Global economic outlook: Trump’s trade policy could damage the positive dynamic in the global economy

19 March 2018 13:33

Global economic growth accelerates mildly in 2018. But the hardening of US trade policy increases the risk of escalation in trade relationships. This would seriously damage the US economy and cause a setback in the recovery of world trade growth.

Gigantic cranes from the Newark-Elizabeth marine terminal

The mild acceleration in the global economy that began last year is continuing in 2018. Many economies are doing slightly better than in the years from 2012 to 2016 (table 1, figure 1). There is however no structural breakthrough as yet to the growth figures seen before the global crisis for the world as a whole. We see this more as a cyclical upturn.

Table 1: Economic prospects for the major economies

Source: IMF, Macrobond, Rabobank

Figure 1: Mild acceleration in global growth to continue this year

Source: IMF, Macrobond, Rabobank

Trump’s trade measures increase the risk of a trade war

In our outlook for 2018, we mentioned the effects of an unanticipated hard Brexit, escalation of geopolitical tensions and a hardening of the actual trade policy of the US as the major downside risks. It is especially the last of these risks that is currently the subject of public interest. Until recently, Trump’s policy featured strong words but not much action. But this would seem to be changing. The president has now announced that he will impose import tariffs on steel and aluminium. This is mainly significant because Trump has cited national security as the basis for this decision, invoking article 232 of the US Trade Expansion Act. He is thus departing from the normal practices of international trade. Within the framework of the World Trade Organisation, member states have so far been very cautious when it comes to invoking a threat to national security. This is why the reactions from other countries have been so severe. The risk of a US trade war has thus increased (see figure 2).

Figure 2: Trump tactics: tough as steel

Source: Rabobank

A trade war, in which countries respond to trade restrictions by imposing trade restrictions themselves, ultimately means that everybody loses. This is why Trump’s decision on steel and aluminium has been contested in his own party, and his top economic adviser Gary Cohn has resigned (in Dutch). In a recent study, we describe how a trade war will negatively affect the economy, and not least the US economy. Import tariffs increase inflation and depress consumption. Higher inflation will lead to expectations of higher interest rates, with lower investment and consumer credit as a result. But the US competitive position will also be hurt by higher prices of imported semi-finished products (see figure 3).

Figure 3: How import tariffs damage the domestic economy

Source: Rabobank

A trade war would of course also affect the volume of world trade. After several moderate years, the growth of world trade picked up in 2017 (figure 4), with major contributions from Europe, the US and China. If Trump’s trade policy were to lead to a serious escalation in trade relations, this could very well lead to a new decline in the growth of world trade. This would damage economic growth (box 1).

Figure 4: After several moderate years, the volume of world trade picked up in 2017

Source: Macrobond Note: 12m/12m world trade growth and contribution by region, seasonally adjusted

The risk of escalation in international trade relations has increased sharply in recent weeks. And the upcoming mid-term elections in the US increase the pressure on Trump to achieve a political success in the eyes of his supporters. The departure of moderate advisers such as Gary Cohn also means that there are less counter-arguments in the White House. But so far we are still assuming that both the Americans and their trading partners will wish to avoid a general trade war and that trade measures will thus remain restricted to specific sectors and actions. Our forecasts for the major economies stated below are based on this assumption.

Box 1: Trade between countries: the economic impact

There is a large amount of literature going back many years on the economic effects of free trade between countries. IMF (2016) gives a concise list of this literature. In summary, free trade leads to specialisation between countries and therefore to higher productivity (Ricardo, 1817). Foreign competition also leads to more efficient production (Helpman and Krugman, 1985). Consumers benefit from lower prices and a wider choice of products (Broda and Weinstein, 2006). Trade also leads to shifts in income between sectors (Stolper and Samuelson, 1941). This explains why workers in certain sectors are worse off as a result of trade (Autor, Dorn and Hanson, 2013). Free trade also influences the relative prices of products, which may work to the disadvantage of certain consumer groups (Fajgelbaum and Khandelwal, 2016).

