Lamy: World trade in 2009 registers sharpest decline since World War II

Thank you very much to the European Policy Centre for organising this morning’s discussion.

I am grateful for the opportunity to present the case for international trade as an important part of a global solution to the recent economic downturn. As economies attempt to recover from the crisis, keeping international markets open is vital.

Turbulent times

These are not easy times. We know that in 2009, growth of real world GDP was negative, estimated at -2.2 per cent. Furthermore, the global unemployment rate reached its highest level ever, with the International Labour Organization estimating the number of jobless worldwide at over 200 million. The adverse impact of the recent financial crisis on the world economy in terms of output and employment is undeniable.

World trade has also been a casualty of this crisis, contracting in volume terms by around 12 per cent in 2009 — the sharpest decline since the end of the Second World War. The main explanation for this freefall in trade has been the simultaneous reduction in aggregate demand across all major world economies. The drying up of trade finance during this period has also been a contributing factor. To a much lesser degree, trade has been adversely affected by some instances of increased tariffs and domestic subsidies, new non-tariff measures and more anti-dumping actions.

We started last year with a collapse in trade, a drying up of trade finance, concerns that donors would reduce funding for “Aid for Trade”, and worries that protectionism would kick in. And yet one year on from the onset of the crisis, we see that, to this point at least, the multilateral trading system has proven its sturdiness as a bulwark against runaway protectionism.

In most developed economies, including the EU, stimulus packages have been instrumental in preventing further deterioration in output while preparing the path to recovery. The jury is still out though on whether some of the measures introduced to stimulate economies contain provisions that favour domestic goods and services at the expense of imports.

But the positive impact of national stimulus packages is fleeting and worries are mounting over the huge budget deficits rung up by many governments. Economies urgently need other sources of growth -- sustainable engines of growth which will not add to our already seriously indebted economies. This is where trade can be an important part of the story, both in the long-run and in the short to medium-term.

Trade as a source of growth and jobs

In the long-run, economic growth is driven very significantly by technological progress and the quality of domestic institutions. Trade has an important role in this context.

First, it can enhance technological progress by increasing the incentives to innovate, facilitating transfer of technology and fostering “learning-by-doing” effects.

Second, trade reform may directly increase the quality of institutions by leading to the adoption of certain institutional norms. Moreover, the preferences that underlie such institutional reforms may be the indirect consequence of the workings of market forces associated with trade.

In the short-to-medium run, trade allows external demand to provide a buffer for economies facing low domestic demand during periods of recovery from the crisis. This is especially important in several developed economies, where domestic demand is likely to be subdued for a while as domestic savings are reconstituted and the financial system recovers. Trade openness vis-à-vis a diverse set of countries is important for mediating the effect of a shock.

More generally, trade can increase income or output levels through efficiency gains from specialization based on comparative advantages, greater competition, access to a larger variety of intermediate inputs, scale economies and an intra-industry reallocation of resources.

Moreover, exports, in particular, can increase the levels and growth rates of income or output as they often have a high value-added component. This is especially true in developed countries, where firms specialise in the high value-added segment of the global supply chain. Importantly, the value-added component of exports is likely to have a positive effect on domestic demand due to backward linkages with several sectors in the economy.

In fact, evidence suggests that the domestic content of value added by exports is higher as countries develop. For example, in 2008, 80 per cent of the value of the goods exported by the US had a domestic content, while this share was only 42 per cent for Malaysia. In addition to the value-added argument, there is evidence of “learning-by-exporting”, which increases productivity and hence promotes growth.

As a digression, it is also worth noting trade may help keep prices of goods down as economies recover from the crisis. This means that prices will not increase as much in response to an increase in output or a reduction in unemployment when economies are open to trade because trade allows countries to source important goods or inputs from the rest of the world.

An increase in levels of output or income is crucial to the process of recovery from the recession. But equally crucial is a reduction in rates of unemployment. Today unemployment is intolerably high. More must be done to empower our citizens. Trade can be part of the solution. So how does trade alleviate this concern?

