Depec Highlight Bradesco

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1 Depec Highlight Bradesco August 8, 2018 Trade war likely to curtail growth and increase volatility Thomas Henrique Schreurs Pires Calls for ramped up protectionism have become louder since late February, resulting in a series of protectionist threats by the U.S. government. In recent months, some of those threats were acted upon, triggering immediate retaliation from some of the affected countries. As the situation escalates, trade tensions from the last quarter have moved beyond rhetoric and into actual protectionist actions. While it may be too early to measure the impact on the global economy, it is widely believed that, contrary to what its advocates may suggest, trade wars tend to be lose-lose scenarios. Table 1: Major trade restriction measures announced so far Country Measure Status Raised tariffs on washing machines (to 20%) and solar panels (to 50%) Raised tariffs on steel (to 25%) and aluminum (to 10%) U.S. Raised tariffs on $50 billion of Chinese goods (to 25%) Raised tariffs on $200 billion of Chinese goods (to 25%) needs approval Raised tariffs on EU-made cars (to 25%) China Raised tariffs on $50 billion of U.S. goods (to 25%) Canada Raised tariffs on U.S. steel and iron (to 25%) Raised tariffs (to 10%) on $12.8 billion of U.S. goods Mexico Raised tariffs on $3.0 billion of U.S. goods (to 25%) European Raised tariffs on $3.2 billion of U.S. iron and steel (to 25%) Union Raised tariffs on $300 billion of U.S. goods (to 25%) Source: Bradesco That conclusion is reinforced when we consider the benefits of global trade, which include: (i) a favorable climate for innovation, which raises the overall productivity of the economy; (ii) access to better products, since international competition doesn t just lower prices, but also drives up quality; (iii) each country becoming specialized in its most productive industry, which leads to increased economic integration and a globally linked production chain; and, finally, (iv) an increase in domestic investments and in both portfolio and direct foreign investment flows. That being said, one could reasonably expect that a more restrictive international trade environment could temporarily undo some of these benefits. On the other hand, it is tempting to defend trade restrictions by resorting to the argument that it protects domestic job markets and productivity in so-called strategic sectors. But this argument does not hold up when we look at the economic indicators. A good example is NAFTA, which boosted trade betwee Canada, the United States and Mexico and led to lower unemployment rates and higher wages in all countries including in the manufacturing sector, which is currently pushing for increased trade restrictions. Of course, as was the case with NAFTA and other trade agreements, economies are now moving towards increasingly specialized production which also means a more specialized workforce, with workers being shifted to the most productive sectors of each economy. While this shift may result in short-term unemployment in some less competitive segments, overall employment tends to rise in the medium term. Macroeconomic Research Department 1

2 Chart 1: Unemployment rate in the U.S., Mexico and Canada ( ) in % Canada Mexico U.S Beyond the specific case of NAFTA, the increasing importance of trade to the world economy has helped boost GDP growth and technological development, largely because it promotes domestic investment and foreign investment flows. An interesting example of that is India, which has experienced improved economic growth since moving to significantly open up its economy to international trade and investment. Chart 2: Total trade vs. India GDP growth In % Total trade, in % of GDP GDP growth (right axis) Macroeconomic Research Department 2

3 After looking at some examples of how international trade can benefit local economies, a similar analysis suggests that a trade war, or increased restrictions to trade and investment flow between countries, will have negative effects on these economies. Although the greatest impact from such effects is more likely to be felt over the long term, business confidence and manufacturing activity surveys have already shown a decline since the end of the first quarter which, combined with a slowdown in world exports, should translate into slower growth for the global economy until the end of the year. Businesses and consumers tend to react preemptively to a more restrictive global trade environment, which explains why we have already seen some impacts on consumption and investment. Chart 3: Growth of world exports in volume vs. Global PMI Growth of annualized 3-month moving average vs. PMI, in points 25% Growth of 3-month moving average of exports PMI (right axis) 60 15% 55 5% -5% 50-15% 45-25% -35% 40-45% Source: Bloomberg, Bradesco Given this outlook, we may also witness a decline in portfolio and direct foreign investment flows over the next few quarters. The mere uncertainty about which rules will apply in the future can hinder long-term decisions. In addition to the negative long-term effects on GDP growth, this slowdown in investment can also tighten credit conditions in countries that face current account deficits, and which depend on capital flows to finance their external imbalance. Thus, if trade tensions rise even further, we may expect a negative effect on global growth over the medium and long terms, when the impacts of reduced investment and sagging productivity growth on the global economy are expected to be more pronounced. In other words, not only is a trade war unlikely to bring out a clear winner, but it will probably result in lower allocation efficiency, a decline in productivity and, ultimately, slower GDP growth over the medium and long terms. In addition to the effects on the real economy, trade barriers could create a vicious cycle of negative consequences due to higher volatility in the financial markets, which would be particularly damaging for countries that are more reliant on financing. Some of these effects may start out as minor disruptions, but could become more intense over the next few months. Macroeconomic Research Department 3

4 Chart 4: Current account as a % of GDP Selected countries, in% Taiwan Thailand Germany Norway South Korea Hong Kong Japan Italy Hungary Russia Spain China Portugal Poland Ecuador Brazil France Greece Peru Chile India Mexico Indonesia Ukraine Australia United States of America South Africa New Zealand Canada Colombia United Kingdom Argentina Turkey Macroeconomic Research Department 4

5 Technical Staff Director of Economic Research and Studies Economists Fernando Honorato Barbosa Andréa Bastos Damico / Constantin Jancsó / Ellen Regina Steter Hanna Farath / Estevão Augusto Oller Scripilliti / Fabiana D Atri / Igor Velecico / Leandro Câmara Negrão / Mariana Silva de Freitas / Myriã Tatiany Neves Bast / Priscila Pacheco Trigo / Rafael Martins Murrer / Robson Rodrigues Pereira / Thomas Henrique Schreurs Pires Interns Ana Beatriz Moreira dos Santos / Camila Medeiros Tanomaru / Felipe Yamamoto Ricardo da Silva / Isabel Cristina Elias de Souza Oliveira / Lucas Maia Campos / Renan Bassoli Diniz / Thaís Rodrigues da Silva economiaemdia.com.br DEPEC BRADESCO is not responsible for any acts/decisions taken on the basis of the information available through its publications and projections. All data or opinions contained in the information herein is carefully checked and prepared by fully qualified professionals, but should not be taken, under any circumstances, as a basis, support, guidance or standard for any document, assessment, judgment or decision-making, of a formal or informal nature. Thus, we emphasize that all consequences and responsibility for the use of any data or analysis of this publication are assumed solely by the user, exempting BRADESCO from all actions resulting from the use of this material. We also point out that access to this information implies acceptance of this term of responsibility and usage. The total or partial reproduction of this publication is strictly prohibited, except with authorization from Banco BRADESCO or full citation of the source (naming of the authors, the publication and Banco BRADESCO). Macroeconomic Research Department 5