Is The Trade Resurgence Sustainable?Knowledge Wharton
Amid reports of rising economic nationalism and potential trade wars, what gets missed is that the strong uptick in trade over the last two years looks likely to wind down even without the newest threats. Business should pause before associating this expansion with the trade bonanza of the 1990s and 2000s — trade’s golden years. In this opinion piece, economists Erik Lundh and Abdul Erumban of The Conference Board explain why the mega-trends that once turbocharged trade have lost much of their muster. Something else is afoot, and it looks all but certain that the trade recovery will be short-lived.
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Recently, the popular narrative surrounding international trade has involved nationalism, protectionism and trade wars. It may therefore come as a surprise to hear that global trade has been experiencing something of a resurgence.
After a decade of anemic trade growth, the last year-and-a-half has seen an acceleration. While some fear that growing trade tensions will damage this progress, even greater challenges are afoot. The reality is that the gains have been a cyclical response to the recent uptick in the global economy — an uptick that is temporary. The golden years of trade are not coming back; they never were.
According to economist Richard Baldwin, during the 1990s and 2000s three unusual megatrends coalesced and upended the nature of international trade. Ongoing advancements in transportation systems greased the flow of goods across borders. Second, rapid improvements in information and communications technologies unlocked new ways to fragment and disperse production networks, which led to the rise of global value chains. Finally, vast emerging markets like China opened to the outside world and became integrated into concurrently improving global trade frameworks – namely, the World Trade Organization (WTO).
Fast forward to today: These formerly disruptive catalysts have largely run their course and now hardly move the trade needle. Our research indicates that, instead, we have simply returned to an era where global supply and demand underpin the ebb and flow of global trade cycles.
“The appetite for improving international trade laws has largely evaporated. “
To better understand the current trade landscape, a detailed examination of these trends is necessary.
Throughout the 20th century, improvements in transportation systems allowed businesses to expand their geographical customer and production base. While advancements in this area were not unique to the 1990s and 2000s alone, this period saw sizable progress in air and sea freight that resulted in reduced shipping times, lowered costs and increased logistical predictability.
For example, increased efficiencies in air freight made it possible to rapidly ship components between factories across the world. In the 1980s, a bad batch of wires from a distant supplier could halt an assembly line for weeks, as new parts slowly made their way by boat. Rapid air delivery significantly reduced this turnaround time and made distance less of a factor.
These newly unlocked efficiencies widened established trade routes and allowed new ones to open. Today, incremental improvements continue, but not of the magnitude seen in previous decades.
Advances in Information, Communications Technologies (ICT)
Truly global production networks require more than just efficient transportation, however. They also require forms of communication that enable advanced coordination across great distances. Monumental leaps in information and communications technologies during the last two decades of the 20th century made this possible.
Prior to the 1990s, international business was fueled by faxes, telex machines, written correspondence, and expensive and oft-spotty telephone calls. Over the next decade, however, most of these forms of communications were replaced by email, transferable digital files, and cheap, high-quality calls. The impact of these staggering developments allowed global supply chains to take root and flourish.
While there have been some meaningful advancements in this area more recently, such as cloud computing and video conferencing, progress has generally been incremental. Indeed, most businesses continue to rely on the same core communications technologies that they did a decade ago.
New Markets, Improved Institutions
The 1990s and 2000s also saw big gains in the streamlining and standardization of global trade rules. Starting in the mid-1990s, the World Trade Organization (WTO) eased many geopolitical hurdles that had long closed the door to new markets. Among the new entrants to the global trading system was China, which had only recently reopened its borders following decades of self-imposed isolation.
“The current trade uptick is merely a cyclical response to a recovery in global GDP growth.”
The global integration of China and other nations, including Vietnam and Russia, into the WTO unlocked access to new resources and low-cost labor as well as new markets and sources of revenue. This enticed global manufacturers in advanced economies and brought a massive shift in global production footprints that accelerated trade.
The picture looks far different today. Many of these major markets have now been fully integrated into the global economy, and few large new markets exist to bring into the fray. Furthermore, the appetite for improving international trade laws has largely evaporated. Instead, protectionism appears to take center stage, as evidenced by America’s recent adoption of new steel and aluminum tariffs, and India’s rising customs duties on a range of products.
What’s Behind Today’s Trade Uptick?
With these three megatrends no longer delivering a strong economic punch, we believe the current trade uptick is merely a cyclical response to a recovery in global GDP growth. According to estimates from The Conference Board, global GDP growth accelerated to 3.2% in 2017 — a rise from 2.6% in 2016 and 2.7% in 2015. We expect 2018 global growth will improve to 3.3%. These improvements have helped bolster international trade by increasing imports from several key economies, including the U.S., the European Union and China.
However, in the medium term, a decade of slower growth appears all but certain. The global economy is facing both supply and demand constraints, including slower labor supply growth and rapidly aging populations. Furthermore, with the “long soft fall” in China’s economic growth already underway, the impetus from this key emerging market is limited. The likelihood that China’s slowdown will be fully offset by improvements in other emerging markets, like India, is small.
This global slowdown bodes badly for trade, as it will limit its natural course of expansion.
The Future Landscape
While trade growth looks unlikely to return to its heyday anytime soon, a few emerging megatrends have the potential to disrupt the trade landscape once again.
On the upside, further technological developments have the potential to fragment and globally disperse the production of services. Think of a doctor in India using advanced ICT and robotics to perform surgery on a patient in Indonesia, or the remote maintenance of machinery in Brazil by an engineer in Germany. At present, these kinds of activities have just begun taking root, but have the potential to be transformative in the years ahead.
On the downside, look to current advancements in manufacturing automation facilitated by robotics and artificial intelligence. These developments may allow manufacturers to avoid prohibitively high labor costs in advanced economies and relocate production facilities closer to their customers. Indeed, anecdotal evidence shows this may already be occurring.
In Germany, for example, Adidas is building a new high-automated shoe factory. And Casio will soon begin producing calculators back in Japan. The adoption of similar technologies could even lead to more production closer to final customers in emerging markets. The likely result: reduced cross-border trade.
What Firms Must Do
Because the global economy is on a slower growth path in the medium-term, businesses should investigate whether they can withstand significant disruptions arising from global economic and geo-political events. Can the firm stay afloat if a buoyant global economy isn’t there to provide cushioning for stressed sales and revenues?
Additionally, businesses should consider how existing manufacturing technologies might improve their production networks globally. Local production may now be a more pragmatic option than outsourcing or decentralized supply chains in some industries.
Finally, businesses should monitor – and experiment with – more exotic technological developments. Advancements in additive manufacturing, roboticization, machine learning, virtual presence and other fringe technologies are occurring, but have yet to seriously disrupt goods and services production. However, they may in the years ahead. As such, it’s best to have some experience with these technologies when the time comes to seriously adopt them.
Article by Knowledge@Wharton