By Invitation. The fallout from the surging tide of protectionism

Free trade has helped foster faster world growth and lower inflation, as decentralisation of manufacturing chains have yielded cost advantages.

It has also enabled higher incremental participation of emerging markets in the global growth process.

Why then are we seeing this rising tide of protectionism — that, too, from the US which is considered the bastion of free markets?

Those left behind

Apart from its merits, globalisation has also inevitably led to a redistribution of share of income away from labour towards capital.

Lower-cost labour resources have appropriated traditional jobs in a widespread manner.

Decades of this trend has predictably sown the seeds of angst among various groups which find themselves isolated or unable to benefit from the prosperity that free trade has conferred upon others.

This is also a consequence of excessive specialisation and a reluctance to upgrade labour productivity and efficiency.

This is the point at which economic rationale gives way to political environment and adopts the façade of nationalism, however misplaced the premise might be.

Faced with growing income inequalities, protecting domestic industries through higher tariffs is a time-tested tool to soothe the nerves of aggrieved parties.

Whatever be the motive, we will, for the moment, confine ourselves to assessing the possible impact of these wars, especially now that the US-China stand-off is likely to move to the next level.

According to the Organisation for Economic Co-operation and Development (OECD), a (permanent) 10 per cent rise in trade costs can lower global GDP by 1-1.5 per cent in the medium term.

Adverse effects of protectionism are also reinforced by retaliation by other countries in response to protectionist measures.

This will be accompanied by increase in policy uncertainty, thereby dampening business confidence, and reducing capital and R&D expenditure.

There is already significant anecdotal evidence from global corporates including American and Chinese ones, bemoaning the adverse effects of increase in tariffs.

Protracted implementation of barriers will lead to broader international tensions and increase general price levels.

Our analysis shows that increasing number of global value chains leaves regions such as Europe and Asia vulnerable to widespread trade shocks. Sustained trade wars would hurt a large number of economies which are significantly open in nature.

Asian countries such as Philippines, Korea, Malaysia, Singapore, Hong Kong etc, are significant participants in global value chains.

Within Europe, countries such as the Netherlands, the UK and Germany are also very vulnerable to trade disruptions on a large scale.

The other channel of impact is through the sentiment route.

Policy uncertainty of this magnitude leads to significant scaling up of risk aversion worldwide, triggering widespread capital flight, especially from emerging markets. This has indeed been the case over the past few months, and has necessitated policy intervention to protect the currencies of the most affected nations.

India not immune

India’s dependence on trade is limited, but we have not been immune from the vagaries of Foreign Portfolio Investment (FPI) outflows, and consequently have witnessed the rupee registering new lows against the dollar.

Though India’s macro fundamentals are much better, recent market reactions to countries such as Turkey and Argentina show that during panic events, all emerging markets tend to be painted with the same broad brush, notwithstanding the inherent differences.

Trade confrontations are far from over, and related parties have merely come up for air, and fresh salvos are possible going ahead, which will trigger another round of volatility in global asset markets.

All said and done, we believe there is some ‘method in the madness’ about how each phase of the retaliation plays out on the part of the US administration; in the medium term, some resolution may be forthcoming based on some concrete wins for the US. Only time will tell if our prognosis is correct.

The writer is Group Executive and Head - Global Markets Group, ICICI Bank.

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