Publications /
Opinion

Back
Investors Fear Regime Change
Authors
October 28, 2019

Global GDP has slowed sharply, from near 4% in late 2017 to half that rate on an annualized basis in recent quarters. The downturn in fortunes over the last two years has come as a big surprise. The rapid expansion of 2016/2017 was broad based but died young. Prior to it we had suffered seven long years of slow growth in the wake of the global financial crisis

Why did such a sharp and steady slowdown occur against a background of loose monetary policy, supportive fiscal policy, low inflation and absence of evident large imbalances? As argued in the IMF’s World Economic Outlook report issued last week, the evidence points to the uncertainty over trade tensions as a major contributor.

Manufactures, which are the most traded sector, slowed far more than services. Investment slowed even as consumption remained solid. And world trade has decelerated massively, from growth of nearly 6% in 2017, to zero over the last year, a very unusual occurrence.

The global slowdown has occurred against a background of protectionist steps initiated in Washington and retaliated on by others. These measures included, among many others, the first invocation of national security to tax aluminum and steel and subsequently to threaten autos, and the use of section 301 (unfair trade), unprecedented since the creation of the World Trade Organization, to justify across the board tariffs against China.

In surveys, business executives point to trade tensions and the uncertainty they generate as their single biggest concern. Stock markets have become extraordinarily sensitive to trade news. And the weakness in activity persists despite negative real interest rates. Trade tensions have not only slowed growth but they have also preempted the normalization of monetary policy.

Many were complacent initially about the effects of tariffs, since tariffs were applied to only a small part of world trade, and the effects of tariffs on GDP are known to be small. But this calculus was wrong. Tariffs affect specific sectors in a big way and trade disputes can turn into trade wars, so investors struggle to anticipate where the axe might fall. The cause of the slowdown is not tariffs themselves, but the fear of regime change. In this case, regime change is the passing of the rules-based trading system and its replacement by power struggle.

When policymakers talk seriously about decoupling from China, about imposing 25% tariffs on automobiles, about the collapse of the WTO’s judicial function because of the United States’ refusal to replace its judges, that is the start of regime change.

Economists know quite a bit about the effects of regime change in international trade. Many refer to Smoot-Hawley tariffs and the Great Depression. More recent instances include the sanctions on Iran which have devastated its economy, and the blockade of Gaza which is estimated to have reduced living standards by over 12%. Even these examples fail to convey the potential effects of trade wars in economies where complex production chains have become internationally integrated. To be sure, regime change of the kind we may be entering does not have to mean a total interruption of trade, but it does mean that firms can no longer be sure that they can rely on international trade for customers and suppliers.

Whether or not we have regime change depends crucially on the US, China and the Europeans. Will the US continue to flaunt the rules-based system or is Trump a temporary aberration? Will China adapt its system and conform more closely to that of its major trading partners? Are the Europeans willing to liberalize their agricultural markets, reduce their high tariffs such as those in cars and garments, and is Germany is willing to spend more?

Everyone wants a deal, but it would be naïve to believe that, even after Trump, Americans will lose their fear of a rising China. China is ready to liberalize more and protect intellectual property better, but it would be naïve to think that China is willing to abandon its highly successful Communist-party-controlled and state-driven model. Meanwhile, Europeans, who often claim that they are the virtuous exception, are instead among the most impervious to change  

So much is at stake that I believe compromises can be found, allowing the rules-based trading system to survive. But a lot will have to change for that to happen, and it is far from certain that the political will exists. Growth has slowed because investors have taken notice.  

