Trade flows: Adapting to sea-changes in commerce

Financial Times, November 08, 2011
China: Rising costs prompt fresh strategy

When the global financial crisis erupted in 2008, concerns in China centred on the fate of its export sector, an essential cylinder in the economy’s engine, writes Simon Rabinovitch.

The government halted renminbi appreciation in its tracks and unveiled a series of tax rebates to support exporters.

With international turmoil again lapping at China’s shores, the government’s tune has changed. It has not turned its back on exporters, but neither is it rushing to rescue them. Mild renminbi appreciation has continued and no new tax rebates have been introduced.

The difference is easy to explain. Exports are playing a smaller and smaller role in Chinese growth. And those companies that are succeeding as exporters are moving up the value chain, producing more sophisticated goods.

Looked at from the outside, exporting prowess is a defining characteristic of the Chinese economy. China overtook Germany as the world’s biggest exporter in 2009 and the gap has only grown bigger since then, with Chinese exports rising 31 per cent in 2010 and on track to go up another 18 per cent this year.

From the inside, though, exports are of diminishing importance. The country’s trade surplus peaked at 8.7 per cent of gross domestic product in 2007 and will fall to about 3 per cent this year.

“In the past, we used trade to drive our growth. But now, trade has been hit and domestic demand is beginning to pick up the slack,” says Zhang Yanling, executive vice-president of the Bank of China.

Weak demand in the US and Europe, the two biggest export destinations, is a serious problem. But an even bigger challenge is a purely made-in-China phenomenon – labour costs are climbing 10-15 per cent a year.

The export factories that thrive in China’s coastal provinces have long staffed their assembly lines with low-paid migrants drawn from a labour pool in the poorer interior that was once seen as inexhaustible. But the working-age population is now growing much more slowly, a result of China’s one-child policy that was launched in 1979.

“The tightness in the labour market is not going to go away. It’s going to be with us for many years to come,” says Peng Wensheng, chief economist at Beijing-based Chinese International Capital Corporation, an investment bank. “Other emerging markets clearly have one advantage over China. That is demographics.”

Soaring labour costs naturally have the biggest impact on labour-intensive production. And the data do indeed show that China is getting squeezed out of sectors such as textiles and shoes. Its share of total low-end light manufacturing imports in the US and Europe has peaked over the past 24 months, notes Jonathan Anderson, an economist with UBS. Cambodia and Bangladesh are among those eating into China’s market share.

Beijing is not shedding much of a tear for its exporters. The government has declared a goal of moving up the value chain. It wants to spur domestic innovation and get away from the processing trade, where Chinese workers simply assemble components made elsewhere, such as putting chips on to motherboards.

Rising labour costs help nudge China in the right direction. It has started to notch up impressive progress. Ordinary trade – where goods are mostly made in China from start to finish – grew twice as quickly as processing trade in the first three quarters of this year, Dragonomics, an advisory firm, observes.

So, China has less reason to be concerned about the fate of its export sector than in 2008. But it is not about to stand idly by when threats arise.

One area receiving increased attention is the proposed Basel III framework for bank regulation that would make trade finance more costly. Chinese banks have come out strongly in favour of a report by the International Chamber of Commerce (ICC) arguing that trade finance is a low-risk asset class that should not be over-regulated.

Ms Zhang at the Bank of China, who is also vice-chair of the ICC’s banking commission, says: “Trade financing affects small- and medium-sized enterprises (SMEs) most seriously. In this financial crisis, it is SMEs that have been hardest hit. This is a sensitive issue for us.”

India: Delight at agreement with Pakistan

An important sign of India’s greater global trading possibilities is an improbable development on its doorstep, writes James Lamont.

A thaw in vexed relations with neighbouring Pakistan promises to break a freeze that has afflicted south Asian trade flows for decades, making it the world’s poorest performer in terms of intra-regional trade.

Trade between the two nuclear-armed rivals has been minimal since the independence of both countries from British rule 64 years ago. Today the flows between Pakistan, a country with a population the size of Brazil, and India, the world’s fastest growing economy after China, are little more than $2.7bn.

When Pakistan’s cabinet this month declared Most Favoured Nation Status for India, New Delhi could barely suppress its delight over a promising trade diversification.

The move, which will allow Islamabad to start removing formidable barriers to imports of Indian goods, has been described by Anand Sharma, India’s commerce minister, as part of a “paradigm shift”. He has backed a target of raising bilateral trade to $6bn within three years.

“It will be beneficial for the both countries. It opens up pathways for elevating our economic engagement to a much higher level,” he says.

