Trade is War – and the fight regional

Exposure to US-China Trade

Trade is War – and the fight regional

Pin-insights

Trade has rarely been free, global trade agreements may just have been a 'blip' and regional trade agreements to gain momentum

The United States, along with Canada and Mexico, are driving the shift away from popular acceptance of the terms of trade

The European Union probably will follow in lock-step because the Single Market cannot be overrun by China’s production

It is too early to draw conclusions for emerging markets – and especially about South-East Asia – but we might be tempted to guess

 

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Since Adam Smith and Ricardo, economists have given a theoretical backing to flourishing global trade based on the comparative advantage countries share with one another

Simply stated, a country may be more efficient in the production of all commodities but, the production of some goods being relatively more advantageous, that country still will find beneficial to specialize in those products and import the others from less efficient countries

Creating flows of international trade where less efficient countries are not shut out, but where they provide the complement more efficient countries do not care to produce, the Ricardo model of two countries and two commodities still underpins much of the global thinking

Meant as a simple presentation of a general rule, it will be intuitively understood that by introducing multiple commodities and multiple countries, the model generates complex calculations in a smooth continuum of ‘relative’ advantages

But continuity will make relative advantage less straightforward on an economic plane, and even less of a guideline in intra-governmental relations

This is not to suggest that most economies have not found considerable advantage to global trade, as empirical observation confirms day after day

Source Our World in Data - Federico, Giovanni and Antonio Tena-Junguito  (2016 b)

The fact is well-know : the first ‘container ship’ conceived by Malcom McLean, a converted WWII – T2 tanker, refitted to carry containers on and below deck, sailed from the Port of Newark (New Jersey) for Houston (Texas) in April 1956, carrying fifty-eight 35-foot containers...

T2 tanker - August 1943

The considerable savings of intermodal shipping container logistics, from longshoreman hand-loading at $5.86 a ton to container transfer at $0.16 a ton, fits the dramatic expansion of international trade, multiplied by 20 at constant prices beteen 1956 and 2014

Source - Maersk Madrid - Triple-E class vessel - capacity 20,568 TEUs

(1) TEU (Twenty foot Equivalent Unit) is the unit of the capacity of a container ship

Facilitated by, and in parallel with, the revolution in logistics, trade is linked to economic growth by way of global economic integration, highlighting such factors as

  • sharpening of competition, encouraging productivity-enhancing investments
  • economies of scale, with the large volumes generated by worldwide demand lowering unit prices
  • innovation, with fast dissemination of technological research and industry standards

 

While every one of these factors is beneficial to national economies, none of them can be tied strictly to pre-existing comparative advantage

More realistically, it can be shown that most developing countries, and specifically the Asian ‘tigers’, have managed to transform their economies, by way of capital accumulation,

  • from a low-cost base of labor-intensive commodities, verifying the comparative advantage model at its most basic, 
  • to manufacturers of technologically advanced products, creating a strong investment base along the way

 

An attractive alternative to war

At every stage, governmental interference in trade relations keeps the national interest on the forefront

As a source of wealth, and of national security, the protection of the internal market by large economies is an all-time favorite,

  • from China’s centuries of controlled trade
  • to 17th century France nurturing state manufactures and merchant fleets
  • to U.S. protectionism, following the Civil War, insulating America's growing industries
  • and  to 19th century British Empire world dominance

Access to ports was a key source of taxation, – with entry to 16th century Spain’s American colonies limited to Spaniards on Spanish ships – or constrained even more by Japan, allowing one trading post, Dejima, in the bay of Nagasaki, and one trading company, the Dutch East India Trading Company (VOC), for … two centuries from 1641…down to 2 ships per year in the 18th century

Two Dutch ships and numerous Chinese trading junks in front of Dejima at Nagasaki Bay, circa 1820

Protection of natural resources for the national economy has been another favorite, driving national policy no less persistently,

  • from the 1669 edict of Colbert, Minister of France’s Louis XIV to reorganize the management of the French forests for ship building
  • to the quite recently lifted (Dec. 2015) ban on the export of U.S. crude oil stemming from the 1920 Mineral Leasing Act
  • or the China’s control over production of rare earths, elements used to make electric vehicles and consumer electronics, already called a “significant and growing risk,” according to a Pentagon study

And unequal treatises facilitating entry of industrial goods on less advanced markets have been too familiar to be worth a discussion – such terms of trade were familiar ...and have been taking on new forms

But technology remains the all-time focus of nations because of the military edge it might offer or the industrial and trading advantages it secured

