At a glance
It is easy to argue that protectionist economic and foreign policies being discussed, threatened or implemented around the globe are simply the result of political bravado or Twitter rants. That would be ignoring events and elements that, over the last several decades, have combined to create today’s unique international economic environment.
Similarly, arguing that a few global leaders are responsible for a potential trade war is dangerous because that offers the hope that a simple change of mind is all that is required for things to go back to “normal”. We have a new normal, one that will likely see reductions in free trade between major nations and territories.
“We are in a global economy, where countries trade with one another,” says Professor Mahendhiran Nair FCPA, vice-president, research and development, Monash University Malaysia and CEO of Monash Malaysia. “Some countries have resources, others have services.
“In the early days we had countries that were self-sufficient, but over a long period of time they realised that no single country can produce everything. We all have to rely on others. This is where open markets came in and various agencies were established to enable trade, meaning countries could sell and buy goods and services easily.”
Countries, of course, also originally helped protect their domestic industries by introducing tariffs. However, these tariff barriers were typically replaced by free-trade agreements that were broadly recognised as mutually beneficial. Exporter nations were able to pursue economies of scale, a positive for all parties as it enriched exporter nations and reduced cost of goods for importers, also bringing down retail prices.
The tipping point
Free trade, Mahendhiran says, is good for everybody. Certain non-tariff barriers such as standards can still be put in place, but free trade is a big driver of economies. What has changed?
Countries have been able to keep cost of products low for two reasons. Developed economies have used technology to keep costs of production low, while developing nations have exploited access to cheap labour. That delicate balance has now tipped, Mahendhiran says.
“Over the last 20 to 30 years, many of the Asian economies, in particular Japan, Korea and now China, have adopted better technology. Larger pools of labour in China and India, plus the fact that such nations have access to better technology, means their competitive and comparative advantages are far greater than a lot of the developed countries.”
This development caused irreversible changes to the shape of business in developed nations. In order to benefit from the competitive advantage offered by countries such as China, firms in Western nations began to relocate their manufacturing functions offshore. More recently, they also began offshoring their R&D, design and development centres.
In the US, an enormous number of manufacturing jobs were lost and, more recently, the lower end of the middle class is also seeing an erosion in jobs. While the US has also seen a large increase in jobs in the services sector, entire manufacturing industries have moved to Asia, and American companies have also been shifting production to Mexico, Canada and Europe.
During the last US election, Donald Trump’s greatest support came from the industrial belt, where job losses had been most severe. He was voted into office under the promise that he would bring back those jobs. In order to do that, he must ensure local industry is price-competitive with businesses that relocated offshore, but this is not possible in a free-trade environment.
To bring these jobs back, tariffs, which push up the cost of manufacturing and, as a result, increase the cost of the final product, must be introduced. However, there’s a fine balance between recovering manufacturing jobs and making products unaffordable.
This problem is not unique to the US; it is the new shape of things globally. Smart businesses are adjusting the way they operate as a result.
In addition, it remains to be seen whether the jobs in the US that shifted to the services sector will move back to manufacturing if Trump creates the right environment for it. Perhaps more importantly, bringing back manufacturing jobs does not address the need for access to higher paying, good jobs that can help the working class and lower-middle class advance.
How trade wars change business
“The cost curve has shifted as a result of technology, but I wouldn’t be keen to use the term ‘trade war’ just yet,” says Mike Sewell FCPA, director of Market Gap Investments.
“I think there is a lot of pushing and shoving going on at the moment, but the narrative has gotten ahead of the reality.”
While technology has given developing nations certain advantages, it also offers benefits to businesses in developed regions. Opportunities offered by 3D printing, Sewell says, or by digital systems that support more sophisticated manufacturing have allowed for improvements in quality and speed.
“Your country might not be as cheap for manufacturing, but your quality is likely improving and your costs are driving down and can be better managed. That may not mean that you should repatriate all of your manufacturing to Australia, but some of it can be. Then, there’s the sophistication often desired in assembly.”
