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IMF Chief Says Trade System is in Danger of Being “Torn Apart”

Making it clear that President Xi Jinping’s recent speech on opening up China’s market and cutting back on tariffs was in no way a concession to the United States, China’s Commerce Ministry said Thursday that the country will be ready to hit back if the trade tiff with the U.S. continues to escalate.

As such, it may be too early to take talks of a trade war off the table.

But current relations and the air of protectionism, according to International Monetary Fund managing director Christine Lagarde, have left a trade system long rooted in rules and shared responsibility, “in danger of being torn apart.”

In a speech outlining the priorities for global trade at the University of Hong Kong, Lagarde said the global economy is currently experiencing an upswing that could afford the world higher incomes and living standards—though policies and actions haven’t aligned with capitalizing on that growth.

“The window of opportunity is open,” Lagarde said. “Yes there is new urgency because uncertainties have significantly increased—from trade tensions, to rising financial and fiscal risks, to more uncertain geopolitics.”

For now, according to Lagarde, the outlook for the economy is “mostly bright.”

“We see global momentum—driven by stronger investment, a rebound in trade and favorable financial conditions—which is encouraging companies and households to increase their spending,” Lagarde said.

The favorable outlook led the IMF in January to project global growth of 3.9% for this year and next.

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Advanced economies are expected to grow above their potential, with Europe seeing an upswing that’s better spread across the region, and the U.S. enjoying further accelerated growth thanks to an expansionary fiscal policy. The outlook for Asia continues to be positive, with growth led by China and India, which are both enjoying rising exports and increasing domestic consumption. Challenges remain in Sub-Saharan Africa, though Lagarde said commodity exporters are seeing a “modest upswing.”

This aside, however, Lagarde said, “We can see darker clouds looming.” And those darker clouds could take the form of slowing economic growth.

“It will slow because of fading fiscal stimulus, including in the U.S. and China; and because of rising interest rates and tighter financial conditions as major central banks normalize monetary policy,” Lagarde said. “Add to this the issue of aging populations and weak productivity, and you have a challenging medium-term outlook, especially in the advanced world.”

The No. 1 solution Lagarde offered for skirting the slowing growth scenario is to “steer clear of protectionism in all its forms.”

Import restrictions, she said, lead to more expensive products and limited choices, and they prevent trade from helping to boost productivity and the spread of new technology.

“As a result, even protected industries eventually suffer as they become less dynamic than their foreign competitors,” Lagarde explained. “And yet, discussions about trade restrictions are often bound up with the concept of trade deficits and surpluses. Some people argue that these imbalances indicate unfair trade practices.”

Hinting directly at the goings on between the U.S. and China—and the U.S. and much of the world when it comes to trade deficits—Lagarde said unfair trade practices have little impact on a country’s overall trade deficit, which is driven more by a country spending above its income. Offering an example, she said a country focused on assembling smartphones will tend to have a trade deficit with the country that produces the components, but a surplus with the countries that buy the finished phones.

“The best way to address these macroeconomic imbalances is not to impose tariffs, but to use policies that affect the economy as a whole, such as fiscal tools or structural reforms,” Lagarde said.

Countries have a responsibility to help improve the global trading system by playing by the rules, curbing policy distortions that favor themselves, better protecting intellectual property and abiding by rules they signed up for as members of the World Trade Organization, Lagarde explained.

“But that system of rules and shared responsibility is now in danger of being torn apart,” she said. “This would be an inexcusable, collective policy failure.”

The answer, according to Lagarde, has to be reducing trading barriers and settling disagreements without turning to “exceptional measures” as a solution. It will also be rooted in supporting developing countries to increase trade in services, and digitizing governments to facilitate greater efficiency.

“We need that spirit of cooperation to avoid protectionism—and to sustain the global upswing,” she said.