The Future of World Trade_LANDSCAPE DEF (versie die gedrukt is)

ING Commercial Banking

The world trade comebackTrade growth will once again outpace GDP growth

ING Commercial Banking The world trade comeback / April 2015 2

Colophon

International Trade research ING Global Markets Research

Trade SpecialApril 2015

AuthorsRaoul LeeringHead of International Trade Research+31 6 13 30 39 44

Filip BekjarovskiTrainee International Trade Research


Contents

Executive summary 4

I Introduction 6

II Trade through the decades: ups and downs 7

III Drivers of the ratio of world trade growth to world GDP growth 11

a. Shifts in import demand 11

b. Protectionism/Free trade agreements 14

c. Exchange rate battle and macro policies 16

d. Offshoring/Reshoring 17

e. Foreign direct investment 24

f. Trade finance 26

g. Innovations and trade 27

h. Geographical division of trade 29

i. Product division of trade 30

IV Conclusions 32

References 33


Executive summary

• The slowdown in the growth of world trade, especially in relation to GDP growth, has led some commentators to believe this development marks the end of globalisation. But in fact it is a common feature of economic downturns. In the period 1980-1982 the ratio of world trade growth to GDP growth was also around 1, similar to the ratio since the start of the financial crisis. Having said this, the current ratio is far below the historical average of 1.7.

• Based on experiences during earlier periods of recovery of the world economy, the current (cautious) upswing will push the ratio of trade growth to GDP growth up to 1.2 at the end of 2016. This normal cyclical effect stems from the fact that demand for durable consumption goods and investment goods increases disproportionately in economic upturns and these goods are overrepresented in global trade.

• On top of this the ratio will be lifted by specific European factors. The long economic downturn in the EU has pushed the growth of world trade down disproportionately, reflecting Europe’s over representation in trade. On top of this, the relatively large share of investment in the decline of European demand hurt world trade more, with investment being relatively import sensitive. This implies that the current increase in European growth rates will make world trade recover disproportionately. ING expects these specific characteristics of the European economy to drive the ratio up by 0.1 percentage point to 1.3 before the end of 2016.

• But for the ratio to come close to its long term average of 1.7, more is needed than this cyclical push. Import ratios around the world have to show structural rises again. We believe this will happen in the next couple of years because: - Implementation of the Bali agreement on

lowering customs procedures will ultimately lift world trade by 4.1% and world GDP by 1.1%. The Bali agreement will lift the ratio by 0.14 percentage point from 2016 onwards, on the assumption that it will take five years to implement this agreement and that it’s done in equal steps so the benefits, in terms of the upward effect on trade growth and GDP growth, will be spread out equally over this period. The effect of this 0.14 per year brings the ratio in between 1.4 and 1.5 during the 2016- 2020 implementation period, as long as the world economy is in a cyclical upturn (otherwise the cyclical influence on the ratio will start working in the opposite direction again). Of course any delays in the implementation of Bali will also delay the upward influence on the ratio.

- If negotiations on the Transatlantic and Pacific trade agreements (TTIP and TPP) deliver results that are acceptable for European, American and Asian governments and parliaments an upward effect on world trade in the medium to long term will appear as well. This will push the ratio up but how much and when is unclear because it is unknown when negotiations will be finished and what the outcome will be.

- Trade will also be stimulated by continuing offshoring of production to developing economies. Although reshoring has increased, offshoring will continue to dominate in the years ahead because there are many developing countries that have maintained or improved their attractiveness as production locations, notwithstanding wage costs rises in some of them. The relatively low stock of inward Foreign direct investments (FDI) in countries such as China, India, Philippines and Indonesia suggests ample scope for more FDI. Now that business confidence is recovering in most advanced economies, ING expects a recovery of their outward FDI to add to the already visible increase of outward FDI by Asian countries such as China. These developments will increase the trade in intermediates and thereby push up the ratio of world trade growth to growth of GDP.

- The geographic spread of trade- and offshore- enhancing innovations (e.g. in ICT and logistics) is far from finished. Some countries, like India, have below average internet penetration which means above average costs of trade formalities. Although there are no reliable data available to quantify the effect on trade of an optimal spread of these technologies, we expect it to be significant.

- In the long run innovations like 3D printing and robotics will be trade diminishing, but in our view they will not have the scale to seriously push down the growth rate of trade in the short to medium term. Besides, at the same time, trade


enhancing innovations like lighter containers are appearing as well.

- The composition of trade will shift towards more demand for tradable consumer goods in developing countries, reflecting the rise of their middle classes, and less demand for tradable consumer goods in advanced economies, reflecting ageing. Given the expected further increase of the share of developing countries in the world economy and their above average import ratios, especially in Asia, these developments will add up to a stimulus for the world trade-GDP ratio in the medium term.

- Another potential structural driver of trade that can push the ratio upwards is trade in services. The ICT revolution makes products tradable that were not tradable before (retail sales, education, etc). This development has been on hold since the start of the crisis. But with consumption and investments rising in advanced economies, where consumers and producers have the best access to internet, services might provide renewed stimulus to world trade in coming years.

- On the downside, the conflict in the Ukraine could still lead to an escalating trade war between the West and Russia, which would be a clear negative for trade since Russia is a significant player in world trade. Harm to trade could also stem from increased exchange rate volatility if the current currency battle escalates.

- On the upside a closing of the recent draft agreement between Western governments and Iran, with its economy the size of South Africa’s, would be a positive for world trade.


I Introduction

The current debateWith a projected growth of 3.7% in 2015 (IMF 2015), world trade will, for the fourth year in a row, fail to clearly outpace world GDP growth. This marked difference with the fifteen years in the run up to the financial crisis has led some to believe that world trade growth will not return to outpace world GDP. The deadlock in the Doha negotiations, the lack of new big entrants in the world of free trade, reshoring of production, and technological developments like 3D printing and robotics are just some of the arguments used by the proponents of this hypothesis. In this ING Trade Special we will weigh these arguments and put forward some arguments of our own to assess the future of world trade.

Why bother about trade growth?Trade is more than just a side product of growth. It can be an independent source of growth with positive effects on the standard of living. Frankel and Romer (1999) conclude that, dependent on the estimation method, research shows that a 1% increase in the share of trade to GDP raises per capita income somewhere between 0,5% and 2%. Exporters are more productive and when they enter the foreign market they raise the overall productivity level in the industry (Wagner, 2012). There is also some evidence that exporters learn by exporting and experience faster productivity growth rates relative to enterprises that limit themselves to domestic sales. In addition, catering to a larger market enables companies to achieve internal and external economies of scale and thereby reduce the unit costs of production.

Trade improves welfare also by allowing countries to focus on the production of goods and services for which they have a comparative advantage. Liberalisation of trade usually results in lower prices for (tradable) consumption and investment goods. In addition, consumers and producers enjoy more product varieties as trade involves huge amounts of intra sector cross border exchange of goods and services.


