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View from Davos January 2 2014

The new bridges of world trade

Trade is changing. Flows between emerging markets continue to develop, high wages are sending some production back to Europe and the US, meanwhile Africa is making a bid to stem its reliance on raw commodities.
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The new bridges of world trade

Trade between the world’s emerging markets – the imprecisely defined South-South trade – has been the big growth story of the past decade. While trade involving a developed country still represents the vast majority of total global trade, the proportion has been decreasing. Corridors between emerging economies, on the other hand, are expanding fast. According to the World Trade Organisation (WTO), South-South trade has doubled as a percentage of global volumes in the 20 years to 2011 to reach almost $20,000bn. And with world exports representing more than 30% of global gross domestic product (GDP), cross-border trade will continue to be the fastest way to prosperity for developing countries.

The importance of international exports has been recently highlighted by the symbolic, although timid, first global trade deal ever reached by the WTO since it began in 1995. During the WTO’s ministerial conference in Bali last December, the 159 member countries agreed to set common custom standards and ease the flow of goods across borders.

Different routes

At the same time and because of past WTO tardiness, other major trade agreements are being forged, such as the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnership, which are both in outline form.

“You move at a regional level, you move at a multilateral level; [these partnerships] reinforce each other. I think that the world trading system is heading along a very positive course,” says C Fred Bergsten, director emeritus and founding director of the Washington-based Peterson Institute for International Economics.

If the international trade system is on a positive course, there are many economic and geopolitical factors that can still influence its speed and direction. For example, Ukraine's trade structure would change if it had successfully concluded talks with the EU. As it is, the backing away from any deal by the government has caused street protests. Instead the government may forge a closer relationship with Russia, involving different trade flows.

Currently, with some developed economies such as the UK showing signs of economic recovery, prospects for traditional trade flows are strong again. At the same time, the preponderance of growth in emerging and even frontier markets is leading to new opportunities in South-South trade. There are, for example, hopes for new trade routes between fast-growing Turkey and post-conflict Iraq. These are the new bridges of world trade.

New China

When looking at new trade flows, the first example to examine is China. According to WTO data, China’s exports and imports of goods and commodities have gone from about $120bn in 1990 to $3867bn in 2011, and represent about one-fifth of the world’s total trade. Despite China’s economic slowdown, its $8200bn GDP will continue to fuel international demand for raw materials. Its funding muscle and ability to sustain loss-making investments abroad to secure commodities is leading to major developments in China's trade structure.

Key changes are taking place with regard to trade currencies. Tireless efforts of Chinese officials to push the renminbi as an international clearing currency have led to many swap lines being signed around the world. The English-language newspaper China Daily reported late last year that the country had for the first time allowed roubles to circulate unrestricted in its territory, in Suifenhe, in Heilongjiang province, on the border with Russia. China's intentions are to forge better trade relations with Russia. Some observers expect this to be reciprocated so that renminbi can be traded freely across the border. 

In recent years, the traditional export trade corridor from China to Europe and the US has been joined by the growth in intraregional trade in the Asia-Pacific region and other South-South flows. One of the most improved corridors between emerging markets is that between the Asia-Pacific and the Middle East, which now represents more than 5% of global trade and is explained largely by exports between China and India and the United Arab Emirates.

In addition to this, dramatic changes have taken place in China-Africa trade flows. Traditionally, Africa regarded its agricultural commodities as something to be harvested as quickly as possible so they could be swiftly sold off and monetised, says Edward George, head of soft commodities research at pan-African lender Ecobank. The vast majority of cotton produced in Africa, for example, is still exported unprocessed to China, which then sells textiles and threads back to the continent, satisfying almost entirely its import needs.

Share of total trade between geographical regions in world trade in 1990
Share of total trade between geographical regions in world trade in 2011

Raw potential

An even more pertinent example is the trade in cashew nuts. The world’s highest quality cashews are to be found in Guinea-Bissau but, again, these are exported completely unprocessed while the highest profits are captured by processors elsewhere.

According to the Food and Agricultural Organisation of the UN, Africa produced 1.8 million tonnes of cashew nuts in 2011, 42.4% of world production. However, at least 90% of these are exported raw to India, Vietnam and Brazil, the world’s leading processors of cashews. “It is one of the most interesting trade flows between Africa and south-east Asia. If [producers] did process them and shell them in west Africa, they would double the value overnight,” says Mr George.

India has made the cashew problem worse. The country has reduced exports of the processed product because internal consumption has risen, leaving a gap in international supply. Africa’s prolific raw cashew supply is saturating that end of the market. Investing in the right processing machines, which reduces the not-irrelevant health risk of shelling cashews by hand, could take the trade to a new level.  

This may be on the cards. Multinational food company Olam invested in the untapped potential of the cashew sector and in 2012 it inaugurated the first fully mechanised factory in Côte d’Ivoire, the largest producer of cashews at 500,000 tonnes per year. The facility is one of the world’s largest. If the market continues to develop and is appropriately regulated, this investment may well lead to others in the future.

