Weak trade growth and financial distortions are exacerbating slow global economic growth, according to the OECD’s latest Interim Economic Outlook.

The global economy is projected to grow at a slower pace this year than in 2015, with only a modest uptick expected in 2017. The Outlook warns that a low-growth trap has taken root, as poor growth expectations further depress trade, investment, productivity and wages.

Over the past few years, the rate of global trade growth has halved relative to the pre-crisis period, and it declined further in recent quarters, with the weakness concentrated in Asia. While low investment has played a role, rebalancing in China and a reversal in the development of global value chains could signal permanently lower trade growth, leading to weaker productivity growth. Lack of progress – together with some backtracking – on the opening of global markets to trade has added to the slowdown.

Exceptionally low – and in some cases negative – interest rates are distorting financial markets and raising risks across the financial system.  A disconnect between rising bond and equity prices and falling profit and growth expectations, combined with over-heating real estate markets in many countries, increases the vulnerability of investors to a sharp correction in asset prices.

“The marked slowdown in world trade underlines concerns about the robustness of the economy and the difficulties in exiting the low-growth trap,” said OECD Chief Economist Catherine L. Mann. “While weak demand is surely playing a role in the trade slowdown, a lack of political support for trade policies whose benefits could be widely shared is of deep concern.

”Monetary policy is becoming over-burdened. Countries must implement fiscal and structural policy actions to reduce the over-reliance on central banks and ensure opportunity and prosperity for future generations.”

The OECD projects that the global economy will grow by 2.9 percent this year and 3.2 percent in 2017, which is well below long-run averages of around 3¾ percent. 

The small downgrade in the global outlook since the previous Economic Outlook in June 2016 reflects downgrades in major advanced economies, notably the United Kingdom for 2017, offset by a gradual improvement in major emerging-market commodity producers.  

Growth among the major advanced economies will be subdued. In the United States, where solid consumption and job growth is countered by weak investment, growth is estimated at 1.4 percent this year and 2.1 percent in 2017. The euro area is projected to grow at a 1.5 percent rate in 2016 and a 1.4 percent pace in 2017. Germany is forecast to grow by 1.8 percent in 2016 and 1.5 percent in 2017, France by 1.3 percent in both 2016 and 2017, while Italy will see a 0.8 percent growth rate this year and next.

In the United Kingdom, growth is slowing following the 23 June referendum to leave the European Union. While a strong response from the Bank of England has helped stabilise markets, uncertainty remains extremely high and risks are clearly on the downside. In this environment, the UK is projected to grow by 1.8 percent in 2016 and 1 percent in 2017, well below the pace in recent years.

Growth in Japan will remain weak and uneven, at 0.6 percent in 2016 and 0.7 percent in 2017, with the appreciation of the yen and weak Asian trade weighing on exports. Canadian growth is projected at 1.2 percent this year and 2.3 percent in 2017.

China is expected to continue facing challenges as it rebalances its economy from manufacturing-led demand toward consumption and services. Chinese growth is forecast at 6.5 percent in 2016 and 6.2 percent in 2017. India will continue to grow robustly, by 7.4 percent in 2016 and 7.5 percent in 2017. Despite some improvements, Brazil’s economy continues experiencing a deep recession, and is expected to shrink by 3.3 percent this year and a further 0.3 percent in 2017.

The Interim Economic Outlook renews calls for a stronger collective response using fiscal, structural and trade policies to boost growth. On the fiscal front, low interest rates offer governments additional fiscal space for investing in human capital and physical infrastructure to promote short-term demand, long-term output and inclusiveness.

On the structural side, more ambitious policies are needed, particularly those that boost trade, including commitments to stand still on new protectionist measures, roll back existing ones and urgently tackle other obstacles to trade and investment.

The OECD also released an Economics Policy Paper, Cardiac Arrest or Dizzy Spell: Why is World Trade So Weak and What can Policy Do About It? in conjunction with the Outlook.

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Cardiac arrest or dizzy spell: Why is world trade so weak and what can policy do about it?

World trade growth was rapid in the two decades prior to the global financial crisis but has halved subsequently. There are both structural and cyclical reasons for the slowdown. A deceleration in the rate of trade liberalisation post 2000 was initially obscured by the ongoing expansion of global value chains and associated rapid emergence of China in the world economy. Post the financial crisis global value chains started to unwind and, possibly associated with this, Chinese and Asian trade weakened markedly. These structural changes were compounded by insipid demand due to anaemic growth of global investment, as well as intra-euro area trade, both of which are trade intensive.