II Trade through the decades: ups and downs

The growth of world merchandise trade in value terms averaged 10% a year over 1961-2013, well above the average nominal growth of world GDP (8%, figure 1). But trade growth has varied considerably across decades. In particular, world merchandise trade has been volatile. This can be expected, given the price volatility

of important trade classes like commodities and fuels. Between the start of 2012 and the fourth quarter of 2014 nominal world merchandise trade has on average grown by 2.4% per year, less than the average growth of nominal world GDP (2.8%), thereby clearly lagging its trend.

In comparison, the historical growth rate of the value of trade in services has been lower, with 8% annually over 1980-2013. But at the same time trade in services has been less volatile. Nevertheless, world trade in services has been also lagging its trend recently (figure 2).

Figure 1. Historical growth of world merchandise trade, nominal values

* Throughout the report trade is defined as imports plus exports; Data Source: WTO.

-30%

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● Increased recycling of goods and materials

● Repairing existing goods more often

● Buying less new goods

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_ Growth of merchandise trade value _ Growth of world GDP_ Average growth of world trade

Figure 2. Value of world trade in services, 1980=100

ING Global Markets Research; Data Source: WTO.

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The recent slowdown of trade is also evident in volume terms, but less markedly (figure 3). The average annual growth rate of world trade in volume terms has been 5.7% since 1970 and only 3.3% since 2012. More importantly, world trade growth no longer outpaces growth in world GDP. During the fifteen years leading up to the crisis, growth of world trade grew 1.9 times faster than world GDP growth. Taking into account earlier decades, during which trade growth deviated less from production growth, the ratio has been 1.7 on average between 1970 and 2013 (figure 4 and 5).

The fluctuation in the world trade to world GDP ratio over the decades is the result of the fact that trade levels (imports and exports) are about three times as volatile as GDP. Engel et al. show this in their 2011 study.

Trade depends heavily on economic stability. In periods of economic calm, world trade growth has markedly exceeded its long term average. The 1993-1997 and 2003-2007 periods are good examples of this (figure 3). Economic turmoil on the other hand is bad news for world trade. The start of the Global Financial Crisis (GFC) in 2008 is the best example of this. The scarcity of liquidity, the very sharp drop of business confidence and the lack of trade finance caused world trade in 2009 to show its biggest decline since WW II. But the deep economic crises in the beginning of the 1980s and the beginning of the 1990s, the Asian Crisis of 1997 and the bursting of the dot com bubble in 2000/2001 also left clear marks on world trade and the trade to GDP ratio (figure 3).

During economic downturns, increased uncertainty reduces the incentives of customers to commit to large purchases. This reduces the demand for durable

Table 1. Volatility and co-movements in International trade

Volatility and co-movement in international trade

Standard deviation of GDP (%)

Relative standard deviation* Correlation with GDP Corr(IM, EX)Real

importsReal

exportsNet

exports/GDPReal

importsReal

exportsNet

exports/GDP

Average 1.51 3.25 2.73 0.78 0.63 0.39 -0.24 0.38

* Average for OECD sample in the period 1973-2006. Source: Engel & Wang (2011); ING Global Markets Research

** Standard deviation relative to the standard deviation of GDP

Figure 3. Historical growth of volume of world trade in goods and services

ING Global Markets Research; Data Source: IMF & OECD.

-10%

-5%

0%

5%

10%

15%Average growth of world production

Real world production growth

Average growth of trade volume

World trade volume growth of goods and services

20132011200920072005200320011999199719951993199119891987198519831981

_ World trade volume growth of goods and services_ Average growth of trade volume

_ Real world production growth_ Average growth of world production


_ Real world production growth_ Average growth of world production

-10%

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0%

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15%Average growth of world production

Real world production growth

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World trade volume growth of goods and services

20132011200920072005200320011999199719951993199119891987198519831981





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goods disproportionately as businesses and consumers can usually hold on somewhat longer to their current durables. Trade in durable goods on average accounts for 70% of imports and exports in OECD countries (Engel et al., 2011). Because of the over representation of durable goods in cross border trade, an economic downturn hurts trade disproportionately.

These past experiences show that it is normal for trade growth to decrease faster than GDP growth during a crisis. In addition, weak trade growth often lingers on in the aftermath of a crisis (Freund, 2009). The current

situation fits this pattern (figures 3 and 4). This raises the question whether the current slowdown in trade is ‘just’ a typical (post) crisis development or represents a real structural break.

Examining the historical development of trade relative to world GDP in more detail gives some answers. The world trade to world production ratio has varied considerably across decades. In the 1950s and 60s, when trade and production both grew fast, the ratio was around 1.65 (figure 5). In the 1970s the ratio went up before coming down steeply in the 1980s.

So, from a long term perspective the trade-income relationship characterising this period is not anomalous. But compared to the 1990s and the first 8 years after the turn of the century, during which the ratio was 1.9 on average, the current performance of world trade is weak even compared to most other periods of economic downturn. For the period after 2011, the ratio is around 1 on average.

The period from the 1990s up until the start of the financial crisis was the heyday of the latest wave of globalisation. Among other things this period is

Figure 5. Growth of world trade, and world GDP; the ratio of world trade growth to world GDP growth in volumes (right axis)*

* The ratio of world trade growth to world GDP growth on right axis. ING Global Markets Research; Data Sources: IMF & OECD

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2009-2015 2001-2008 1991-20001981-19901971-19801961-19701950-1960

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GDP Growth

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● Trade volume growth ● GDP growth ● Ratio of trade growth to GDP growth _ Average trade to GDP growth

● Trade Volume Growth ● GDP Growth ● Ratio of Trade Growth to GDP Growth _ Average Trade To GDP Growth

Figure 4. Recent developments in trade growth and GDP growth (in volumes)*

* Historical average based on the period 1970-2014. Forecast for 2015 based

on IMF estimates. ING Global Markets Research; Data Source: IMF & OECD.

-10%

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Average Growth of Trade

Trade volume growth

2014201220102008-15%

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_ Trade volume growth _ Average growth of trade _ World production growth

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Figure 6. World trade value in goods and services, 1949=100, trend line based on 1949-2008

ING Global Markets Research; Data Source: WTO

characterised by the inclusion in world trade of Eastern European countries, Russia and, of course, the spectacular contribution of China to the growth of world trade. Multinationals implemented numerous global value chains which steeply increased the trade in intermediate goods. These global value chains were made possible by the ICT- revolution that spectacularly cut the cost of coordinating work between geographically distant locations.

A structural break in world trade?Figure 6 shows that the current trade growth level is deviating from the trend. It indicates a structural decline in growth rates since the start of the financial crisis.However, given that trade growth has varied markedly across the decades, the selection of a time period for calculating a trend line is extremely relevant. Calculating, for example, the trend line for the period from 1980 onwards, results in the different conclusion that current developments do not really lag the trend (figure 7)!

Nevertheless, formal tests conducted by IMF and World Bank economists Constantinescu et al. (2015) confirm the existence of a structural break in the trade-income relationship in the 1990s relative to the preceding decades. So structural breaks do occur and this is not surprising given that there is no economic law that guarantees that trade should grow faster than GDP. There is a priori no reason why world trade is not experiencing a structural break today.

However, a formal test for a structural break requires a sufficient number of observations after the break and consequently we are unable to perform one. Nevertheless, to assess the likelihood of a structural break, we proceed by analysing developments in some of the drivers of the trade-production ratio.





