Introduction
For several decades, trade among nations increased rapidly, spurred by, among other things, multilateral trade liberalization under the auspices of the General Agreement on Tariffs and Trade (GATT), which went into effect in 1948, and then the World Trade Organization (WTO), which replaced GATT in 1995.
The figure below shows the marked expansion in both U.S. and global trade (exports plus imports) as a percentage of gross domestic product (GDP), which is a standard measure of openness to trade. The world trade-to-GDP ratio climbed from about 25% in 1970 to a peak of about 61% in 2008. Similarly, the U.S. trade-to-GDP ratio rose from about 11% in 1970 to a peak of about 31% in 2011.
The fact that both peaks occurred more than a decade ago suggests a general pattern of slowing trade, at least in proportion to the sizes of the respective economies. But why?
Specialization along the lines of comparative advantage, the business efficiencies gained from scaling up to meet global demand, and the consumer benefits from having access to specific varieties of goods produced by different nations all point to benefits from a greater integration of world markets. Yet, we see a reduction in trade measured as a percentage of GDP for both the U.S. and the world economy.
In this essay, economists from the Federal Reserve Bank of St. Louis explore different aspects of trade to help explain the headwinds that may be slowing the process of globalization, including:
- How are trade blocs and geopolitical tensions affecting trade?
- How has the U.S.-China trade relationship changed over time?
- What are critical goods, and how are they susceptible to international trade shocks?
- What are the risks to global value chains, and how are governments protecting them?
Challenges to Trade from Trade Blocs, Geopolitical Tensions
By Subhayu Bandyopadhyay
Two issues that are central to current U.S. trade relations are trade blocs, such as the U.S.-Mexico-Canada Agreement (USMCA), and the trade effects of geopolitical tensions, such as the ongoing Russia-Ukraine war.
The Impact of Trade Blocs
Trade economists generally agree about the benefits of global free trade, such as lower production costs made possible through international specialization along the lines of comparative advantage. However, the role that trade blocs, such as the one formed by the USMCA, play is less clear. USMCA is a free trade agreement in which those nations conduct free trade within the bloc but unilaterally decide their respective tariffs vis-à-vis nations outside the bloc.
One of the reasons that such blocs exist is the greater feasibility they afford in terms of reaching agreements among a relatively small number of nations. However, there are two major obstacles to such agreements:
- First, while such blocs may create new trade among member nations (a positive), they may divert sourcing of imports from more efficient nonmembers to less efficient member nations (a negative). Even if the net effect appears positive, an agreement may not materialize because of several other factors, including political opposition or disagreements among members on nontrade issues like harmonization of labor working conditions across member nations.
- Second, of prime concern is the income distribution effects of such agreements. Workers in industries whose exports increase with an agreement will likely support it, but workers in industries seeing greater import competition will likely oppose it. Such income distribution concerns, which are almost always associated with trade liberalization within blocs, can lead to political opposition to their enactment.
Indeed, U.S. trade in goods with Canada and Mexico grew rapidly around the time that the North American Free Trade Agreement (NAFTA) went into effect in 1994, creating a free trade zone for Mexico, Canada and the U.S. (See the figure below.) However, potential wage and job loss concerns, among other factors, influenced the U.S. decision in January 2017 to back out of the Trans-Pacific Partnership. Similar concerns led to renegotiation of NAFTA, which was replaced in 2020 by USMCA.
Geopolitical Tensions and Trade
As we have recently seen with Russia’s invasion of Ukraine, geopolitical conflict can severely disrupt trade. Prominent markets affected by this conflict have included the world grain and oil markets. Production challenges in conflict zones and in shipping (such as the blockade of Black Sea ports) have raised concerns about global shortages in food grains.
At the same time, trade sanctions by the European Union (EU) have led to a sharp decline in Russia’s trade with the EU and a substantial diversion of its trade to other countries, including China and India. This diversion has been costly both for the EU and Russia. Prior to the conflict, the EU received most of its imports of oil and natural gas from Russia. While the EU must now manage its energy shortage, Russia has been able to sell its Urals crude oil at substantial discounts to markets that have not been blocked by sanctions.
Overall, conflict in any part of the world can be a significant trade impediment. International trade is based on reliable transactions among entities operating in different parts of the world. Such relationships typically require time and resources to build. To the extent that conflict disrupts such relationships, it also raises the costs and uncertainties related to trade. Accordingly, geopolitical tensions present a central challenge to the process of globalization.
