By Maurice Obstfeld

April 17, 2018

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Container ship in Colombo, Sri Lanka: the recent escalating tensions over trade present a growing risk to the global economy (photo: STRINGER/REUTERS/Newscom).

The world economy continues to show broad-based momentum. Against that positive backdrop, the prospect of a similarly broad-based conflict over trade presents a jarring picture.

Three months ago, we updated our global growth forecast for this year and next substantially, to 3.9 percent in both years. That forecast is being borne out by continuing strong performance in the euro area, Japan, China, and the United States, all of which grew above expectations last year. We also project near-term improvements for several other emerging market and developing economies, including some recovery in commodity exporters. Continuing to power the world economy’s upswing are accelerations in investment and, notably, in trade.

Looking at the largest economies, our 2018 growth projections, compared with our earlier October 2017 projections, are 2.4 percent for the euro area (up by 0.5 percentage point), 1.2 percent for Japan (up by 0.5 percentage point), 6.6 percent for China (up by 0.1 percentage point), and 2.9 percent for the United States (up by 0.6 percentage point). U.S. growth will be boosted in part by a largely temporary fiscal stimulus, which explains over one third of our upgrade over last October for 2018 global growth.

Despite the good near-term news, longer-term prospects are more sobering. Advanced economies—facing aging populations, falling rates of labor force participation, and low productivity growth—will likely not regain the per capita growth rates they enjoyed before the global financial crisis. Emerging and developing economies present a diverse picture, and among those that are not commodity exporters, some can expect longer-term growth rates comparable to pre-crisis rates. Many commodity exporters will not be so lucky, however, despite some improvement in the outlook for commodity prices. Those countries will need to diversify their economies to boost future growth and resilience.

Escalating risks

Looking past the next few quarters, moreover, there are notable risks to the outlook. As our new Fiscal Monitor documents, global debt levels—both private and public—are very high, threatening repayment problems as monetary policies normalize in an environment where many economies face lower medium-term growth rates. As the new Global Financial Stability Report shows, global financial conditions remain generally loose despite the approach of higher monetary policy interest rates, enabling a further buildup of asset-market vulnerabilities. Geopolitical risks should not be discounted; and, of course, the recent escalating tensions over trade present a growing risk.

Perceptions of these risks could already be taking a toll. For example, while global purchasing managers’ indexes remain in expansionary territory, they have recently softened—in advanced and emerging market economies alike—owing in part to weakening export orders. Financial conditions remain easy, as just noted, but have tightened somewhat since the start of the year.

At the IMF, we have been saying for a while that the current cyclical upswing offers policymakers an ideal opportunity to make longer-term growth stronger, more resilient, and more inclusive. The present good times will not last for long, but sound policies can extend the upswing while reducing the risks of a disruptive unwinding. Countries need to rebuild fiscal buffers, enact structural reforms, and steer monetary policy cautiously in an environment that is already complex and challenging.

Trade tensions

Instead, the prospect of trade restrictions and counter-restrictions threatens to undermine confidence and derail global growth prematurely. While some governments are pursuing substantial economic reforms, trade disputes risk diverting others from the constructive steps they would need to take now to improve and secure growth prospects.

That major economies are flirting with a trade war at a time of widespread economic expansion may seem paradoxical­—especially when the expansion is so reliant on investment and trade. Particularly in advanced economies, however, public optimism about the benefits of economic integration has been eroded over time by long-standing trends of job and wage polarization, coupled with persistent sub-par growth in median wages. Many households have seen little or no benefit from growth.

These trends are more due to technology change than to trade, and even in countries where trade backlash is not prominent, public skepticism about policymakers’ ability to generate robust and inclusive growth has spread. Voters’ disillusionment raises the threat of political developments that could destabilize a range of economic policies in the future, reaching beyond trade policy.

Governments need to rise to the challenges of strengthening growth, spreading its benefits more widely, broadening economic opportunity through investments in people, and increasing workers’ sense of security in the face of impending technological changes that could radically transform the nature of work. Fights over trade distract from this vital agenda, rather than advancing it.

The recent intensification of trade tensions started in early March with the United States’ announcement of its intent to levy steel and aluminum tariffs for national security reasons. The announcement has fed into several bilateral negotiations aimed at reducing U.S. trade deficits with individual trading partners. These initiatives will do little, however, to change the multilateral or overall U.S. external current account deficit, which owes primarily to a level of aggregate U.S. spending that continues to exceed total income. Recent U.S. fiscal measures will actually widen the U.S. current account deficit. Compared with our October 2017 projection, which preceded the recent U.S. tax and spending changes, we now expect the United States’ current account deficit for 2019 to be roughly $150 billion higher.

Current account imbalances can play an essential economic role, but when they become excessive, they carry risks, including the risk of generating trade disputes. In the present global environment, the burden of reducing excess global imbalances should be shared through multilateral action—excess deficit and excess surplus countries alike need to adopt macroeconomic policies that align their spending levels more closely with their incomes.

Even in the absence of excess global imbalances, however, coping with inequitable trade practices, including intellectual property concerns, requires dependable and fair dispute resolution within a strong rule-based multilateral framework. There is room to strengthen the current system rather than risk bilateral fragmentation of international trade. Plurilateral arrangements, if consistent with multilateral rules, can also provide a useful springboard to more open trade. In this respect, the eleven-country Comprehensive and Progressive Agreement for Trans-Pacific Partnership and the forty-four-country African Continental Free Trade Area hold out promise. 

Each national government can do much on its own to promote stronger, more resilient, and more inclusive growth. Multilateral cooperation remains essential, however, to address a range of challenges in addition to the governance of world trade. These other challenges include climate change, infectious diseases, cyber-security, corporate taxation, and control of corruption—among others. Global interdependence will only continue to grow and unless countries face it in a spirit of collaboration, not conflict, the world economy cannot prosper.