2 November 2015

Global economy in a sharp slowdown

By Ian Stewart

This is the latest edition of Ian Stewart’s Monday Briefing. You can view previous editions and sign up to receive future editions by email here.

Global GDP growth remains disappointing. At the start of the year the global economy looked set to expand by 3.0% this year; the actual outcome looks likely to be closer to 2.5%.

Growth has been hit by a multitude of factors. But one consistent theme is the weakness of trade. In the 1980s and ’90s global trade often grew at twice the pace of broader GDP growth, in so doing provided a big impetus for global activity. This impetus has all but disappeared.

Between 2012 and 2015 global trade grew at an average annual rate of 3.2%, roughly in line with global output growth of 3.3%.  Trade is now growing at the slowest rate outside a recession on record.

What explains the slowdown in the rate of growth of global trade?

The aftermath of the financial crisis and the recession are the most obvious suspects. High levels of uncertainty and continued public sector austerity have dampened demand and slowed growth in exports of goods and services. The Bank of England recently estimated that such post-crisis effects explain around 60% of the recent weakness in global trade. On this interpretation trade flows will get a significant boost if demand heads back to pre-crisis levels.

But some of the factors weighing on trade seem to be here to stay.

The impetus to global trade from the industrialisation of Asia seems to be fading. As Japan rebuilt its economy from the 1950s investment spending rose as a share of GDP fuelling demand for foreign expertise and capital goods. At the same time Japan targeted Western demand with new, efficient export industries, particularly in consumer products. This pattern of import and export led growth was repeated by the “Asian Tigers” of Hong Kong, Singapore, South Korea, and Taiwan from the 1960s and China from the 1980s.

The industrialisation of Asia in the last 60 years lent important support to global trade. But as Asian industrialisation has slowed so investment spending has declined in importance and their demand for goods has softened.

Trade may also have been hurt by the slowing pace of trade liberalisation. The average tariff imposed on imports by developing countries dropped from 37% in 1980 to under 10% in 2010, giving a significant boost to trade. With tariffs already at low levels the scope for trade-boosting liberalisation has reduced. The big gains to trade from cutting tariffs may already be banked.

A final, paradoxical factor is rising prosperity itself. As people become richer they spend a higher proportion of their income on services, such as education, leisure and health. Whereas virtually all goods can be shipped thousands of miles most services need to be provided locally. Most of us get our hair cut, our dry cleaning done or a meal out close to home. The result is that as expenditure rises the share going on less tradeable services increases, slowing growth in demand for goods.

So what are the implications of weaker global trade growth?

Most obviously economies and companies that depend on exports will find conditions more challenging. Countries with high export dependence include South Korea and Germany. The US and UK are have a relatively low level of export dependence. Companies that export will need to work harder to build and retain market share.

Slower export growth creates incentives for policymakers to gain advantage for their exporters by weakening their currencies. We are likely to see more attempts to engineer currency devaluations to improve export performance.

And if growth isn’t coming from trade policymakers will be more reliant on domestic demand. This points to continuation of the cheap money policies of recent years which aim to boost growth.

There is a further, more subtle, implication. In the rich world consumer spending accounts for the lion’s share of the domestic economy, with government spending in second place. Government spending is being squeezed by the need to reduce public sector borrowing.  That leaves consumer spending as the big support for GDP growth.

In the absence of an export-led growth governments must hope that rising incomes, low inflation and cheap credit keep consumers spending.

Ian Stewart is Chief Economist at Deloitte