How a virus may alter trends in international trade
August 31, 2020
When US giant Apple mentions it may shift $40bn worth of production out of China, while travel restrictions and physical distancing presents a huge multi-billion dollar threat to many western universities, you sense that a virus may just significantly change or accelerate trends in international trade.By Guillaume Dejean – Western Union Business Solutions
The fragility of modern supply chains
When the world’s number one factory shut down, it plunged an entire global supply chain infrastructure into darkness. This is the painful experience international companies lived through and one that may have lasting consequences as leaders are forced to navigate long-term strategic decisions in months that could have otherwise taken years.Beyond the tragic human consequences of COVID-19, this period has revealed the ‘fragility of modern supply chains’ according to the World Economic Forum[1], and for Oxford Economics[2] the explanation for this lies in ‘lack of diversification’, with supply chain strategy often driven by cost reduction and not risk management for global crisis.As we’ve now entered the early phase of what looks like a slow and gradual economic recovery, the decisions made by companies to counter supply chain risks, and the investment of time and people into this, could have a lasting impact on global trade. The question is how? Europe’s automotive, pharmaceutical and travel sectors are some of the areas we’ll investigate in this article as we uncover how a virus will change trends in international trade and business.
What was research telling us before COVID-19?
Before COVID-19, our FX Barometer Report uncovered that 50% of companies surveyed were planning more trade with China over the next five years. Retail, Food, Pharmaceutical, Financial Services and Travel were all sectors that had expressed the strongest inclination towards that market. In light of recent events, would a business still point to China as a key investment opportunity for future trade, or would we see greater focus on global diversification?We know that when China put the entire province of Hubei under lockdown, overnight manufacturers around the world were unable to source goods that were vital components in their supply chain. Global carmakers were notably among the most impacted by the sudden break in trade. A recent report from the Society of Motor Manufacturers and Traders (SMMT) suggested that the pandemic will cut the annual output of the UK automotive sector by a third this year.More importantly though, the global supply shock quickly turned to public anger as vital medical supplies that were required to save lives came to a halt, exposing European countries’ exposure and reliance on global trade in mission critical sectors. This experience will inform future supply chain diversification, and according to a specialist in supply-chain logistics at MIT -Professor David Semchi-Levi - this will make firms rethink business models that previously prioritized cost-cutting.
How trade decisions may pivot on COVID-19
Outsourcing activities and cost-cutting policies were broadly set up by a company to preserve or improve its competitiveness. However, a virus with no vaccine, the subsequent health-crisis, and the devastating break in supply chains should lead to a great shift in mindset towards risk reduction and diversification. With this in mind, we must also reflect on the complexity of our modern supply chains which have become much more integrated with more intermediaries over the years.World trade data[3] shows that between 1990 and 2007, global trade volumes grew twice as fast as real GDP, as globalization increased interconnections and trade between countries and made companies more efficient and profitable. Yet this acceleration came to a halt around 2015 and the below chart appears to suggest that an unravelling is underway.The textile industry in Europe where manufacturing was almost fully outsourced to Asia was significantly impacted by the crisis as numerous factories in Southeast Asia halted activities because of the lack of raw materials coming through from China. Could India and other Asian countries benefit at China’s expense in 2021? One leading indicator here could be reports[4] suggesting that Apple is considering moving a fifth of its production capacity of smartphones from China to India over the next five years, worth a total of $40bn.Yet this isn’t a new phenomenon. Recent years of US-China trade tensions had already put increasing pressure on US firms to reduce reliance on, and exposure to, the Chinese economy. This development was known to many as the ‘China plus one strategy’, and a trend that was also evident in our recent FX Barometer Report data. Many sectors including retail were telling us before COVID-19 hit that moving overseas trade back into domestic markets was a serious consideration. Could today’s pandemic accelerate such a change?
Education, travel and services will not be immune to change
Numerous articles have now been written about how COVID-19 will transform trends in supply chain strategy and its impact on international trade. This crisis has highlighted the imbalances of our globalized economy and questions the sustainability of this. However, what is also important to note here is that goods trade will not be the only facet of international business affected. If you look at the services sectors and higher education for example, top tier universities across Europe, North America and Australia have all relied too heavily in recent years on international student fee income, and especially fee income from overseas Chinese students.Furthermore, consider the tourism industry which has been brought to its knees by COVID-19. In our March 12 article titled ‘Coronavirus – what if?’ we pointed out the big issue this industry will now face. Simply put, Chinese tourists are the world’s biggest spenders, contributing $258bn and 17% of total foreign tourism spending globally in 2018.
Key considerations for international firms
It’s reasonable to argue that change is already underway as leaders seek to avoid making the same mistakes of the past. So what should companies consider as they now think about 2021 plans, diversification and risk mitigation?
- Diversification key but profits still matter – The saying ‘never put all your eggs in one basket’ comes to mind. The shortage of personal protective equipment and pharmaceutical products in some developed economies during the pandemic, and the political consequences of this, should drive diversification here. However, it cannot be the silver bullet as having a larger portfolio of suppliers can cause pitfalls too. Indeed, streamlining suppliers minimizes time spent on red tape. It also allows a firm maximize volume leverage and negotiate better pricing which will be key as companies face increased competition coming out of the crisis. A firms’ ability to compete, and remain profitable going into 2021, will affect jobs and this will impact livelihoods.
- Relocating is not always a solution – The huge progress made in automation and digital technology could encourage some corporates to bring previously outsourced activities back home, while for others, those long-term initiatives with high fixed-capital investments may be too difficult to reverse. Furthermore, administrative, labour, and technological costs are barriers to consider when thinking about moving activities back home. For some industries with high labor-intensity and less reliance on technology, relocating activity too far from Asia might be a viable option. However, politics and government policy may continue to play a huge role here in coming years, especially in countries like the US, Japan and South Korea. Mission-critical sectors like medical has already become a major flashpoint in politics.
- Acceleration of the China plus one strategy? Can a manufacturer or even a university destroy years of integration and relationship building, and at what cost? Given large investments made in this area and the growth potential of the Chinese market (1.4bn population5) we know this will be a difficult discussion. It would require a large amount of cash to relocate a production site and not everyone has such resources like Apple does. Besides, another priority for companies is strengthening their balance sheets, so risk mitigation may not win out here. Meanwhile, the rapid resumption of Chinese factories in late March may remind international companies that China’s ability to bounce back quicker than others would be a crucial asset should the world suffer a second wave of the pandemic.
- Risk assessment – Assessing both upside and downside risks and simulating future scenarios is top of mind for leaders and one of the scenarios companies will address is: what if China or another key market for supply or demand shuts down again for three months? Therefore companies should rethink the balance between efficiency and profits versus resilience and sustainability. Speed, and being able to respond to any potential future lockdown in weeks and not months will be another key factor. Yet COVID-19 should not be looked at during risk assessment as the only ‘megatrend-type’ issue of our time. Think about climate change and potential natural disasters that can destroy infrastructure; think about rising populism or how the recent BLM movement could impact politics and future trade negotiations. Crucially, let’s also not forget that redefining the US-China economic and trade relationship will be a huge focal point for US President Donald Trump in the upcoming US elections.
[1] World Economic Forum report – May 2020[2] Oxford Economics report in collaboration with Baker McKenzie– April 2020[3] World Trade Organisation data – 2018[4] The Economic Times report – May 2020