Coping with crisis: trade matters

In the coming weeks I shall seek to establish why it is I believe that trade policy, at the global and national levels, represents the third and final important lesson to come out of recent worldwide efforts to cope with the global economic recession, financial crisis and credit crunch (squeeze).

Recovery and risks

2009091004guyanalogoI had claimed last week, the admittedly growing widespread optimism that economic recovery will take place for most economies some time during this, the final quarter of 2009 and in some instances going well into 2010 has to be juxtaposed against several crucial downside risks which could serve to deny this projected outcome. I had highlighted six of these downside risks last week.  The first downside risk I pointed out is that the recession could take a ‘double-dip’ particularly if the stimulus packages, which are presently shoring up national expenditures in the leading economies are withdrawn for whatever reasons, too early. One possibility is that premature or precipitate terminations of stimulus packages could follow from an overly optimistic view that recovery is already firmly underway. Second, consumption, which represents a large share (70 per cent and more) of national expenditure in the leading industrialised economies, has not yet rebounded enough to be able to sustain a continued rise in overall national expenditure in the period to come. As a result the recession could return.

Third, so far economic recovery has not led to job creation in virtually all economies. This is of some concern since employment is a major contributory factor to consumption expenditure and thus global recovery. Fourth, the housing market crisis and its repercussions on residential home mortgage securities markets in the leading economies have not been resolved. The so-called toxic assets that nearly brought down the global financial system and created the credit crunch as well as a massive loss of confidence among investors have not disappeared, even though there is very little discussion of this issue today.

Fifth, the deficit financing that has provided for the stimulus package of governments around the world, opens up the prospect of future inflation down the road. The sixth downside risk which I highlighted is growing protectionism. This could well lead to the collapse of global trade. Based on international experiences in the 1930s it is a natural response for governments that are undertaking countercyclical expenditure at times of economic distress to want to focus on those projects which seem to bring immediate benefits to their peoples and constituents. ‘Buy local’ campaigns are thus very effective, because they hit a responsive chord among the population.

The fallacy of composition

The truth is, however, that if all economies pursued such an objective, then the exports of all countries would decline. In turn falling economic growth, reduced employment and declines in consumption would be accompanied with declining opportunities for international trade. In today’s global economy, much more than at any previous historical period, economic performances of all economies are highly contingent on opportunities for global trade. Before I demonstrate why this is the case, let me first draw a parallel with the so-called miserly approach of practising thrift and prudence at times of economic catastrophe. Most Guyanese have grown up with the old adage fixed in their minds: ‘Always save for a rainy day.’ When the advice is given to one person and he/she follows it, it becomes very useful advice. At times of economic uncertainty, however, if all persons follow this adage savings would rise and spending would fall. But at times of economic hardship, as I have previously shown in the discussion of stimulus packages, you do not want spending to fall. Economists refer to this more generically as an example of the ‘fallacy of composition.’ What is good advice for one individual is bad advice when all individuals or a large number of individuals follow it.

There are several instances of international agencies advising Guyana and Caricom governments to pursue projects for which they claim there are excellent market prospects. They then proceed to give the same advice to scores of other developing countries facing similar production possibilities, urging them to follow suit. When these many other countries do the same, what were excellent market prospects disappear. Overproduction, price collapse and a market glut follow. The projects become a nightmare for those owning and executing them.

Globalisation and openness

The basic reason why trade policy is so vitally important is that since the rampant advance of globalisation after the 1980s, the global economy has become unprecedentedly more open. The global prosperity of the past three decades has unmistakeably been dependent on the rapid expansion of global trade in goods and services. Indeed it has been calculated that three-quarters of global growth in GDP in recent times has been dependent on the growth of global trade in goods and services.

I had previously given the example of the United States economy in these columns. In the 1960s, the US economy was largely self-sufficient. External trade, and this was confined then largely to trade in goods (merchandise trade), accounted for about ten per cent of US GDP. Since then the growth of US trade, like global trade, has been faster than its GDP. The result is that today the US trade/GDP ratio is about 30 per cent. Additionally, US trade has shown a most dramatic expansion in the rising share of trade in services. With this sort of global openness, if countries turn inwards at times of crisis, and adopt measures to bias expenditures away from imports and towards domestic suppliers, global trade will enter into a downward vicious cycle. For as incomes decline and employment worsens, if cuts are made in imports (other countries exports) these will call forth cuts in imports (our exports) by other countries with rising negative multiplier effects felt among an expanding number of countries.

Next week I shall continue the discussion from this stage and supply important data in support of the spread among both rich and poor countries of increasing dependence on international trade in goods and services for their economic prosperity. In this sense trade matters to all countries. None is exempt from this dictum.