Getting to the Truth on Trade, and Yes, Ricardo Can Still Rest In Peace

Trade volumes, trade agreements, and tariffs have been the focus of capital markets over the last year. Capital markets have taken the existing unencumbered trade regime as a given, and priced in the continuation of the existing order of ever-expanding trade and lower tariffs that would benefit all parties involved.

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However, that changed with the rise of non-traditional political leadership characterized by policies that seek to alter traditional trade agreements with the intended goal of: benefiting domestic industries to drive stronger domestic employment opportunities, and ultimately improve wage growth that has been stagnant for those at the lower end of the economic ladder.

More recently, export-oriented companies and countries—particularly emerging markets—have experienced significant volatility in their debt, equity, and currencies valuations. Capital markets have priced in a greater degree of uncertainty based upon the anticipation that a new, more limited global trading regime may be developing.

To understand what the impact of limited global trade may be going forward, we suggest examining trade volumes and the concomitant share of world trade.

Probably the best source that brings together worldwide monthly data on global trade is the Dutch Government’s Bureau for Economic Policy Analysis (CPB). The CPB provides monthly trade volume and price data for both advanced and emerging economies—covering nearly 99% of world trade.

For our purposes, examining trade volumes and excluding price volatility from value measures is probably most helpful as the latter can cloud the true trade picture.

Exports in Chart 1 clearly highlight that trade volumes have grown since the trough in 2012!

Through the challenges of the last seven years—which includes slowing Chinese growth, commodity price shock, emerging market currency volatility, and a European sovereign debt crisis—trade volumes managed to stay steady, and accelerating alongside the recovery in global growth over the last two years.

Of note, though, is the growth rates of trade volumes are declining from peaks of +5% experienced in late 2016-17, reflecting a healthy capital expenditure rebound from the 2014-15 commodity correction, which at the time challenged both developed and emerging economies.

The most recent decline as shown in Chart 1 probably reflects a reversion to mean in trade volumes from these distortions, and perhaps may be a function of global growth also coming off lofty levels. In the future, perhaps we should reasonably expect growth in trade volumes of 1-3%.

An analysis of the major shares of world trade lend support to our perspective that the exchange of tariffs between the U.S. and China may only impact a marginal segment of overall global trade—even if the most pessimistic tariff and trade barrier outcomes occur.

While tariffs and non-trade barriers can and will impact trade volumes and prices, volumes will only be modestly impacted by the current tensions. For example, in Chart 2 above, China-U.S. trade represents just under 3% of world trade. Despite the protectionist political rhetoric, we should expect freer and fairer trade in the coming years, perhaps with some short-term pain from capital markets as the details of trade agreements are sorted out.

David Ricardo, the father of comparative advantage, and investors can rest easy, as global trade volumes continue to grow, albeit at a more modest pace.

Gerhardt P. Herbert September 2018

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