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Figure 7. World trade value in goods and services rebased, 1980=100

ING Global Markets Research; Data Source: OECD & WTO





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Figure 8. Monthly import volume rebased, January 2008=100

ING Global Markets Research; Data Source: IMF

III What drives the ratio of trade to GDP?

What is behind the decline of the ratio of world trade to world GDP since 2011? Many reasons have been put forward and we will add some. We will have a look at the following drivers and also have a tentative look into the development of these drivers in the near future:

a. Shifts in import demand

b. Protectionism/Free trade agreements

c. Exchange rate battle and macro policies

d. Offshoring/Reshoring

e. Foreign direct investment

f. Trade finance

g. Innovations and trade

h. Geographical division of trade

i. Product division of trade

a. Shifts in import demandThe fall in the growth rate of world trade can partly be attributed to relatively weak import demand from Europe (figure 8). This relates first of all to the lagging economic growth in the EU. IMF figures show that while the world economy showed an average growth rate of 3.2% during 2009-2014, the GDP of the EU grew on

average only 0.2% per year. The EU economy has lagged the growth of the world economy before, but this time by more than during previous downturns.

Given the overrepresentation of Europe in world trade Europe accounts for 35% of world trade, while it accounts for 25% of world GDP, the relatively weak

_ United States _ EU (28) extra-trade _ China

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performance in Europe has been a significant factor in explaining the slowdown in world trade growth. But the effect on the ratio of world trade growth to world GDP growth is limited. This is due to the fact that every percentage point of lower EU growth not only diminishes world trade growth significantly, but also growth in world GDP.

Because the EU is overrepresented in world trade relative to world GDP, slower EU growth pushes down the ratio somewhat. But it can only explain a small part of the decline in the ratio from 1.85 during 2000- 2008 to 1.04 during 2012-2014. A “what if” analysis shows this. If the EU were to have had the same economic growth as the US during 2012-2014, the ratio of world trade growth to world GDP growth would have nudged up by ‘just’ 7.5% from 1.03 to 1.08.1

Besides the amplifying influence on world trade of Europe’s disproportionate share in trade, there is a second reason why Europe has put extra downward pressure on world trade and the ratio: a recent shift in the composition of European demand. Investments have suffered more in Europe than in other regions (figure 9). This is relevant because investment is the demand category with the highest import sensitivity. So, the shift away from investments in Europe has been an extra negative for European imports and thereby for world trade, but has had a smaller effect on the ratio of world trade growth to world GDP growth.

If Europe’s investments would have developed just as in the US during the 2012-2014 period, the ratio of world trade growth to world GDP growth would have risen from 1.03 to 1.15 a tentative estimate shows.2

Figure 9. Deviations of pre-crisis trend for different demand components

* Index, trend volume in 2014 = 100. Bars below or above show deviations

from pre-crisis trend (1980-2008). Data Source: World Bank, UN Comtrade

data; ING Global Markets Research.

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Figure 10. World average import ratio and its main regional drivers

ING Global Markets Research; Data Source: World bank development indicators

_ World _ Developing economies _ EU28 (European Union)

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1 if the EU had US growth levels (2.2% per year instead of 0.4%), the extra

1.8% would lead to 0,25 (EU share in world GDP)* 1.8% = 0.45pp of extra

world GDP per year. It would also lead to 0.35 (EU share in world trade)*1.8

= 0.63pp of extra world trade per year. Add 0.63% to the average growth

rate of world trade (3.3%) and the growth of world trade would have been

3.93%. Add 0.45% to the world GDP growth (3,2%) and we find that

world GDP growth would have been 3.65%. The ratio of world trade growth

to world GDP growth doesn’t rise much though. It would have been 1.08

(3.93/3.65) instead of 1.03 (3.3/3.2).

2 Europe’s investment is 20% of Europe’s GDP. If 60% of this is imported, this

translates into 30% of total imports (trade ratio = 0.40). If the deviation of

investment demand from the trend had not been -30%, but -10% (as in the

US), total EU- imports would have been 6% higher (0.30*20pp). World trade

growth would have been 2.1%-point higher (0.35* 6%). World GDP would

have been 1.5% higher (0.30*6%). Given the GDP rate of 3.2 and the trade

growth of 3.3, the ratio would be 1.15 instead of 1.03


The main reason for the ratio to have fallen so significantly since its peak in trade growth to GDP growth 2008 is that import ratios stopped rising. This is partly a cyclical phenomenon because import ratios have a cyclical component, reflecting the pro-cyclicality of demand for durable consumer goods and investment goods that are over represented in world trade. This is why the import ratios of the EU and the world were also stagnant or decreasing during the economic downturns at the beginning of the 1980s and the beginning of the 1990s (figure 10).

Looking forward, the (cautious) economic upturn of the world economy will cause world trade to rise more than world GDP because thus durable goods make up 70% of world trade in goods. We assume that the cycle will bring the ratio in Q4 2016 to the same level as after the first two years following the recession at the beginning of the 1980s (1983-84). That was a period which also wasn’t blurred by any huge upward structural stimulus on trade (contrary to the recessions in the beginning of the 90s and 2000s). A recovery that resembles the recovery in the 1980s will shift up the ratio from 1 for 2012-2014 to 1.2 at the end of 2016.

This normal cyclical effect will be reinforced by the reversal of the specific European effects that were mentioned above. The increased overrepresentation of Europe means that the European recovery will push up the ratio more than during economic recoveries in the past. Moreover, a normalisation of European investments may push the ratio up another 0.1 percentage points.

All told, these cyclical effects might result in a ratio of world trade growth to world GDP growth of 1.25 at the end of 2016.3

Besides cyclical factors, structural developments also have been at play. In the fifteen years up to 2008 the average import ratio in the world rose almost every year and cumulatively it rose 63%, from 19% to 31%. The inclusion of China and other countries into the world of free trade, but also the enhanced economic integration in the EU (creation of the single market), pushed up import ratios (figure 10). Now that import ratios are no longer rising structurally, the ratio of world trade growth to world GDP growth is hovering around 1. For the ratio to keep rising after the upward impulse from the cycle, upward pressure is needed from structural drivers.

Summing up: World trade has been hit disproportionately by the recession in Europe due to its high share in world trade and the overrepresentation of investment in the decline of European (import) demand. If the budding European recovery continues, world trade will grow disproportionately and the ratio of trade growth to world GDP growth will rise more than was common during earlier economic upturns. But for the ratio to come close to its long term average of 1.7, import ratios would have to be pushed up again by structural factors.

