REMARKS BY JAVIER GUZMÁN CALAFELL, DEPUTY GOVERNOR AT THE
BANCO DE MÉXICO, ON "ATTACKS OF TARIFFS: WHAT ABOUT
CURRENCIES?". EURO50 GROUP & CIGI MEETING. Bali, October 12, 2018.1
I thank the organizers, and especially Nina Massis and Edmond Alphandéry, for
the invitation to join you in this event.
Ten years after the outbreak of the financial crisis, the global economic
recovery appears to have peaked, with GDP growth rates for this and the next
couple of years projected to stabilize at levels similar to those recorded in
2017, and to decline subsequently to a less vigorous pace in line with lower
potential rates of growth in many economies. Further to the envisaged loss of
momentum going forward, a number of remaining legacies, as well as new
perils, continue to tilt the balance of risks for the outlook to the downside.
Chief among the latter is the rising trend of protectionism, evidenced by more
restrictive trade policy stances, both actual and intended, in a number of
countries, leading in turn to heightened tensions or outright conflict between
governments. Of course, the specific nature and extent of these tensions is
varied and broad-ranging, and while there has been some relief in virtue of
progress achieved in some particular cases, such as the recently announced
agreements in the North America region and between the United States and
Korea, ongoing hostilities in other fronts remain a major source of concern.
Of particular note is the clash between China and the United States, which is
widely regarded as the one with the potentially direst consequences, not only
for the economies directly involved but, also, globally. In fact, the performance
throughout this year of a number of variables points to the effects that such a
situation may already be exerting on the world economy.
For instance, international trade volumes have notably slowed down relative
to the upward trend they had displayed since 2015, while other indicators on
the output side, such as export orders in global manufacturing PMIs, sentiment
indexes for trade oriented sectors, and capital goods orders in some of the
main economies, are showing a declining trajectory that, if sustained, would
eventually be reflected in international trade figures.
Why is such a potential setback in global openness to trade so worrisome?
Naturally, the complexities of the trade and financial networks and
interlinkages embedded in the global production framework, give rise to a
multiplicity of channels through which higher tariffs and other protectionist
measures can affect the world economy.
Directly, the cross-border flow of goods and services (a long-standing engine
of growth for both national and the world economies) would be severely
hindered by the increased costs resulting from such policies. The situation is
particularly worrisome in the case of intermediate goods and services, given
the relevance they have come to acquire in the current context of global value
chains (GVCs).
Indirectly, the uncertainties derived from such a retreat from globalization and
free trade may have an adverse impact on business and household confidence,
thereby leading the former to postpone or scale back investments plans for
new or expanded production, and the latter to follow suit in regards to their
planned consumption expenditure paths. Furthermore, an environment of
heightened protectionism has the potential to impinge on financial conditions,
given the resulting increase in the perception of risk among market
participants.
Arriving at an accurate, exhaustive assessment of the macroeconomic
implications of a more restrictive environment for international trade is a
complex task. However, some of the potential implications are evident.
First, activity levels in both countries directly involved and the global economy
would take a significant hit from an escalation of trade conflicts. In the case of
tariff-imposing countries, and their retaliating trade partners, higher import
prices harm firms by increasing their production costs, and households by
decreasing their purchasing power and disposable income. Thus, GDP is
weighed down by the combined declines in both consumption and investment.
Further to this, aggregate demand from these sources can also be affected by
the above-noted detrimental consequences deriving from a loss of confidence
and tighter financial conditions. As for countries not directly involved in a trade
dispute, the impact on their economies would depend on a number of factors,
including their size, openness to trade, exposure to countries imposing tariffs,
and degree of integration into GVCs, among others. Although it may be argued
that some of these countries could be in a position to reap benefits from a
potential diversion of trade flows, the net effects from such a restrictive
environment are most likely to be negative.