Pakistan’s top business leaders, far from fearing cut-throat competition from Indian goods, see opportunities in exporting cement, engineering products, food products and banking services to India.

“It’s a very good gesture,” says Mian Muhammad Mansha, one of Pakistan’s biggest industrialists and chairman of Muslim Commercial Bank. “I would like to compete with Indian banks [in their home market]. I would like to open for business there.”

Trade experts view the granting of MFN status as a pivotal step that could in time unlock trade across the region. “Intra-regional trade in south Asia has been low, owing much to the geo-economic dynamics as well as other factors, and not merely the existing tariff regimes,” says Pradeep Mehta, a former adviser to the World Trade Organisation.

“Some of the impediments to regional trade include high transaction costs, limited port and transport infrastructure, and, crucially, the lack of political will.”

The breakthrough with Pakistan reflects a far wider global outreach by India’s trade negotiators over the past three years, as they seek markets for a fast-growing services-orientated economy.

India, famously protectionist in the past and renowned for formidable tariff and non-tariff barriers, is negotiating bilateral trade agreements with the European Union, Israel, New Zealand, the US, South Africa and Japan. It has already chalked up agreements with the Association of Southeast Asian Nations and South Korea.

Some of these, like the EU trade deal, are not progressing as fast as partners would like. Equally, India faces a big challenge balancing its trade relationship with its neighbour China. Bilateral trade is expected to top $60bn this year, but is heavily skewed in China’s favour.

Mr Sharma, a former junior foreign minister, has brought dynamism to the portfolio. He has combined a mix of diplomacy and publicity with determination to expand bilateral relationships with countries such as lAustralia, which until three years ago was based mainly on commodities, and Ethiopia, a country which some Indian business leaders identify as offering strong possibilities for them. The drive to diversify and smooth trade flows has also coincided with strong export performance over the past year, in spite of a contraction in overall world trade, which had helped narrow a trade deficit.

From April to September this year, India recorded a meteoric export growth of 52 per cent year-on-year. The pace of this expansion of engineering, petroleum and jewellery exports has slowed a little reflecting uncertainty in the global economy. In September, export growth eased to 36 per cent from 44 per cent in August. “Exports continue to grow over last year, but the heady numbers have gone,” says Rahul Khullar, the commerce secretary. Imports too have slowed. In August, they were growing 42 per cent year on year. But in September, this fell dramatically to 17 per cent.

This export performance reflects the success of New Delhi’s push to boost merchandise exports to $500bn by 2014 through incentive schemes.

In the current fiscal year, Mr Sharma predicts exports to surpass $300bn. In the first eight months of this year, they already total $231bn.

“The continuous stress in advanced economies has had a minimal impact on India’s export growth as India has managed to explore new markets through export diversification,” says Soumya Ghosh, head of economic research at the Federation of Indian Chambers of Commerce and Industry.

“The growth prognosis of new export destinations [in Asia, Africa and Latin America] holds promise,” says Soumya Ghosh, head of economic research at the Federation of Indian Chambers of Commerce and Industry. “We believe this may help mitigate the possible decline in exports to the US and EU.”

Japan: Regional trade deal stirs tensions

Trade deals often inspire heated rhetoric, but political debate in Japan over the Trans-Pacific Partnership has in recent months reached new heights of hyperbole, writes Mure Dickie.

For supporters of Japanese involvement in the TPP, the regional trade pact is seen as almost a last chance to shore up competitiveness and ensure growth for a nation beset by demographic decline and anaemic domestic demand.

Naoto Kan, former prime minister, portrayed possible involvement in the pact as part of a historic “21st-century opening of Japan” that would rank with the end of feudal rule in the late 19th century and postwar revival as a peaceful trading nation.

But opponents see the TPP as an existential threat to farming and the life of the Japanese countryside, as well as a potential danger to sectors such as medical services that have hitherto been shielded from international competition.

“Resolutely Oppose a TPP That Will Destroy Regional Economies and Society” ran one banner in a demonstration of thousands of farmers and agricultural association officials in central Tokyo last month.

A placard at the same protest was even more direct: “No! No! No! No! TPP, No! No! No! No!”, it read.

Masahiko Yamada, a former Japanese farming minister and Diet member for the ruling Democratic party (DPJ), has emerged as one of the most vocal opponents to efforts of its leaders to push entry to the TPP and other trade deals that would require opening the agricultural sector.

Mr Yamada warns that tensions over the TPP – currently the centrepiece of multilateral efforts to lower barriers to trade in goods and services around the Asia-Pacific region – have the potential to fracture the DPJ.