Naturally, an increase in incomes creates jobs in different sectors by increasing demand in the domestic economy, which has subsequent multiplier effects. This resulting increase in jobs is what may be termed the “second-round” effects.

But trade, in general, and exports, in particular, are also likely to contribute directly to the reduction of unemployment in the recovery phase following the financial crisis. These “first-round effects” relate to the experience of a number of countries where the share of employment which depends on exports is typically large.

For example, it is estimated that in 2008, 22 per cent of total employment in Germany depended on exports. Similarly, in the United States, two out of every ten manufacturing jobs in 2006 were related to exports of manufactured goods. There are also a large number of workers involved on the import side of trade. In Australia, for instance, 1 in 10 workers were involved in import related activity in 2008.

Going forward, preliminary estimates suggest that exports could contribute to about 40 million jobs in China and manufacturing exports could create about 160,000 jobs in the United States in 2010.

These findings appear to be particularly relevant in the current situation as trade has the potential to pick up strongly and lead to new hiring, particularly in export-oriented sectors.

Of course, one must remember that not all the jobs created in export-oriented sectors will go to previously unemployed workers. Some will go to previously employed workers who are transferring to the export sector because of better opportunities.

Even so, this re-allocation is economically valuable. It means that workers are moving from sectors where their marginal product is lower to those where it is higher. This results in productivity gains to the economy and hence increased output and unemployment. But given the current high rates of unemployment the world over, it is likely that many of those getting these jobs in the export sector will be from the ranks of the unemployed.

It must also be acknowledged that with import competition and outsourcing, trade may lead to job loss in certain sectors of the economy. This is where domestic programmes to train workers and foster greater mobility in labour markets can enable those displaced to find jobs in the more efficient, expanding sectors of the economy. And this is also where social safety nets can help them bear the burden of transition in the short-run.

So what can we say in terms of the role of trade policy during this period of recession? The key point is that trade can have a positive impact on incomes or output and job creation during this economic downturn. But for this, international markets must remain open and countries must continue to trade on the basis of comparative advantage.

Keep trade open and keep opening trade

Specialization of production and export structures on the basis of comparative advantage is at the very heart of European economic integration. A free-trade area enables countries in the region to reap the efficiency gains of trade opening that arise from comparative advantage, scale economies, increased competition, access to a variety of intermediate inputs and intra-industry resource allocation. Furthermore, given that the EU represents an even deeper form of integration with free movement of factors across its constituent countries, it can facilitate adjustment in the face of an asymmetric country-specific economic shock.

We must therefore ensure that trade remains open. But we must also work to keep opening trade through the conclusion of the Doha Round. A Doha deal would provide new market opportunities through the reduction of tariff barriers and domestic subsidies. But it would also reduce the fixed costs of trading by addressing, for example, customs procedures and red-tape in the part of the negotiations devoted to “trade facilitation”.

Finally, and very importantly, the DDA [Doha Development Agenda] will provide for more certainty in trading arrangements by securing binding commitments from member countries. This is especially important for economic growth to create jobs, as experience from past recessions suggests that employment growth will be sluggish in the aftermath of the crisis even though output expansion may have resumed.

During the “dotcom” crisis, for example, the US economy stopped contracting in November 2001 and began growing again, in terms of output. But the US unemployment rate continued to climb until June 2003, a full 19 months later.

One reason commonly advanced to explain this “jobless recovery” is the uncertainty faced by employers about whether the economic expansion they are witnessing is sustainable. Only if they are convinced that demand growth is durable will they be willing to commit to new hiring. A successful Doha Round will greatly reduce uncertainty relating to protectionism, the spectre of which may hinder new hiring, especially in the export sector, since it is the most vulnerable to trade restrictions.

Of course, opening markets may expose countries and individuals within countries to greater volatility. But the response cannot be to turn away from openness. It must be to ensure that market opening is accompanied by international rules and international and domestic policies, such as Aid for Trade, that ease any potential adverse impacts during the transition period.

If there was a geopolitical sense in launching the Doha Development Round in 2001, another year when the world was put to the test, it is today economically imperative to conclude it.

Thank you very much for your attention.