were three-and-a-half times the average seen since May 2012 (WTO 2018).

Trade tensions between the Unites States and China escalated through much of 2019, with import tariffs imposed in 2018 and raised in 2019 (Figure 6). There are indications that tariff increases have reduced real incomes in both the United States and China, with the costs to consumers outweighing the additional government revenue (Amiti, Redding, and Weinstein 2019; Fajgelbaum et al. 2019). These trade tensions, combined with recent cyclical headwinds, have weighed on global trade. In addition, the uncertainty created and the likely disruptions to global value chains will discourage firms from investing. More recent progress in implementing a phase one trade deal between China and the U.S. has, in part, helped to ease trade uncertainty.

So far, the cost of trade tensions between the United States and China have been modest compared to the size of the economies involved. If trade tensions were to spread and worsen, however, the consequences for global growth could be sizeable. If tariff rates on all bilateral U.S.-China trade flows were increased by 25 percentage points, the impact on world growth could be significant, especially if confidence were to also retreat (Freund et al. 2018). Similarly, if all WTO members were to increase tariffs to legally-allowed upper bounds, this could translate into a decline in global trade flows of about 9 percent, similar to the contraction seen during the global financial crisis in 2008-09 (Kutlina-Dimitrova and Lakatos 2017).

Weakening trade sets back global poverty reduction efforts, as the poorest EMDEs rely heavily on trade for economic growth, with advanced economies their main export destinations and capital imports driving investment (World Bank 2017c). Higher trade openness is associated with lower poverty and inequality, and helping countries transition out of low-income status, provided other policies are implemented that target adjustment costs (Goldberg and Pavckik 2004; Winters, McCulloch, and McKay 2004). Tariff reductions have also been found to proportionately increase the incomes of the poor (Dollar and Kraay 2002; Sachs and Warner 1995).

# 3.3 Financial market risks

Notwithstanding still-benign global financial conditions, rising indebtedness makes EMDEs vulnerable to disorderly financial market developments. Several events could trigger a materialization of this risk.

First, in advanced economies, deteriorating growth prospects could increase corporate default rates, especially in an environment where the share of low-rated corporate bonds and the use of less transparent leveraged loans and collateralized debt obligations (CDOs) have increased (Figure 7).<sup>9</sup> High-yield debt markets, including those for leveraged loans, have grown rapidly since the financial crisis and now exceed pre-crisis levels (FSB 2019). The overall size of the leveraged loan market is estimated at $2.2-2.4 trillion, mainly in the United States and the European Union (EU). The accumulation of this debt since 2009 has significantly outpaced growth in the earnings of the corporations taking on these loans. Debt is around five times earnings (before interest, tax, depreciation, and amortization) in the United States and EU and six times earnings

> 9 Leveraged loans are loans to non-financial corporations that have high debt levels, below-investment grade credit ratings, or a spread at issuance higher than a certain threshold (FSB 2019).