Trade Tensions and Financial Stability - PowerPoint Presentation

1. Trade Tensions andFinancial StabilityAndrew K. RoseNUS-BusinessBerkeley-Haas, ABFER, CEPR and NBER

2. Multilateral Trade WeakeningBefore we become concerned, we should try to understand causesFirst, some long run causesRose G20: Trade Tension and Financial Stability 2

3. Declining Trade Growth: Long Run CausesNot all barriers to trade are “artificial” impediments (protectionism)Some are “natural”Slowing Growth of Tradeables Most trade is in goods (finished or not); productivity gains in secondary production have slowed over time (Gordon)Demand shifts from goods to services as income risesEspecially true as populations ageMany services are hard to tradeMost services hard to liberalize/harmonize/regulate Hence proliferation of RTAs … intrinsically hard to negotiate, getting tougherRose G20: Trade Tension and Financial Stability 3

4. Long Run Causes, continuedStalled technological progress in transportation costs reductionFew significant changes since containerizationCould be one real beneficiary of blockchainCountry compositionSmall countries trade more than the large; countries just aren’t getting smaller anymore (they used to; dissolution of Soviet Union, Yugoslavia, Czechoslovakia, Sudan, … Alesina)Hard to see any of these causes reversing themselvesRose G20: Trade Tension and Financial Stability 4

5. Long Run Causes, concludedThree NotesA striking long run omission: declining “artificial” trade barriersProtectionism trended down from 1945 on … no more!Not JUST Trump … Doha never completed …Climate Change could also raise transport costsSavings Glut from Germany, China, …Global imbalances mean global trade tensionsPopulist backlash could lower trade per se (US)Lowers real interest rates, hence nominal interest ratesThereby makes central banks less able to respond to negative shocks, greater financial instabilityHence rethinking of monetary framework by central banksMoving to fixed exchange rates becomes even less plausible … a risk reducerRose G20: Trade Tension and Financial Stability 5

6. Short Run Causes of Trade WoesUnder-appreciated: absence of serious recent liberalizationTrade liberalization is like riding a bicycle (Bergsten)Rise of US dollar (Gopinath)US fiscal expansion; issuer of safe assets; European, Asian woesWhen US $ appreciates, trade tends to shrinkRose G20: Trade Tension and Financial Stability 6

7. Dollar Appreciation: Big, Recent, SustainedRose G20: Trade Tension and Financial Stability 7

8. Short Run Causes of Trade Woes, cntdExplicit protectionism (duh!)Policy-induced uncertainty, a consequence of protectionism: TrumpExacerbated by lack of institutional support for rules-based nature system (WTO appellate judges)Enduring since … What does victory in trade war consist in? Objective? US trade balance (given savings and investment)?Rose G20: Trade Tension and Financial Stability 8

9. Trade Policy Uncertainty: Dramatic, RecentRose G20: Trade Tension and Financial Stability 9

10. This Uncertainty is Induced … and CostlyLowers physical investment (hence growth slowdown)Much evidence (Bloom, Davis, …)This further lowers trade, since capital goods disproportionately traded; vicious cycleAlso manifest in corporate spreadsLowers firm investment in supply chains (make not buy)General unraveling of efficient/complex international supply chainsRose G20: Trade Tension and Financial Stability 10

11. Another Short Run Cause: Soft Power ErosionPart of trade decline because of loss of ‘soft power’Hard power: ability to coerce via military and economic massSoft power: ability to co-opt via attractionKey political figures, regimes extraordinarily unpopular abroad“Soft Power and Exports”: a country’s exports rise when its leadership is approved by other countries Standard gravity model of bilateral exports (year x importer/exporter FE, controls)Panel of data from 2006 through 2017Annual Gallup survey:  people in up to 157 countries asked about approval of job performance of leadership of China, Germany, Russia, UK, USAStrong, robust result: ceteris paribus, country’s exports are higher if its leadership is approved by the importerRose G20: Trade Tension and Financial Stability 11

12. ‘Soft Power’ Promotes Exports1 pp increase in leadership approval raises exports by around 2/3% (statistically significant, robust) … and Trump (2017) is >20pp less popular than Obama (2016)Key leaders (BoJo and the Donald) are very unpopular abroadSymmetrically, loss/lack of soft power lowers exportsRose G20: Trade Tension and Financial Stability 12

13. Trump Very Unpopular AbroadRose G20: Trade Tension and Financial Stability 13

14. Summary: Causes of Trade TensionLong RunSlowing Growth of Tradeables, transition from Goods to ServicesStalled Technological Progress in Transport CostsStalled Liberalization, Savings GlutShort RunProtectionismRise of US $Policy-induced UncertaintyLoss of Soft PowerAll likely to be persistentRose G20: Trade Tension and Financial Stability 14

15. Effects of Trade Tensions on Financial StabilityMost Visible and Immediate Consequence of Trade Tension is MacroSlower growth … because of uncertaintyHeightened possibility of macro downturn, recessionHence more financial instabilityBut there are plenty of more insidious and indirect effects …Rose G20: Trade Tension and Financial Stability 15