Australian manufacturers are using best-in-class local and international components to build best-in-class products, Sewell says. One of his clients has parts coming from Taiwan, mainland China, Germany, Italy and Australia, with all assembly carried out in Australia.
“Technology allows them to get the best value and quality for their particular product from all around the world,” he says. This also allows the brand to leverage the all-important “Made In Australia” message.
How does a potential trade war introduce new risk for such an organisation? Can smart businesses avoid the potential negative effects of a trade war by spreading their manufacturing facilities around the globe? Certain highly prudent companies have begun to do so.
James Crabtree, associate professor of practice at the Lee Kuan Yew School of Public Policy in Singapore, points to the example of US industrial conglomerate General Electric (GE).
Two years ago, the business announced a major shift towards the localisation of its production into particular national markets. New factories would be built in countries such as India and Saudi Arabia in order to sidestep risks of a “protectionist global environment”, GE told the market. Importantly, Crabtree says, GE’s plans included the ability to shift production between locations to prevent sudden supply blocks or cost fluctuations.
Such diversification of manufacturing is the exception, rather than the rule, Crabtree says.
“Today’s supply chains are more brittle than you think,” he warns. “Just look at what happened after the event in Fukushima. One small city in Japan got knocked out of the global supply chain and all sorts of things went wrong for numerous global organisations.
“On the one hand you have GE, a major American manufacturing conglomerate that has been very clever. They decided they were going to follow a strategy of radical localisations. If you can do that, then you are in a much better situation. But not everyone can do that. Not everyone is GE. If you are a mid-sized Australian company, you’re not suddenly going to set up numerous, interchangeable global facilities.”
Understanding risk in trade wars
As business has globalised, risk has increased. Over the last few decades, Crabtree says, supply chains have lengthened enormously. This is partly a result of free-trade agreements. Thirty years ago, a factory in the US likely worked with suppliers from the surrounding states. Today, brands such as Apple source hundreds of different parts from around the world and assemble most of the final products in China.
Every ocean that must be crossed and every border that must be negotiated increases the risk for a business.
“GE localised, but another option is to centralise,” Crabtree says. “A company’s management might want to reduce risk by simplifying, by bringing things closer to home. For an American business, instead of having a supplier mix in Vietnam, Cambodia and Thailand, you might try to shift into Mexico, for instance. I read an excellent story recently that said we should all spare a thought for the supply chain managers, for the accountants and for the auditors. These are the people who are trying to work it all out.”
Sewell agrees, saying that risk mitigation in an increasingly globalised business environment is key to business success.
“It’s an ideal, particularly with small businesses and niche businesses, that they leverage all available quality and expertise from around the world,” Sewell says.
“They must look at the best way they can do that, but they must also fully understand the implications. When they go offshore, how do they manage that risk?”
Whether related to Trump, Brexit, China’s One Belt, One Road initiative, or recent troubles in Italy, Turkey and Argentina, or any of the other numerous, globally connected events, permanent change is being imposed on the global economy.
“Businesses need to recognise the risk in the landscape,” Sewell says. “Their CPAs must develop a risk-management matrix that the business regularly reviews.”
Trade war winners and losers
Who wins a trade war? It’s hard to say, but perhaps it’s the politicians who promised jobs in specific domestic industries. Who loses a trade war? Consumers, exporters from other territories, exporters from the local territory, local manufacturers as their input costs rise and businesses that do not properly prepare.
“If you’re an economist, a trade war is a backward step, right?” Crabtree says. “The theory tells us that gains from trade are substantial. But if you want to see the silver lining to a trade war, it is the fact that policymakers in the last 20 or 30 years have been rotten at sharing the gains from trade. People with education and people who live in cities gobble up almost all of the goodies that float out of the economic prosperity brought on by free trade.
“The path we’re going down at the moment is not a good one, but in order to justify a more prosperous and open economy, we need to put in place a range of safeguards that will help those who are affected negatively.”
To some extent, this is a democratic moment. There is some possibility that this is a slap in the face. It might just convince people to redress some of the problems that have developed over the last 20 years.