In focus - Trade protectionism and the global outlook

Section 3 of the Monetary Policy Report - November 2019

A number of trade barriers have been introduced since mid-2018, the most significant of which have been higher tariffs on bilateral trade between the US and China. This increase in protectionism has contributed to the slowdown in global growth, both via the direct effects on trade flows, supply chains and import costs, and via the wider indirect effects on business sentiment, uncertainty and investment around the world. Further protectionist measures taken since August have led the MPC to revise down its projection for the global economy and the forecast for UK output growth.

For most of the past 50 years, there has been a general trend across the world towards trade liberalisation. Tariffs on goods have fallen steadily: the average global tariff rate fell from 8½% in 1994 to 2½% in 2017 (Chart 3.1). Since mid-2018, however, that trend has begun to reverse. In particular, bilateral tariffs on trade between the US and China have risen substantially.

The fundamental shift in the direction of trade policy has affected global business sentiment. Measures of trade and economic policy uncertainty have increased sharply during 2019 (Chart 3.2) and surveys suggest that investors view a trade war as the top risk to the global outlook. These developments have taken place at a time when the global economy was already slowing, reflecting the tightening of financial conditions in 2018 — particularly in emerging markets — and slowing growth in China.

This section sets out the MPC’s assessment of the impact of trade protectionism on the global economy. It discusses how protectionist policies affect the economy (Section 3.1), developments in trade policy to date (Section 3.2) and provides estimates of their impact on global economic growth so far (Section 3.3). The final section (Section 3.4) briefly sets out how the slowdown in the global economy has affected the MPC’s forecasts.

Chart 3.1 Global tariffs have been falling steadily, while trade has been increasing as a share of world GDP

Average global tariff rate and the world trade to GDP ratio

Sources: World Bank and Bank calculations.

(a) Average trade-weighted tariff rate. Data are to 2017.

Chart 3.2 Global economic policy uncertainty has increased, particularly in relation to US trade

Global economic policy and US trade policy uncertainty

Sources: and Bank calculations.

(a) Monthly measure reflecting the frequency of articles in US newspapers that discuss policy-related economic uncertainty and also contain one or more references to trade policy.
(b) Monthly measure of media citations of terms related to economic policy uncertainty, based on data from 20 countries. The index is weighted by PPP-adjusted GDP and together these countries account for an estimated 70% of global GDP. For details, see Baker, S R, Bloom, N and Davis, S J (2016), ‘Measuring economic policy uncertainty’, The Quarterly Journal of Economics.

3.1 How trade protectionism affects the economy

Imposing trade barriers tends to reduce output in the near term…

Trade barriers make it more costly, or more difficult, for domestic businesses and consumers to buy goods from abroad, reducing trade flows. These barriers often take the form of tariffs, which for a given exchange rate increase the price of imported goods relative to those that are domestically produced.[1] Non-tariff measures including import quotas or changes to regulatory standards can also create barriers to trade.

A rise in the cost of imported goods due to tariffs will lower real incomes and in turn weigh on domestic demand growth. Some domestic production which uses imports as inputs might also be constrained if trade barriers cause supply-chain disruption.

…and in the long run.

Lower trade can reduce productivity growth as businesses are less exposed to global competition and new ideas, less able to exploit comparative advantages by specialising, and less able to benefit from economies of scale. Historically, there has been a strong relationship between trade openness and output via productivity. A study by Feyrer (2009), for example, suggests that a 20% reduction in trade flows tends to drag on output by around 5% in the long run. The integration of global supply chains in recent decades may have intensified that link.

The impact may spill over to other countries.

Countries that are not directly exposed to an increase in trade barriers might nonetheless feel some effect from their imposition elsewhere. Some might benefit from positive ‘trade diversion’ effects if they produce close substitutes for products supplied by those countries that become subject to tariffs. Most countries are likely to be negatively affected by the reduction in global demand, however, particularly if they supply inputs for affected countries’ exports.

