COVID-19 ~The Last Nail in the Coffin of Free Trade?
By Ananya Pratihari and Vaibhavi Rajput
Over the past few months, the pestilence, which wreaked havoc in Wuhan, an industrial hub in China has gripped the globe, strengthening its hold on the world economy through an ever active domino effect on Global Value Chains. It threatens to bring the whole world into a recession of sorts, one that has been estimated to be much worse than the Great Depression along with upending many established business models. Travel restrictions have been imposed indefinitely with no expected relief in the near future. Hundreds of millions of people are in effective lockdown in almost all countries across the globe. With no proven treatment in sight for this highly contagious disease, the crisis has erased trillions of dollars from global stock markets. In fact, it has endangered the livelihoods of a vast number of MSMEs and wage earners.
Keeping that in mind, it’s imperative to understand the impact of COVID-19 pandemic on global free trade, which has posed a double whammy on most of the developing and underdeveloped economies with demand as well as supply crunches.
Has free trade really been free? ...
With most of the economic activities coming to a standstill, potential questions have emerged related to the significant risk of free trade as numerous countries have stepped towards disguised protectionism. But most importantly what has to be understood is that the world’s progress towards free trade has been on a decline in the past few years with very few Free Trade Agreements being signed. Historically, most of the countries have subscribed to the concept of Free Trade Agreements, which aims at minimizing the trade barriers. The contemporary trade tensions have compounded the shift that has been underway since the Financial Crisis of 2008-09. Cross-border investment, trade, bank loans, and supply chains have all been shrinking relative to the world quotient. Globalization has slowly and gradually been diminishing with the new era of “slowbalization” taking a bolder hold of the ground. There is a movement towards a narrative that supposes the economic nationalism stance as the main one.
According to the November 2019 IMF World Economic Outlook, international trade in goods and services has grown at a mediocre rate of around 3% annually, since 2012 (as shown in graph).
Source: International Monetary Fund, World Economic Outlook Database, October 2019.
Between 1985 and 2007, World Trade increased, on average, twice as fast as world production, whereas for the past four years it has barely managed to strike a slow pace. Hence, in the status quo ante of the present social distancing times, World Trade was not quite promising either. The International Monetary Fund provided three explanations for this decline in World Trade :
The slowdown in Global Economic Growth;
The halt in Trade and Investment Liberalisation Agreements
The maturity of International Production Chains that would have exhausted their advantages.
The second reason - “the halt in trade and Investment Liberalisation Agreements.” also requires a nuanced understanding. The global environment has become increasingly protectionist in the past few years with very few Trade Liberalisation Agreements being signed. The following are a few TLAs which reflect the point made above:
Transatlantic Trade and Investment Partnership negotiations were launched in 2013 and ended without any conclusion at the end of 2016. This bilateral agreement between the United States and the European Union would have been the largest bilateral agreement in the world had it been successful.
Trans-Pacific Partnership (TPP) was a proposed Free Trade Agreement among the 11 Pacific-Rim economies. Before President Donald J. Trump withdrew the United States’ participation in the same in 2017, the TPP was set to become the world’s largest free trade deal, covering 40 percent of the global economy. However, the remaining members of the trade pact have gone ahead with a newer version called the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP).
The world almost received a greater free trade agreement, known as the Doha Round Trade Agreement. If it had been successful, the Doha Agreement would have reduced tariffs across the board for all WTO members. The talks were finally suspended in June 2006 owing to various reasons, one of them being resistance by the EU and the U.S. to lower their farm subsidies. The prospect of increasing tariffs is also looming.
The above mentioned are a few of the Agreements which highlight the rather punctuated journey towards a Free Trade regime.
In contemporary times, we are witnessing a sharp rise in the attitude of raising trade barriers across several countries. These barriers which were once on the path of lowering as a part of consolidated efforts towards a free trade environment faced further backlash due to the pandemic. According to the World Trade Organization (WTO), global trade is expected to fall by between 13% and 32% in 2020 as the pandemic disrupts normal economic activity and life around the world. Henceforth, what we saw in terms of global integration of trade and finance as a significant rise, is going to be hit hard in the long run.
To secure medical supplies, several countries are imposing export restrictions. Some countries are imposing export restrictions on cereals and other food items. According to the International Food Policy Research Institute, this behavior can, in aggregate, have dire and unintended consequences which will affect the vulnerable viciously in food-importing countries, increasing prices and exacerbating issues of food insecurity already inflamed by the pandemic.
The Impending New Normal...
With supply crunches breaking all records due to trade barriers, there’s no doubt that countries will try to move onto some remedial measures. From an Economist's lens, one of them can be termed as ‘import substitution’. Countries will try to build themselves up and move towards self-reliance. For instance, in India, the disruption is approximated to be around 50% of our trade which is directly linked with the Micro, Small, and Medium Enterprises (MSMEs) sector as even large players have sub-contracted to the smaller producers. Hence, there will be more focus on polishing the domestic skills and, naturally, the priority of any government in such stressful times would be to create jobs for its people.
In the post- COVID-19 landscape, risk mitigation is set to become the cornerstone of numerous industries’ supply chain strategy. Companies such as Tata Motors and Suzuki are keen on increasing local sourcing of Automobile Assembling and parts instead of buying specific parts from China, given the disruption in supply caused due to the shutdown of economic activities in manufacturing hub, Wuhan. Despite being a leading supplier of high-quality medicines to several countries, the Indian pharmaceutical industry is highly dependent on China to produce medicines. The hampering of Active Pharmaceutical Ingredients (APIs) production in China due to the emergence of novel coronavirus has prompted the Indian government to set aside nearly $1.3 billion for pharmaceutical companies to shift away from its dependence on APIs produced in China. These are just a few of the several ways countries will try to move towards self-reliance and adopt protectionism policies.
According to Professor Biswajit Dhar, import substitution is all set to become a new normal ever since the first decade of the 20th century.
The Way forward...
The World Trade Organization and governments of various countries can play a crucial role to arrest the movement towards diminishing free trade levels. Economist David Ricardo was among the first to put forth the view in his book, On the Principles of Political Economy and Taxation, that free trade expands the diversity and lowers the prices of goods available in a nation while better exploiting its homegrown resources, knowledge, and specialized skills. Not only this, but a mix of local production and foreign trade allows countries to experience faster growth while better meeting the needs of its consumers. Governments need to resist protectionist measures to rebound at a quicker pace.
Trade Policy Cooperation is required to preserve open markets in difficult times like these. This requires the countries to be confident that all the members of WTO are bound to their obligations and thus, can be in the right frame to cooperate. The WTO trading system can help in reinforcing that confidence. Although WTO allows its members to impose trade restrictions in certain limited cases, it needs to check the proliferation of such measures which can negatively affect the countries that depend on international trade for the bulk of their needs.
As per the WTO’s expectations for the year 2021, recovery in trade is expected, but it will be highly dependent on the duration of the outbreak and the effectiveness of the policy responses. Therefore, without any policy cooperation and effective measures along with the backdrop of plummeting World Trade Rate to World Output Ratio, weighed down by trade tensions and slow economic growth, it would not be wrong to say that COVID-19 might be the last nail in the coffin of free trade.