/Trade uncertainty is rising and can harm the global economy

Trade uncertainty is rising and can harm the global economy

Policymakers around the world are fretting about trade uncertainty and its impact on the global economy. For instance, Christine Lagarde – the managing director of the International Monetary Fund: 

“Overall, we estimate that US-China tariffs – including those implemented last year – could reduce global GDP by 0.5% in 2020 … This amounts to a loss of about $455 billion, larger than the size of South Africa’s economy.” (Lagarde 2019)

Similarly, the World Bank’s Global Economic Prospects argues that:

“Confidence and investment could be markedly impacted by a sudden rise in policy uncertainty – triggered, for instance, by substantial new trade barriers between major economies.” (World Bank 2019)

In addition, the effects are likely to be felt more in the “manufacturing sector, where global value chains prevail, has been hit hard by tariffs and the associated uncertainty on the future of trade relationships,” says the Organisation for Economic Co-operation and Development (OECD 2019) in its latest Economic Outlook

Existing work on trade uncertainty

Recent developments have inspired efforts to measure trade uncertainty. Progress, so far, has been mostly made in measuring trade uncertainty in the US – the US trade policy uncertainty index of Baker et al. (2016) – and for the global economy as a whole. 

For instance:

  • Hlatshwayo (2018) has constructed an index of trade protectionism uncertainty, focusing on the public’s attention to trade uncertainty and risks by aggregating references to trade protectionism in newspapers for 44 countries, from 2003 onwards. 
  • The BlackRock Investment Institute has constructed a global index of trade tensions that focuses on the market’s attention to trade risk. This aggregate index is from 2005 onwards and is constructed using Thomson Reuters Broker Report, the Dow Jones Global Newswire, and Twitter. 

A new measure of trade uncertainty

We have constructed the World Trade Uncertainty (WTU) index. It uses Economist Intelligence Unit (EIU) country reports to measure uncertainty related to trade for each of 143 countries, on a quarterly basis, from 1996 onwards. To the best of our knowledge, this is the first effort to construct a panel of trade uncertainty index for a large set of developed and developing countries. The index captures uncertainty related to trade (for example ‘uncertainty over the renegotiation of the North American Free Trade Agreement’, or ‘market uncertainty over future trade policy will weigh on investor sentiment’). 

We construct the WTU index by counting the number of times ‘uncertainty’ is mentioned, in proximity to a word related to trade, in the EIU country reports. Specifically, for each country and quarter, we search through the EIU country reports for the words ‘uncertain’, ‘uncertainty’, and ‘uncertainties’ that are near the following words: protectionism, North American Free Trade Agreement (NAFTA), tariff, trade, United Nations Conference on Trade and Development (UNCTAD) and World Trade Organisation (WTO). 

World Trade Uncertainty is rising sharply…

Globally, the WTU index is rising sharply, having been stable at low levels for about 20 years (Figure 1). 

Figure 1 World Trade Uncertainty index, 1996Q1 to 2019Q2 (equally weighted average)

Christine Lagarde

Sources: The source for the data on key dates in the US-China trade negotiations comes from Bown and Kolb (2019). Item #6 comes from the BBC (2019).
Notes: The font in blue indicates the tariff measure taken, and the font in black indicates the narrative of the World Trade Uncertainty index. The WTU index is computed by counting the frequency of uncertain (or the variant) that are near the following words: protectionism, North American Free Trade Agreement (NAFTA), tariff, trade, United Nations Conference on Trade and Development (UNCTAD) and World Trade Organization (WTO) in EIU country reports. The WUI is then normalised by total number of words and rescaled by multiplying by 100,000. A higher number means higher trade uncertainty and vice versa.

In the figure, the source for the data on key dates in the US-China trade negotiations is Bown and Kolb (2019). Text in blue indicates the tariff measure taken, and text in black is for the narrative of the World Trade Uncertainty index. 