The United States: trade provocations could negate the growth from tax cuts

President Trump booked his first big domestic policy success at the end of last year with tax cuts for households and corporations. This is providing a short-term boost for the already strong US economy, albeit accompanied by higher risk in the longer term due to the associated large increase in government debt. If the new trade restrictions were to lead to a large-scale trade war, then the boost to growth from the tax cuts could be amply negated. If however the US restricts itself to specific trade measures and is able to avoid a wide-ranging trade conflict, we see the US economy growing by around 2.6 percent this year.

Eurozone: healthy growth, but the peak is probably behind us

The eurozone economy is expected to grow by a healthy 2.4 percent this year. But the economic sentiment indicators suggest that the peak in growth has been reached. There could be slower growth with effect from next year. The economic growth in the eurozone is broad-based. Both exports and domestic spending are strong. Exports are evidently not suffering much from the relatively strong euro. The fastest growth this year will probably be in investment, supported by high producer confidence and low interest rates. And consumption is benefiting from rising employment. Unemployment is rapidly falling to 8 percent. And there are also signs that finally - albeit gradually - there may be more wage increases on the cards. This could contribute to the desired normalisation of monetary policy, although we expect the ECB to maintain its cautious pace and we do not see the first interest-rate hike happening before September 2019.

The United Kingdom: 2018 should bring clarity regarding the future trade relationship with the EU

The United Kingdom will shortly begin negotiations with the EU regarding its future trade relationship. There will also have to be substantial agreements regarding a transition period. Time is pressing: a general political agreement will have to be reached this autumn. Because “nothing is agreed until everything is agreed”, citizens and businesses will have to continue to cope with a high level of uncertainty regarding the outcome of the negotiations. We believe the most likely outcome is a free trade agreement in between those of the EU with Canada and with Switzerland, given the ‘red lines’ set by the UK with respect to more far-reaching forms of integration with the EU post-Brexit. Such an agreement would mean no trade tariffs on goods, but there will be non-tariff barriers that will make future trade more expensive. A ‘softer’ Brexit is also possible, as is a hard Brexit with no agreement. The UK economy is meanwhile suffering the effects of the lower pound since the Brexit referendum (mainly in the form of higher inflation), and also the effects of uncertainty with regard to the future. We expect economic growth to decline from 1.7 percent in 2017 to 1.4 percent and to slow further in the years to follow.

For Australia, we expect economic growth to be slightly below trend at around 2 percent. This is due to a cooling housing market and declining population growth, as well as lower demand for iron ore from China. The Chinese market accounts for 35 percent of Australian exports. Australia is therefore also exposed to the effects of an increasing trade conflict between the US and China.

Emerging markets: positive economic growth

The emerging markets are also generally contributing positively to the economic momentum in the global economy at the moment. They are benefiting from both good domestic dynamics and demand for their exports from other countries.

The Chinese government is keeping the economy well on track to achieve its own medium to long term target of doubling GDP in real terms between 2010 and 2020. At the same time, this entails a gradual reduction in the annual growth figures, which nonetheless will continue at above 6 percent per year for the time being. Domestic demand has become the major growth driver, and this is expected to continue. Exports will however continue to make a contribution. In this context, trade relations with the US will be a particular item of attention for the Chinese government.

The Brazilian economy emerged from a deep recession last year and we are currently seeing a continuing recovery, which we expect to result in economic growth of 2.2 percent this year. This has been aided by economic reforms as well as the recovery in world trade. The elections to be held this year against the background of huge corruption scandals form the most important source of domestic risk. For now, we are assuming that these will lead to the election of a market-friendly new administration. Relatively low inflation and interest rates are also contributors to our expectations of higher investment.

The Indian economy has recovered from the far-reaching reforms and has now begun to grow again. In the fourth quarter of 2017, the economy posted growth of 7.2 percent (y-o-y) and we expect economic growth to reach 7.9 percent this year, due among other things to strong growth of domestic consumption, a recovery in business investment and an accommodative policy from the government.

Russia has recently taken centre stage in geopolitical terms, with its military intervention in Syria and its suspected interference in the US elections in 2017. But the economy is no better than moderate. Although the economy emerged from recession in 2017, growth is expected to be less than 2 percent per year in the coming years, which is rather low for an emerging market.