Trade policy uncertainty is at all-time highs—and that’s bad news

Trade policy uncertainty is at all-time highs—and that’s bad news

Policy uncertainty is at an all-time high and that has trade and investment looking down. Photo: ADB

By Abdul Abiad, Irfan A. Qureshi

After 500 days of trade conflict, policy uncertainty is growing worldwide and the negative effects are being felt.

We are now 500 days into the current trade conflict, which started when the United States imposed tariffs on $10 billion worth of imported washing machines and solar panels on its trading partners on January 22, 2018. Through the course of 2018, tariffs have been imposed on almost half a trillion dollars’ worth of goods, by the US and by its trading partners in retaliation.

This rise in tariffs has had negative effects on the parties involved and on the global economy, but a distinct and potentially important concern relates to trade policy uncertainty and its impact. Trade policy uncertainty may cause firms to postpone investment decisions until the uncertainty is resolved, affecting economic activity.

To measure trade policy uncertainty, we build on the news-based index in the 2016 study, Measuring Economic Policy Uncertainty. These indicators are based on the number of news articles that mention trade policy uncertainty, capturing the degree of uncertainty that the public perceives about trade policy actions. While the original measure of the study captured US trade policy uncertainty in general, we have refined it to capture US trade policy uncertainty vis-à-vis Asia.

US Trade Policy Uncertainty vis-a-vis Asia, 1985-2019

This analysis indicates that this uncertainty is now at an all-time high. If we look at a country-specific trade policy uncertainty measure for the People’s Republic of China (PRC), we see that it was high in 1995 during a US–PRC trade conflict over intellectual property rights and was also elevated in the late 1990s and early 2000s when the PRC was in the process of joining the World Trade Organization. The uncertainty began rising again in 2016 during the last US presidential election campaign and in 2017, spiking to all-time highs in 2018 when the current trade conflict began in earnest.

  Trade conflicts increase uncertainty and decrease investment

We have also analyzed the effects high trade policy uncertainty can have on investment. We capture these by estimating a “vector autoregression model” similar to that used in the 2016 study. We find that periods of high trade policy uncertainty in the PRC—like those observed in 1995, the early 2000s, or at present—have statistically significant and measurable effects on PRC investment. Spikes in trade policy uncertainty tend to depress investment by one percent in the three quarters after the shock. There is no significant effect on investment beyond the third quarter. Our empirical results indicate that domestic firms may postpone investment decisions until uncertainties in trade policy are resolved.

PRC Trade Policy Uncertainty

What does this mean for policy? First, it suggests trade conflicts—or even just the threat of conflict—can have negative economic effects by increasing uncertainty and decreasing investment. There are tangible benefits to greater policy predictability and certainty. Second, our global trading system is in dire need of mechanisms for rapidly and fairly settling trade policy disputes.

This blog post is based on research from the April 2019 Asian Development Outlook.