With changing trade policy towards a more diversified economy

This article is based on the script of my remarks about Changing US Trade Policy and the Impact on Regional and Global Trade Pattern at TPM Asia, Shenzhen, China, on October 9th, 2019.

So far, the current United States (US) trade policy changes seem not to have caused the damage many feared. But this may change. “With no sign of a trade agreement, 2019 will be a difficult year; without a trade deal, 2020 may be worse,” an American Chamber of Commerce report stated.

We can hardly ignore the impact of the current US trade policy on regional and global trade pattern – and it's causing concerns and uncertainty in respect to future economic growth. While some countries benefit from the changes, other economies suffer. History shows that at the end there are no winners in a trade war situation. Nevertheless, the current developments may eventually lead to a more diversified, more balanced and more inclusive global economy.

Important to note is that the changes in global value chains (GVC) are not resulting entirely from changing trade policy. Many of the developments we are observing today are in fact consequences of structural system changes. Globalization is entering a new phase of growth and development, driving supply chains that are more locally and regionally concentrated.

A.     Global trade pattern started shifting in the mid-2000s

Supply chains are maturing and the digital transformation of the economy is showing its impact. Three major developments may proof that point.

1-     Goods production value chains became less trade intensive

Exports declined from 28.1 to 22.5 percent of gross output in goods production value chains, according to a McKinsey Global Institute paper. Outputs continue to grow in absolute terms, but the share traded across borders is in decline. At the same time, cross-border services are growing more than 60 percent faster than trade in goods. The trade services market already exceeds that in goods when measured in value-added terms. This is a threat for goods trade but also an opportunity for the more technologically savvy and digitally advanced economies to leapfrog.

2-     Labor-cost arbitrage is in decline

Global value chains are becoming more knowledge-intensive and reliant on high-skill labor. Today, less than 20 percent of goods trade is based on labor-cost arbitrage. In many value chains, that share has been declining over the last 10 years. Across all value chains, the investment in intangible assets, such as research and development, brands, and intellectual property, has increased from 5.5 to 13.1 percent, since 2000.

3-     Goods value chains have shortened

With technological progress and the ability to ensure good levels of quality in far-away factories, with the move towards higher added-value products and the reduced reliance on intermediate inputs, with the rise of emerging markets’ share of global consumption by roughly 50 percent over the last decade, with consumers demanding instant gratification which makes speed to market a critical competitive factor, and the rising trade and economic uncertainties that require flexibility and resilience, goods production value chains have been becoming increasingly locally and regionally concentrated. Especially in automotive, computers and electronics in Asia and Europe. Today, emerging and developing nations are consuming more of what they produce, while exporting a smaller share.

B.    The impact of trade policy on the flow of goods

The changes in US trade policy has caused a significant redesign of global manufacturing networks and with it shifts in production value chains.

1-    Some countries help to fill the supply gap

“Mexico picks up exports where China slips”, Bloomberg wrote some time ago - analyzing the 2018 growth of certain product categories. Newly established Chinese factories in the NAFTA member state increased Mexico to US exports.

In the Asia region, India, Malaysia, Thailand, and Taiwan saw upticks in exports to the US in 2018. In 2019, Viet Nam is exporting 40 percent more to the US than in the same period in the previous year. Vietnamese exports to the US account for 26 percent of the country’s gross domestic product (GDP).

On the other hand, trade-reliant economies are hit. With escalating US-China trade tensions, Singapore for example has cut its forecast for economic growth to almost zero for this year. As a reference, German export driven economy shrunk by 0.1 percent in the second quarter of 2019.

2-    World economic growth is sluggish

“…while trade disputes between China and the United States may create opportunities for a few countries, the overall effects on the global economy are negative”, we can read in the United Nations World Economic Situation And Prospects: September 2019 Briefing, No. 130. The World Bank (WB) expects global growth to weaken and sees substantial risks going forward.

