Open economies to face global crisis

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By Pascal Lamy (China Daily)
Updated: 2009-04-17 07:44

In the face of the first global economic crisis, international trade is in sharp decline. World Trade Organization (WTO) economists forecast trade to fall by 9 percent in volume terms this year, the biggest contraction of global trade since the end of World War II.

The main explanation for this contraction is the simultaneous reduction in demand across all major economies of the world. This weakness has not spared even the vibrant economies of countries like China, with its growth for this year forecast to fall to the lowest level in nearly two decades.

Trade finance, which greases the wheels of international trade, has become more scarce and even when it is available it is much more expensive. This drying up of liquidity is contributing to the contraction of trade.

The rise of intermediate goods trade and global supply chains has enabled an ever finer international division of labor, with many countries contributing to the production of the final output. But as the fall in final demand works its way through these supply chains, it is magnifying the contraction in trade.

Many troubled countries are also facing increased pressure to take protectionist actions which some governments find difficult to resist. The WTO is monitoring trade measures adopted by its members in the context of the crisis. In our last report we have witnessed increases in tariffs and in new non-tariff measures.

Even the fiscal and financial measures that have been introduced to stimulate economies contain features that favor domestic goods and services at the expense of imports. While there is no indication that these measures are of a magnitude that rival the protectionism of the inter-war years, they represent a serious source of concern.

Highly open economies appear to be bearing the brunt of this crisis, with growth turning sharply negative for economies like those of Singapore and South Korea. Some observers have seized on this to argue that trade openness has made economies more vulnerable to the crisis, and consequently part of the solution must mean turning away from openness. They are wrong on both counts.

The degree to which trade contributes to the decline in economic output represents one form of vulnerability to the crisis. But given that no country will be able to fully escape the crisis, there is a far more important form of vulnerability. This is faced by poor countries that are unable to cushion their citizens from declining incomes which are falling from already low levels. It may be that the best indicator of vulnerability to the global recession is simply per capita income.

On this score, more open economies are better placed to deal with the crisis than less open economies. Countries gain from trade as a result of the increased economic efficiency brought about by specializing in goods or services in which they have comparative advantage. By expanding markets, trade also enables enterprises to operate with increasing returns to scale.

This means that even small increments to inputs lead to large increases in output. These efficiency gains from the international division of labor translate into higher incomes. The distribution of this income is in the hands of governments through adequate domestic redistribution policies.

But it is clear that many of these same economies that have been hit hard by the crisis have enjoyed decades of high economic growth, so any reduction in incomes comes from relatively high levels. Governments in these countries have been able to accumulate resources to spend in alleviating the worst effects of the current recession.

In addition, a global economic crisis of this severity is extremely rare. This means that over time, the contribution of external demand to increasing income outweighs losses suffered during economic downturns, including this one. We also know that this global crisis will eventually end. When it does, economies that are more open will be better placed to stage a faster and stronger recovery.

Retreating from trade openness is not a solution to the economic crisis. For countries that depend on trade and have specialties according to comparative advantage, a reversal of policy will impose significant costs on the economy.

What is more, the erection of new barriers to trade will risk retaliation from trade partners. Rather than reviving economies, the effect of this about-face would be to precipitate a downward economic spiral and worsen what is already a dire situation.

The appropriate policy response is to address the roots of the crisis. China is leading on this front. It has announced a $585 billion stimulus package in order to boost domestic demand.

This is second in absolute size only to the US Recovery and Reinvestment Plan but it is bigger as a share of national output, representing about 12 percent of China's GDP. China is also addressing the deficiency of trade finance with its export credit agency expanding operations in both the short-term and long-term end of that market.

China's stimulus package will help broaden the sources of its economic growth by increasing the contribution of domestic consumption. It will also contribute to boost other countries' economies through its own imports. China has a huge domestic market and this rebalancing between domestic and external sources of growth is not only possible, it is also needed.

This option is not available to smaller economies with minuscule domestic markets. But the ability to effect this transformation would not have been possible without its previous policy of opening up to trade and investment. By gaining access to foreign direct investment and technologies, China's opening enabled it to modernize its economy and grow rapidly.

In the end, there is no better alternative to an open global trading system. Together with forceful steps to stimulate global demand and to shore up financial systems, the successful conclusion of the WTO Doha Round remains the litmus test of governments' willingness to be serious about open trade.

The author is Director-General of the World Trade Organization.

(China Daily 04/17/2009 page9)