“I’m deeply concerned that if our party really forces this issue through, then it may split,” he says.

Such tough talk in part reflects expectations that the pact would require fundamental opening of the agricultural market, exposing Japan’s small-scale farmers of rice – the traditional staple – to competition from more efficient overseas suppliers.

In principle, the TPP requires members to cut import tariffs to zero, but Japanese manufacturers argue that the impact on agriculture will be more than outweighed by the benefits to exporters, who are a vital growth engine.

Manufacturers have recovered impressively since supply chains were disrupted by the earthquake and tsunami that hit north-east Japan on March 11. Exports in September rose 2.4 per cent year-on-year for a trade surplus of Y300bn.

But companies say they are under extreme pressure from a rising yen and would struggle further if they are locked out of low-tariff regional and bilateral trade deals.

Worries focus in particular on competition from South Korea, which in recent years has increasingly threatened to outshine Japan in sectors ranging from computer chips to consumer electronics.

The South Korean challenge has been driven by rapid technological advance, impressive productivity gains and a cheap won. In addition, Seoul’s success in sealing tariff-cutting trade deals with key markets – including the US and European Union – means its companies are soon to get a new edge. By contrast, trade deals sealed by Japan in recent years have been with less important trading partners such as India.

Though Seoul has so far been cautious on the TPP, the Keidanren, an influential Japanese business lobby, says South Korea has implemented or agreed economic partnership agreements with nations accounting for nearly 40 per cent of its trade, compared with under 18 per cent for Japan.

Japanese exporters hope the TPP will win them freer access to the US market, while also paving the way for progress on tariff-cutting agreements with South Korea, China and Europe.

Yoshihiko Noda, Japan’s current prime minister, insists farmers’ worries cannot be allowed to stop efforts to remove barriers to trade. “It’s not a matter of whether or not a high level of economic integration can coexist with a revival of agriculture. It has to,” Mr Noda says.

South Korea: Deal with US is ‘win-win’

Soon after the US Congress passed the long-delayed free trade agreement with South Korea in mid-October, South Korea’s President Lee Myung-bak made a rare visit to an auto plant in Detroit, along with his US counterpart Barack Obama, to promote the landmark deal to disgruntled US workers, writes Song Jung-a.

“Some of you may think that the FTA will cost you your jobs. But that is not the case,” Mr Lee, wearing a Detroit Tigers cap, told hundreds of workers at the plant. “President Obama and I can promise you here that the FTA will protect your jobs and create even more work for others. I expect that Detroit will become a livelier city.”

President Obama also touted the deal, which will be the largest since the Nafta accord was signed with Canada and Mexico more than a decade ago, as a “win-win for both countries”. He predicted it would support at least 70,000 American jobs and boost the US economy by more than its last nine trade agreements combined.

It is doubtful how many of the US auto workers bought the two leaders’ arguments for the bilateral trade deal but South Korea’s previous FTAs with other countries have certainly worked in favour of Asia’s fourth-largest economy. South Korea saw its combined trade surplus with five economic entities with which it has FTAs more than double last year to $18.8bn, accounting for 46 per cent of the country’s total trade surplus of $41.2bn, from just $7bn before the trade deals were signed. Trade volume with the five economic entities with which South Korea has FTAs – Chile, Singapore, the European Free Trade Association (Efta), India and the Association of Southeast Asian Nations (Asean) – increased to $154bn last year, from $92.5bn a year before each FTA went into effect, according to Seoul’s trade ministry.

South Korea has aggressively pursued FTAs with its main trade partners in recent years to boost its export-driven economy, highlighted by the sealing of a trade accord with the European Union, which came into force in July.

Now, all eyes are on its long-pending trade pact with the US, its third-largest trading partner, which many South Koreans hope will boost the slowing economy. The deal was finally ratified by the US Congress last month, after languishing for more than four years because of complaints from US motor unions but it remains unclear whether it can be approved by the South Korean parliament as well .

South Korea now ranks as the world’s seventh-largest exporter, with its global trade poised to break the $1,000bn mark this year. If the pending deal with the US is ratified by the South Korean national assembly, it will be the only country in the world that has FTAs with all three of the world’s largest economic blocs – the US, EU and Asean.

“The path we need to take is absolutely clear. With a lack of natural resources and a limited domestic market, we cannot sustain growth without exporting. This is why free trade agreements are important for Korea,” said President Lee in a recent radio address, urging Korean lawmakers to ratify the bill quickly.