Spillovers could also occur via reduced business confidence and increased uncertainty. The introduction of trade barriers may make businesses more uncertain about the potential market for their products and services, and whether further protectionist policies will follow. That uncertainty is likely to reduce business investment, lowering the rate of global capital accumulation and so supply growth.

Global financial conditions could also be affected. The price of companies’ equity or corporate bonds might fall, for example, if investors expect trade barriers to reduce profitability or increase the risks around it.

3.2 Recent developments in trade policy

The US-China trade war has led to a significant increase in bilateral tariffs…

Tariffs on goods traded between the US and China have been increasing since mid-2018 (Table 3.A). At the time of the August Report, the US had levied tariffs on a total of US$250 billion of imports from China, with China implementing tariffs on US$110 billion of imports from the US in response.

Table 3.A Tariffs on goods traded between the US and China have been implemented in stages

Tariff rates by implementation date

Sources: Ministry of Commerce of the People’s Republic of China and Office of the United States Trade Representative.

(a) The Chinese authorities specified a target list of 5,078 products that could be subject to tariffs. That target list had a total value of US$75 billion

…with further increases since the August Report.

In September, US tariffs on a further US$112 billion of imports from China came into effect, and China responded with measures applied to some goods on a US$75 billion target list of US imports. As a result, bilateral tariffs between the US and China are estimated to be around 15 percentage points higher than at the start of 2018 (Chart 3.3). The initial waves of US tariffs on Chinese imports were predominantly levied on industrial supplies and capital goods, but more recent tariffs have affected a broader range of products, including consumer goods (Chart 3.4).

Chart 3.3 The average tariffs on bilateral trade between the US and China have increased since mid-2018

Weighted average tariff rates

Sources: Ministry of Commerce of the People’s Republic of China, Office of the United States Trade Representative and Bank calculations.

Chart 3.4 The most recent US tariffs on Chinese imports have affected consumer goods

Total value of goods affected

Sources: Eikon from Refinitiv, Office of the United States Trade Representative, US Census Bureau and Bank calculations.

The US had previously announced a further increase in tariffs from 25% to 30% on US$250 billion of imports from China, but this increase was subsequently suspended. However, new 15% tariffs could still be introduced on almost all remaining US imports from China in December.

Other policies have also increased trade barriers.

While there are some recent examples of measures that reduce trade barriers — the EU and Japan agreed a trade deal which came into force in February for example — the number of protectionist measures introduced around the world over the past couple of years has been much larger (Chart 3.5). Some of these have raised non-tariff barriers. Japan, for example, has imposed restrictions on exports of certain raw materials to South Korea. Tariffs between countries other than the US and China have also increased. The US introduced new tariffs on US$7.5 billion of imports from the EU in October, following a long-running dispute over state subsidies to aircraft manufacturers.

Chart 3.5 The number of protectionist trade measures introduced has increased significantly in 2018 and 2019

Trade measures introduced globally (a)

Source: Global Trade Alert database.

(a) Number of trade measures introduced in each year. Data have been adjusted for reporting lags.

Trade barriers could increase further…

Further trade measures could be implemented in future. The US administration is considering whether to impose tariffs on imported automotive products. If imposed, these could lower exports to the US from a number of regions, including the EU. Moreover, some previously proposed trade agreements which would have reduced trade barriers — such as that between the EU and the South American trade bloc Mercosur — are now in doubt.

…as the rationales for measures broaden.

As trade measures have become more widespread, the stated aims of trade policies has broadened significantly. Initially motivated by concerns over bilateral trade imbalances, trade measures are now being introduced in response to a range of issues, including immigration, intellectual property protection and control of new technologies. Protectionist measures could become more pervasive and persistent: over a third of respondents to a recent Bank of America Merrill Lynch survey considered the US-China trade war to be the ‘new normal’ with no expectation that it will be resolved.

