month, underlines a sharp increase in trade protectionism. Approximately $340 billion a year of trade faced tariffs, the report said, marking the second-highest figure on record, surpassed only by the $588 billion in restrictions reported in WTO’s earlier monitoring report.

All these reports, released in quick succession this month, flag trade tensions as detrimental to economic growth. Yet, bilateral conflicts continue, and while there is no alternative to WTO however ineffective and slow it may be at times, not all conflicts can be resolved by the WTO. This year and next are critical to seeing if sparring countries can come together and find effective institutional frameworks for trade negotiations that benefit all.