Increased tariffs are a significant part of President-elect Trump’s programme and the one most feared by investors. Various 2025 scenarios have emerged to suggest the application of these tariffs will be more nuanced; that Trump’s ambition is to "strike deals" rather than implement measures blindly, emphasising his negotiating talent over potential stubbornness. While attractive, this argument misses an essential point: it is no longer possible to anticipate a return to free trade in the coming decade. Populist parties may have criticised free trade in recent years, but it has widely-known qualities such as reducing wealth gaps between countries or capital profitability – at least in some cases. This week, Simply put assesses the structural consequences of ending free trade, particularly for emerging market (EM) countries.
Read also: Higher US tariffs: winners and losers
Trading to equalise economic disparities
For those of us who studied economics in the 1980s and 1990s, international trade theories constituted a significant part of the curriculum. Among these theories, Hecksher and Ohlin, revised by Samuelson (HOS), was a central element. In the 1930s, these two economists revisited an idea from the 19th century called ‘comparative advantage theory’ by David Ricardo. The short version of this theory imagines a country with abundant capital (cheap) but that lacks labour (expensive) trading with a country in the opposite situation. If these countries drop their tariff barriers and trade freely, the country with abundant labour will specialise in labour-intensive goods production and the other in capital-intensive goods production. In doing so, labour prices in the first country and capital returns in the second increase, equalising initial disparities.
There are a few case studies of this theory's application – the US and China being one. Since China entered the WTO in 2001, its wage growth rate has largely increased, while its capital returns (its scarce factor) have declined. For the US, the opposite has generally occurred: wage growth has slowed while capital returns have been maintained in real terms. This scenario is clearly visible in figure 1, which covers the 2001-2014 period: free trade contributed to reducing the disparities between the two economies. Obviously, the effects are more spectacular on the Chinese side and are not solely due to free trade. In any case, figure 1 supports the HOS theory.
FIG 1. Wage growth (left) and real rates (right)1
What the end of free trade could mean
A major lesson from this 20-year free trade example is that it has allowed certain developing countries to partially bridge their standard of living gap with G10 countries. An exit from free trade could thus interrupt this convergence process that has lasted nearly a quarter of a century.
And this is not theoretical, the process has already begun. Figure 2 shows that between 2001 and 2018, the GDP per capita ratio between China and the US increased from 2% to 16%, representing a considerable reduction in per capita income gaps between these two countries. The US hasn't particularly suffered: its per capita income increased from $37k to $60k per capita, effectively doubling over the period, whereas in the eurozone it has only increased from $20k to $39k over the period. Since 2018, when tariff barriers were first imposed, the convergence appears to have halted. The key point here is that behind investors' short-term anxieties lies a structural situation that has been taking shape for five years now: a slower convergence between emerging and developed markets that could be a factor for the decade ahead – and with investment implications that currently remain uncertain.
FIG 2. GDP per capita in dollars and ratio between GDP per capita between China and the US1
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What this means for All Roads
The current allocation of our All Roads strategy favours EM sovereign credit over our allocation to EM equities. We believe this positioning is consistent with the structural trend towards slower convergence between developed and emerging markets. While this trend likely doesn't compromise the solvency of emerging countries and their credit prospects, it could potentially weigh on the earnings growth of EM corporates and consequently impact equity performance. Even so, our allocation maintains the flexibility to revisit this positioning opportunistically according to evolving market trends.
Simply put, an exit from free trade could negatively impact the convergence between developed and emerging countries.
To learn more about our All Roads multi-asset strategy, click here. Macro/nowcasting corner
The most recent evolution of our proprietary nowcasting indicators for global growth, global inflation surprises and global monetary policy surprises is designed to track the recent progression of macroeconomic factors driving the markets.
Our nowcasting indicators currently show:
- Our growth indicators consistently underline the ongoing recovery environment, with 57% of data showing improvement over the past month
- There is a noticeable shift in our inflation signals: previously inflation surprises were both positive and increasing, while now they are positive yet diminishing, which bodes well for government bonds
- Monetary policy should maintain its accommodative stance across all analysed regions. In the US, the latest Federal Open Market Committee minutes corroborate the insights provided by our indicators
World growth nowcaster: long-term (left) and recent evolution (right)
World inflation nowcaster: long-term (left) and recent evolution (right)
World monetary policy nowcaster: long-term (left) and recent evolution (right)
Reading note: LOIM’s nowcasting indicator gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).
