* Financial crisis has hit trade hard
* Not clear if trade disruption could limit output recovery
* Many economists say trade will pick up faster than output
By Jonathan Lynn
GENEVA, Aug 11 (Reuters) - As signs grow that the worst of the global slowdown is passing, fears are being voiced that world trade could hold back the recovery.
The answer depends on whether trade is seen as a reflection of the broader economy or a transmission belt for the downturn. The links between finance and trade are still little understood.
World trade has experienced its biggest contraction since the 1930s -- much sharper than the fall in economic output.
Some economists argue that damage to trade finance and global supply chains, and a series of open and furtive protectionist measures in the meantime, could hamper the recovery in trade, and with it the rebound in output.
"There is good reason to fear that trade growth will lag rather than lead any recovery, and that this will itself constrain the pace of recovery," consultants PFC Energy said.
Globalisation -- the integration of the world economy -- could go into reverse as national self-interest takes priority over the promotion of trade, they said in a recent note.
REBOUND
Yet behind the continuing headlines of contracting trade, the first signs of a recovery are also evident.
Of 18 countries reporting trade data for June so far, almost all show a rise in imports and exports over the previous month, said World Bank senior economist Caroline Freund.
"Although trade was still 25 percent lower than in June last year, this is the first generalised spark in trade flows since the beginning of the crisis," she said in a blog last week.
A study by Freund on the policy portal VoxEU.org concluded that trade would contract overall by 12-20 percent this year.
But, like many economists, she forecasts a powerful bounce.
"In terms of the rebound in trade I think it will be fast -- that's what's happened in previous episodes, so that trade falls fast but it also comes up really fast," she told Reuters.
Why trade has contracted so sharply in the current downturn is still being debated.
It seems the financial crisis that triggered the downturn delivered a triple blow to trade, Ronald McKinnon, emeritus professor of economics at California's Stanford University, told a recent symposium in the magazine International Economy:
-- it created insecurity, and when incomes fall and people and businesses feel less secure they can easily postpone purchases of manufactured goods and consumer durables -- the goods that are traded most;
-- the risk of bank insolvency dried up trade finance, which is used to fund 90 percent of the $16 trillion in world trade;
-- malfunctioning wholesale financial markets made it hard for exporters and importers to hedge currency transactions.
Great uncertainty remains over what will happen now to the financial sector, and how that affects trade.
A combination of protectionism and re-regulation after the crisis is putting banks under stricter national control, which could affect cross-border financial integration, said Nicolas Veron, research fellow at the Brussels think-tank Bruegel.
No one predicted that the financial crisis would be transmitted to trade in the way it has been, he told Reuters.
"There seem to be some deeper linkages between the financial system and the real economy than was traditionally assumed."
SUPPLY CHAINS AND FINANCIAL INTEGRATION
But the fact that trade has risen and fallen more strongly than output in the past 50 years leads Freund and others to suggest it will again rapidly outpace economic growth.
In the 1960s trade grew twice as fast as output, but in recent years it has grown more than 3.5 times as fast, said Freund, who has studied the elasticity of trade to income, as this relationship is known. In recessions, trade contracts nearly 5 times as fast as output, she said.
One reason is the growth of global supply chains.
Many goods such as mobile phones or digital cameras use small pieces that cost almost nothing to trade, so it makes sense to source them from different countries.
Trade elasticity grows if there is more of an incentive to outsource when demand is high. An increase in GDP that prompts more outsourcing will lead to a bigger increase in measured trade as more parts travel round the world to be assembled.
For example when a U.S. family decides not to buy a Cayenne sports utility vehicle, German exports go down by $40,000.
But Slovak exports to Germany also go down by about half that amount -- because while the final assembly of the car takes place in Leipzig, the coachwork is made in Bratislava.
For a mobile phone made with dozens of components, this magnifying effect can be huge.
Once global demand returns, so the theory goes, the economic logic for outsourcing parts and assembly will reassert itself. (For the full International Economy symposium go to http://www.international-economy.com/TIE_Sp09_WorldTrade.pdf ) (For the full article by Caroline Freund on VoxEU.org go to http://www.voxeu.org/index.php?q=node/3731 ) (For Caroline Freund's blog go to http://crisistalk.worldbank.org/2009/08/a-spark-in-international-trade.html )