Impact of U.S.-China Trade Relations
By Maximiliano Dvorkin
In the early 1970s, the U.S. and Chinese governments reestablished diplomatic relations, which played an important role in opening trade between the two nations. However, the expansion in U.S.-China international trade was gradual and did not take off until the early 1990s.
For example, in 1987, U.S. imports from and exports to China represented about 1.5% of all U.S. imports and exports, while trade with Canada and Europe was more than 10 times larger. By 2000, however, imports from China accounted for more than 8% of all U.S. imports, and in 2017, this figure peaked at about 22%. U.S. exports to China also have increased substantially over time, though the magnitude has been smaller, peaking at about 8.5% of all U.S. exports in 2017. Still, because of these large increases, China and the U.S. are now major trade partners, with levels of trade similar to those between the U.S. and Canada, Mexico and the EU.
Increase in Trade between the U.S. and China
Several factors explain the large increase in U.S.-China trade over time. For one, the U.S. government adopted policies that reduced protectionism and favored international trade. Trade agreements with Canada first, and then with Canada and Mexico, are two important examples. Over time, the sum of U.S. imports and exports as a share of U.S. GDP increased from 17% in 1985 to about 30% in 2013.
In addition, the U.S. government granted conditional normal trade relations to China in the late 1970s, which implied that tariffs on imports from China to the U.S. could not be higher than those of the most favored nations under the WTO, even though China was not part of this organization until 2001. Still, important changes in policies and economic conditions in China favored increased trade. In particular, the loosening of rural-urban migration restrictions promoted the reallocation of agricultural labor into cities. Foreign direct investment and foreign ownership of export processing firms were permitted, substantially increasing the amount of capital used in production, particularly for exports.
Top Imports and Exports from China
Economic theory suggests that countries will tend to export goods and services in which they have a comparative advantage. In the case of U.S.-China trade relations, some clear patterns emerge in the composition of imports and exports across industries.
In 2015, three years before the U.S.-China trade war, imports from China accounted for 21.5% of all U.S. imports. However, about 50% of all U.S. imports of furniture, textiles, apparel and leather products came from China. Computers, electrical equipment and appliances from China accounted for nearly 42% of all U.S. imports in these categories.
U.S. exports to China represented a smaller fraction of all U.S. exports—less than 8% in 2015. These exports were more concentrated in agriculture, forestry and fishing products, with China representing close to 25% of U.S. exports of these goods. Somewhat smaller but still significant were beverages, tobacco products and wood products, with China accounting for nearly 20% of all U.S. exports of these goods in 2015.
Trade with China and Its Effects on U.S. Employment
International trade has always been a popular topic of discussion, particularly due to its effects on labor markets. Several academic papers in economics measure these effects, more precisely the role of the large increase in U.S. imports of Chinese goods in explaining large declines in U.S. manufacturing jobs.
The figure below shows the relationship between the concentration of imports from China that competed with goods produced in specific U.S. industries in 2015 and the change in those industries’ shares of U.S. manufacturing employment between 1990 and 2015. By construction, the sum of all changes in the share of employment adds up to zero. Each point in the figure is an industry in the manufacturing sector.
The figure shows a negative correlation between U.S. imports from China and U.S. manufacturing employment. This suggests that industries that face stronger competition from Chinese goods tend to see a contraction in employment relative to other industries. While some caution needs to be exercised in the interpretation of this correlation, several academic papers find this to be a causal relation.
The 2018 Trade War
The gradual and almost uninterrupted expansion of U.S. trade with China suddenly came to a halt in 2018 when the U.S. government imposed a series of import tariff increases. The first round of U.S. tariff hikes applied to a small number of goods—such as solar panels, washing machines, and steel and aluminum products—from all countries. Subsequent rounds of tariff increases applied to a large set of goods imported from China; these tariffs were generally higher on goods the U.S. imported more of—such as machines, computers, electronics and appliances.
Some countries, including China, retaliated and imposed or increased tariffs on U.S. goods. China increased tariffs the most on U.S. agricultural goods, food and beverages, and transportation equipment.
This trade war caused U.S. imports from and exports to China, and to a lesser extent those with other major trade partners, to fall. Between 2018 and 2019, U.S. imports from China fell by 17% and exports to China declined by 11.5%. More recently, however, the amount of U.S. trade with China has substantially recovered, partially due to a surge in U.S. consumption of goods during the pandemic years and an increase in U.S. imports from China in goods that did not experience a tariff increase.
Critical Goods and International Trade Shocks
By Fernando Leibovici
Some goods are critical to economic activity and welfare even though they account for a small portion of aggregate output and consumption. For instance, COVID-19 vaccines have been critical to both economic activity and welfare throughout the pandemic, despite accounting for a small fraction of economic output as a whole. Similarly, recent shortages of natural gas and semiconductors have shown how important these inputs are to production despite accounting for a small share of production costs for the typical industry.