The slowdown in world trade growth post crisis, if sustained, will have serious consequences for the medium-term growth of productivity and living standards. Trade policy has significant potential to reinvigorate trade growth but the political environment for reforms is difficult, with a growing polarisation of OECD electorates into pro- and anti- globalisation supporters. Further trade and investment policy liberalisation should be introduced as part of a wider package of structural reforms to spread the benefits of freer trade and investment more widely.

Introduction and summary

A remarkable two decade period of rapid globalisation, during which the trade intensity of global GDP increased rapidly, came to an end with the financial crisis. Instead of world trade growing at more than double the rate of global GDP, in the wake of the crisis it has barely exceeded the growth rate of global GDP, slowing sharply from an average of 6½ per cent per annum over the two decades to 2008 to 3¼ per cent per annum over 2012-2015. During 2015 trade volume growth weakened further to 2½ per cent, and was again anaemic in the first half of 2016.

There are both cyclical and structural contributions to this slowdown. Trade growth in the pre-crisis period was boosted by world-wide liberalisation of trade policy, particularly through multi-lateral agreements, NAFTA and deepening of the EU single market during the 1990s. A further boost to trade came from the growing importance of global value added chains (GVCs), whereby production processes are fragmented across countries and so increased trade, particularly in intermediate products. As trade liberalisation measures slowed around 2000, world trade remained supported by the ongoing expansion of GVCs and was given a further boost by a growing contribution from the rapid emergence of China into the world economy.

Since the financial crisis the contribution to world trade from GVCs and trade liberalisation has plateaued and with creeping protectionism from a myriad of small measures has gone into reverse. The fading of the impetus from these structural factors has been compounded by cyclical weakness following the 2008-09 global financial crisis. Weak demand in Europe, which is a trade-intensive region, and weak investment, which is a trade-intensive component of expenditure, have both exacerbated the weakness in world trade. More recently in 2015, the weakness is explained by faltering trade in China and other Asian countries, possibly associated with some withdrawal of China from GVCs.

The exceptional nature and coincidence of favourable structural factors that boosted trade in the precrisis period suggests that, world trade is unlikely to return to sustained high growth rates without substantial policy action. Any recovery in world trade will also partly depend on how changing production specialisation in China and other emerging markets affect the expansion of GVCs. A more rapid entry of lower income countries in Africa and Asia into manufacturing GVCs would boost their productivity and counter-balance the effect on world trade of greater concentration of China in more domestically focussed services.

Additionally, how far world trade growth recovers from the current nadir will also depend on policy action. Policy action would ideally take place across a range of fronts, including rolling back protectionist measures, implementing agreements already reached (trade facilitation and the Trans-Pacific Partnership), concluding on-going sectorial negotiations in services and reviving multilateral negotiations on new issues such as digital trade. Empirical estimates presented in this paper suggest that trade liberalisation at the same pace as occurred during the 1990s could boost world trade growth by 1-2% per annum.

Such policy action is warranted because trade is an important engine of growth, in a context where growth and productivity performance in many countries has been poor. Trade, and the related expansion of global value chains, boosts growth through increased productivity by improving resource allocation, increasing scale and specialisation, encouraging innovation activities, facilitating knowledge transfer, fostering the expansion of more productive firms and the exit of the least productive ones. Policy action to restore growth in world trade intensity might be expected to raise mediumterm total factor productivity growth on average by around 0.2% per annum, based on recent OECD estimates of the effect of trade intensity on productivity. This is substantial in the context of OECD total factor productivity growth, which has averaged only 0.5% per annum over the past ten years.

The political environment for trade related reform in the OECD is, however, difficult, with the electorate increasingly polarized into pro- and anti-globalisation groups. A pre-requisite for reform is better evidence and communication of the net benefits of freer trade as well as acknowledging the costs and how these will be tackled. The benefits of greater trade do not affect all parts of the economy and society equally and the associated income re-distribution and reallocation of resources has also likely affected the level of political and social opposition to freer trade, which has grown in Europe and North America in recent years. Trade and investment reforms need to be introduced as part of a package of structural reforms to improve labour and product markets and to spread the benefits of freer trade more widely.