News in Charts: Donald Dark: more than just a peso problem

Our most recent quarterly forecast, some of which was presented earlier this week at an event hosted by Thomson Reuters in London, included a risk scenario that we called ‘Donald Dark’. That scenario envisages growing isolationism, and a sharp drop in global trade, hastened by a protectionist Donald Trump presidency in the US. Emerging markets (EMs) have been the greatest beneficiaries of globalisation. They stand to lose the most if it goes into reverse.

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For almost 200 hundred years the fact that trade is beneficial has been a fundamental tenet of economics. Reinforcing this view, rising trade intensity over the past forty years has coincided with increased standards of living. However, the gains from global trade in recent decades have not been equally shared – within or among countries. Branko Milanovic’s so-called ‘Elephant Chart’ shows that income growth in the 20 years to 2008 was concentrated in the lower and upper-most percentiles of global income distribution. Many blue collar workers in the advanced economies experienced little or no growth in their incomes, while employees in EMs, together with the very wealthiest, have enjoyed marked growth.

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The flipside of stagnant blue collar incomes in the advanced economies has been a substantial increase in average living standards elsewhere in places like Brazil, China and India. EMs have reaped handsome rewards from the world’s more open exchange of goods and services. It has boosted economic growth rates, and resulted in a rapid improvement in standards of living. A move away from globalisation risks delivering a negative shock to the global economy, with EMs particularly affected.

The politics of envy

The unequal distribution of income growth has not gone unnoticed by voters. When polled, the poorer a country is, the more likely its population is to favour free trade and inward investment. In developing economies, the benefits of both are more tangible. By contrast, only a minority of the public in advanced economies believe that free trade is beneficial. The US public may be the most skeptical of all, with just one in five Americans believing that trade creates jobs or raises wages. Mr Trump has tapped into that sentiment, promising to slap high tariffs on imports into the US and renege on free trade agreements such as NAFTA. The risk is that other countries reciprocate, leading to increased barriers internationally and a downturn in global trade.

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Not just a peso problem

To date, currency markets have been a reliable bellwether of Donald Trump’s chances of being elected President. The Mexican peso has risen and fallen with the implied odds of Mr Trump being elected. Nearly 80% of Mexico’s exports go to the US and he has threatened to impose a 35% tariff on them, prompting Mexico’s central bank governor to suggest a Trump presidency would hit Mexico’s economy like a “hurricane”.

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However, our risk scenario produces a lot more than just a peso problem. Other trade-dependent EMs would also be severely affected. In Vietnam, gross trade as a share of GDP tops 150%, with exports to the US accounting for almost one fifth of GDP. Economies that are more open generally, and with large exposure to the US specifically, would be most at-risk.

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Openness to trade increases an economy’s vulnerability to isolationism, but the alternative does not guarantee immunity. Some countries that have relatively low trade intensities, such as Brazil, would suffer negative consequences via indirect channels. These include lower commodity prices from weaker global demand, as well as increased risk aversion in financial markets with associated declines in investment and an increased cost of capital. Countries that are relatively closed, have low external debt and are not dependent on commodity exports should be the least affected. On that basis, India stands out as an outperformer.