The Effect Of Trade On International Growth

By Brent Radcliffe | April 01, 2013 AAA

Her massive blue and red bow cutting through the sea, the CMA CGM Marco Polo is a fitting symbol for the transformative power of international trade. At 1,300 feet in length and capable of carrying over 16,000 14-ton shipping containers, the ship plies the oceans between some of the world’s busiest ports: from Shanghai and Hong Kong in Asia, to Rotterdam and Hamburg in Europe. In just five years the maximum capacity of the largest container ships has increased by 3.3%, and is linking emerging and developed economies on a scale unimaginable a century ago.

World trade is big business. Ultra large container ships like the CMA CGM Marco Polo are in such high demand that the drawback of not being able to fit into the Panama Canal is not enough to stop their keels from being laid. According to the World Trade Organization, world merchandise trade value grew by 20% in 2011, to $16.7 trillion.

Trading at Home Vs. Abroad
Much of the world’s trade, however, isn’t between far-flung ports of call as much as to other economies in the region. This can be a blessing and a curse, since trading close by reduces costs but also increases the possibility of economic problems in one regional trading partner affecting other. For example, exports from European countries are overwhelmingly directed to other European countries, to the tune of 71%. While Europe is home to many developed economies that demand quality manufactured goods, the sovereign debt crisis may have been less painful had Europe sent more goods to other continents.

The growth of emerging economies has been one of the major factors in the rapid increase in trade. In the early-to-mid 2000s emerging economies experienced GDP growth of up to 6% while advanced economies hovered just under 2%. The IMF has indicated that since the financial crisis of 2008, however, growth in emerging markets has slowed while mature markets have remained relatively stable. The Conference Board, a research organization, estimates that GDP growth in emerging and developing economies could decline from 5.5% in 2012 to 5.0% in 2013, a drop of nearly 10%. This slow down is significant, since emerging economies contribute an estimated 2.4% to world GDP growth.

Growth in emerging and developing economies inevitably slows down. This happens as the big benefits from the reallocation of resources dries up, requiring governments to make structural reforms in order to continue to grow. These reforms can create more robust domestic markets for goods and services, but require strong governmental and financial institutions to take hold. In order for international trade to really flourish, governments also have to look at red tape and other barriers to trade.

The greatest risk to global trade is the interconnectivity that trade creates. Businesses and economies are increasingly connected, making scenarios in which supply or financial shocks can quickly spread from one region to another more likely. The factor precipitating the bank crisis in Cyprus was the exposure of Cypriot banks to Greek sovereign debt, but that same exposure had caused a financial contagion long before Cyprus looked for a bailout. The disaster at Japan’s Fukushima Daiichi nuclear reactors not only caused a disruption to the global supply chain, but also caused trade to and from the world’s third largest economy to hiccup.

Increasing the Supply Chain
How can businesses take advantage of the global supply chain while also protecting themselves from potential shocks? The World Economic Forum, a club of some of the world’s most successful businesses, met this past January to discuss how to improve international trade. The marked difference between this year’s meeting and previous ones was the recognition that the increased connectivity between businesses in different countries was creating a “super supply chain” that had the potential to not only improve growth but to inhibit it as well. The World Economic Forum members identified five key steps that can help governments improve supply chain efficiency and increase international trade:

  1. Create policy on a national level by identifying long-term objectives, and then continuously with businesses to ensure that legislation and regulations are moving the economy toward efficiency.
  2. Have government institutions focus on specific objectives related to supply chain management.
  3. Bring in small businesses to the table when discussing the regulatory environment to ensure that regulations represent their interests as well as the interests of larger companies.
  4. Work with other countries through free trade agreements and other international agreements to harmonize or simplify regulations.
  5. Move toward the use of electronic documentation and filing rather than using paper.

Effects of Reducing Barriers
Reducing supply chain barriers can potentially be a bigger boost to GDP than than removing tariffs. Improving border administration and transport and communications infrastructure could increase global GDP by 5% and would have six times the effect of removing all global tariffs. The World Bank estimates that a 10% increase in infrastructure spending adds 1% to output, with this growth being more pronounced in developing countries. This runs contrary to what many may think, since trade barriers are often cited as the main impediment.

Improving infrastructure and administration costs money, which may be a tougher sell to governments facing fiscal constraints even if the benefit is greater than repealing tariffs. Additionally, the existence of barriers protects some domestic industries from competition, and removing these barriers may cause friction. Prioritizing which supply chain barrier to focus on will provide businesses with a clear set of objectives to work with, rather than having companies guess what is going to happen when planning for 10, 15, or 20 years in the future.

Take Action
For investors, the prudent approach to finding the future economic darling is to examine what countries are addressing the fundamental issues that impact the ease in doing business in a country: quality of and investment in infrastructure, ease of doing business and regulatory climate. The easier it is to move goods around a country the easier it is for consumers to make purchases, and reductions in corruption and red tape cut costs further. Investors who pay attention to these factors will be at an advantage compared to those who follow the latest fad.

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