16. More Persistent Costs of Trade ReductionLower trade integration is costly in income, productivity, welfareMostly small nowCosts are mostly in long run supply-side because of foregone productivity and competition (also foregone consumer variety)Likely to cumulate (consider quasi-autarkies: Cuba, North Korea, Venezuela)Frankel-Romer, Alcala-Ciccone, Hall-Jones estimates are big… though others (Rodrik, Subramanian and Trebbi) are notBanal Second Moment Effect: less trade means less vulnerability to terms of trade shocksImportant for developing countries, commodity exportersTangent: current protectionism is NOT counter-cyclicUS perpetrating during long boom with low unemployment and inflationUnleashed protectionist pressures may be MUCH higher during next recessionCould lead to bigger future negative welfare consequencesRose G20: Trade Tension and Financial Stability 16

17. Two Other Consequences of Slowing TradeBusiness Cycle SynchronizationFinancial StabilityBoth Longer RunRose G20: Trade Tension and Financial Stability 17

18. Business Cycle Synchronization is EndogenousBCS is affected by trade (Frankel-Rose)Consider two economies hit by shocks which engage in tradeEffect of exogenous decline in trade barrier on BCS? Ambiguous in theoryNegative: If most trade comparative advantage, then more specialization leads to lower BCS IF most shocks are idiosyncratic or productivity shocksPositive: IF most trade intra industry OR most shocks are either common or preferenceEmpirically, no ambiguity: more trade leads to higher BCS in practiceUse gravity determinants as instrumental variablesQuite robust: Baxter-Kouparitsas, meta-analysisRose G20: Trade Tension and Financial Stability 18

19. Trade explains part of BCS riseTrade has been rising (faster than income) for decades … until recently …So no surprise that business cycles are becoming more synchronizedBy symmetry, lower trade leads to more idiosyncratic business cyclesIn future, business cycle risk might be more national, hence diversifiableLess pronounced global business cycle makes work of G20 and IMF easierLikely increases financial stabilityRose G20: Trade Tension and Financial Stability 19

20. Reduced BCS affects Financial StabilityLower Trade and BCS means recessions – and hence financial stability issues – become not only more idiosyncratic diversifiableBut also fewer and more shallow recessionsWhy?Rose G20: Trade Tension and Financial Stability 20

21. Financial Integration follows Real IntegrationIn theory and practice, real integration precedes, causes financialEmpirically overwhelming: liberalize goods markets before services; both before factor markets (capital and labor)Far more countries have significant IMF AREAER restrictions on financial flows than goodsDeviations from LOOP big for goods; often immeasurably bigger for stocks/bondsMcKinnon’s sequencing: international financial liberalization the final stepFinancial integration a result of policy choices, typically following real integrationEx: Europe 1992: capital and labor freedom followed trade liberalizationGenerally, goods markets more liberal than services, both more liberal than financial flowsSo a world with less real (G&S) integration is likely to also be less financially integratedRose G20: Trade Tension and Financial Stability 21

22. Financial Integration Falls with Trade TensionsAs with goods and services, less integration has its costsSavings flow less efficiently to good investmentsRisks can’t be spread as widely across bordersBut considerable skepticism about size of benefitsRodrik, Gourinchas and Jeanne , …Different from trade integrationRose G20: Trade Tension and Financial Stability 22

23. And … Financial Integration Has CostsQuasi-Consensus on additional risks of financial integrationContagion following currency crises in 1992, 1994, 1997, 1998, …(Relative) Immunity of the financially close in 2008-09 during GFCInternational capital flows often “hot”; banking booms riskyMore financially closed countries systems may suffer smaller crises compared with open economies, also experience less fewer financial crisesThis compares open with closed, not rich and poorFinancial systems of developing countries – often closed – can be looted more effectively by domestic criminals (often their leaders)Weaker institutions (including weak monitoring, including foreign) the cause Rose G20: Trade Tension and Financial Stability 23

24. Financial Insulation not the ObjectiveStill, protectionism may deliver inadvertent benefit at little costCost of lower trade partially offset by lower contagion, fewer spillovers from foreign shocksRose G20: Trade Tension and Financial Stability 24

25. ConclusionMany effects of trade tension on financial stability … And they’re not all bad!Rose G20: Trade Tension and Financial Stability 25

26. Effects of Trade Tension on Financial StabilityShort Run, Bad: higher likelihood of recession, raising financial instabilityLong Run, Bad and Good: less trade, lower income and welfareBut may enhance real and financial stabilityImport fewer real shocks; financial repression bad for welfare but good for stabilityLong Run, Good: less globally coordinated business cyclesMore easily diversifiable riskLong Run, Arguable: encourage rethinking of monetary frameworkExchange rates won’t become more rigid, solidifying financial instabilityLong Run, Arguable: less financial integrationFewer gains from integration (uncertain magnitudes)Fewer risks from contagionMore dramatic for OECD than developing countries/emerging marketsRose G20: Trade Tension and Financial Stability 26