Figure 11. Percent of imports affected by trade restrictions

Source: Emine et al. (2014); ING Global Markets Research





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3 Investments in the EU will rise by 3.2% on average in 2015 and 2016 in the EU

(compared to 0.9% last year). Because of the share of 20% of investments in

EU GDP, this increase of 2.3pp will bring an extra contribution of investments

to GDP of 0.46% per year in 2015 and 2016. Given a constant import ratio this

also raises EU imports by 0.46pp a year. This EU extra growth per year leads to

0.25 * 0.46 = 0.12pp of extra world GDP per year and 0.35 *0.46 = 0.16pp

of extra world trade per year. Given the starting point of a growth rate of 3.4

for world trade and for world GDP in 2014 the forecasted extra investments

drive the growth of world trade in 2015-2016 to 3.56% on average and

3.52% for world GDP. This results in a ratio of 1.02, 0.02 more than in the

average ratio during 2012-2014. This overrepresentation effect also happened

during the recovery in 1983-1984, but then the overrepresentation was half

of today’s. So the net effect is a rise of the ratio of 0.01. The increased EU

overrepresentation in world trade creates a similar affect for the recovery in

consumption and pushes up the ratio by 0.04pp. So the total upward effect of

the overrepresentation is 0.05pp, which makes the ratio 1.25 in our forecast.


b. Protectionism/Free trade agreements Since the start of the financial crisis protectionism has been on the rise, but it would be incorrect to blame the recent slowdown in trade on the emergence of protectionist measures. Unlike previous crises, such as the great depression in the 1930s, the financial crisis of 2008 was not followed by a huge increase in trade protection. Protectionist measures have affected only slightly over 1% of world imports for the period after the financial crisis (Figure 11).

The WTO World trade report (2014) and several academic studies have documented the low growth of trade restrictions in the aftermath of the Lehman crash. Gawande et al. (2011) show that even though the crisis brought about increased demands for protection, these demands had a very limited effect. The economic interest of domestic enterprises that are involved in cross border value chains have provided an effective counterweight to rising trade protection tendencies during the crisis.

Developing countries have engaged in relatively higher trade protection mainly in the form of customs procedures, import quotas and tariffs, especially in 2012 (Figure 12). Developed countries on the other hand (figure 12) have engaged predominantly in trade remedies (using existing escape routes within current anti protectionist regulations). Nevertheless, in both country groups the percent of trade affected by new protectionist measures is, as said, limited. Widespread membership of institutions such as the World Trade Organization (WTO) has curbed nationalistic trade policies and enabled international trade cooperation. In 2014 free trade has taken a hit from the mutually-imposed sanctions between the West and Russia in response to the conflict in the Ukraine.

Figure 12. Percent of developed and developing country imports affected by trade restrictions

Source: WTO (2014,) WTO monitoring database and UN Comtrade; ING Global Markets Research

0.00 0.05 0.10 0.15 0.20 0.25

Customs procedures

Import duties,quotas or taxes

Local content

Trade remedy

Other measures

0.0 0.1 0.2 0.3 0.4 0.5

Customs procedures

Import duties,quotas or taxes

Local content

Trade remedy

Other measures

0,00 0,05 0,10 0,15

Customs Procedures

Import duties, quotas or taxes

Local Content

Trade Remedy

Other Measures

Developed G-20 Developing G-20





● Other

● 2010 ● 2011 ● 2012 ● 2010 ● 2011 ● 2012

Table 2. Average tariff rates for different country groups

Average tariff rates Most-favoured nation (MFN) rate Bound rate

Average 2009-2011 Change since 1996 Average 2009-2011 Change since 1996

World 8.5% -2.0% 27.0% -3.8%

Developed 2.7% -1.9% 6.3% -1.3%

G-20 developing 10.1% -5.5% 29.2% -9.8%

Other developing 13.0% -1.7% 29.6% -7.1%

Least developed countries 7.1% -2.1% 42.2% -2.4%

* Note: Changes are from average 1996-98 to average 2009-11. Source: World trade report 2014; ING Global Markets Research


The inclusion of (former) communist regimes in the world of free trade has been one of the key drivers of growth of world trade during the past two and a half decades. Therefore, some have claimed that since major transition economies have already integrated into the world marketplace, there will be little room for trade growth in the future. We tend to disagree. Although a very large step has been taken, many countries cannot yet be characterised as free trade countries. Table 3 shows that, although average tariffs are at historically low levels, they can still be reduced significantly. This is especially true in developing countries.

Since 1996, developing countries within the G20 have slashed average tariffs by a third. Nevertheless, the average still stands at 10%, almost five times as high as the average tariff in the developed world. The average level in other developing countries is even higher and they have made less progress in reducing tariffs. The same story holds for the upper bound of the tariffs: developing countries have much higher rates. This means that there is still scope for trade agreements to reduce tariffs and thereby increase world trade. At the same time this also means that the developed world has less to offer in the negotiations when it comes to tearing down tariff walls.

But tariffs are just a fraction of trade costs. Non-tariff barriers such as customs procedures, product standards, anti-dumping legislation and labelling standards can very well be legitimate, but they are also used to deter trade. Non tariff barriers now deter trade flows more than tariffs. Empirical studies find that when countries are limited in imposing tariffs because of international trade agreements, their governments often use non-tariff measures to protect domestic industries. Enterprises find customs procedures to be a significant obstacle for participation in global value chains (WTO 2012). The global competiveness report for 2014-2015 shows that customs procedures have a significant effect on the trade of some emerging economies. In some countries customs clearance procedures can still take up to 30 days. Brazil is one of the countries that have very high customs burdens and has also seen a deterioration in this area over the past five years. Besides Brazil, customs procedures deteriorated in several other big markets including China, South Africa and Turkey (see table 3).

So, both tariff and non-tariff data show that there are ample opportunities to increase world trade and thereby world welfare by reducing trade barriers. It is no wonder that the World Trade Organization started the multilateral Doha round in 2001, aiming to remove trade barriers. But negotiations have stalled for years now. Divergent stances have emerged on agriculture subsidies, industrial tariffs, non-tariff barriers, services and trade remedies. Along these lines, most lines of contention have emerged between developed economies (led by EU, USA, Japan) and developing economies (led by India, Brazil, China, South Korea, South Africa). Disagreements between the US and EU over agricultural subsidies have also hindered progress.

However, one major multilateral trade deal is the Bali Agreement (end 2013) which aims, among other things, to reduce customs procedures. Implementation was held up by India until November 2014, but it is currently in the process of parliamentary ratification by all WTO member states. Once implemented, this agreement will make a difference. As result of modernisation of their organization, customs agents and forwarding companies should be able to complete all the necessary paperwork even before the shipment arrives at the harbour of destination, contacting just one single office. The potential benefits of the Bali agreement are substantial. According to the Peterson Institute of International Economics step by step implementation of the Bali agreement could increase global trade by as much as $1000 billion, equally divided between developed and developing countries. This is equal to an increase of 4.1% of global trade and a rise of 1.2% of world GDP. It will take several years -we estimate 5 years- to reap these fruits, but it will drive up the ratio of world trade growth to world GDP growth by almost 0.2 percentage points.

