International trade is shrinking fast amid the global credit crunch and economic recession that was triggered by the U.S. subprime loan problem. From the end of the Asian currency crisis up until 2008, international trade had experienced continued growth primarily due to the sustained economic expansion, high economic growth in emerging economies, and continuously increasing demand for imports by the United States, the world's largest importer. At the same time, the production and outsourcing of goods and services between the U.S., European Union, and East Asian economies increased markedly through both market transactions and intra-company transfers related to foreign direct investments. It must not be forgotten that these activities had boosted the pace of foreign trade above that of economic expansion.
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All of these trends have completely changed from 2008 onward. The economic downturn is so significant and extensive that countries across the world now see their trade figures contracting. Falling prices of assets held by individuals and corporations have begun to affect the real economy by causing a decrease in consumption expenditures, postponement of capital investments, deterioration in employment, and economic contraction.
The effects of these negative developments are now impacting global trade. One reason why the contagion has spread so extensively to affect so many countries can be seen in the recent expansion of cross-border outsourcing of production processes. Many of the affected countries had incorporated themselves into international production networks. By looking at changes in U.S. imports and Japanese exports in the chart below, we can see trade trending upward from 2000 until the sudden downturn in 2008.
The total value of a country's imports is determined by its economic size. Thus economic contraction results in a decrease in international trade, provided that there is no big change in a country's import propensity. Meanwhile, a reduction in exports leads to a decrease in domestic demand, hence contributing to an economic downturn.
The vicious cycle of contracting trade leading to further deterioration of the world economy must be stopped. To find a way out, in the short run we have no choice but to count on the monetary and fiscal policies of the countries involved. Following moves made by the U.S. at the epicenter of the economic turmoil, where the government and monetary authorities had taken steps to facilitate the disposal of bad assets, ease credit, and roll out significant fiscal stimulus programs, the Japanese authorities implemented their own fiscal stimulus and monetary easing measures. These measures, which were implemented in rapid succession at the end 2008, were justifiable and necessary short-term responses to the crisis.
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In addition to issues that require macroeconomic policy measures, additional issues must be addressed through trade policy in order to break the vicious cycle of economic recession and trade contraction. At the time of the Great Depression, which began in 1929, many countries responded with import-restrictive measures to protect domestic industries and workers against competition from imports. The Smoot-Hawley Tariff Act of the U.S., which imposed huge increases in tariffs on imports, was designed to protect domestic jobs at the expense of safeguarding free trade.
This led to further declines in other countries' exports to the U.S., prompting them to retaliate by raising tariffs on U.S. exports, which only served to deepen the Great Depression. In the midst of the present economic downturn, calls for the protection of domestic industries and workers have been mounting since 2008 in countries across the world as their economies contract and their employment situations worsen.
At the Group of Twenty (G20) financial summit held in Washington on November 15, 2008, leaders agreed to reject 1930s-style protectionism and not turn inward; refrain over the next 12 months from raising new barriers to investment or to trade in goods and services, imposing new export restrictions, or implementing measures inconsistent with the World Trade Organization (WTO); and strive to reach an agreement on modalities that would lead to a successful conclusion to the WTO's Doha Development Agenda. The G20 summit declaration was reaffirmed in ministerial and summit meetings at the Nov. 19-23 Asia-Pacific Economic Cooperation forum held in Lima, Peru.
Indeed, the allure of protectionism must be firmly rejected and world leaders were absolutely right to have made such a public pledge. But it is crucially important to ensure that the pledge is honored.
First, the WTO, as a trade watchdog, needs to strengthen its monitoring function to help prevent countries from pursuing protectionist policies. Just like a bicycle that falls when it stops moving, free trade will fall if we don't keep pedaling. The Doha Round is the symbol of free trade, and bringing it to a successful conclusion would create an effective deterrent to protectionism. At the moment, however, WTO members have yet to agree to resume negotiations.
