A sideways look at economics

International trade is like bacon: you can never have too much of it.

It is now almost 200 years since the British economist David Ricardo first wrote at length about the virtues of international trade. His Theory of Comparative Advantage explains why it is advantageous for a country to focus on making whatever goods or services it is best placed to make, and then to exchange those goods or services with other countries whose productive skills lie elsewhere. It has become a fundamental tenet of economics that more trade is good, and less trade is bad.

As a consequence, countries agreed with each other to reduce trade barriers, and regional blocs – making it easier to exchange goods and services across borders – have sprung up too. As a share of global GDP, global trade rose steadily from just over 20% in the early 1960s, to as much as 60% on the eve of the financial crisis. It fell off sharply in 2009, only to bounce back again the following year. But since 2010, global trade has stalled. And on some measures it has gone into reverse. Has the world lost its hunger for trade?

In our view, some of the slowdown reflects a worrying trend towards growing isolationism in a number of the world’s major economies. Workers in the west appreciate that the benefits of free trade are not equally shared, but instead of attempting reform some have chosen to simply reject it. The UK’s Brexit vote may be seen as part of that trend. So too is the growing popularity of Donald Trump – a US presidential hopeful who has built his campaign around a protectionist, anti-trade message.

While there is no evidence to suggest increased barriers to trade will boost growth, some workers have reason to think they could benefit individually. Looking across the major economies, we find that a sharp fall in global trade would lower potential growth. However, it would also raise the labour share of income as workers would be less exposed to competition from overseas. So workers get a larger share of a smaller pie. The flipside, of course, is that owners of capital get a smaller share of a smaller pie – enough to make equity investors lose their appetite.