What’s at Stake with Production Shocks
Shocks to critical goods can expose the U.S. economy to systemic risk. One potentially significant source of vulnerability to such shocks arises from a dependence on international trade to access these goods. Geopolitical risk (such as war), reliance on risky trade partners and shocks to trade institutions can severely disrupt the short- and medium-run access of the U.S. economy to critical imported goods.
To evaluate the extent to which the U.S. depends on international trade to access these goods, we looked to the 16 infrastructure sectors identified as critical to the security and resilience of the U.S. economy by the Cybersecurity and Infrastructure Security Agency, part of the U.S. Department of Homeland Security. Out of the 16 sectors, we focused on seven that are relatively easier to trade in internationally: chemicals, communications, critical manufacturing, energy, food and agriculture, medical and pharmaceutical, and information technology.
The degree to which these sectors depend on trade is reflected in the highly disaggregated U.S. input-output tables below, published by the Bureau of Economic Analysis in 2012, the most recent data available at this level of aggregation. These tables capture the input-output linkages across all sectors of the U.S. economy. The top figure shows these industries’ imports-to-absorption ratios—or imported goods as a percentage of the sector’s aggregate demand. The bottom figure shows the net exports-to-absorption ratios—or net exports (the value of exported goods minus the value of imported goods) as a percentage of the sector’s aggregate demand. These findings show that the critical sectors of the U.S. economy most reliant on international trade are communications and information technology (IT).
More than 60% of total U.S. demand for the goods in these two sectors is imported. In addition, these sectors consistently run significant trade deficits. The difference between imports and exports of these goods is greater than 40% of total U.S. demand for these goods. Medical supplies and energy also are highly dependent on international trade.
Semiconductors as a Critical Input
Within communications and IT, semiconductors have been in the spotlight in recent years. While accounting for a small fraction of aggregate GDP, semiconductors are critical inputs to the production of computers, toys, appliances, automobiles and many other goods. Because they are integral to the production of many goods, and viable substitutes are difficult to find, semiconductor shortages have had notable global effects. For instance, recent disruptions in the production of cars along with their sharp price increases have been attributed to the shortage in semiconductors.
To examine the extent to which the U.S. economy depends on the rest of the world to access semiconductors, we plotted the U.S. trade deficit in these goods vis-à-vis major trade partners. The figure below shows that the U.S. trade deficit in semiconductors with China increased fairly steadily from 2008 to 2018 before reverting to a trade surplus in 2020 in the aftermath of the U.S.-China trade war. In contrast, the trade deficit in semiconductors with Taiwan accelerated in recent years, likely as a substitute source given the reduction in semiconductor imports from China. Similarly, net exports with the rest of the world also decreased steadily until 2016, and then again starting in 2020.
Thus, we find that the U.S. is a net importer of semiconductors, that this pattern has grown over time, and that geopolitical relations among China, Taiwan and the U.S. may be of utmost importance to the semiconductor industry and the sectors into which it feeds.
Potential vulnerabilities such as these are reflected in recent remarks by U.S. Treasury Secretary Janet Yellen in advocating “friendshoring” as an approach for advancing trade that is free, fair and secure, as well as “modernizing our trade relationships and supply chains to make them more resilient to global shocks.”
Significant dependence on international trade is likely to reflect the vast benefits of cross-country specialization based on comparative advantage. Yet, such patterns of production might simultaneously make the U.S. economy vulnerable to trade-related shocks, which might limit access to such goods in the short and medium run. Given the critical nature of these goods and the potential for such shocks to be costly, monitoring conditions in these sectors will be important to the overall stability of the U.S. economy.
Global Risks and Supply Chain Disruptions: A Return to Protectionism
By Ana Maria Santacreu
After decades of trade liberalization, the world has experienced a return to protectionism. Today, most international trade consists of intermediate goods, and about 70% of that trade is organized in complex global value chains (GVCs) that involve services, raw materials and components crossing borders multiple times. The figure below shows that GVC participation in global trade increased steadily from 1970 until plateauing in the early 2000s due to the rise in automation, increases in labor costs in developing countries, technology wars and the subsequent protectionist measures implemented by some governments.
An important benefit of GVCs is that firms can take advantage of specialization. Instead of producing everything in-house, firms can outsource parts of the production process to countries that have a comparative advantage (such as faster production or lower costs) in that particular stage. However, this structure of production poses risks: Shocks to one sector can propagate along the chain, causing bottlenecks, supply shortages and price increases.