3.3 The impact of trade policy measures to date

Trade between the US and China has fallen significantly since trade barriers increased…

US-China tariffs have increased the price of imported goods in both countries and that has weighed directly on import growth. US imports from China fell by more than 10% in the year to 2019 Q2 and Chinese imports from the US were around 25% down on a year earlier (Chart 3.6).

Chart 3.6 Bilateral trade between the US and China has contracted sharply since tariffs were first introduced

Import growth (a)

Sources: IMF Direction of Trade Statistics and Bank calculations.

(a) Three-month moving average. Current prices, not seasonally adjusted.

…and evidence of trade diversion to other countries appears to be limited.

Those sharp declines in US-China bilateral trade flows might have been expected to lead to a boost to trade elsewhere as demand is diverted to other regions, but there has been little evidence of this so far. The rate of growth of US imports from some Asian economies such as Vietnam and Cambodia has increased since mid-2018, but imports from China are more than five times as large as from those countries combined. For most of the largest emerging economies in Asia, growth of exports to the US has not risen to the same extent (Chart 3.7). That suggests that the negative effect on those countries from disrupted supply chains may have more than offset any positive effect from trade diversion.

Chart 3.7 US import growth from some emerging economies in Asia has risen, but in most cases there has been little evidence of trade diversion

US import growth by country (a)

Sources: US Census Bureau and Bank calculations.

(a) Three-month moving average. Current prices, not seasonally adjusted.
(b) This swathe includes the six emerging economies in Asia with the highest share of US imports, other than Cambodia, China and Vietnam.

Global trade and output growth have both been slowing…

The increase in protectionism has led to a notable decline in global trade growth. World trade growth has fallen by 5½ percentage points over the past year (Chart 3.8), of which around 2½ percentage points is accounted for by lower imports growth in the US and China. Alongside this lower global trade growth, global GDP growth has fallen by 1 percentage point.

Chart 3.8 World trade growth has decreased notably and world GDP growth has also fallen

World trade in goods and PPP-weighted world GDP (a)

Sources: CPB Netherlands Bureau for Economic Policy Analysis, IMF World Economic Outlook and Bank calculations.

(a) Volume measures.
(b) Constructed using real GDP growth rates of 181 countries weighted according to their shares in world GDP using the IMF’s purchasing power parity (PPP) weights.
(c) Three-month moving average.

…but trade protectionism is only part of the story.

Factors other than trade protectionism have also weighed on global output growth. These factors include a tightening in financial conditions during 2018, particularly in emerging markets, as asset prices adjusted to tighter policy in the US and China. Some country-specific factors caused particularly sharp slowdowns in countries such as Turkey and Argentina. The ongoing slowdown in China has dragged on growth in countries that rely on Chinese demand for their exports, such as Germany.

The direct impact of new trade barriers introduced since mid-2018 is estimated to have been modest…

The direct effect of increased protectionism on world GDP growth via trade flows, supply chains and import costs appears to have been modest. That reflects the fact that tariffs to date have been largely contained to two countries.

A general equilibrium model of the global economy which simulates the direct effect of higher tariffs on global output suggests that PPP-weighted global GDP is currently around 0.1% lower as a result of trade barriers introduced since mid-2018 (Table 3.B).[2]

Table 3.B Trade measures are estimated to have reduced global GDP via direct channels, but have also weighed on business confidence, which has had a further indirect effect on global output

Estimated impacts on the levels of GDP

(a) Percentage changes in the level of GDP in 2019 Q2.
(b) Peak effect on the level of GDP during the forecast period.
(c) Effects may not sum to the totals due to rounding.
(d) The direct tariff impact on Chinese GDP assumes that the Chinese authorities loosen policy to offset some of the impact of higher tariffs.

External estimates also suggest that the impact of US-China tariffs has been relatively small to date. A recent study by Fajgelbaum et al (2019) found that US-China tariffs had reduced US GDP by just 0.04%. These estimates are sensitive to the underlying assumptions, however, including the monetary policy response.[3]

…but the indirect effects on investment via reduced business confidence may have been larger.