The recent spikes in the WTU index broadly agree with previous measures of trade uncertainty. The index spiked around the third quarter of 2018, coinciding with a series of tariff increases by the US and China (the US tariffs on $34 billion of Chinese imports, and the China’s tariffs on $34 billion of US imports). The index dropped in the fourth quarter of 2018 as US and Chinese officials announced a deal to halt the escalating of tariffs at the G20 meeting in Buenos Aires on 1 December. It spiked again in the first quarter of 2019 following the tariff increase on $200 billion of imports from China, scheduled to go into effect on 1 March.

While spikes in trade uncertainty relate mostly to US-China trade tensions, increases in trade uncertainty have been also felt in key US trading partners such as Mexico, Canada, the European Union and Japan (Figure 2). 

Figure 2 Country-specific World Trade Uncertainty index, 2018Q2 to 2019Q2

Economist

Note: The WTU index is computed by counting the frequency of uncertain (or the variant) that are near the following words: protectionism, North American Free Trade Agreement (NAFTA), tariff, trade, United Nations Conference on Trade and Development (UNCTAD) and World Trade Organization (WTO) in EIU country reports. The WTU index is then normalised by total number of words and rescaled by multiplying by 100,000. A higher number means higher trade uncertainty and vice versa.

… and it is contributing to the recent rise in overall uncertainty

The latest reading of the WUI data shows a sharp increase in global uncertainty in the second quarter of 2019 (Figure 3). While the latest spike is the result of uncertainty over Brexit and US trade policy, trade uncertainty explains more than 70% of the increase in uncertainty since the first quarter of 2018. 

Figure 3 World Uncertainty Index, 1996Q1 to 2019Q2 (GDP weighted average)

Euro

Note: The WUI is computed by counting the frequency of uncertain (or the variant) in Economist Intelligence Unit country reports. The WUI is then normalised by total number of words and rescaled by multiplying by 1,000. The WUI is then normalised by total number of words, rescaled by multiplying by 1,000, and using the average of 1996Q1 to 2010Q4 such that 1996Q1-2010Q4 = 100. A higher number means higher uncertainty and vice versa.

Uncertainty comes at a cost

We find that increases in uncertainty foreshadow significant output declines. Based on our estimates, the increase in trade uncertainty observed in the first quarter could be enough to reduce global growth by up to 0.75 percentage points in 2019. 

This result corroborates recent evidence on the negative effect of trade uncertainty. Ebeke and Siminitz (2018) find that “the investment-to-GDP ratio is on average 0.8 percentage points lower for five quarters following a one-standard-deviation increase in the level of trade uncertainty.” Handley and Limão (2017) conclude that “increases in global trade policy uncertainty could have long-term negative impacts on trade and investment. Until confidence in the world trading system to deliver stable trade policy is restored, the uncertainty costs of this trade war are likely to linger.” 

References

Ahir, H, N Bloom, and D Furceri (2019), “The global economy hit by higher uncertainty”, VoxEU.org.

Ahir, H, N Bloom, and D Furceri (2018), “World Uncertainty Index”, Stanford, mimeo.

Baker, S R, N Bloom, and S J Davis (2016), “Measuring Economic Policy Uncertainty”, The Quarterly Journal of Economics 131(4): 1593–1636.

BBC (2019), “G20 summit: Trump and Xi agree to restart US-China trade talks”, 29 June. 

Bown, C, and M Kolb (2019), Trump’s Trade War Timeline: An Up-To-Date Guide, Peterson Institute for International Economics. 

Ebeke, C, and J Siminitz (2018), “Trade Uncertainty and Investment in the Euro Area”, IMF Working Paper. 

Handley, K, and N Limão (2017), “Policy Uncertainty, Trade, and Welfare: Theory and Evidence for China and the United States”, American Economic Review 107 (9): 2731-83.

Hlatshwayo, S (2018), “Unpacking Policy Uncertainty: Evidence from European Firms”, IMF Working Paper.

International Monetary Fund (2019), G-20 Surveillance Note, June 2019, IMF. 

Lagarde, C (2019), How to Help, Not Hinder Global Growth, June 2019, IMF. 

OECD (2019), Economic Outlook, May 2019, OECD.

World Bank (2019), Global Economic Prospects, June 2019, World Bank.