US Watch – US trade weakness cyclical not structural

by: Maritza Cabezas

In this publication: The past few years showed a pronounced slowdown in US foreign trade. Cyclical factors, including a strong USD, have been holding down trade. Meanwhile, the US continues to score high in competitiveness surveys, suggesting weakness is not structural. We expect trade to improve in the coming years, but we don’t think that it will reach the rapid expansion of the pre-crisis years. However, there are downside risks, trade conflicts will likely take centre stage regardless who wins the US elections.

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Global trade weakens…

Global trade growth has slowed sharply in recent years, while at the same time the political debate favouring protectionism is gaining ground. These trends are raising questions about the future of global trade. Indeed, global trade growth in 2015 was the weakest since the global financial crisis. after four consecutive years of below-average growth. The weakness in global trade in 2015 was the result of the sharp slowdown in emerging markets related to the end of the commodity super cycle and slower growth in China. At the same time, advanced economies have also shown softer growth in domestic demand, which has resulted in weaker import growth. Finally, there might be some structural factors explaining weaker global trade growth. For instance, the process by which a product is manufactured in parts in more and more countries may have matured.

….with pronounced slowdown in US trade

Turning to the US, trade volumes weakened considerably in 2015. In volume terms, US export growth fell to -0.6%yoy in Q4 2015 from 2.4% yoy in Q4 2014. Meanwhile growth in import volumes also fell, albeit at a slower pace to 2.9% yoy from 5.4%. However, this weakness has been going on for a while. The US, once the world’s leading trading partner, was surpassed by China in 2011 and although trade in both countries has continued to weaken since then, the US has not been able to win back its leading role.

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Cyclical factors and a delay in the trade policy agenda are pulling down US trade

The dominant factors affecting US trade growth in the past few years have been the strong currency and weaker demand in the US and abroad. Meanwhile the delay in implementing the trade agenda has also contributed to weaker trade flows. This note looks at the cyclical factors and the trend in trade policies and what these developments mean for US trade potential. We expect US trade to improve, but we don’t think that it will reach the rapid expansion of the pre-crisis years. There are downside risks, including the rising popular perception that free trade hurts the US economy. We think that trade conflicts will likely take centre stage regardless who wins the US elections. The most recent Bloomberg Politics Poll, suggests that 65% of surveyed are in favour of more restrictions in trade, while 22% favour fewer restrictions.

Strong currency one side of the story…

The strength of the US dollar in trade weighted terms (USD TW) had a larger negative impact on trade flows than we expected. The USD TW appreciated by 23% in the period 2014-2015. Since the start of the year it has weakened by 5%. It actually made quite some difference that the stronger USD TW was the result of divergence in monetary policies and weak commodity currencies and not the result of greater US competitiveness and an improving trade balance. Indeed, from a trade perspective, the boost to import growth was limited as consumers did not reap the benefits of more affordable imports resulting from a stronger US dollar. In fact, US consumers have been relatively cautious despite the improvement in their disposable incomes, resulting from lower oil prices. Meanwhile the impact of a strong dollar was compounded by weak external demand, which resulted in a sharp decline in export growth. The good news is that a weaker USD TW should give export growth a boost, while the adjustment for import growth should be less painful.

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160523-W4…weak domestic demand the other part of the story

Another driver of the US trade slowdown is related to weak domestic demand, which has resulted in weaker import growth. However, we think that the causality is now turning from weaker exports to weaker investment growth. Indeed the prolonged slowdown in export growth, is having some impact on income growth. This has led to weaker US investment growth and resulted in weaker import growth, particularly of, durable goods. Since the end of 2014, there has been a sharp fall in US import growth of durable goods. Meanwhile, US exports have also encountered weak investment growth abroad. For instance, China’s transition to a consumption-based economy has resulted in a slowdown in the pace of investment growth and the demand for capital goods. .

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Policy-related issues weighing on trade

US trade is being limited by some structural slowdown in world trade, as well as by the more difficult environment to put in place trade deals. In the past few years, there has been some delay in the US trade policy. Lately the trade agenda seems to be moving forward. The Trans-Pacific Partnership has been completed, but the full benefits will not be seen for many years. The reason is that tariffs are set to be lowered only gradually, the benefits will be modest in the near term. There are other initiatives that are on the cards, including a free trade agreement between the US and the EU and the restoration of the “fast track” trade negotiations.
However, it is too early to assess the trade strategy that will be adopted after the US elections. The tone lately is of increasing scepticism regarding the achievements of globalisation and even of reversing certain trade deals. At this point it is mainly a political debate on trade.

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…but the US continues to score quite high in global competitiveness

On top of low tariffs and a weak currency, competitiveness also matters for US trade. The US ranks third in the Global Competitiveness Index of the World Economic Forum. Much higher than the major trading partners, including China. This suggests that the US export underperformance is more cyclical than structural. The structural components of competitiveness, including labour market efficiency, financial market developments, innovation capacity and market size are ranked quite high. Meanwhile, factors that could improve productivity, including health and education are relatively weak. In fact, an inadequate educated work force is cited as one of the most problematic factors in doing business. In our view, well targeted infrastructure spending and investment in education are necessary to support US and global trade growth. On balance we expect trade growth to improve in the coming years as cyclical factors fade and trade conflicts remain manageable. We don’t think that it will reach the rapid expansion of the pre-crisis years, given weak global trade growth though.