International trade bolstered by greater regional integration and new trade pacts

Global trade faces protectionist headwinds that are dampening the outlook for growth in the coming years. According to the World Trade Organisation (WTO), trade volumes grew by close to 3% in 2018 and are expected to decline slightly to 2.6% in 2019 before rebounding to 3% in 2020. This may be the first time since the 2007-08 global financial crisis that growth will fall below a 3% average, as significant uncertainty driven by an escalating US-China tariff war, acrimonious Brexit negotiations, and wariness surrounding US involvement in several multilateral trade agreements affect 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 have been ratified or 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). 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 is challenging and overhauling the free trade policies that have governed US economic policy for decades. However, the Trump administration claims that the global trade system is unfair and prejudicial to US companies, arguing that its trading partners impose excessive tariffs on the US and steal its intellectual property.

In June 2019 Christine Lagarde, then-managing director of the IMF, forecast that the US-China trade war would cut global GDP by 0.5%, or around $455bn, by 2020. An ongoing tariff war between the US and China escalated during the second half of 2018 and most of 2019. As of August 2019 the US had imposed a 25% tariff on $250bn worth of Chinese imports, with plans to introduce a 10% tariff on an additional $300bn in Chinese goods the following month. China 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. The US has warned of higher tariffs on additional imports if China continues to retaliate. While China does not have the ability to match US tariffs onefor-one – it imports $130bn of US goods, compared to around $500bn in exports destined for the US – it has other policy tools at its disposal. It can respond by disrupting US businesses in the country and undervaluing the yuan. In August 2019 China devalued its currency in order to offset the impact of the trade restrictions.

Trade relations between Mexico, Canada and the US have also come under strain following trade tariffs imposed during 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 imposed levies on metal imports on its North American trade partners, applying a 25% tariff on steel imports and a 10% tariff on aluminium in May 2018. EU exports also faced the same tariffs, and the bloc, along with Mexico and Canada, responded with countermeasures targeting US exports, particularly food, steel and alcohol.

Renegotiation of the NAFTA agreement, which commenced in May 2017, centred mostly on quotas, labour and procurement laws, and rules of origin. With midterm elections in the US and a change of presidency in Mexico occurring in late 2018, negotiators from the three countries signed a last-minute deal on November 30, 2018 to overhaul the agreement, thereby ending several months of uncertainty.

NAFTA 2.0

The revised pact, which has been renamed the US-Mexico-Canada Agreement (USMCA), sees mixed results across industries. Tech and digital companies are likely to benefit from more stringent and sweeping 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 up greater domestic market share to foreign competition.

Meanwhile, North American auto parts manufacturers are expected to benefit from the agreement, at least in the short term, as new provisions stipulate higher local content requirements for auto and truck parts, a move that is ultimately aimed at curbing Asian imports. Consumers, however, will feel the pinch as the costs of vehicles, trucks and parts increase.

New provisions on minimum wages in the auto industry are ultimately designed to disincentivise US and Canadian manufacturers from moving production to Mexico. OBG spoke to Luis Rossano, a member of the so-called Cuarto de Junto, a private sector team 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 successful brokering of the 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 firms to diversify – a long-awaited objective that can also mitigate risk”. Furthermore, Rossano told OBG that the new wage provisions – requiring that 40% of auto parts in North America be manufactured by workers earning at least $16 an hour by 2023 – are in line with existing production dynamics.

In other words, with a number of minor changes, the new guideline targets can easily be reached. This provision is also not pegged to inflation, so an average wage of $16 per hour in 2023 will likely impose less of a constraint than it might in 2019. 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”.

In August 2019 democrats in the US House of Representatives were working towards ratification of the USMCA. In June 2019 the revised pact was ratified by Mexico, while in Canada it received its second reading in the House of Commons. If it is ratified by the three governments, the revised agreement will be a major political victory for President Trump’s administration. It is also likely to soothe economic volatility in Mexico, where President Andrés Manuel López Obrador has publicly stated he will not attempt to modify the deal. In May 2019 the US agreed to lift steel and aluminium tariffs on Canada and Mexico, removing a significant hurdle to ratifying NAFTA 2.0.

