The value of trade across borders has grown faster than the growth in the cumulative production (GDP) of all countries for more than half a century.
But, as the recent tariff and trade wars have escalated, so has the grimmer outlook for the value of international trade and global efficiencies that the world has been developing over decades.
We expect the value of world trade to be about 167 times larger in 2020 than it was in 1960 and the world economy to be 65 times larger in the same span. The reason trade is carrying more value than what is being manufactured has to do with cultivating global efficiencies.
Today, to no one’s surprise, it is much easier logistically to cross country borders with raw materials, work-in-process (component parts) and finished goods than it was half a century ago. This means that portions of what is being produced are crossing country borders multiple times before final assembly into finished goods.
Several reasons exist for why countries and companies realize value based on global efficiencies by engaging in multiple border crossings to make one product (e.g., automobiles). Lowering barriers to border transactions (e.g., tariffs) and specialization in production (e.g., component parts) are two of the primary macro-specific reasons.
In short, the globe has become structured as a dynamic, ever-evolving and increasingly efficient complex web of supply chains. We have come to rely on these increased global efficiencies in production to progress toward a better world, improve standards of living, and several emerging markets advancing to become high-income nations.
For decades, these global supply chains have supported a cumulative win-win for the world. Some technical data illustrate this point. From 1960 until 1972, the ratio between the value of what was traded across country borders to the cumulative production (GDP) for all countries was between 1.00 and 1.17.
Basically, we traded about the same value of goods and services as what we produced. From 1973 to 1999, the trade-to-production ratio was between 1.32 and 1.92. But, from 2000 to 2017, we have hovered between annual ratios of 2.00 and 2.60.
The troubling part is that for the first time in seven years, we expect this global efficiency ratio to go below 2.60 in 2018, and then become lower in 2019 and 2020 (2.57 to 2.59). What does this mean? Generally, we can say that the efficiencies the world has developed in its global web of supply chains are now threatened with the escalation of tariffs and various forms of trade wars.
Perhaps people who are skeptical about the positive value of trade and don’t buy into these global efficiencies would make an argument that populous countries can leverage their growing population and produce more. Unfortunately, this is just not the case.
While population is a key determinant of the amount of production that can be done in a country, the data are more nuanced than that. By a 3-to-1 ratio, trade across country borders is more valuable than population to a country’s production output (using data from United Nations, World Trade Organization and the World Bank, 1960 to now).
Let’s say the skeptic buys into the argument that trade can be a positive for a nation. The skeptics next question, then, is: Do we really need to engage in regional trade agreements that oftentimes entail complexities that make it difficult to understand who benefits?
Plus, trade agreements frequently result in certain industries benefitting more than others, and some industries in a country are likely to be disadvantaged.
Why don’t we just trade as a country and not engage so deeply in these trade agreements? The reason is that any given country — even the United States — cannot be a world leader in every category of raw materials, component parts or finished goods.
This is also where we return to the globe now being structured as a dynamic and complex web of supply chains. These chains can only function efficiently if barriers to cross-border trade are not creating undue friction.
Also, what’s important to understand is that there is a correlation of 0.991 between the number of regional trade agreements that are active in the world and the cumulative value of trade across country borders (using data from the World Trade Organization, 1960 to now).
Simplistically, the more regional trade agreements in force, the more we trade across country borders, with pronounced trading taking place between countries in an agreement.
So, here we are. What we do know is that the world has created global efficiencies over decades that are now being politically challenged from its half-century of global win-win evolution to a more nationalistic country-win scenario, wherein some countries win and some countries likely lose.
This win-win to win-lose value-shift will lead to established global efficiencies being tested. Indications are that we are already on a downward slope in global production efficiencies by the actions taken so far in countries’ political arenas.
Tomas Hult is professor in the Broad College of Business at Michigan State University and executive director of the Academy of International Business. In 2016, Hult was selected as the Academy of Marketing Science Distinguished Marketing Educator, as the top marketing professor worldwide for scholarly career achievements.