Pandemic-Related Shocks
The COVID-19 pandemic exposed the vulnerabilities of relying heavily on foreign suppliers. Two recent Federal Reserve Bank of St. Louis Review articles noted that U.S. industries that are more exposed to foreign shocks through GVCs experience larger declines in economic activity and larger increases in prices.
- Santacreu, Leibovici and LaBelle (2021) found that industries sourcing inputs from countries with stricter lockdowns experienced larger declines in output and employment during the first months of the pandemic.
- Santacreu and LaBelle (2022) found that exposure to global bottlenecks played a significant role in U.S. cross-industry producer price index (PPI) inflation between January and November 2021.
A back-of-the-envelope calculation suggests that if bottlenecks had followed the same path as in 2019, PPI inflation in the manufacturing sector would have been two percentage points lower in January 2021 and 20 percentage points lower in November 2021. More recently, the Russian invasion of Ukraine and geopolitical risks in China have exacerbated these vulnerabilities.
These shocks and their consequences have triggered protectionist measures by governments around the world. For instance, in the first months of the pandemic, countries introduced export controls on personal protective equipment necessary to mitigate the spread of COVID-19. By the end of April 2020, 279 country-product pairs (such as masks from China) were subject to these export restrictions. In October 2022, the Biden administration banned certain chip exports to China; and more recently, in response to Russia’s invasion of Ukraine, the U.S. and other governments have limited high-tech exports to Russia.
Many of these controls have taken the form of unilateral responses by governments to protect the supply of goods considered critical from a national security standpoint. A different strategy that has been proposed by several economists and policymakers is to instead increase international cooperation among allies. Rather than depending solely on one or a few suppliers or perfectly diversifying supply chains, the alternative could be to regionalize supply chains and form trade agreements with a few trusted trading partners, also known as “friendshoring.”
Conclusion
In this essay, we examined several factors that have led to the recent slowdown in trade as a share of GDP. First, we focused on blowbacks to trade blocs and on geopolitical tensions with their respective challenges to the process of global free trade. Second, we noted the rapid emergence of China as a major U.S. trade partner, and how U.S. labor market effects from Chinese imports have led to difficulties in that relationship. Third, we examined how shocks to imports of critical goods (or inputs) cause vulnerabilities for the U.S. economy, and how that may prompt policymakers to look for more reliable sources of imports. Finally, we discussed how global value chains are susceptible to global risks (such as the COVID-19 pandemic and the Russia-Ukraine war), which may prompt policymakers to resort to protectionism or increased dependence on friendly nations (“friendshoring”).
While globalization presents opportunities to reap gains from trade through removal of trade barriers, it also exposes nations to international vulnerabilities. Our examination of the opportunities and challenges associated with trade can help inform discussions intended to weigh the risks and benefits of continued global market integration.
Endnotes
- U.S. trade in goods with NAFTA partners also increased as a share of total U.S. goods trade during the 1990s.
- The U.S.-Canada Free Trade Agreement launched in January 1989. NAFTA, which included Canada, Mexico and the U.S., began in 1994. This was later replaced by USMCA in 2020.
- See David H. Autor, David Dorn and Gordon H. Hanson’s “The China Syndrome: Local Labor Market Effects of Import Competition in the United States,” American Economic Review, 2013; and Lorenzo Caliendo, Maximiliano Dvorkin and Fernando Parro’s “Trade and Labor Market Dynamics: General Equilibrium Analysis of the China Trade Shock,” Econometrica, 2019.
- Ibid.
- For more on these topics, see my April 10, 2020, On the Economy blog post, “Protectionism and Dependence on Imports of Essential Medical Equipment,” and my Aug. 26, 2021, On the Economy blog post, “Critical Goods and International Trade Dependence in the U.S.”
- Global value chains utilize production processes across different organizations or countries that specialize in specific tasks. For more information about the organization of global value chains, see Organization for Economic Cooperation and Development’s webpage, “Global Value Chains and Trade.”
- For an overview on the rise in global value chains, see Pol Antras' 2020 working paper, “Conceptual Aspects of Global Value Chains.”
- For an analysis of critical goods shortages in the global economy and the role of policy, see Fernando Leibovici and Ana Maria Santacreu’s 2023 working paper, “Shortages of Critical Goods in a Global Economy: Optimal Trade and Industrial Policy.”
- For more on increasing trade cooperation, see Chad P. Bown’s “The Return of Export Controls,” Foreign Affairs, 2023.