The trade pact with the US is forecast to boost South Korea’s real GDP by 5.7 per cent over the next decade and create 350,000 new jobs. Bilateral trade between the two, which reached $90.2bn last year, is expected to increase substantially, as the agreement is set to scrap tariffs for more than 90 per cent of products within three years. Seoul’s finance ministry forecast that the trade deal would increase the country’s annual trade surplus by $2.77bn over the next 15 years.

Despite all the expected economic benefits, South Korea’s opposition parties are strongly opposed to the pact, calling for the “unfair” trade deal to be revised and for more relief measures to be introduced for those hurt by the agreement. “We need to think carefully whether we should hurriedly approve it just because the US ratified it. We cannot accept a losing trade deal,” said Sohn Hak-kyu, leader of the opposition Democratic Party.

To appease angry farmers and various small businesses that could be hit hard by the trade pact, the government plans to spend a total Won27,400bn to support their livelihoods over the next decade.

Analysts expect the opposition parties to accept the agreement in the end, as the national assembly is controlled by the ruling party. However, they caution that the high-profile deal may not bring huge economic benefits immediately, given the sluggish US economy.

Bark Tae-ho, a trade expert at Seoul National University, expressed disappointment that some service sectors were excluded from the agreement. “It is regrettable that we did not open up medical and education sectors. The deal could have offered a chance to upgrade our underdeveloped service sector,” says Mr Bark. “When Koreans talk about FTAs, they often boast that they can now export more products abroad. But the economic effects of market opening should be felt by both sides equally,” says Mr Bark.

“The government should make more efforts to ensure that an environment for fair competition is provided for imports,” he adds.

He also points out that tariff reductions do not often lead to lower consumer prices in Korea due to non-tariff barriers and distributional inefficiencies. Foreign businessmen often complain that the thorniest obstacles they face in Korea tend to be non-tariff barriers. For example, soon after Korean lawmakers approved its trade agreement with the EU, they put limits on areas where supermarkets could open to protect small family-run corner shops and inhibit expansion by foreign supermarkets such as Tesco.

Australia: Push to sign pacts across region

Chilean wines and South Korean drinkers are not an obvious pairing, writes Sarah Mishkin.

Australia’s vineyards are far closer than to Korea than Chile’s, and Australian producers have been ramping up their marketing across Asia, yet Chilean wines are more popular.

And Chile has sealed a free-trade agreement with South Korea, which pushed its producers to market their wares more aggressively to Korean drinkers. Australia’s free trade agreement with South Korea is still in the works.

There was a clear advantage for Chilean winemakers, says Lucy Anderson, Asia regional director for Wine Australia, a government-backed trade group. “We expect and hope that Australia’s [trade agreement with South Korea] will go through early next year.”

Australia has been pushing hard to seal trade deals across Asia to bolster its status as a regional leader and increase the trade that has made it one of the strongest developed market economies during the financial crisis.

Chinese demand dominates Australia’s exports. In 2010, nearly a quarter exports went to China. Japan, with 16 per cent of exports, was the second largest partner, according to Australia’s Department of Foreign Affairs and Trade.

China’s growing demand for iron ore and coal have reshaped Australia’s economy, giving even more importance to the mining and resources sectors. Even in wine, just 1 per cent of overall exports, China has become the leading overseas market for high-end wine, and Ms Anderson says more and more producers are looking to expand there.

Smaller Asian nations are also significant markets. Last year, Australia exported goods worth a combined A$15.8bn to Taiwan and Thailand together, which is more than it exported to either the US or UK that year.

But as the global Doha trade talks stumble, Australia is not just turning to seal bilateral and regional deals, so its goods can get privileged access to overseas markets. Beyond that, trade deals are a way for Australia to put its imprimatur on shaping the development of the region’s trade ties.

“There’s a strong conviction in Australia that promoting this sort of integration that moves economies into positions where they’ll support open markets is very important in the long run for building prosperity in the region,” says Alan Oxley, a career Australian trade negotiator who now runs a policy consultancy, ITS Global.

The trade deals that Australia pursues, he says, are comprehensive agreements that liberalise movement of goods as well as services, and promote inward investment.

Other regional heavyweights, namely China, have been more willing to negotiate deals that omit discussion of investment and services.

“It’s important for Australia to be on the ground floor and have a say in what the rules of the game are going to look like,” says Joshua Meltzer, formerly with the Australian department of foreign affairs and trade and now a fellow at the Brookings Institute. “Free trade agreements are a vehicle for driving economic reform towards greater transparency and greater openness, and that’s true of most of the FTAs that are being negotiated.”