Brexit Troubles

Across the Atlantic, Brexit negotiations between the UK and the EU continue. After multiple delays, the UK was again unable to formally leave the economic and political bloc by the latest deadline of October 31, 2019. With Prime Minister Boris Johnson and his Conservative party winning a parliamentary majority in general elections held in mid-December 2019, Brexit is still planned for 2020, yet how the agreement will be structured is yet to be seen.

In 2018 the UK exported £291bn worth of goods and services to the EU, representing 45% of all exports. Imports from the EU stood at £357bn, equal to 53% of all imports. The UK’s 2018 trade deficit with the EU was therefore £66bn; a surplus of £28bn in services trade was outweighed by a deficit of £94bn for goods.

Opening New Doors

An agreement between the US, Canada and Mexico was saved by last-minute negotiations, and despite the potentially negative global trade repercussions of the US-China tariff war and Brexit, 2018 also saw numerous distinctly positive developments. Several new major free trade areas have emerged and negotiations for others are advancing.

Following 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, the CPTPP is more of an umbrella agreement encompassing 18 separate free trade agreements among the member countries. Participating nations are expected to see their economies expand by 1.7% more than they otherwise would have by 2030, according to 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 2-3% by 2030, compared to 1% or less for New Zealand, Japan, Australia, Canada, Mexico and Chile.

The conditions for activation of the CPTPP were agreed to come into effect 60 days after at least 50% of signatories ratify the agreement. The pact came into force for six initial countries, including New Zealand, Mexico, Japan, Singapore, Canada and Australia, on December 30, 2018 and for Vietnam on January 14, 2019. As of early August 2019 the four remaining nations – Brunei Darussalam, Chile, Malaysia and Peru – had yet to ratify. 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

The US and China are noteworthy absentees from the CPTPP, as the latter preferred to forge its own multilateral trade pacts. China has not shown any interest in joining the CPTPP and has instead focused on another major Asia-Pacific trade partnership – the Regional Comprehensive Economic Partnership (RCEP). The RCEP is a free trade agreement that involves the 10 members of ASEAN plus five dialogue partners (Australia, China, Japan, South Korea and New Zealand). In 2019 India made the decision to opt out of the agreement.

Technically an attempt to harmonise existing free trade agreements among member countries rather than a new pact, formal RCEP negotiations began in 2012 and were expected to conclude in November 2018. However, disagreements among negotiators pushed back the original timeline. Once ratified, the RCEP is forecast to drive 5.1% GDP growth in ASEAN countries by 2021, as well as boost employment and facilitate technology transfer.

Decades 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 fourth-largest trading bloc in the world – had been ongoing for almost 20 years, but in June 2019 an agreement was reached. Bilateral trade between the two blocs exceeded $87.5bn in 2018, according to the European Commission. The EU is Mercosur’s second-largest trade partner, accounting for 21.5% of its total, and the EU exports goods worth around $45bn to the South American bloc.

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 red tape, intra-African trade stands at less than 20% of total trade, compared to 60% for Europe and 30% for ASEAN countries. 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.

The 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 freer trade will boost industrial capacity and investment on the continent, allowing African economies to move away from their traditional commodity export dependence. More developed industrial economies such as Egypt are hoping the AfCFTA will be a boon for local exporters in industries such as garments and other textiles. Mervat Soltan, chairperson of the Export Development Bank of Egypt, told OBG that the 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.

AfCFTA entered into force in May 2019 after 24 member states ratified the agreement through their respective parliaments and was officially launched in Niamey, Niger in July 2019. The dismantling of tariffs is expected to start in July 2020. The International Centre for Trade and Sustainable Development expects intra-African trade to increase by as much as 52% by 2022. Following the commitment to the AfCFTA made in July 2019 by Nigeria, one of the region’s largest economies, the forecast looks even more likely to become a reality.