Now more important than ever: A successful completion of the Doha round of multilateral trade liberalisation

Axel Dreher, Stephan Klasen, Andreas Fuchs, Jan-Egbert Sturm 29 October 2008

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As the financial crisis drags on, the costs on the real economy are becoming increasingly visible and painful. According to recent research, recessions accompanied by credit crunches and housing busts are longer and substantially costlier than “normal” ones. Based on evidence from 122 recessions, three IMF economists show that, while recessions associated with severe credit crunches or housing price busts on average last only one quarter longer, the output costs of such recessions are two to three times greater than recessions without financial turmoil (Claessens 2008).

Clearly, financial crises are not automatically followed by recession. However, this time, recessions in most industrialised countries are – if not already occurring – well on the way. According to World Bank President Robert Zoellick (2008), the “deceleration of growth and deteriorating financing conditions will trigger business failures and increase the risk of banking emergencies.

Some countries will slip toward balance of payments crises.” In the words of ILO Director-General Juan Somavia (2008), “we need prompt and coordinated government actions to avert a social crisis that could be severe, long-lasting and global.” According to the ILO's estimates the “number of unemployed could rise from 190 million in 2007 to 210 million in late 2009,” while “the number of working poor living on less than a dollar a day could rise by some 40 million – and those at two dollars a day by more than 100 million.” The IMF (2008) predicts a major global slowdown.

The world needs more than monetary policy

This time, monetary policy alone will not be enough to get us out of recession and overcome the crisis. The effect of a joint cut of key interest rates by the world’s leading central banks on October 8 did not show much of an effect. When it is no longer sufficient for monetary policy to soften in order to stimulate investments, an increase in confidence must be achieved by other means. Arguably, so, besides solving the trust problems in the financial sector, the real sector has to be strengthened in order to avoid or soften recession.

There are two possibilities. The first has been discussed in some detail, and already been implemented in a number of countries:

  • A fiscal stimulus based on a substantial increase of government expenditures.

However, fiscal stimuli – while useful – have their well-known problems and are not generally known for their long-run effectiveness (see Auerbach, 2005, for a discussion). They would have a long-term impact only if governments spend their money on profitable public investments, which hardly happens (as the experience of Japan shows, e.g.). During the last two weeks credit markets almost collapsed, with firms and financial enterprises hoarding cash. This clearly shows that all the stabilisation plans were unable to unlock the credit markets by themselves.

As second stimulus to the real economy, we thus propose

  • A revival of the Doha Round of trade liberalisation.

According to various studies the gains from liberalisation under the Doha Agenda might be substantial (e.g., Decreux and Fontagné, 2006).

Economic liberalisation came under severe fire in the wake of obvious imbalances in the financial sector. According to the Herald Tribune (October 13, 2008), financial crisis is likely to give rise to a new era of regulation – over and above the financial sector. Leading politicians in various countries discuss restricting executives' salaries, which gives impetus to those who seek new measures to address climate change, call for new food safeguards, prescription of drugs and – in particular – imports from (less-regulated) trading partners (Herald Tribune, October 13, 2008). However, regulations in the financial sector must not be confused with trade restrictions. To the contrary, the recent analysis of Spahr (2008) shows that exposure to risk in terms of financial instability decreases with globalisation. It is also well known that economic globalisation does increase economic growth (e.g. Dreher, 2006).

Global slowdown and protection

The inevitable global slowdown will also intensify calls within countries for more protection against imports, as it has invariably done in economically hard times, most severely in the inter-war period from 1918-1940. This way, the real threat exists that the second golden age of international trade will also end with new rounds of protectionism, maybe partly under the guises of bilateral trade agreements.

Figure 1 Globalsation and economic growth, partial leverage plot, 1970-2000

As can be seen in Figure 1, however, economic globalisation did increase economic growth significantly and substantially over the years 1970-2002, controlled for other determinants of growth (Dreher 2006). Frankel and Romer (1999) and Sturm and Jakob de Haan (2005) show that trade is one of the very few variables which (besides investment itself) stimulates growth over longer periods of time. The economics literature also shows that well-functioning institutions depend on open markets (Aizenman und Noy 2005). The positive influence of economic freedom and private initiative is clearly confirmed in empirical research (De Haan and Sturm, 2000). And clearly, investment and trade are interrelated: the prospect of larger markets does stimulate investment (Forte 2004).

