It is time for a break from Brexit. Over recent weeks, while we have been fretting about the political chaos here, the world’s stock market investors have been worried about several other things. One of them is trade protection, which could lead to a global economic slowdown and a downturn in corporate earnings. How serious is the protectionist threat?
Contrary to first impressions, the scale of the trade conflict so far has been fairly small. The share of the world economy affected by the US tariffs implemented this year, on steel and aluminium and other sectors, as well as on bilateral US-China trade, amounts to about 2.5pc of world trade, or around 0.5pc of world GDP.
Even if we add the tariffs that have been explicitly threatened, we are still talking about total tariffs applying to only about 5pc of world imports and about 1pc of world GDP.
But things won’t necessarily stop there. Trade wars can easily get out of control. The episode that haunts us is the Great Depression of the Thirties. The infamous Smoot-Hawley Tariff Act was passed in the US in 1930, leading to worldwide retaliation. Between 1930 and 1932, world trade fell by 23pc.
It is widely assumed that the outbreak of protection was a leading cause of the Great Depression. In fact, this judgment is misplaced. Protection certainly didn’t help but it wasn’t the underlying cause of what went wrong.
The recent history of trade policy and its effects is more reassuring. Growth in world trade was not affected by the so-called “Nixon shock” in 1971 – when President Nixon imposed a 10pc tariff on imports – or by the protectionist episode in the Eighties during Ronald Reagan’s presidency.
In recent decades, the only occasion when trade slumped was during the global financial crisis. Between 2008 and 2009, world trade fell by 13pc. But that was due to a collapse in aggregate demand around the globe and a reduction in the availability of trade finance, rather than an outbreak of protection
Subsequently, there has been some creeping protection but it was the election of President Trump in November 2016 on an avowedly protectionist programme that really set the cat among the pigeons. It is difficult for politicians to resist the lure of protectionism because there are often easy votes to be won. The gains to workers and businesses are concentrated in the particular industries being protected while the losses, in the shape of increased import costs because of tariffs, are spread thinly.
If there were to be a severe global outbreak of protection, the effect on world GDP would not be catastrophic. Capital Economics estimates the impact of a 25pc tariff imposed on all goods trade by all countries would be to reduce world GDP, relative to the amount it would have been, by 2-3pc.
For most economies, what happens to domestic demand and to productivity in domestic-facing industries is the most important determinant of living standards. Admittedly, there is an asymmetry here between large and small economies.
An economy like the US is sufficiently large that it can generate substantial economies of scale while catering to its own domestic market. At the other extreme, a small country like Singapore cannot, and a breakdown of the open world trading system would have a much larger impact on its economy. The UK lies between these extremes.
The threat of Nafta breaking up has receded. During his election campaign Trump described Nafta as the “worst trade deal ever signed”. But his US-Mexico-Canada agreement, which he called a “truly ground-breaking achievement”, is almost identical.
The agreement presidents Trump and Xi reached at the G20 summit could prove to be the prelude to a lasting truce between the US and China. For now, all they have agreed is to leave tariffs unchanged for 90 days and for China to import a “very substantial” amount of agricultural, energy and industrial goods. But China’s decision to reduce tariffs on imports of US cars from 40pc to 15pc raises hopes for a deal.
Yet the longer-term risks look greater. I suggested in this column three weeks ago that the US economy will probably slow next year, and that the next presidential election is likely to be fought against the backdrop of an economy notably softer than at present. That would surely make protectionist policies all the more appealing to the electorate.
At least the threat of a trade war between the US and the European Union seems to have been put on hold. Mind you, the threat of US tariffs on all car imports is still a live one, particularly given the difficulties the American car industry is facing.
Moreover, protectionist sentiment may be set to intensify in the EU, as the economy slows and resentment towards the governing elites builds. This is likely to be reflected in big gains for populist parties in the May elections to the European Parliament.
With the UK no longer within the EU, restraining the natural instincts of the French, the EU could turn in a protectionist direction. If the US, China and the EU all turned protectionist simultaneously that would be bad news for the world economy.
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