This article was originally published on La Stampa

RELATED CONTENT

  • Authors
    Mohamed Obaidy
    May 30, 2019
    This paper empirically examines the impact of exchange rate arrangements on current account imbalances within the African context. Following Friedman’s hypothesis (Friedman, 1953), we test the propositions stating that flexible exchange rate regimes limit the magnitude of real external shocks and permit smoother adjustments of external imbalances. Using a new de facto exchange rate regime classification, we employ two empirical methodologies to test this hypothesis: we first apply a ...
  • Authors
    Mouhamadou Moustapha Ly
    May 29, 2019
    The world economy has gone through several systems to determine a value between country’s currencies. After the Second World War and the so-called gold standards, major world economies engaged into a system of fixed exchange rate of currencies against the dollar and, the whole system was backed by the value of USD against gold. After the end of that mechanism known as the Bretton Wood system in the 1970s, major world economies decided to liberalize the system of international exchan ...
  • Authors
    Sous la direction de
    Philippe Chalmin
    April 9, 2019
    Les cours des matières premières ont, une fois encore, été marqués par une importante volatilité en 2017 et 2018. Si de nombreux facteurs économiques permettent de l’expliquer, la raison politique fut également bien présente. Les Annual Report tensions commerciales entre la Chine et les États-Unis on Commodity et, plus globalement, la montée des incertitudes ont pesé Analytics and sur les perspectives macroéconomiques mondiales et sur Dynamics « le dynamisme des marchés ». Comptant ...
  • Authors
    April 5, 2019
    Next week, the 2019 Spring Meeting of the International Monetary Fund (IMF) and the World Bank will take place in Washington, in this 75th year since the birth of the two institutions. Christine Lagarde, the IMF's managing director, speaking on Tuesday at the US Chamber of Commerce, offered an appetizer about the macroeconomic projections to be released. Last January, the IMF reduced its forecast of global economic growth to 3.5 percent in 2019 and 2020, lower rates as compared to ...
  • Authors
    Ahmed Rachid El-Khattabi
    March 22, 2019
    The author of this blog, Ahmed Rachid El Khattabi, is an alumnus of the 2018 Atlantic Dialogues Emerging Leaders program Rapid urbanization and climate change are two of the biggest challenges for cities. As much of the world is urbanizing, cities are growing thirstier, constantly seeking out new water supplies to keep up with demand. These challenges are especially significant for many growing cities that, due to historical reasons, are not located near water resources. Climate ch ...
  • Authors
    March 5, 2019
    China’s economic growth has been in a downslide trend since 2011, while its economic structure has gradually rebalanced toward lower dependence on investments and current-account surpluses. Steadiness in that trajectory has been accompanied by rising levels of domestic private debt, as well as slow progress in rebalancing private and public sector roles. As the ongoing trade war with the US continues to unfold, it remains unclear at which growth pace China’s rebalancing will tend to ...
  • Authors
    Philippe Chalmin
    February 27, 2019
    Rarement, autant qu’en 2018, les marchés mondiaux de matières premières et de commodités auront été lle jouet non pas des tendances des « fondamentaux » (offre/demande et leur évolution), mais bien des convulsions d’une situation géopolitique mondiale qui, sous la houlette quelque peu déréglée des États-Unis de Donald Trump, a été particulièrement imprévisible. En effet, si 2018 restera dans les annales des marchés, c’est bien parce que les matières premières se sont retrouvées au p ...
  • Authors
    February 20, 2019
    Ce papier évalue les effets asymétriques des cycles économiques sur le chômage et la pauvreté au Maroc, à travers un modèle VAR estimé sur des données trimestrielles allant de 2003 à 2012. Ce modèle inclut les composantes cycliques de quatre variables à savoir : l’output-gap, le salaire minimum réel, le taux de chômage et le taux de pauvreté. Afin de tester la robustesse des résultats, deux versions du modèle VAR ont été estimées, en utilisant les composantes cycliques calculées se ...
  • Authors
    Olalekan Samuel
    Mma Amara Ekeruche
    Adedeji Adeniran
    February 12, 2019
    This study was carried out within the framework of the Global Economic Governance Africa (GEGAfrica) funded by the UK Department for International Development. The GEGAfrica programme is a policy research and stakeholder engagement aimed at strengthening the influence of African coalitions at global economic governance forums and increase, inter alia, the visibility and the outreach of African views at the regional and worldwide levels. Policy Center for the New South was requested ...