Japan, which is bound to suffer materially when there is a contraction in global trade, should take the initiative to lead the negotiations at the WTO. However, Japan must first build a national consensus on the relevant issues before representing its position to the world. This is no time for those concerned with agricultural issues to feel relieved about the failed agricultural trade negotiations at the WTO. Instead, they should be working on the development and implementation of domestic measures to enhance the productivity and competitiveness of Japanese agriculture.
This would require a major shift from conventional agricultural policies, which are heavily reliant on import control measures, to agricultural land and other policies that are geared toward motivating farmers to increase overall agricultural productivity. Given their high safety and quality standards, Japanese farm products have the potential to become differentiated tradable goods. Any progress that can be made in the agricultural negotiations would be a significant step toward halting the vicious cycle of trade contraction and economic deterioration.
Second, trade liberalization under a multilateral framework is now becoming more important than regional trade agreements. In times of steady global economic expansion regional trade agreements have played a considerable role in reducing trade barriers. However, in periods of economic contraction such as today, they are ineffective at preventing nonmember countries from leaning toward protectionism. Furthermore, a regional trade agreement may have the unwanted effect of becoming a block economy.
In an environment of declining international trade, international monitoring and public commitments to multilateral free trade negotiations under the WTO are the most effective means of preventing protectionism. This makes the WTO principles of most favored nation (MFN) treatment and multilateral free trade more important than ever before.
Third, trade is subject to the significant influence of monetary policy. In response to the ongoing economic crisis, the U.S., Japan, and the EU have eased their monetary policies to stem the credit crunch, and implemented fiscal stimulus measures to prop up domestic demand, which in the process has caused a sharp appreciation of the yen against the dollar. Empirical studies have shown that abrupt and drastic changes in foreign exchange rates can have considerable effects on international trade.
Japanese companies, which have already been suffering from rapidly decreasing overseas demand, must now face the growing uncertainty that some of them may be able to withstand additional shocks brought on by the sharply appreciating yen, which in itself is a result of monetary policy differences between the world's major economies. This could lead to heightened unemployment by diminishing consumption expenditures and postponing capital expenditures, which would slow the Japanese economy even further.
In this regard, the Bank of Japan (BOJ) should be commended for moving quickly to slash the target for its key policy rate (i.e., uncollateralized overnight call rate) from 0.3% to 0.1% after the U.S. Federal Reserve adopted an effective zero interest rate policy. Amid falling export demand, changes in foreign exchange rates have had a non-negligible impact on export-oriented companies. In implementing monetary policies, central banks need to pay close attention to the impact volatile foreign exchange rates have on international trade.
Lastly, we would like to discuss trade finance facilities specifically designed to prevent trade from contracting. The financial crisis could hinder exports by reducing the availability of trade credit. Particularly in East Asian countries, it is important to prevent a shortage of trade credit from becoming an obstacle for exports. Credit risks in export trade are normally covered by trade credit insurance. However, when a credit crunch imposes constraints on the availability of trade credit insurance, companies may be forced to lose out on their export opportunities.
Japan has been calling for the creation of a trade reinsurance network among export credit agencies in East Asian countries. The proposal is quite meaningful because such a network would help preemptively prevent trade from stagnating in the event of a credit crunch. Needless to say, however, Japan must strictly avoid any action that may be perceived as mercantilist, i.e., an attempt at increasing exports through competition to lower export credit conditions. Therefore, the enhancement of such a reinsurance network should be pursued in a manner that ensures transparency and openness under a multilateral framework, not within the limited scope of East Asian countries.
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Time and again, Japan has revived its economy in the past by expanding exports. By leading the effort toward enhancing WTO functionality and by implementing measures to prevent protectionism and realize truly free trade in an environment of contracting global trade, Japan can help the world economy find a quick way out of its doldrums, which in return would help the Japanese economy stage a recovery of its own.
* Translated by RIETI.
January 27, 2009 Nihon Keizai Shimbun
