What emerging markets reveal about international trade flows

Global trade faces protectionist headwinds that are dampening the outlook for growth in the coming years. According to the World Trade Organisation (WTO), trade volume grew by 4.7% in 2017 and is expected to have moderated slightly to 4.4% in 2018 and dip to 4% in 2019. Although this means growth will fall below the 4.8% average seen since 1990, it is still above the 3% average achieved since the 2007-08 global financial crisis. Nevertheless, significant uncertainty driven by an escalating US-China tariff war, acrimonious Brexit negotiations, and wariness surrounding US involvement in several multilateral trade agreements is affecting business confidence and investment decisions.

Nevertheless, although US protectionist measures and President Donald Trump’s fiery rhetoric currently dominate global headlines, trade blocs in Latin America, Asia Pacific and Africa are creating exciting new multilateral trade areas. Furthermore, several major bilateral trade agreements are in the pipeline and are expected to further boost trade.

US Protectionism

President Trump has taken an unconventional policy direction on trade, engaging in tit-for-tat tariff wars and withdrawing from major multilateral agreements like the Trans-Pacific Partnership (TPP) trade pact. In trying to encourage US consumers to purchase local goods and by imposing taxes on imports from major economic partners such as China, the EU, Canada and Mexico, President Trump’s administration has started challenging and overhauling the free trade policies that have governed US economic policy for decades. President Trump’s administration has previously claimed that the global trade system was unfair and prejudicial to US companies, arguing that other countries were imposing excessive tariffs on the US and stealing its intellectual property.

The IMF has previously forecast that trade wars could cut global growth by 0.5% by 2020 and Morgan Stanley estimates that it could reduce global GDP by around 0.8%. An ongoing tariff war between the US and China has escalated during the second half of 2018. As of November 2018 the US had imposed tariffs on Chinese goods – including consumer goods, electronics and food – worth $250bn, and Beijing had responded with tariffs on $110bn worth of US exports, including aircraft and coffee. With neither side seemingly willing to de-escalate the situation, further tariffs are expected. Washington has warned of further tariffs on an additional $267bn worth of goods if China continues to retaliate. Beijing cannot match US tariffs because its imports from the US total only around $130bn, far below its total $500bn of exports to the country. Nevertheless, China can still respond by disrupting US businesses operating in the country and also by potentially devaluing its currency in order to offset the impact of the trade restrictions.

Furthermore, trade relations between Mexico, Canada and the US have also come under strain following trade tariffs amid the backdrop of the North American Free Trade Agreement (NAFTA) renegotiations. Immediately after assuming office, President Trump threatened to exit NAFTA unless the US could renegotiate more favourable trade terms. To apply pressure, his administration subsequently hit its North American trade partners with levies on metal imports, imposing a 25% tariff on steel imports and a 10% tariff on aluminium in May 2018. The EU was also hit by the same tariffs and, along with Mexico and Canada, responded with countermeasures targeting US exports, particularly food, steel and alcohol. Renegotiations of the NAFTA pact, which began in May 2017, centred on quotas, labour and procurement laws, and rules of origin. With mid-term elections in the US and a change of presidency in Mexico looming in late 2018, negotiators from the three countries signed a last-minute deal on November 30, 2018 to overhaul the agreement, thereby ending months of uncertainty.

NAFTA 2.0

The revised pact, which has been renamed the US-Mexico-Canada Agreement (USMCA), sees mixed results across industries. North American auto parts manufacturers are expected to benefit, at least in the short term, as new provisions stipulate higher local content requirements for car and truck parts, a move ultimately aimed at curbing Asian imports. Consumers, however, will feel the pinch as the costs of cars, trucks and parts increase. Tech and digital companies are also likely to benefit from stringent and wider intellectual property regulations and digital trade provisions. However, Canadian dairy farmers are set to face increased competition from US producers as the revised pact opens a bigger domestic market share to foreign competition.

Furthermore, new provisions on minimum wages in the auto industry are ultimately designed to disincentivise US and Canadian manufacturers from moving production over to Mexico. OBG spoke to Luis Rossano, a member of the-so called “Cuarto de Junto” private sector team that was involved in the NAFTA renegotiations and CEO of RPC Group, a plastic products design, engineering and manufacturing company operating in the automotive industry. Following the brokering of USMCA, Rossano expects “international investors’ appetite for Mexico’s automotive industry to remain, although with some degree of deceleration, which can also be used as an incentive for resilient Mexican companies to diversify – a long-awaited objective that can also mitigate risk.” Rossano told OBG that the new wage provisions – requiring that 40% of cars parts in North America be manufactured by workers earning at least $16 an hour by 2023 – are in line with already existing NAFTA production dynamics.