Secondly, further to the short-term effects on the level of GDP noted above,
trend growth over the long run is likely to fall as well, once the global economy
adjusts to a higher-tariff environment. This is explained partly by the
undermined efficiency with which labor, capital, and other factors of
production are allocated under conditions of lessened competition and more
restricted access to global markets, thereby inhibiting the innovation process
and the consequent gains in productivity, a fundamental driver of growth. In
addition, higher trade barriers also hamper to a significant extent the
international transfer of technology, know-how and best business practices,
foundations on which emerging and developing economies are particularly
reliant. To the above one must add the adverse effects on confidence and
financial conditions. In this respect, it may be useful to note that one of the
main reasons behind the stagnation of private investment in my country for a
significant period already, is precisely uncertainty related to trade negotiations
with the United States and Canada.
Thirdly, notwithstanding weakened demand pressures arising from subdued
levels of activity, inflation is likely to adjust to the upside under a more
protectionist environment. Further to the direct effects on imports prices
brought about by higher tariffs, less competition from abroad in labor and
goods markets pushes domestic prices and wages upwards, while the above-
noted efficiency losses on the supply side of the economy (including those
resulting from the potential disruption of GVCs) should act in a similar way. In
fact, we must not forget that the effect of international trade on competition
and production costs is one of the major explanatory forces for the period of
low inflation that we have seen at the global level in recent years.
As noted earlier, the hard evidence that to date can be gathered regarding the
impact of the ongoing episode of increased protectionism in the global
economy is still scant. If any conclusion can be drawn, it is that said effects
have been relatively small, albeit not insignificant and definitely not to be
overlooked.
Emerging market economies (EMEs) have faced tighter (and tightening)
external financial conditions over the last several months, which have
translated into declining capital inflows and the consequent pressures on their
exchange rates. In addition to specific, idiosyncratic factors that have been at
play, especially in instances where episodes of acute stress have been present,
this has reflected fundamentally the tightening of monetary policy by the
Federal Reserve, in an environment of global uncertainty deriving from a
combination of factors.
Obviously, a more restrictive trade policy stance in the United States and other
countries has been one of them, although the extent to which this has affected
different economies is varied. In this regard, it is again relevant to refer to the
Mexican experience, where the trajectory of the exchange rate of the peso has
been heavily influenced by news and expectations about NAFTA (now USMCA),
in some episodes the single most important factor driving the value of our
currency. In any case, trade policy shifts remain far from being the main
determinant of exchange rates in EMEs in general. Nevertheless, it is also true
that their potential to affect EME currencies and other financial variables
should not be underestimated.
For the already explained reasons, trade-related events can severely distress
the economic and financial prospects of EMEs. Furthermore, through its
potential impact on inflation, protectionism may accentuate the challenges
resulting from the ongoing normalization of monetary policy in a number of
advanced economies. More generally, the potential for an increase in
protectionism to a level implying systemic risks at the global level is a scenario
that cannot be discarded.
The exercises carried out by a number of institutions on the impact of higher
levels of protectionism depict a grim picture. For instance, recent simulations
by the IMF2 suggest that, in a high-tariff scenario compounded by adverse
confidence effects and tighter financial conditions, the net negative impact on
the level of global GDP peaks at about 0.8 percent below the baseline
trajectory in 2020. The accumulated output losses over 2018-2023 amount to
around 3.2 percent of world GDP. To have an idea of the order of magnitude
of this figure, suffice to say that it compares with the G20 objective of raising
these countries' collective GDP by 2 percent above baseline over the five years
to 2018, and that it is roughly equivalent to the size of Germany at present.
Additionally, it is worth highlighting that, according to these results, none of
the considered countries or regions benefits from such a situation, although
some lose more than others.3
Notwithstanding the rigor with which these models are devised, we must not
forget that they face severe limitations when trying to capture the effects of
high levels of uncertainty. Furthermore, it is also important to bear in mind
that a burst of protectionist actions would hardly take place in isolation. Most
likely, it would be accompanied by other negative events, such as currency
wars, the implementation of inward looking policies in other areas and an
additional backlash against globalization. In light of these considerations, it
would be reasonable to take quantitative exercises like the ones described
above as conservative estimates, or rough qualitative guides as to what we
may face going down this path.
Indeed, it is difficult to understand why the world economy is again facing such
high stakes, after the experience with protectionism during the Great
Depression of the 20th century, and with the burden of the global financial
crisis still present in many economies.