The effects of the global slowdown will be particularly felt by the developing countries who benefited greatly from high global growth and falling trade barriers. Asian and Latin American exporters of manufactures were the great winners of previous rounds of trade liberalisation and commodity exporters in Africa and Latin America greatly benefited from the recent boom in commodity prices that is now coming to an end. Conversely, these countries stand to lose particularly if there is no progress and maybe set-backs in global free trade. A successful Doha round should focus particularly on removing remaining barriers to trade in manufacturing in rich and emerging markets, and on removing trade barriers and distorting agricultural policies such as direct subsidies to producers or export subsidies in industrialised countries. If, additionally, poor developing countries will be given the opportunity of preferential access to markets in rich and emerging nations, support to promote their trade and export infrastructure and institutions, and time-limited transfers to deal with the adjustment costs of rising food prices for food importers, all countries of the world would benefit from a successful conclusion of the Doha round.

The revival of the Doha Round will not be the magic pill to end global recession. However, monetary policy alone cannot bring back confidence to investors. The effectiveness of fiscal stimuli, while needed, might also be limited. A quick success of the Doha Round could thus be an important integral part of fostering investor confidence. Confidence in the real sector of the economy will emerge; but particularly confidence that spirals of regulations, spreading from the financial to the real sector will not occur. At the same time, government action would also instill confidence in the ability of political actors to work together in reducing the impact of a global slowdown and in demonstrating the ability of the world political community to see this crisis as an opportunity to look beyond short-sighted interests to lock in long-lasting benefits to the world economy.

References

Aizenman, Joshua und Ilan Noy, 2005, Endogenous Financial and Trade Openness: Efficiency and Political Economy Considerations, mimeo.
Auerbach, Alan J., 2005, The Effectiveness of Fiscal Policy as Stabilization Policy, University of California, mimeo.
Claessens, Stijn, M. Ayhan Kose and Marco Terrones, 2008, What Happens During Recessions, Crunches and Busts? forthcoming IMF Working Paper.
Decreux, Yvan and Lionel Fontagné, 2006, A Quantitative Assessment of the Outcome of the Doha Development Agenda, CEPII Working Paper No 2006-10.
Dreher, Axel, 2006, Does Globalization Affect Growth? Evidence from a new Index of Globalization, Applied Economics 38, 10: 1091-1110.
Forte, Rosa, 2004, The relationship between foreign direct investment and international trade Substitution or Complementarity? A survey, CETE, mimeo.
Frankel, Jeffrey and Romer, David, 1999, Does Trade Cause Growth? American Economic Review, 89, 3: 379-399.
International Monetary Fund, 2008, World Economic Outlook, Financial Stress, Downturns, and Recoveries, Washington, DC.
Haan, Jakob de and Jan-Egbert Sturm, 2000, On the relationship between economic freedom and economic growth, European Journal of Political Economy 16: 215-241.
Somavia, Juan, 2008, ILO says global financial crisis to increase unemployment by 20 million Press release, ILO/08/45, Internatiopnal Labour Organization, Geneva, October 20.
Spahr, Roland, Is Globalization Risky? Beijing, mimeo.
Sturm, Jan-Egbert and Jakob de Haan, 2005, Determinants of Long-term Growth: New Results Applying Robust Estimation and Extreme Bounds Analysis, Empirical Economics 30:3, 597-617.
Zoellick, Robert, 2008, Modernizing Multilateralism and Markets, Annual Meetings 2008: Opening Plenary Session, Board of Governors of the World Bank Group, October 13.

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Topics:  Global economy International trade

Tags:  Doha Round, global recession, beggar-thy-neighbour

Professor of International and Development Politics, Heidelberg University

Professor of Economics, University of Göttingen

PhD candidate in Economics, University of Goettingen; and Researcher, Chair of International and Development Politics, Heidelberg University

Professor of Applied Macroeconomics and Director of the KOF Swiss Economic Institute, ETH Zurich

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