Growth is also likely to have been dampened by the decline in global business confidence and associated pickup in uncertainty (Chart 3.2), which are likely to be related to the increase in trade protectionism. Surveys of investor confidence have fallen since mid-2018, and are below their historical averages (Chart 3.9). In turn, four-quarter business investment growth across G7 countries (excluding the UK) has slowed from around 6% to less than 2% over the past year. Capital goods orders for the US and euro area continue to weaken.

Chart 3.9 Business confidence indicators have weakened globally

Survey indicators of investor confidence

Sources: Eikon from Refinitiv, ifo Institute for Economic Research World Economic Survey, Sentix, State Street Corporation and Bank calculations.

(a) Not seasonally adjusted.

These confidence effects can also be seen in financial markets. On days where there has been news about protectionist measures, US equity prices have tended to fall, while equity market volatility and risk premia have risen. That probably reflects investors’ judgements that higher trade barriers will weigh on some companies’ profits. The market-implied paths for interest rates have fallen significantly since mid-2018, in part reflecting expectations that looser monetary policy will be required to offset the impact of protectionism on global demand.

The size of these indirect effects is hard to quantify. There is a deep and long-standing literature establishing the link between higher uncertainty and lower spending (Section 4), but uncertainty linked to trade policy is hard to measure. Even if it were possible to represent trade policy uncertainty in one measure, its impact may not be well captured by models based on past relationships. There are few past examples of a sudden escalation in trade tensions following a long period of liberalisation.

To gauge the indirect effects of trade policy measures, Bank staff have estimated the impact of increased uncertainty on US business investment. Results from this approach suggest that increased uncertainty will reduce the level of US business investment by between 5% and 7%. Since China has also been directly affected by rises in tariffs, the effect on investment is assumed to be similar there. Uncertainty is also assumed to weigh on investment in the euro area. Businesses in some euro-area countries rely heavily on external demand and annual business investment growth has fallen from around 4% in mid-2018 to around 2% in 2019 Q2. Overall, the indirect effects of protectionism are judged to have reduced the level of PPP-weighted global output by 0.4% to date, somewhat larger than the direct effects (Table 3.B).

3.4 The impact on the MPC’s forecasts

Trade protectionism has contributed to lower-than-expected global output growth.

The escalation in trade protectionism has contributed to the sharper-than-expected slowing in global growth over the past year and a half. In May 2018 — before the start of the US-China trade war — the MPC projected that PPP-weighted global growth would be around 3¾% in 2019 Q2. The outturn was 1 percentage point lower than that forecast.

Protectionism continues to weigh on the MPC’s latest projection for global output growth…

The MPC expects trade protectionism and the associated increase in uncertainty to continue to weigh on global growth over the forecast period. On top of the effects seen to date, it is expected to lower PPP-weighted global GDP by a further 0.6%, such that protectionism is estimated to drag on global GDP by up to 1.1% in total (Table 3.B).

While trade protectionism continues to weigh on activity, global growth is projected to pick up a little during 2020. That pickup is partly accounted for by a recovery in growth in some emerging economies which have been hit by idiosyncratic shocks, for example in Turkey and Argentina. It is also supported by accommodative policies in the US and euro area.

…and on the MPC’s projection for UK GDP growth.

Slow global growth is assumed to affect UK growth through trade channels. In addition, as in other countries, the higher uncertainty and reduced confidence associated with trade tensions weighs on UK business investment (Section 1).

  1. In isolation, tariffs levied on imports would be expected to cause an appreciation of the exchange rate that would lower the impact on domestic prices. If another country reciprocates, however, that would reduce the exchange rate effect so the result would be higher prices in both economies.

  2. For more details on the model, see

  3. See Tenreyro, S (2019), ‘Monetary policy and open questions in international macroeconomics’, John Flemming Memorial Lecture.

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