Economic policy uncertainty can affect trade volumes by influencing firms’ decisions on whether to import inputs or invest in serving foreign markets
Last month, amid escalating trade tensions, the World Trade Organization lowered its forecasts for global trade growth in 2019 to 1.2% (down from its April prediction of 2.6%) which would make it the slowest expansion in global trade since the financial crisis of 2008-09. Much of this slowdown can be attributed to heightened policy uncertainty, suggests new research.
In a study published by the World Bank, Cristina Constantinescu and others specifically find that a 1% increase in uncertainty can decrease goods and services trade growth by 0.02 percentage points. The increased uncertainty since 2018, they argue, could have reduced trade growth by a percentage point over last year.
To measure policy uncertainty, they used data from the Economic Policy Uncertainty indices of 18 countries over 24 years. In these indices, compiled by another group of researchers, uncertainty is measured by capturing the frequency of terms related to uncertainty and doubt that appear in each country's media outlets.
Economic policy uncertainty can lower trade growth in two ways, the study published by World Bank explains. First, in an uncertain environment, firms are likely to postpone investment decisions, consumers can cut back spending, and banks can increase the cost of finance. Second, policy uncertainty can affect trade volumes by influencing firms' decisions on whether to import inputs or invest in serving foreign markets.
The policy uncertainty also impacts global value chain (GVC)-related trade. This trade refers to the import or export of inputs as part of a production chain. As this requires larger upfront investments and is concentrated in capital-intensive sectors, policy uncertainty can affect these investment decisions. The authors find that, in the long run, GVC-related trade can be as sensitive to policy uncertainty as non-GVC related trade.