Table 3. Burden of customs procedures, selected economies, 2015 and 2010*

Burden of customs procedures 2009-2010 2014-2015

Advanced economies 5.00 5.08

China 4.57 4.35

South Africa 4.32 4.14

Indonesia 3.70 4.03

Peru 3.81 3.96

Thailand 4.06 3.91

India 3.91 3.91

Turkey 3.40 3.79

Romania 4.08 3.70

Russian Federation 2.73 3.59

Philippines 2.98 3.53

Brazil 2.89 2.68

* (7=best and 1=worst)

Data source: Global Competitiveness Report; ING Global Markets research


The Bali agreement brings hope for the Doha round which was initially scheduled for completion in 2005. The stalling of these talks has led countries to turn to bilateral and regional agreements to stimulate international trade. From 1958 to 1999, 75 regional trade agreements were notified to the WTO. From 2000 to 2011, the number of additional regional trade agreements has jumped to 156 (WTO). Taking into account that the implementations of the most recent trade agreements has not been fully completed, we forecast that these regional trade agreements wil lead to extra trade and thereby push up the ratio of world trade to world GDP by 0.1 during 2016-2020.

The Transatlantic Trade and Investment Partnership (TTIP) is one of the free trade agreements under negotiation. This potential agreement between the US and the EU will increase exports by 6% in the EU and 8% in the US, according to calculations of the Centre for Policy Research in London requested by the European Commission. TTIP is expected to increase the size of the EU and US economies by 0.5% and 0.4% respectively. A working paper by Capaldo (2014) that drew media attention in late 2014 suggests that TTIP will lead to a contraction of GDP, personal incomes and employment for the EU. This study highlights that gains in transatlantic bilateral trade would go to the US at the expense of intra-EU trade. Even if this draft study is correct, which we highly doubt, because it assumes that costs of trade are zero and that there are no economies of scale, the agreement would still stimulate world trade, because the money saved by the substitution of the existing (more expensive) intra EU imports by imports from the US will partly be spent on new imports. In addition, the standardisation of rules and regulations will also benefit other countries, potentially causing positive spillover effects on trade globally.

Another agreement under negotiation is the Trans-Pacific Partnership (TPP), a regulatory and investment treaty under negotiation between 12 countries (Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, United States, and Vietnam). Countries such as South Korea and Taiwan have also expressed interest. China is not part of these negotiations. By leaving China out, the contract has therefore often been portrayed as a method to contain China.

China is seeking trade cooperation under the Regional Comprehensive Economic Partnership (RCEP), a potential trade agreement for the ten member states of ASEAN and Australia, China, India, Japan, South Korea and New Zealand. These countries encompass 40% of world trade. The issues negotiated are trade in goods and services, intellectual property and investments, and dispute settlement mechanisms. Countries such as Singapore and Malaysia, which have relatively liberalised trade levels, are putting pressure on India to lower barriers. India is moving with caution in the regional trade deal as it fears increased imports from China, with which it already has a trade deficit. But peer pressure seems to be working. In the latest round of negotiations, India made an offer to give duty free access to 70% of product categories for the ASEAN economies and 40% duty free access for the rest (China, Japan, Korea, Australia and New Zealand). In the previous offer duty free access for 40% of all product categories was granted for all 15 countries.

But the potential fruits from these trade agreements are still far from being reaped. For these deals to be closed, quite considerable resistance among vested interest groups, NGOs and action groups has to be overcome to achieve ratification by national parliaments and the EU parliament.

c. Exchange rate battle and macro policiesBesides tariff and non-tariff barriers, exchange rate policies can also be seen as trade policy. The quantitative easing that was first pursued by the American and English monetary authorities pushed down their exchange rates. This led the Brazilian Finance Minister to speak of a trade war in Washington in late 2010. The Bank of Japan (2013) and the European Central Bank followed in 2013 and 2015 with quantitative easing which weakened their currencies as well.

While the effect of depreciation on economic growth is temporary, especially once other countries take similar steps, expansionary monetary policies have driven up growth through other transmission channels (costs of credit, wealth effects). As a result, trade may have been higher than otherwise would have been the case.

On the downside is the risk that the (openly or hidden) exchange rate policies could turn into a series of competitive depreciations or devaluations. A ‘race to the bottom’ is not a zero sum game. Although countries can avoid losses in price competiveness by joining the currency battle, this leads to a rise in exchange rate volatility. Higher volatility in exchange rates creates uncertainty about returns on foreign business or -if the currency risk is hedged- at least higher costs of trade. Both discourage cross border trade. Elevated exchange rate volatility is a downward risk for trade that is to be taken seriously.

Another policy issue is the asymmetric approach of current account imbalances. As long as nations with current account surpluses refuse to implement reflationary policies (Germany) or are not very successful in increasing domestic demand (China, Japan), pressure


will remain on deficit countries to cut spending. This puts a drag on world trade. And it would also be bad news for the ratio of world trade growth to world GDP growth, if it were to affect the willingness to invest and buy consumer durables, because durables are over represented in world trade. Whether this happens will depend on the effect that rebalancing has on the cycle. If it causes an economic downturn then consumers and investors can be expected to show this behaviour.

Summing up: The exchange rate battle is a negative for trade and the asymmetric rebalancing of worldwide current account imbalances has put a drag on trade and in turn could a negative for the trade to GDP ratio.

d. Offshoring/Reshoring The 1990s saw the birth of the global value chain. The ICT revolution dwarfed the costs of communication and made cross border coordination much cheaper. This made it affordable for enterprises to break up their production processes and locate each production phase in the country where costs of production (including transportation costs) are lowest. Major developed economies such as the US, Germany and the UK started outsourcing (parts of) their production on a large scale.

Being an important part of total costs in most sectors, labour costs became very important in choosing production locations. Western companies offshored large parts of their production to Eastern Europe and Asia. China, with its huge supply of cheap (rural) labour attracted a lot of FDI from Western companies. According to the latest figures from Unctad (2013), in 25 years China moved 15 places up the ranking of the stocks of foreign direct investment, from 17th in 1990 to second place in 2013. Excluding the stock of investments in Hong Kong, China is still number four. As

a percentage of GDP, inward stock of FDI is, however, still relatively low in China (table 4).

Of course FDI is not only about investments driven by offshoring and increasing FDI inflows do not by definition point to offshoring. But other indicators also suggest a development in the direction of offshoring or outsourcing. The share of intermediate products acquired from low wage regions (as a percentage of total intermediates used) has been rising since the mid 1990s and has been more pronounced since the turn of the century (see figure 23).

The rise of trade in intermediates has been one of the reasons for the fast growth of world trade since the beginning of the 1990s. This is partly due to double counting. After all, the value of an export product that is completely produced in one country is booked only once in the recording of export values (say 100). When the same export product with a value of 100 is produced with inputs of two other countries (each worth 30) the registered export value for this product adds up to 160.

Recent developments suggest that there is a turnaround in offshoring. Some well known Western companies have brought production activity back from low-wage countries to their home countries. Apple is bringing back activities from Foxconn China to Silicon Valley in California, Philips withdrew the production of razors from China and brought this back to the Netherlands and Airtex Design Group is shifting part of its textile production from China back to the US.

Recent surveys suggest that reshoring is not limited to a few eye catching companies. According to a Boston Consultancy Group survey, 54% of US companies are

considering reshoring or are actually doing so (2013). In a survey for the eurozone by PricewaterhouseCoopers in the autumn of 2014 almost 60% of the surveyed companies said they had reshored some activities during the past 12 months and slightly fewer than 50% plan to do so over the next twelve months. This survey, however, shows at the same time that almost the same share of eurozone corporations (55%) has offshored part of their production during the last twelve months. Moreover, the survey results gives no information about the size of the operations. This makes it impossible to know whether the stock of offshored business is still growing or is in reverse.

