Small economies and 'the art of no deal'

David Skilling

Straits Times, 29 June 2019

The past couple of months have been a particularly turbulent period for the global economy.  The imposition of additional tariffs on US imports of Chinese goods in May, the subsequent retaliation by China, as well as various sanctions on technology firms like Huawei, have roiled global markets and added further uncertainty to an already subdued global economic picture. 

Elsewhere, the unilateral US threat to impose tariffs on Mexico to pressure the Mexican government on immigration issues (subsequently resolved) and the continued economic trade friction between the US and Europe, show that there are challenges to the world trade system on multiple fronts.  

In this context, there is keen interest in the outcome of the meeting between President Trump and President Xi at the G20 Summit in Japan on Saturday.  However, expectations remain cautious.  And rightly so, given the complexity of the issues.  The bilateral trade deficit between the US and China cannot be resolved through tariffs, unwinding global supply chains is costly and time-consuming, and China is reluctant to undertake deep structural reform to its economic model.  And the increasingly explicit strategic competition between the US and China further complicates matters.

So meaningful progress towards a comprehensive deal at the G20, or indeed anytime soon, is unlikely.  But although anything is possible, my assessment is that a breakdown of talks, or a further escalation in tariffs, is also unlikely.  Although a final deal that would be acceptable for both the US and China is not in sight, neither party wants the economic costs from a further increase in trade tensions. 

But as importantly, the political incentives seem to be for a partial truce or pause rather than for a comprehensive deal (or no deal).  There is political value to Mr Trump in keeping the issue live.  An actual deal, which would necessarily include concessions, would be open to public scrutiny.  This would be politically risky in an environment where both Democrats and Republicans have become increasingly hawkish on China.  Any deal would be criticised. 

In contrast, keeping the trade tensions unresolved allows for tactical escalation and then resolution – as we have seen multiple times, with President Trump claiming credit for resolving tensions that he has created.  The bilateral relationship with China was one of the issues that Mr Trump campaigned on successfully in the 2016 Presidential election, and the tone of his recent campaign launch suggests that this will be the case again. There is an element of political theatre in these trade negotiations: economic diplomacy as reality TV. 

For similar reasons, it is likely that the focus of US trade policy will increasingly extend beyond China – and beyond tariffs.  US tariffs on European exports remains a live threat, for example.  And as with the US/Japan trade tensions in the 1980s, the politicisation of monetary policy – with the aim of lowering interest rates and the US dollar – is likely as well as tariffs.  Mr Trump is already aiming at Federal Reserve Governor Powell for lower interest rates, and last week was complaining at the effect of European Central Bank chief Mario Draghi’s stimulus on the value of the euro. 

This means that the global economy will be subject to ongoing volatility and uncertainty.  Over the next few years, we should expect ‘stop and start’ trade negotiations, punctuated by occasional crises and ultimatums.  Economic and political tension between the US and China, the weaponisation of international commerce, and the continued weakening of global economic norms and institutions (from exchange rate policy to the WTO), will be central features of the global economic landscape for some time.

This uncertainty, and the costs of trade and investment sanctions, will weigh on global growth and markets.  And there are plausible worse-case scenarios with a meaningful escalation in economic and trade tensions.

So what does this mean for small advanced economies?  Small economies, from Singapore to the Netherlands, are deeply exposed to the global economic and political environment.  Small economies have prospered during a period of intense globalisation, with an open, rules-based system.

In particular, Singapore has benefited from the strong growth of cross-border trade and investment over the past decades, and is exposed to trade tensions between the US and China – two of its major trading partners.  Indeed, Singapore’s NODX (non-oil domestic exports) exports were down 16% in the year to May.  And industrial production growth data was also weak, at -2.4% for the year to May.

In terms of Singapore’s overall economic performance, GDP growth in the year to Q1 2019 was 1.2%, the weakest reading since the global financial crisis.  And MTI forecasts GDP growth to be 1.5%-2.5% for 2019, to which I think there is downside risk.  Indeed, on Thursday, government officials said a review of this forecast is on the cards, and a revised forecast is expected when Q2 economic figures are ready from July.

Ongoing global trade and economic tensions will impose a cost on Singapore, despite the potential offset from economic activity relocating to ASEAN away from China.  But Singapore also has a diversified set of export markets and products, and will be able to adapt over time – albeit at a cost.

More broadly, there is little evidence that small advanced economies are suffering disproportionate costs from global trade tensions.  GDP growth across the small economy group is slowing, but continued to out-pace larger economies in the year to Q1 2019 despite a weaker global economy. 

And market pricing also supports this view.  Global equity markets have moved significantly since early May in response to changing sentiment on the state of US/China trade negotiations.  Global equity benchmarks were down by about 5% in May, before partially recovering in June as sentiment improved. 

Overall, small advanced economy equities have moved in line with global benchmarks. Small economy equity markets are not attracting a ‘trade war discount’, or being singled out as disproportionately exposed to global economic and trade headwinds.

Equity markets in directly exposed small economies like Singapore and Hong Kong remain down, in line with other Asian markets such as Japan and South Korea.  But other small economy markets – from New Zealand to Switzerland and Denmark – have performed well over the past two months. 

Some have argued that the shift towards a more constrained globalisation is the end of the small economy model.  As I argued in an October 2018 commentary in these pages, I think that these concerns are exaggerated. 

The various global economic headwinds will clearly weigh on the economic performance of small open economies because of their deep reliance on the global economy.  But small advanced economies continue to generate strong performance relative to their larger country counterparts.  And the historical record of small advanced economies to external shocks is one of resilience: the flexibility and agility of many small economies compensate for their acute external exposures.

This is not to underplay the significance of the structural changes in the global economy: small economies such as Singapore do best in a well-functioning global system, and small economy GDP growth will be lower in this new world. 

But small advanced economies are not just passive recipients of the state of the global economy.  By continuing to make high quality policy choices that build deep competitive advantage, small economies can position themselves to successfully navigate more turbulent global seas over the coming years.

Dr David Skilling

Director, Landfall Strategy Group

twitter: @dskilling

David Skilling