Daniel Gros: The cost of overhyping globalisation

As the world's financial elite converged on Washington, DC, for the annual meetings of the International Monetary Fund and the World Bank, they could not have escaped yet another clarion call to reverse the retreat of globalisation. Faltering trade, it is assumed, must be an adverse trend that needs to be addressed. But the assumption is simplistic, at best.

The problem lies in a lack of understanding of what drove trade growth over the last few decades. To be sure, there have been efforts to grasp the current slowdown. The IMF's latest World Economic Outlook devotes an entire chapter to it.

But no significant new barriers to trade have been identified. Instead, the IMF declares, some three-quarters of the slowdown in trade growth is a result of "overall weakness in economic activity," especially investment. It also asserts that "the waning pace of trade liberalisation and the recent uptick in protectionism" have played a role, though it is not quantifiable.

Even without establishing a clear understanding of what is driving current trends, however, the IMF report calls for action to revive the "virtuous cycle of trade and growth." Clearly, faith in trade is very strong.

But faith is part of the problem. Blind faith in globalisation led many to overhype it, creating impossible expectations for trade liberalisation. When those expectations were not met, many people felt duped and rejected free trade.

This is not to say that there is no empirical case for trade liberalisation. Dismantling trade barriers enables countries to start specialising in sectors in which they are more productive, which leads to higher growth and living standards for everyone. And, indeed, from the 1950s to the 1980s, the process of breaking down the high trade barriers that had been erected during World War II brought major gains.

But these gains petered out eventually. Economic theory implies that the gains from reducing trade barriers decline faster as those barriers become lower. So it should not have been surprising that, by the early 1990s, when tariffs and other trade barriers had already reached very low levels, the traditional benefits of trade liberalisation had largely been exhausted. Eliminating what small barriers remained would not have had much impact.

What did have an impact was a two-decade-long commodity-price boom. High prices enabled major commodity exporters to import more and to pursue growth-enhancing policies at home - a boon to global growth. Moreover, because commodities account for a large share of world trade, rising prices boosted its total value.

Rather than acknowledge the role of commodity prices in bolstering both trade and growth in the early 2000s, most economists and politicians attributed those positive trends to trade-liberalisation policies. In doing so, they reinforced the notion that "hyper-globalisation" was the key to huge gains for everyone.

But the growth fueled by higher commodity prices, unlike that produced by the dismantling of trade barriers, caused a decline in living standards in the commodity-importing advanced countries, because it reduced the purchasing power of workers. No politician dared to make this distinction. So when advanced -country workers were squeezed economically, they concluded that globalisation was the problem.

The role of commodities in the recent struggles of advanced-country workers is reflected in the differences between the experiences of those in the United States and Europe. Because the US produces much of its own oil and gas, the increase in commodity prices had less of an impact on the economy as a whole than in Europe.

But, for individual workers, the impact of rising commodity prices was larger in the US - not least because, in Europe, high sales taxes meant that even a doubling of crude oil prices produced only a modest increase in prices at the pump. Only oil producers, and a small number of workers in the sector, benefited from higher oil prices in the US.

Still, high-priced commodities created the illusion of wealth for the US, which, unlike European countries, did not feel the need to increase its manufacturing exports to balance its external accounts. So the US allowed its manufacturing sector to stagnate, as its external balance deteriorated. As a result, American workers got squeezed from two sides.

When the global financial crisis erupted in 2008, destroying the value of houses that had kept those workers feeling wealthy, the true weight of the situation fell on US workers. This created an opening for demagogues like Republican presidential candidate Donald Trump to win support on promises of prosperity through protectionism.

Having misunderstood the causes of the extraordinary growth in trade in recent decades, political elites over-sold globalisation. When one considers the gulf between their promises - explicit and otherwise - and the actual experience of many workers, the current backlash against trade openness should be no surprise.

But there is good news: If the decline in the volume of trade is due to lower commodity prices, it will largely benefit advanced-country workers. Perhaps this will be enough to ease the demand for unnecessary new trade barriers.

Daniel Gros is Director of the Center for European Policy Studies
©Project Syndicate, 2016