Nevertheless, the survey shows differences between countries in the eurozone. Italy and Ireland are leading in the amount of reshoring projects, followed by Spain and the Netherlands. A survey by the Dutch Statistical Office (CBS, 2013) shows that outsourcing by Dutch companies has diminished compared with 2001-2006. Nevertheless, the share of outsourcing to Russia and ‘other European Countries’ (including some east European countries) increased in the first three years after the start of the crisis in 2008. Another survey, done by TNS Nipo in 2013, showed that only 10% of Dutch companies, who are among the biggest foreign direct investors in the world, actually reshored production and just 5% considered it. This is considerably lower than the outcome in a PricewaterhouseCoopers analysis for the Netherlands that concludes, based on the very small survey group of 42 companies, that slightly over 60% of Dutch companies have reshored over the last twelve months and that 50% are considering it for the next twelve months.

What is behind this shift towards reshoring? Commentators often refer to the relatively steep rise of wages in China (figure 13) which should diminish the


advantage of offshoring to the ‘factory of the world’. Besides this, according to other analysts labour costs will become less decisive as labour will be replaced by capital such as robots and 3D printing (see paragraph on innovations). We now look more in detail at the possible drivers of reshoring to get a better idea of the influence this will have on the growth of world trade in the near future.

The role of labour costs Labour costs per product have been rising fast in some countries that serve(d) as a production location for Western companies. China leads the pack with an average real wage increase of almost 14% a year since 1997, followed by Indonesia, Turkey and Hungary (see figure 13). At the same time wage moderation has taken place in several important advanced economies, leading some commentators to conclude that offshoring is no longer profitable.

While it is true that wages have risen considerably more in emerging markets than in developed markets, this doesn’t mean that China and other emerging markets are no longer attractive for offshoring. These are several reasons for this.

First of all, as figure 14 shows, labour costs in developing economies are still a multiple of labour costs in emerging markets. Even in China, the average wage level is still five to eight times as low as in advanced Pacific economies such as Japan and Australia. Secondly, high wage increases have in many emerging markets been accompanied by high productivity rises. As figure 15 shows this has either put a lid on the rise of unit labour costs relative to developed markets (Philippines, Malaysia and Indonesia), limited

Figure 14. Average monthly wages for countries in Asia & Pacific

0

1000

2000

3000

4000

5000

Australia(2013)

Singapore(2013)

NewZealand(2013)

Japan(2013)

Korea,Republicof (2013)

HongKong

(China)(2013)

Malaysia(2013)

China(2013)

Samoa(2012)

Mongolia(2012)

Thailand(2013)

India(2011/2012)

Philippines(2013)

Vietnam(2013)

Indonesia(2013)

Timor-Leste

(2010)

Cambodia(2012)

Pakistan(2013)

Nepal(2008)

4642

36943419

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1780

65161356541139121521519718317412111973

0

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Philippines(2013)

Vietnam(2013)

Indonesia(2013)

Timor-Leste

(2010)

Cambodia(2012)

Pakistan(2013)

Nepal(2008)





● Other

Figure 13. Average annual real wage rises, developing countries (1997-2013)*,**

* Philippines, Thailand, Paraguay, Indonesia sample from (2013-2002); Source: ILO; Worldbank; ING Global Markets Research

** Peru and Turkey sample from (2013-2005); Source: ILO (2014); ING Global Markets Research

0%

2%

4%

6%

8%

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16%

REAL WAGE GROWTH

ChinaIndonesiaHungaryParaguayBangladeshPeruMalaysiaIndiaThailandPhilippines0%

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8%

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MalaysiaIndiaThailandPhilippines





● Other


Figure 15. Unit labour cost index for emerging markets, in US dollars (2005=100)

ING Global Markets Research; Data Source: Oxford Economics

it significantly (China, Thailand) or even prevented unit labour costs from rising (India, Poland, recently South Africa). It must be said however that the depreciation of some currencies (such as the Indian rupee) vis-à-vis the dollar has also helped.

Although China still has a large market share in several low tech mass production goods it has entered a phase in which it produces more knowledge intensive medium and high tech goods. Other developing countries are partly taking over the role of low cost production location. The clothing industry is an example. Although China still is an important player in this industry, those companies that no longer offshore or outsource to China often (re)locate to other Asian countries such as Vietnam and Bangladesh instead of bringing production back home. This process will repeat itself. As long as there are countries where unit labour costs are much lower than in developed economies offshoring remains attractive from a cost perspective. Countries such as India, Malaysia and the Phillipines have large and young labour forces, so there still is ample space for offshoring. Also when looking at foreign direct investment stock in these countries, there seems to be room for increased investment through offshoring.

The Philippines, India and also China still significantly lag the average for developing Asia. The Philippines saw a steep rise in inward FDI in the second half of the 1990s but stagnated afterwards at a level far below the average of developing Asia (table 4). After a sprint in the five years up to the start of the financial crisis, India is not even close to FDI levels common in countries like Malaysia, Vietnam and Thailand. Even China is among the countries with little foreign direct investment relative to the size of their economy.

Figure 16. Unit labour cost index for developed economies, in US dollars (2005=100)

ING Global Markets Research; Data Source: Oxford Economics

0

35

70

105

140

1752014

2010

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2000

AustraliaSwitserlandItalyCanadaBelgiumFranceGermanyNetherlandsUnitedKingdom

UnitedStates

JapanGreece

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1752014

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AustraliaSwitserlandItalyCanadaBelgiumFranceGermanyNetherlandsUnitedKingdom

UnitedStates

JapanGreece

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PhilippinesSouth AfricaMalaysiaPolandIndia





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● 2000 ● 2005 ● 2010 ● 2014

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VietnamBrazilChinaTurkeyThailandIndonesiaPhilippinesSouth AfricaMalaysiaPolandIndia

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● 2000 ● 2005 ● 2010 ● 2014


This is related to the fact that FDI in China has been restricted to certain sectors. Nevertheless, the government is about to loosen this restriction. At the latest National People’s Congress last March Prime Minister Li Keqiang indicated that the economy will open further, lifting the ban on FDI for some sectors that currently don’t permit it. Besides, cheap labour in the inland of China keeps it an interesting location for offshoring. Some transnational corporations currently prefer to move their production facilities from the more expensive coast to the inland of China instead of moving to another country or reshoring it back home.

Companies taking advantage of these ongoing offshoring possibilities in several Asian countries, will

keep world trade in intermediate products going in the years to come.

Several Eastern European countries also remain attractive for offshoring. Since the 1990s European companies, for example in the transport industry, offshored significant parts of production to countries such as Poland and Czech Republic. Low wages relative to the level of education and skills made these countries attractive production locations. The transfer of technological knowledge that resulted from offshoring has helped these countries to reach higher technological and productivity levels. This has pushed up wage levels, but broadly in line with productivity increases according to ILO-data, making these countries still attractive for

Figure 17. Development competitiveness index for selected economies

ING Global Markets Research; Data source: Global competitiveness index (2014-2015 & 2010-2009).