In other words, with some minor changes the new guideline targets can easily be reached. This provision is also not pegged to inflation and so an average wage of $16 an hour in 2023 will likely impose less of a constraint than it might today. Overall, Rossano believes that the new pact has largely calmed the investment climate in Mexico, although he acknowledges that “there is always some small degree of uncertainty with this – at times erratic and unstable – US administration”.

If it is ratified by the three governments, the revised pact will be a major political victory for President Trump’s administration. It is also likely to soothe economic volatility in Mexico and President Andrés Manuel López Obrador has publicly stated that he will not attempt to modify the deal. However, the pact is still far from a win-win scenario for Mexico and Canada. US tariffs on steel and aluminium remain in place and President Trump’s administration has given no indication whether these will be lifted.

Brexit Troubles

Across the Atlantic, Brexit negotiations between the UK and the EU face an uncertain future. With the UK expected to formally leave the economic and political bloc on March 29, 2019, Prime Minister Theresa May is struggling to mobilise support within her own party for a draft of the Brexit deal with Brussels. Around 43% of the UK’s global trade in 2016, worth about £241bn, was with the EU. Another 12% of total trade is with countries with which the EU has preferential agreements, meaning that the EU Customs Union and the Single Market together account for 55% of the UK’s international trade.

Opening New Doors

NAFTA appears to have been saved by last-minute negotiations, and despite the potentially negative global trade repercussions of the US-China tariff war and Brexit stumbling blocks, 2018 also saw numerous distinctly positive developments. Several new major free trade areas have emerged and negotiations for others are advancing.

Despite President Trump’s 2017 decision to withdraw from the TPP, parties to the original agreement have forged ahead to create a new deal. In March 2018, 11 countries accounting for 13.5% of global GDP signed a new agreement, the Comprehensive and Progressive Agreement for TPP (CPTPP). The deal constitutes the world’s second-largest free trade bloc after NAFTA. Rather than a trade pact in and of itself, CPTPP is more of an umbrella agreement encompassing 18 separate free trade agreements between the member countries. Participating countries are expected to see their economies expand by 1.7% more than they would have by 2030, according to forecasts by the Peterson Institute for International Economics. The biggest winners are in Asia, with the economies of Malaysia, Singapore, Brunei Darussalam and Vietnam expected to grow by an extra 2% by 2030, compared to around 1% or less for New Zealand, Japan, Australia, Canada, Mexico and Chile.

The conditions for the activation of CPTPP were agreed to only come into effect 60 days after at least 50% of signatories ratify the agreement. As of November 2018, seven of the signatories had ratified the pact with the remaining countries expected to follow suit. The agreement is therefore expected to come into effect for the initial six signatories – New Zealand, Mexico, Japan, Singapore, Canada and Australia – on December 30, 2018 and for Vietnam on January 14, 2019. Furthermore, the signatories have left the door open to other countries interested in joining the pact, with the UK, for example, already expressing interest.

China’s Own Course

Apart from the US, China is the other noteworthy CPTPP absentee and has so far preferred to forge its own multilateral trade pacts. China has not shown any interest in joining CPTPP and has instead focused on another major Asia-Pacific trade partnership, the Regional Comprehensive Economic Partnership (RCEP). RCEP is a free trade deal involving the 10 members of the Association of South-East Asian Nations (ASEAN), plus its six dialogue partners (Australia, China, India, Japan, South Korea and New Zealand), which collectively account for 4bn people with a total GDP of $49.5trn.

Technically an attempt to harmonise existing free trade agreements between member countries rather than a new pact, formal RCEP negotiations began in 2012 and were expected to conclude in November 2018. However, disagreements between negotiators, particularly between India and China, have pushed this timeline back to 2019. India is wary of opening its economy to an influx of Chinese goods and has called for limited implementation of tariff concessions, a demand China appears willing to accept to save the pact. When ratified, RCEP is forecast to drive 5.1% GDP growth in ASEAN countries by 2021, as well as boost employment and facilitate technology transfer.

20 Years in the Making

Outside of Asia Pacific, trade blocs in Latin America and Africa are forging ahead with new and promising multilateral partnerships. Negotiations between the EU and the Mercosur group of Argentina, Uruguay, Brazil and Paraguay – the world’s fourth-largest trading bloc – have been ongoing for almost 20 years and appear to be close to wrapping up. The stakes are high: bilateral trade between the two blocs exceeded $90bn in 2016, according to Eurostat. The EU is Mercosur’s number-one trade partner, accounting for 21% of all its trade, and the EU exports goods worth $48.6bn and services worth $25.5bn to the South American bloc.