Further, the African Development Bank's Annual Development Effectiveness Review, released last year, boasted that one-third of Africa's countries that achieved GDP growth rates of more than 6% were largely driven by the private sector’s improved governance and a better business environment. This is mirrored in exporters’ plans for the future.

Specialist investors and the continent’s development bodies are not the only ones to recognise the beginning of structural change in Africa. Jim O’Neill, the former head of asset management and economics research at Goldman Sachs, who coined the term BRIC to describe the emerging economies of Brazil, Russia, India and China, writes in an opinion piece for The Banker that “in Africa, many economies are showing few signs of slowing, despite the turn in commodity prices, which lends support to the view that there is something more fundamentally positive occurring in these countries… It was encouraging on a recent visit to hear African policy-makers say that their future depended on themselves and not China.”

Volatile arbitrage

The cashew case is also indicative of how changing consumer patterns are affecting global trade. While the nut is hardly a luxury item, India’s growing demand indicates a change in consumption patterns by the growing parts of the population entering the middle class.

Sameer Mohan Sehgal, head of trade finance for Europe, the Middle East and Africa at Citi, says this is now apparent in other countries too. “The consumption pattern is changing in some emerging markets. It used to be that production was in emerging markets with a lot more consumption in developed markets. With the growth of the middle class and surplus income in developing economies, international trade is becoming mainly an emerging market-to-emerging market flow.”

Lower unemployment and higher wages have helped expand those middle classes but, on the flip side, they have also made the labour markets of those countries less appealing to multinationals looking to move manufacturing offshore. This, once again, is reshaping trade flows. Wage levels in China, for example, have increased continually during the past two decades, doubling over the past five years. There have been similar cases in other large emerging economies that have been ‘priced out’ of the labour arbitrage game, notes Bartosz Pawlowski, global head of emerging markets strategy at BNP Paribas.

“If I look at manufacturing wages in Turkey over the past four years since 2009, they have effectively doubled, while manufacturing wages in Poland and in South Korea have gone up by only 20% to 25% over the same period,” he says. “While countries in south-east Asia and central Europe benefited from the globalisation of supply chains and flows within emerging markets, some bigger economies that previously had attracted lots of investment have now become too expensive to take advantage of [labour arbitrage].” This applies to Brazil and India too, he adds.

Enter the eurozone

But while wages in some fast emerging markets have risen, labour markets in the industrialised world have weakened. In the eurozone, still afflicted by an economic crisis, Portugal is a case in point. The country is battling with high public debt, severe austerity measures and painful unemployment, but it has recently been very successful in growing its exports, which went from 28% of GDP in 2009 to 41% in the first half of 2013. About 15% of its population is out of work, with a much higher percentage in the case of young adults. However, most workers are skilled, wages are lower and the country’s infrastructure compares well with that of many emerging markets, allowing Lisbon to compete with Mumbai for international business.

“I keep on telling investors when we talk about global trade flows that we have a very big new competitor at hand, and this is the periphery of the eurozone,” says Mr Pawlowski. “Nobody in the past would even consider putting manufacturing factories in Portugal as opposed to Brazil or Poland. I’m now hearing about companies in Portugal suddenly competing with companies from India to win call-centre business. You can be as bearish as you want on Portugal, Spain or Greece, but they have better skilled workforces and infrastructure than many emerging markets. This is taking away some of the trade opportunities from those [other] markets.”

Similarly, in the US, companies including General Electric, Whirlpool and Caterpillar have announced their intention to bring some operations back home because of higher Chinese wages and rising shipping costs, which make Asian production no longer as competitive. This is coupled with a more flexible labour market in the US, as well as efforts to shorten supply lines and reduce inventory by manufacturing products closer to where they are sold.

The shale-gas boom is also strengthening the case for ‘reshoring’ plants as it greatly reduces US energy costs. Protection of intellectual property – often disputed in some developing countries – plays a role too.

“I think it is fascinating that we are hearing a lot of anecdotal evidence of companies thinking about bringing manufacturing back to the US because of cost,” says Mr Pawlowski. “It is cheaper because it is easier to find labour in the US or in Europe – markets there are pretty weak – and because emerging market wages have gone up significantly. Logistically, the cost of running multinational operations is not negligible, so at some stage it becomes attractive to bring manufacturing back.”

Others, however, are less enthusiastic about such evidence. These include the Peterson Institute’s Mr Bergsten, who believes that despite the headline-grabbing examples, these cases are still too few to project a trend. The US, he says, has considerable challenges to overcome to become a competitive manufacturing hub.

South-South trade will very likely continue to be the next decade's buzz term, but the map of global flows may look very different in the next 10 years. Countries competing for multinationals’ offshore business and servicing consumers’ international demand are changing. The race is on and there is everything to play for.

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Silvia Pavoni is editor in chief of The Banker. Silvia also serves as an advisory board member for the Women of the Future Programme and for the European Risk Management Council, and is part of the London council of non-profit WILL, Women in Leadership in Latin America. In 2019, she was awarded an honorary fellowship by City University of London.
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