But success in key negotiations has been slow. Talks between China and Australia, launched in 2005, are “wholly stalled,” says Mr Oxley.

The continued success of Australia and China trade has reduced the pressure on Australia to conclude a free trade deal, some experts say.

Not only is a trade deal seen as less necessary to the success of the relationship, but public antipathy to China has grown alongside its expanding place in the Australian economy.

A leading opposition politician recently downplayed the importance of a China trade deal, suggesting a deal with Japan would be his priority, a move seen by many analysts as a move for the support of the manufacturing sector.

Only 3 per cent of Australians said the government was not allowing enough investment from China, as measured by a 2010 poll by the Lowy Institute. Fifty-seven per cent thought the government was allowing too much investment. A year earlier, only 50 per cent of respondents thought there was too much investment.

The ambivalence Australians feel about China goes beyond the common gripe that Chinese buyers are driving up the price of Sydney flats. As the poll’s authors write about another of their findings: “Almost half of all Australians think our major trading partner may attack us within the next two decades.”

Indonesia: In search of a better balance

Buyers from nearly 100 countries crowded stands in downtown Jakarta last month, placing orders for more than $460m worth of furniture, equipment, shoes and services during a five-day trade fair, writes Anthony Deutsch.

The value of deals at the Indonesian expo rose 26 per cent from 2010, beating even the most optimistic expectations of organisers in the capital – a sign of the strength of the rebound in Indonesia’s export sector since the Asian financial crisis of 1997-1998.

Yet, for all the positive economic momentum – with inflation falling back below 5 per cent and gross domestic product averaging above 6 per cent a year for the past four years – Indonesia’s share of global trade is relatively small considering it ranks as south-east Asia’s largest economy and the world’s 18th largest.

Roughly a third of its exports are of unprocessed natural resources such as coal, oil and precious metals, making Indonesia overly reliant on non-value-added trade. The government hopes to shift the balance by offering tax breaks and encouraging manufacturers to locate there.

The country faces other challenges. It is struggling to lift competitiveness against more productive south-east Asian peers, such as Malaysia and Thailand, and diversify the destinations of manufactured goods. That task is further complicated by weak infrastructure, resulting from a decade of underinvestment that has made Indonesian logistics the most expensive in Asia.

“If Indonesia is going to grow, it is important that this increasing demand is met by supply,” Nouriel Roubini, the economist, said on a recent trip to Jakarta. “It needs more investment in infrastructure, but also in human capital.You need people who have the skills to compete in the global economy. It is crucial to make sure that occurs.”

Even with these constraints, Indonesia’s trade is flourishing. In the first eight months of 2011, total exports climbed 37 per cent to $135bn, putting it on track to hit a $200bn target for the full year.

So far this year, exports to India and China jumped by more than 50 per cent, driven by huge demand for coal and palm oil, commodities in which Indonesia is the largest global supplier. China surpassed Japan as the largest export destination for the first time this year.

Edimon Ginting, senior economist for the Asian Development Bank in Indonesia, says: “Despite the Japanese earthquake and tsunami and other global turmoil, exports expanded rapidly. At the same time, manufacturing is also getting much stronger,” rising from 60 to 62 per cent of total exports this year.

He adds: “Although Indonesia’s export markets are relatively diversified, (they) are still relatively low in such big new markets as India and South Africa,” citing as a main weakness poorly developed trade finance.

Indonesia is experiencing its healthiest growthsince the devastating 1997-1998 financial crisis, when trade collapsed, industrialisation faltered and gross domestic product contracted 13 per cent.

The Asian Development Bank is targeting trade finance to deepen Indonesia’s foreign markets. It provided $200m to the country’s newly established export credit bank, Eximbank, in March to support businesses seeking to enter new market overseas.

Gita Wirjawan, Indonesia’s newly appointed trade minister, says he aims to focus his energy on policies for supporting value-added industries, product diversification and efforts to widen the market for Indonesian goods.

“Clearly, we have to diversify into non-traditional markets, including Africa, the Middle East, central and south America. This is in anticipation of a possible slowdown in traditional export destinations,” he says.

Unlike, say, China, Mr Wirjawan notes Indonesia is very heavily centred on domestic consumption, with about two-thirds of GDP generated at home. That has helped it withstand recent global financial turmoil, but has left it isolated during boom years enjoyed by other south-east Asian countries.

“Indonesia needs to reconfigure itself from an economy centred on domestic consumption to a more export-centric one,” he says. ‘That could help us lift growth from the 6.5 per cent we have now, to a level much higher.”

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