3,5

3,9

4,3

4,7

5,1

5,52014-2015

2009-2010

MalaysiaAdvanced economies

ChinaThailandIndonesiaPhilippinesRussianFederation

BrazilVietnamIndiaBangladesh

3,5

3,9

4,3

4,7

5,1

5,5 2014-2015

2009-2010

MalaysiaAdvanced economies

ChinaThailandIndonesiaPhilippinesRussianFederation

BrazilVietnamIndiaBangladesh0

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100

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● Other

● 2009-2010 ● 2014-2015

● 2009-2010 ● 2014-2015;

Table 4. Stock of inward foreign direct investments as % of GDP

FDI stock as % of GDP 2000 2007 2013

Vietnam 47.3 40.8 47.8

Malaysia 54.1 39.1 46.6

Thailand 24.7 36.9 45.4

Indonesia 18.5 26.6

India 3.5 8.8 11.8

Philippines 17.0 13.7 11.0

China 16.2 9.3 10.3

Belarus 12.5 9.9 23.2

Bulgaria 21.0 90.1 99.6

Croatia 13.0 75.9 56.1

Czech Republic 36.8 62.3 68.6

Hungary 49.3 70.2 85.6

Poland 20.0 42.0 48.8

Republic of Moldova 34.8 42.6 49.3

Romania 18.6 36.9 45.4

Russian Federation 12.4 37.8 26.8

Serbia 77.9

Slovakia 34.2 63.6 61.5

Slovenia 14.5 30.4 32.5

Turkey 7.1 24.0 17.6

Latin America 23.8 32.4 44.2

Developing Asia 25.7 30.0 26.7

World 22.9 32.0 34.2

Source: Unctad; ING Global Markets Research


offshoring. With the labour force relatively well educated and trained, it is possible to outsource more knowledge intensive tasks within value chains, a development that is already taking place. Jobs related to the participation of central and eastern European economies in value chains of Western companies are increasingly highly skilled, research from ING shows.4

Turkey, another country that integrated heavily in cross border value chains, on the contrary, has shown a strong increase in unit labour costs. The same holds for Russia. The average wage growth in these countries has not nearly been compensated by a proportional rise in productivity (Figure 16). Consequently, Russia and Turkey have suffered considerable losses in cost competitiveness over the last decade.

Summing up: Several developing countries have lost (some) appeal as production locations because of rising unit labour costs. However, there are still (big) developing economies that maintain their offshoring appeal from a cost perspective. Not only India comes to mind, but also countries like the Philippines, Malaysia, Poland and South Africa. In addition, (the inland of) China still holds appeal for offshoring.

Other drivers of Offshoring Costs are only one part of the story. Other factors also determine the attractiveness and competitiveness of a country. Many developing economies have been able to substantially improve their non wage competitiveness index over the past five years. The gains have been bigger in several emerging markets than in advanced economies (figure 17).

The Philippines and Indonesia are among the countries that stand out. India on the other hand has not been able to improve its non-wage competitiveness factors. This counterbalances its relatively favorable unit labour cost position. India has reached growth rates equal to China and has high potential, reflecting its market size, its enormous and young labour force and the widespread use of the English language. But the country is still trailing China in almost all aspects of competitiveness (figure 18). It is characterised by a low level of average education, a weak healthcare system, dependence on foreign capital due to a current account deficit and an improving but

still underdeveloped physical infrastructure. These factors mean that India hasn’t fully exploited its potential yet. President Modi, who took office last year, has set in motion a process of implementing significant reforms to address some of the mentioned weaknesses of the Indian economy. This policy seems promising.

The positive development of non wage competitiveness in countries like China, Thailand and Turkey (figure 17) counterbalances their relatively unfavorable wage cost developments. The level of competitiveness of China is almost as good as that of the advanced economies and

Figure 18. Decomposed Competitiveness index, China and India, 2014-2015*

* 7 = best and maximum; 0 = worst and minimum; ING Global Markets Research; Data source: Global competitiveness index 2014-2015.





● Other

● India ● China

1

2

3

4

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6

7 India

China

Innovation

Business sophistication

Market size

Technological readiness

Financial market development

Labor market ef�ciency

Goods market ef�ciency

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Health and primary education

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4 ING, 2014, Valuing a close connection II


better than in almost every other Asian country. It should be said that this is to a significant degree influenced by the fact that market size is related to population size. Nevertheless China is also competitive in many other fields that determine attractiveness of a country. But Malaysia tops the bill and is, according to the Global

Competitiveness Index, even more competitive than advanced economies!

The prospects for further improvements in competitiveness for developing countries in Asia seem quite good. Traditionally weak infrastructure has been

an impediment for some low-income Asian countries in attracting FDI and promoting industrial development. Today, rising FDI in infrastructure industries, driven by regional integration efforts and enhanced connectivity through the establishment of corridors between sub regions, is likely to accelerate infrastructure build-up and

Figure 19. Competitiveness Index 2014-2015 for emerging and developing regions and advanced economies**

* 7 = best and maximum; 0=worst and minimum;

** Group Emerging and Developing Asia: Bangladesh, Bhutan, Cambodia, China, India, Indonesia, Lao PDR, Malaysia,

Mongolia, Myanmar, Nepal, Philippines, Sri Lanka, Thailand, Timor-Leste and Vietnam;

*** Emerging and Developing Europe: Albania, Bulgaria, Croatia, Hungary, Lithuania, Macedonia, Montenegro, Poland,

Romania, Serbia and Turkey Source: Global competitiveness index 2014-2015; ING Global Markets research.

ING Global Markets Research; Data source: Global competitiveness index 2014-2015.

_ Emerging and developing Europe _ Emerging and developing Asia _ Advanced economies





● Other

2,0

4,0

6,0 Advanced economies

Emerging and Developing Asia

Emerging and Developing Europe

Innovation


Market size








Infrastructure

Institutions

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6Innovation


Market size




Institutions

_ Emerging and developing Europe 2009-2010 _ Emerging and developing Europe 2014-2015





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Emerging and Developing Europe

Innovation


Market size








Infrastructure

Institutions

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6Innovation


Market size




Institutions

Figure 20. Competitiveness, emerging and developing Europe for 2015 and 2010*,***

* 7 = best and maximum; 0 = worst and minimum;

ING Global Markets Research; Data Source: Global competitiveness index (2015 and 2010).


improve the investment climate, Unctad concludes in its World Investment Report 2014. The decision to set up the Asian Infrastructure Investment Bank (AIIB) is the latest step in further development.

A comparison between emerging Asia and emerging and developing Europe (figure 19) shows that emerging Asia has better labour market efficiencies and a larger market size. Emerging and developing Europe on the other hand has significantly better education, technological readiness and physical infrastructure. On average developing Europe holds the edge. Figure 20 shows that developing Europe has been continuing to improve its appeal. Like most Asian developing economies, its competitiveness has increased. Both regions therefore are far from being out of the picture as attractive production locations. It comes therefore as no surprise that, for example, automotive companies still move production locations from France and Germany to Eastern Europe, as Cooper Standard announced in January 2015.

