Keep calm and carry on
Trade tensions rumble on, with whiplash-inducing tweets from the White House: from ‘tariffs are the greatest’ to we are ‘believers in no tariffs, no barriers and no subsidies’ within 24 hours. And although there was good news as well – the EU/US truce (for now) and the EU/Japan FTA – the global trade system faces deep challenges. Unfortunately, the emerging global trade tensions are unlikely to be resolved quickly.
A cottage industry has emerged to identify those economies that are most exposed to trade conflict. One of the common themes is that small economies are particularly exposed. For example, Danske Bank recently identified Nordic and Swiss currencies as highly exposed because of a combination of high export shares as well as exports to China. And last week, Maurice Obstfeld, IMF Chief Economist argued that small open economies were highly exposed: ‘the more you are dependent on exports, the more vulnerable you will be’.
This is a plausible argument on the surface. The average small advanced economy export share is 58% of GDP, about twice that of large advanced economies (even after removing re-exports from Singapore and Hong Kong). But the relationship between export shares and trade war exposure obscures as much as it reveals. Clearly small economies will be negatively impacted by trade conflict, but I am not persuaded that this exposure is disproportionately higher for small economies. The specifics of national exposure matter at least as much as the aggregate.
Indeed, small economies continue to travel well. GDP growth across the small advanced economy group strengthened to 2.9% in the year to Q1, ahead of most large advanced economies; eight of 13 small economies were growing at 3.0% or above. And small advanced economy export growth has strengthened over the past couple of months (to 6.1% in the year to May) even as world trade growth has softened.
Similarly equity markets provide little evidence of a disproportionate impact of trade tensions on small advanced economies. Since February, small economies have performed broadly in line with key global benchmarks. It is equity markets in the large economies that are directly in the firing line – from Germany and South Korea to Japan and China (and Hong Kong by extension) – that have performed worse. And although several small economy currencies have been depreciating, this is more likely due to the strong USD and looming monetary policy normalization.
Of course, it is still early days. But the absence of a disproportionate economic or market impact on small advanced economies from international trade tensions is instructive. This response is consistent with my analysis that identifies several reasons why small economies are more resilient to trade wars than might be thought.
First, many small advanced economies are deeply integrated into regional groupings such as the EU, or have a portfolio of FTAs that cover a large share of their trade. This institutional integration reduces the share of their exports that can be directly impacted by protectionist measures.
For small economy members of the EU, exports to other EU countries commonly amount to over 60% of merchandise exports. Adding the EU’s existing and prospective FTA coverage, this covers a substantial share of the exports from the small economies in Europe. For example, Norway, Austria and the Netherlands have around 80% coverage of their merchandise exports; although Ireland’s coverage is just over 60%. The situation is more complicated outside the EU, but small economies like New Zealand and Singapore have been active in securing FTAs. About 95% of Singapore’s exports are covered by FTAs, and about 60% of New Zealand’s.
Second, small economies tend to have relatively limited export shares to the US and China, the key protagonists in the trade dispute. There are some notable exceptions: Israel and Ireland are heavily exposed to the US, and Singapore and New Zealand to China. But geographically proximate markets (Canada to the US; Japan and South Korea to China) are much more directly exposed. Small economies also benefit because their bilateral deficits with the US are (unsurprisingly) small in an absolute sense; and the US runs surpluses with five small economies.
Third, small advanced economies have a relatively high proportion of services in their export profile (tourism, financial and business services, royalties, and so on). Across the small economy group, about one third of exports are services – compared to about 25% for large economies. Exports of services are less likely to be impacted by protectionism, at least as these measures are currently framed.
Fourth, a key mode of international expansion for small advanced economies is through outward direct investment. The ODI shares of small economies are markedly higher than for large economies (135% of GDP, or 76% of GDP excluding Singapore, Ireland and Hong Kong, versus 41% of GDP). This ODI intensity provides a measure of resilience against tariffs and sanctions.
Finally, it is worth noting that the global export market share of small advanced economies has been fairly stable over the past 20 years (relative to larger economies), indicating that small economies are resilient to disruptive changes in the global trading system – such as the emergence of China.
Of course, small advanced economies have benefited from the open, rules-based system of the past several decades – and they should not be complacent about emerging risks to globalisation. But small economies have a track-record of performance and resilience, and many of them have features that mitigate some of the exposure to trade wars. I expect ongoing out-performance by small advanced economies, and would not recommend adopting a negative position on small economies as a general strategy.
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