When the first man-made recession becomes reality

International trade has gone from being 'friendly' to 'hostile'.



By Sanjay Modak (Core Issue)

Published: Mon 7 Oct 2019, 10:23 PM

Last updated: Tue 8 Oct 2019, 12:25 AM

It happens with alarming regularity. Just when the world's economy pulls itself painfully out of a recession and begins to gather a head of steam, economists start mentioning the dreaded R word again. If climate change is the cause of hurricanes, cyclones and typhoons more frequently battering humanity with ever increasing violence, recessions are attributed to what economists call business cycles - booms and busts - which occur with metronomic frequency. In either case, all we can do is to batten the hatches and take cover.
Or is it? Recessions can be mild or severe and while they may happen due to factors beyond our control, or by shocks to the system, in some cases they are caused either by looking the other way until it is too late (2007-08) or, as I argue here, intentionally, due to misguided political whims.
Looking at the signals, the light is amber and could turn red any time. Job creation in the US has slowed. Germany, the powerhouse of Europe, saw negative GDP growth and one more quarter of the same will mean it is officially in a recession.
The rest of Europe, nursing a fragile recovery, and depending heavily on Germany to show the way, will inevitably falter. China is struggling to gain momentum and its manufacturing indices, the bedrock of its economy, are heading downward.
India is seeing a significant slowdown in both consumer spending and industrial production. Stock markets everywhere are increasingly volatile, with no discernible pattern. A more useful barometer is usually the bond market, where we are seeing signs of a so-called inverted bond curve, where interest rates on long term bonds are lower than those on short term bonds. While countries like the US and Germany are issuing debt to raise long term bond yields, the fact that past recessions were predicted by the bond market has spooked investors.
The real reason why we may see a recession sooner rather than later is that international trade, one of the key drivers of GDP growth in an increasingly integrated world, has gone from 'friendly' to 'hostile'. Nobody says trade today is completely free and fair. But it is the best we have got after decades of endless and excruciating rounds of bilateral and multilateral negotiations between nations that started under GATT and continued under its successor, the World Trade Organisation (WTO). And it works to a large extent and helped many countries, most prominently the Asian Tiger economies eliminate poverty in a single generation not so long ago on the back of trade-based economic growth. While protectionism and trade barriers still exist, free trade agreements between countries and groups of countries have proliferated and even formerly high tariff countries like India have learnt that hiding behind tariff barriers and export subsidies does the economy no good.
In the last couple of years, however, we have witnessed something completely different. We are now seeing tariffs used as a political weapon, not just for regulating trade, but as a means of trying to bring trading partners to their knees. As the folly and futility of this 'model' sink in and the US president chops and changes his country's trade policy every other day, who can blame markets for behaving erratically or for investors to rethink their plans?
Ignorance of basic economics coupled with nationalistic demagoguery are a deadly cocktail. Tariffs will not rectify the trade imbalance between America and China. But what tariffs do quite well is raise prices in the home country of both imported finished and intermediate goods. This invites retribution from China. But there is a difference. American consumers are now used to cheap, price-inelastic Chinese-made goods. They have nowhere to turn to for these goods and will buy them even if prices rise due to tariffs. So now it has been estimated that the average American family will pay about $460 more between now and the end of the year purely due the tariffs imposed by their president. On the other hand, Chinese soybean and other importers can turn to alternative countries - witness how Canadian lobster exporters have gained at the expense of their US counterparts who now stare at a 35 per cent tariff and have seen their exports plummet.
The net result of this totally unwarranted trade war is that both consumers and producers in the US will be hurt while the balance of trade between the US and China will remain largely untouched or will widen in China's favour.
The US president has amplified the trade war to include the European Union, a bigger trading partner of the US than China, with tariffs slapped on French wine for example. French wine, unlike Chinese-made consumer goods, is demand elastic and consumers could switch to domestic or other wines. But this will surely invite retaliatory moves from the EU. US exports to the EU are far greater than those to China. The uncertainty and counter measures will cause markets to panic and move sideways. Manufacturing around the world will take a hit as producers realign their export and import markets. In the first half of 2019, the WTO estimates that world merchandise trade grew by only 0.6 per cent, marking a major slowdown.
So, whether we like it or not, whether we are prepared or not, the world's first man-made recession will very likely become a reality as we head into 2020 and beyond. Here is the formula. Start with a booming economy inherited from your predecessor. Slap tariffs willy-nilly on imports from your two biggest trading partners. Refuse to talk constructively. Change targeted goods and tariff levels at random every other week. Then watch as the world's economies stall and head into a tailspin.
Dr Sanjay Modak is Chair, Graduate Programs & Research Department and teaches economics at the Rochester Institute of Technology, Dubai


More news from OPINION