In June 2019, the International Monetary Fund (IMF) downgraded its outlook for the world’s economic output and warned that US tariffs on European cars, a no-deal Brexit and a trade war with China could tank the global economy. The organization expects the global economy to expand by 3.2 percent in 2019, down from the 3.6 percent in 2018. Growth in advanced economies is projected at 1.9 percent in 2019 and 1.7 percent in 2020, while emerging and developing economies are expected to grow at 4.1 percent in 2019 and 4.7 percent in 2020.

3-    Clouds at the horizon

Trade disputes can dampen domestic demand growth in the major economies, namely China, the US and Europe. In the first half of 2019, world semiconductor billings declined by almost 15 percent compared to the same period last year, according to the WB September 2019 Briefing. Production of automobiles in the US contracted 3.4 percent in 2018 and declined further 2 percent in the first seven months of 2019. The automotive industry in the European Union (EU) suffered a decline of over 10 percent in the first half of 2019. The automobile sector is deeply embedded in global value chains (GVC) and therefore highly sensitive to disruptions in trade. Falling demand in China, new environmental standards and changing consumer behavior towards car and ride sharing are the pressures mentioned by industry experts.

In many developing economies, including Mexico, the Republic of Korea, South Africa and Singapore, investment growth has slowed. In the Asian region, Japan’s export volumes declined by 5.6 percent over the first half of 2019, compared to the same period last year. Japanese import volumes fell by one percent. In the second quarter of 2019, exports contracted across most East Asian economies. The largest decline experienced Indonesia, the Republic of Korea and Singapore.

The latest change in US trade policy will not help neither to raise confidence in the global economy. The list of hundreds of European products that will get new tariffs, includes cookies, salami, butter and yogurt, German camera parts, and cashmere items and wool clothing produced in the United Kingdom (UK). The primary target of the US tariffs is Airbus aircraft manufactured in the EU. This could also hurt US airlines such as Delta that have billions of dollars of Airbus orders waiting to be filled, reported Reuters.

C.      How trade policy might impact the future competitive landscape

We might see the impact of the changing US trade policy only in the long run. Economies are adjusting or accelerating their policies. Companies are modifying their manufacturing and supply networks. Advanced economies protect their interests, developing markets open up.

1-     Companies are redesigning their supply chains

Those businesses that can, redesign their supply chains. Mexico, Viet Nam and Thailand have become more strategic in the setup of manufacturing networks. Even if the disputes were to end tomorrow, chains would probably not bounce back to the shape they had before the tensions started. People were reminded of the benefits of geographic diversification. Customers demand higher speed to market. The shifts in supply chains are expected to make the region more inclusive and Asia’s economic ecosystem more balanced.

2-     China is accelerating economic reforms

China has been left with no choice but to advance its economic restructuring. The move into high value-added production has become critical for China’s future development. The country needs to learn to produce microchips, as China might not be able to purchase them from Intel and Qualcomm as before. Temporarily, the US-China trade dispute may play into the hands of technology companies in Japan and Republic of Korea. In the longer-run, Chinese companies will supply their home market. Furthermore, the China government will help Chinese companies to internationalize and compete on foreign markets.

3-     The competitive landscape is likely to change

By moving up the value chain and expanding into foreign markets, Chinese companies will increasingly compete with current, mainly western-based, incumbents. China is also expected to continue driving the belt and road initiative (BRI) to gain new partners, allies and customers. With the BRI, China’s political influence is only to grow. Intra-Asia links and infrastructure will be further strengthened, needed to realize a more balanced regional market.

Conclusions

While protectionism seem to be here to stay for some time, increasing global connectivity will continue to drive economic integration. The large economies, like China, the US and Europe will seek to protecting their turfs. Their multinational (MNC) companies compete on the grounds of those countries that need openness to reap the benefits of global trade and move up the value chain towards more diversified economies.

High performance logistics and transport companies will continue to be critical for GVC. Forwarders and carriers need to prepare for shorter supply chains built around factories, connecting them closely with customers and consumers. The opportunities for the logistics and transport industry are clearly not disappearing but certainly they are changing.