It’s not the end of globalisation (yet), but world trade is splintering

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The fragmentation of global trade as the world splinters into loose geopolitical blocs is starting to show up in the numbers. The World Trade Organisation, however, says the data doesn’t yet reflect deglobalisation.

In the WTO’s annual report, issued on Tuesday, the organisation estimated the cost of splitting the world’s trade system into separate blocs would be about 5 per cent of global real income, with some developing countries incurring double-digit losses.

Global trade has entered a vulnerable phase as the world splinters into geopolitical blocs.Credit: Louie Douvis

In a hypothetical exercise that divided the world into two competing blocs, based on United Nations voting patterns, it calculated that trade between the blocs had grown between 4 and 6 per cent more slowly than the trade within them, even though trade overall has continued to thrive in the post-pandemic period.

The less than hypothetical reality is that those blocs are forming amid the heightened tensions between the US and China and in the aftermath of Russia’s invasion of Ukraine.

There is increased alignment between the US, Europe and – in the Asia Pacific region – economies like Australia, Japan and South Korea on issues of perceived national military and economic security.

Similarly, China and Russia, some countries in the Middle East, and some of the developing economies within China’s sphere of influence are coalescing to various degrees, pushing back against America’s use of trade and financial sanctions and its exploitation of its dollar’s dominance.

Trade flows are being increasingly driven by trade within blocs rather than within what was previously a free-flowing global system.

The initial fracture in what had been decades of increasing globalisation came with the Trump tariffs on China in 2018 and 2019, although that administration, driven by protectionism, also slapped tariffs on imports from long-standing allies. Unsurprisingly, China and others retaliated with tariffs of their own.

Then the pandemic exposed the vulnerabilities of globalisation. Global supply chains were broken and an international over-reliance on China for manufactured goods forced re-evaluations of the cost versus security equations, leading to a push to “re-shore” and “friendshore” the manufacturing of essential and/or strategic products.

The schism between the US and China has intensified as the Biden administration added to the Trump tariffs on about $US300 billion ($467 billion) of China’s exports, with more targeted sanctions on China’s access to key US technology and that of its allies, which especially, but not exclusively, covers semiconductors, the building blocks of 21st-century technologies.

None of those trends will be unwound within the foreseeable future, which means the world has entered a different phase of globalisation, one where trade in key products and services is dominated by trade within the different blocs.

And as the WTO says, that will lead to higher costs and, potentially, more conflict.

Donald Trump has doubled down on his trade policies, promising to introduce a base tariff of 10 per cent (against the current average rate of 3 per cent) on all imports to the US, even those from America’s closest allies, despite the universal conclusion that the substantial costs of the trade wars and tariffs in his first stint in the White House were paid for by American companies and consumers.

While a second term as president might appear unlikely, given his legal woes and electoral standing, it isn’t impossible.

If the unlikely were to occur, and his universal base tariff were implemented, it would inevitably lead not just to enormous tensions within the current US-led bloc, but inevitably to retaliatory tariffs and a new and destructive global trade war that would also impact geopolitics and America’s position in the world order.

While the WTO believes talk of deglobalisation is premature, its fragility is highlighted by the potential of a new administration to wreak havoc, and not just to global trade.

As the WTO’s director-general Ngozi Okonjo-Iweala said in the annual report, the post-World War II economic order was built on the idea that increased trade and economic ties would foster peace and shared prosperity. Countries with close trading relationships are less likely to wage war with each other, she said.

At this point, the view that globalisation is largely intact is borne out by the data, with the WTO saying the value of world merchandise trade rose 12 per cent to $US25.3 trillion last year (partly due to inflation and the increased commodity and fuel prices caused by the war in Ukraine) and the value of the trade in world commercial services increased 15 per cent to $US6.8 trillion.

As noted, however, trade flows are being increasingly driven by trade within blocs rather than within what was previously a free-flowing global system.

Deglobalisation is certainly not in Australia’s interests.

That shift in the directions of the flows damages economies with big trade surpluses more than those with trade deficits, and therefore harms economies driven by exports more than those geared to domestic consumption.

That favours the US, with its structural trade deficits, and some European economies, but hurts China and Germany, whose economic models are built on exports, along with most developing economies and trading nations like Australia and, indeed, most of the major Asia Pacific economies.

Deglobalisation is, therefore, certainly not in Australia’s interests. If there are to be trade sanctions on China, it is in the interests of this region that they are as few and as targeted to purely national defence and economic security as possible.

The Biden administration has been reviewing the broad Trump sanctions on China’s exports ever since it took office in 2020, acknowledging their cost to the US economy, its companies and its consumers. Domestic politics and the general American suspicions and antipathy towards China, however, appear to have overwhelmed economic rationality.

Even if deglobalisation isn’t yet occurring, and although China’s export volumes and values to the US have held up despite the tariffs and a faltering of its exports generally (they were down 8.8 per cent in August relative to a year earlier), it has been displaced by Mexico this year as America’s major trading partner thanks to friendshoring.

China is the biggest victim of the trends in global trade because despite its efforts to boost consumption, its spluttering economy is still overly exposed to exports, with the relatively recently apparent structural vulnerabilities within its economy.

China’s economy has slowed because it is grappling with high debt levels, a property sector that has collapsed and generated shocks within the vast shadow finance sector and a private sector that has become cautious and defensive as President Xi Jinping has tightened the Communist Party’s control over business activity.

As a major market as well as the biggest exporter, China’s economic challenges are going to hurt other economies such as Germany, Japan, South Korea and Australia, that either sell into its market or are significant participants in its supply chains.

While the underlying trend in global trade says trade is becoming less global, the shift by China into a lower growth phase will only add to the complexity, geopolitical tensions and instabilities flowing from the shifts that are already occurring to the patterns of worldwide trade.

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