Negotiators are confident that a deal can be concluded in 2019, although several obstacles still need to be overcome. For the past few years, both sides have been unable to agree on lowering tariffs, as the EU is concerned about the domestic impact of an influx of agricultural produce from South America while Mercosur is hesitant to expose local industries, such as car manufacturers, to European competition.

Africa’s Trade Potential

Intra-African trade has long been restricted by excessive non-tariff measures. These trade barriers include long waiting times at borders, import quotas, and excessive or complex regulations, among others. Undermined by excessive red tape, intra-African trade stands at less than 20% of total trade compared to 60% for Europe and 30% for ASEAN countries, for example. Recognising the billions of dollars of trade potential not being actualised, 44 African heads of state signed the African Continental Free Trade Area (AfCFTA) agreement in March 2018.

AfCFTA’s goal is to create a single market for goods and services for the 55 African Union (AU) member countries, which have a combined GDP of $2.3trn and 1.2bn people. The AU hopes that greater free trade will boost industrial capacity and investment on the continent so that African economies can move away from their traditional commodity export dependency. More developed industrial African economies such as Egypt are hoping AfCFTA will be a boon for local exporters in industries such as garments and other textiles. Mervat Soltan, chairperson of Egypt Export Development Bank, told OBG that AfCFTA “greatly expands the opportunities for Egyptian exporters” even though they “will be under considerable pressure to meet the demand for lower prices” amid increased competition. For the agreement to come into force, half (or 22) of the signatories need to ratify the pact through their Parliaments, and the AU expects this to happen by early 2019. The International Centre for Trade and Sustainable Development expects intra-African trade to increase by as much as 52% by 2022 if the agreement is implemented. However, this will likely depend on getting large economies such as Nigeria, which has so far shunned the agreement, on board.

New Bilaterals

Growth in global trade also saw several prominent bilateral agreements fleshed out in 2018. Gearing up for Brexit, the UK has laid the groundwork for bilateral trade talks with various major trading partners, including Canada, China and the US. It has also expressed interest in joining the CPTPP. President Trump’s ongoing shake-up of US trade policy and tariff war with China has seen it making overtures to Japan, which has been a major advocate of multilateral agreements. Trade negotiations between the US and Japan – respectively, the world’s largest and third-largest economies – began in September 2018. The talks between the two countries have the potential to fundamentally reshape the world’s auto industry and grant US farmers greater access to the Japanese market.

Meanwhile, China has been moving forward with its own bilateral trade talks, particularly in the Middle East. In July 2018 China inked a raft of trade agreements with the UAE and Kuwait, as Beijing eyes the Gulf Cooperation Council (GCC) region as a gateway for its Belt and Road Initiative into the Middle East and further afield. China’s strategic trade partnerships in the region will focus on infrastructure investment, trade facilitation and technology sharing. Pakistan also has its sights set on increased trade with GCC countries, striking a deal with the GCC in July 2018 to enhance trade relations. A Pakistan-GCC free trade agreement has been in the works since 2009 but Islamabad’s policy inconsistency and onerous bureaucratic hurdles have been blamed for delays. Nevertheless, there appears to be renewed enthusiasm to finalise negotiations in 2019.

Global Growth

Although the expansion of multilateral and bilateral agreements demonstrates positive signs for global trade dynamics, growth potential in 2019 remains susceptible to the outcome of the US-China tariff war and Brexit negotiations. Escalating tensions remain the biggest risk to global trade growth, which is forecast by the Economist Intelligence Unit to dip to 2.8% in 2020 before rising again. The automotive industry is already feeling the impact of US steel and aluminium tariffs, while Chinese tariffs on US agricultural products like soybeans is reshaping global production. These changing trade patterns are forcing some producers to adapt to new conditions while also creating opportunities for growth in other countries. For example, Brazil’s soybean exports have risen significantly as China turns away from the US. In 2017 Brazil supplied over 53% of China’s total soybean imports, with exports of the commodity rising by 40%. This trend has forced US farmers to adapt, and many are now offsetting lower exports to China by shipping their produce to Brazil to backfill rising internal demand.

Elsewhere, manufacturers and consumer goods companies are still assessing how trade tariffs will affect consumer prices along with their own production costs. Although the uptick in tariffs between the US and China has generated global trade uncertainty, emerging economies continue to pioneer greater regional integration. As such, the trade growth outlook for emerging economies remains positive, with total trade surging by 7.2% in 2017, up from 1.9% in 2016, according to the WTO. Import demand also appears to be on the up, with merchandise trade growth rising by 3.1% in 2017.