  • technical expertise was jealously protected at the Arsenal of Venice for the construction of the warships and the trading vessels which generated the city’s wealth for more than four centuries…operating on a scale unheard of – with the Republic operating 3000 ships to control the Mediterranean by 1450 and the Arsenal employing 16 000 men in its 16th century heyday
Venice 1727 - the Bucintoro -  destroyed wantonly on Napoleon's orders in 1798
  • protection of intellectual property has always been keenly pursued in the national interest, but never achieved for very long, be it in the medieval textile industry with horizontal looms, the spinning wheel and the fulling mill in England or the 19th century production of steel-nib pens, in Birmingham (UK)

Even so, in the rapid spread of new technologies, trade and the traveling cohorts of merchants, technical minded visitors, the simply curious and ...the spies have always played center stage

 

Trade, in summary, has rarely been free but the vast advantages derived worldwide from globalization of the exchange of goods changed the perception

As international trade agreements created a positive halo, bringing vast benefits in developed economies and lifting emerging markets out of poverty, global trade has been taken for granted

This is not to be …and the current trade tensions only shock the system because they take place on an over-sized global arena and because businesses assumed national interests somehow faded in the push of international trade

 

One globalized market is not to be

The range of non-tariff barriers has never ceased to be relevant and mercantilism – a focus on the domestic economy, protected to favor national wealth accumulation – is alive and shared across the world

But China, today, is exposing international trade to extreme strain not only  because of its exceptional size and the rate of its expansion

Impact of the sheer volume of Chinese trade on international competition is compounded by the country's unusual development path, deviating from any emerging markets experience

Instead of 

  • moving from low-tech products (apparel, commodities) with low-wage workers
  • to mid-end products (such as household goods) as the work force gained expertise and more investments were directed both domestically and internationally
  • and entering ultimately high-tech manufacturing

China remains a major player at every level of manufacturing, covering the full range of workers qualification and advancing with speed

Source WSJ Dec.17, 2018 China Trade Leviathan (graphics) - paywall

Christmas decorations - one example, from many, of complete domination achieved by Chinese exporters by 2017

 

Quoting from the 2016 study 'Structural Adjustments and International Trade - Theory and Evidence from China' , Hanwei Huang, Jiandong Ju, Vivian Z. Yue, comparing the data in 2007 with that in 1999, conclude

  • manufacturing productions became more capital intensive.
  • on the other hand, exports became more labor intensive

According to the authors, this finding is at odds with the familiar observation that over time, as a developing country accumulates capital, the specialization and export patterns change towards capital-intensive goods following a country’s move towards free trade

China should produce and export more capital intensive goods - and the authors note that indeed China is producing more capital intensive goods but exports remain more labor intensive

Our interpretation of the authors' observations, when capital intensity is modelled in three ranges, quite high - quite low and middling, is a dynamic process

  • Relative capital availability initiallly drives specialization - favoring the growth of eiter labor intensive or capital intensive industries - resulting in either case in a stable export contribution
  • Over time, access to capital favors industries with intermediate factor intensities and, as capîtal intensive industries gain ground, their contribution to exports increase - and the contribution of less capital intensive activities falls

The authors conclude that, on this base, the theoretical predictions on specialization and export participation for the labor abundant country are consistent with the Chinese data

The implications for the Chinese economy appear to be that the vast size of the Chines labor market

  •  favors a capital- deepening  of factor intensities in  the 'intermediate' range, in industries more focused on the domestic market than on exports
  • while preserving the established labor-intensive exporting industries

We suggest the dynamics may change over time, but the shift towards more capital-intensive industries will be slowed by the need to provide manufacturing jobs, in labor-intensive industries and, at least for now, answer, first and foremost, domestic demand 

 

A global market, vast but swaddled

2012 - a dynamic overview from Our World in Data

 

The consequences are dire for emerging economies aiming for a foothold in developed markets - both in the US and in the European Union

  • exposed to being squeezed out by China
  • and rejected by the large importing economies

The dominance of China as volume producer in labor-intensive manufacturing limits the access of emerging economies to international trade

  • constraining their export potential to base materials and agriculture products
  • stunting the expected development of their economies 
  • depriving their workforce of the benefits of global exchange with developed markets

Projecting trade trends into the not so distant future,  a rebalance of the overweening Chinese imports can be expected

  • the globalized economies will favor regional trade agreements – as has been confirmed by the US, revisiting the free trade pact with Mexico and Canada
  • emerging markets should benefit if - and only if - the developed economies recognize the need to integrate their immediate Southern neighbors in their broad regional arrangements

An extension - in a tentative form - of US trade to Latin American countries may become relevant in a geopolitical perspective

Regional trade agreements of the EU with North African countries, Turkey and possibly Russia are either in place or being explored and carry similar long term implications – although, reluctant to confront China, its premier export market for now, Germany only slowly adjusts to the new regional reality

None of these assumptions is iron-cast but the fast evolving landscape of international trade allows for more than a glimmer of probablility

Our follow-up report wil narrow down on the US trade options, regarding imports and protection of technology