So far, it has been the scary monster that has stayed in the forest. Economists have been worrying for at least two years, in some cases more, about the potential impact on the world economy of an American recession. Financial markets really began to worry about it only in February, when trouble in the American home mortgage market first emerged and briefly made investors wonder whether they had under-rated the level of risk, all over the world. That is why the International Monetary Fund felt obliged, in the latest edition of its twice-a-year “World Economic Outlook”, to devote a chapter to the possible effect on the rest of the world of an American economic slowdown. Its conclusions were sanguine: as long as that slowdown is not severe, the global impact should also be mild.

            That is certainly what the arithmetic seems to say, and the experience of previous American recessions during the past few decades confirms it. Unless the world’s largest economy is slumping for reasons shared with a lot of other countries, such as an oil-price shock, then others should quickly be able to decouple themselves from an American slowdown. Since the current mild slowdown is occurring for domestic American reasons, namely falling residential property prices, the impact on others should also be mild. But, being economists rather than political scientists, the IMF’s analysts may have missed out the most important reason to be rather more fearful. Clues to it lie, nevertheless, in another chapter of the IMF’s “World Economic Outlook”, one devoted to the globalisation of labour. By that, it means the effect on workers worldwide of the arrival of a huge new supply of labour in China, India and the rest of East Asia.

            America’s fortunes are bound to have an impact on the rest of the world for as long as it continues to account for such a large share of global output and, more important, global trade. Despite rapid growth in China, India and other emerging markets, the United States still accounts for one-third of global output. Its share is smaller if you adjust GDPs for “purchasing-power parity” (PPP), i.e. for the fact that prices are lower in poor countries and so incomes stretch further. But while such adjustments are necessary if you want to compare living standards, they are irrelevant if you are looking at countries’ global impact. That takes place chiefly through trade, and trade takes place at market exchange rates, not PPPs. America accounts for nearly 20% of world imports. So if its consumption drops during a recession, anyone exporting to it is sure to suffer. Latin American countries, for whom more than 50% of their trade is with the United States, would be the worst affected.

            How severe that direct effect would be will depend, obviously enough, on how severe America’s recession or slowdown turns out to be. Until now, it has been pretty mild. Employment growth has remained remarkably strong, despite the slump in the housing market. Unemployment has stayed low or even fallen in some months, a trend that if it is sustained will support both incomes and consumer spending.

            Something else, though, has also got under way in the past couple of months that may portend a less happy set of circumstances. It is the presidential election campaign for 2008 which, in accordance with American tradition, has begun well over 18 months ahead of the actual vote. This campaign is coinciding with an extremely weak incumbent president, one who is struggling to get any of his initiatives through Congress. The effect can already be seen on trade policy. And it is in trade policy that the most worrying linkages between the American and global economies may turn out to lie.

Paper and protectionism

The worst omen during April had a Chinese flavour to it. It was the decision by the White House to take action against Chinese paper exporters to the United States over the allegedly unfair effects of subsidies, through cheap loans, on the paper companies’ pricing. Whether or not this accusation is justified is not important, for the time being. There are plenty of Chinese industries that could have been accused, at any time in recent years, of gaining an unfair advantage through the cheap, often costless, loans they receive from state-owned Chinese banks. What is important right now is that the White House chose to take action. The reason must be that it is feeling that the domestic politics of trade are getting hotter.

            This is partly because the Bush administration is so weak, and yet despite its frailty still wants to get trade deals passed by Congress. It has just negotiated, for example, a bilateral trade deal with South Korea, which will lapse unless Congress votes to  approve it. Now that the Democratic Party has a majority in both houses of Congress, the White House has to try a lot harder to gain its support. An anti-Chinese gesture, such as the action against the paper firms, may be calculated to show that the Bush administration is being tough on trade, so that bilateral preferential trade deals like the Korean one should be supported. China is, after all, the favoured target of Democrat protectionists.

            Although this explanation is probably true, it is almost certainly inadequate. The mood in America has turned against free trade. The belief that China’s huge trade surplus represents unfair behaviour at America’s expense is growing. It is growing despite the fact that American unemployment remains low.

            The reason lies in incomes, not in unemployment. As the IMF’s chapter on labour showed, the share of national income going to labour has fallen steadily over the past 15-20 years, under the influence of information technology and globalisation. Skilled workers have not fared badly. But unskilled workers have been hurt, with their incomes flat or even falling. Competition from the huge supply of cheap unskilled labour in countries like China is the reason. Democrats, with congressional districts in traditional manufacturing areas and with strong trade union backing, are always sensitive to pressures from ordinary workers and their unions.

Now, as Democrats struggle to find the right tone of voice and policies to propose on the central issue of American politics, namely the war in Iraq, the likelihood is that the policy debate during the Democratic primaries will increasingly move to the topics of inequality, of wages, and of trade. That has been made likelier by the fact that the Democratic frontrunner, Hillary Clinton, clearly has a serious contest on her hands. The ability of Barack Obama, the charismatic and talented black senator from Illinois, to almost match Mrs Clinton’s fundraising during the first quarter of 2007 shows that the party and its supporters are deeply divided between them. The third strong Democratic candidate, John Edwards, who comes from a textile-producing area in the Carolinas, is bound also to use trade as his main drumbeat.

Threats made during an election campaign don’t necessarily matter. But the chances are that the American economy will indeed be slowing down during the rest of 2007 and into 2008, and unemployment will start to rise. That could set a tone for the new administration and new Congress in 2009 that is strongly protectionist; and between now and then, the Republicans will also seek to show that they take tough stands against Chinese unfair trade. It is through such political amplifying mechanisms that a mild downturn in America could actually have a much bigger impact on world trade and thus the world economy than the IMF’s economists currently think. To paraphrase, or perhaps subvert, the 1992 Clinton campaign slogan, “It’s the politics, stupid”.