Summing up: Determinants of competitiveness other than labour costs have improved in many Asian countries and still are at attractive levels in emerging and developing Europe. This enables both regions to maintain their offshoring appeal.

Infrastructure investments Infrastructure deserves extra attention because of its important role in facilitating trade. The empirical literature suggests that doubling the length of paved roads boosts trade by 13% and doubling the number of paved airports per 1,000 square kilometres boosts trade by 14% (World trade report 2013). India is aware of these benefits and invested heavily in its underdeveloped road networks over 1990-2005. Another country that invests hugely in infrastructure is the Republic of Korea (Figure 22).

Figure 21. Developments in competitiveness for economies in developing Europe*, **


** EDE = average for emergining and developing europe- calculated with the omission of countries without data in both periods.

ING Global Markets Research; Data Source: Global Competitivness Index 2014-2015.

3,6

3,8

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LithuaniaPolandTurkeyBulgariaRomaniaHungaryMacedoniaEDEMontenegroCroatiaSerbiaAlbania0

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PakistanGambiaBolivia NigerNigeriaSaudi ArabiaMacedoniaOmanKorea, Rep. of India0

20

40

60

80

100

120

MacedoniaOmanKorea, Rep. of India





● Other

Figure 22. Top ten increase in road networks 1990-2005 period (%)

Data source: World bank; Source: World Trade Report (2013); ING Global Markets Research;


Some emerging markets have experienced substantial improvements in the general quality of infrastructure. Most notably, Turkey, Indonesia, Romania and Russia have made substantial advances in the quality of their overall infrastructure in the past five years (table 5). Other countries such as Thailand, South Africa and Brazil show a deterioration for the same time period. They need much more investment.

Offshoring: the factsHow have corporations responded to all the above changes in determinants of offshoring? Recent data are not available but data until 2012 suggest that rising wage costs in several Asian and Eastern European countries have not significantly discouraged the process of offshoring. On the contrary, after the dust from the financial crisis settled, companies from advanced economies resumed offshoring (Figure 23). Offshoring is measured by the ratio of imported intermediates from low-wage countries to total intermediates used in the respective country (which can also include outsourcing, which also has a downward effect on home production and employment). The figure shows that net offshoring to Asia is rising across all major advanced economies. Offshoring to Eastern Europe is popular with European companies.

Summing up: Our findings on reshoring, anecdotes and survey evidence indicate that reshoring has increased over recent years. But they show at the same time that offshoring is continuing. Information on the net score is missing. Hard data is available for indirect indicators of offshoring and this points to the ongoing dominance of offshoring, at least until 2012. This aligns well with the fact that other determinants of attractiveness of emerging countries, besides labour costs, have improved in many Asian countries and in emerging and

developing Europe. This has enabled them to maintain their offshoring appeal. We expect offshoring to continue in the years to come but at a slower pace. The rapid expansion of the pre crisis period will probably not return, reflecting the counterweight of reshoring.

e. Foreign direct investmentAs already discussed, the rise of global value chains have been accompanied by a boom in foreign direct investment by Western companies in Eastern Europe and Asia. While the crisis put a lid on FDI, it has recovered and, as a percentage of world GDP is higher now than before the crisis. The stock of FDI in most Eastern European countries has increased. In developing Asian countries it has diminished on average since the crisis, but this doesn’t hold for all Asian nations (table 4 on page 20).

FDI flows have been low since the start of the crisis, but 2013 could well have been the turning point. According to Unctad’s World Investment Report 2014 the value of announced greenfield projects recovered, with an increase of 9% to a healthy level but still far below historical levels. Cross-border M&A increased by 5%.

The geographical division is different this time. Developing and transition economies largely outperformed developed countries, with an increase of 17% in the values of announced greenfield projects and a sharp 73% rise in cross-border M&A. Countries such as China are increasingly looking abroad to spend the large surpluses accumulated with the export led growth model. At the same time in developed economies the level of both greenfield investment projects and cross-border M&A has declined, by 4% and11% respectively5. Figure 24 shows that the decline of inward FDI in developing countries (as a percentage

of GDP) is somewhat smaller than during the economic downturn after the bursting of the dotcom bubble. This could be caused by the fact that, this time around, emerging economies started investing in other emerging economies.

Table 5. Quality of overall infrastructure (7=best) for the 2010-2015 period*

Quality of overall infrastructure 2009-2010 2014-2015

Advanced economies 5.53 5.51

Turkey 4.16 5.10

South Africa 4.74 4.49

China 3.99 4.36

Indonesia 3.15 4.17

Russian Federation 3.34 4.13

Thailand 4.77 4.07

Romania 2.37 3.79

India 3.21 3.75

Philippines 3.12 3.66

Peru 3.00 3.50

Brazil 3.43 3.11


ING Global Markets Research; Data source: Global Competitiveness Index

5 The weak FDI by developed countries is a contrast with the picture that

emerges from figure 23. An explanation could be that the rise shown in

figure 23 is mainly caused by outsourcing rather than offshoring production

(outward FDI).


Figure 23. Net offshoring for selected advanced economies per region**

* Orange = offshoring to Asia; Green = offshoring to Brazil and Mexico; Blue = offshoring to Eastern Europe. Source: Marin (2014) and Timmer (2012). ING Global Markets Research

** Offshoring is measured by the ratio of imported intermediates from low-wage countries to total intermediates used in the respective country

0,000

0,005

0,010

0,015

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'11'10'09'08'07'06'05'04'03'02'01'00'99'98'97'96'950,00

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'11'10'09'08'07'06'05'04'03'02'01'00'99'98'97'96'950,00

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'11'10'09'08'07'06'05'04'03'02'01'00'99'98'97'96'950,000

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'11'10'09'08'07'06'05'04'03'02'01'00'99'98'97'96'950,00

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'11'10'09'08'07'06'05'04'03'02'01'00'99'98'97'96'95

USA Germany Italy

UK France Netherlands

_ Asia _ Eastern Europe _ Brazil and Mexico


All in all, the underperformance of FDI compared to total investments has been a lot smaller this time around. After the bursting of the internet bubble, the total investment ratio of developing countries kept on rising, just as in the current crisis (figure 24), but FDI in developing countries fell deeper than during the recent risis.

Due to the rise of FDI by developing and transition economies, their shares in the worldwide flow of greenfield investment and M&A projects were at historically high levels in 2013 (68% and 31% respectively). We are witnessing a broadening of the number of countries that do outward FDI, implying that offshoring now has more engines than only Western companies.

Recently, weak FDI flows from advanced economies do not mean that there is no scope for developed economies to increase their FDI in developing countries. The relatively low stock of inward FDI in countries such as China, India, Philippines, Indonesia and Turkey (table 4) suggests ample scope, especially because most of these countries have continuing appeal as locations for producing goods and services. The fact that domestic investment has been high in developing countries supports the view that expected returns on investments in those countries are still attractive. Moreover, interest rates are at historical lows and many Western multinationals hold large cash holdings, so financing greenfield or M&A investment should not be a problem.

f. Trade finance The availability of trade finance has also been put forward in the debate on reasons behind the slowdown of trade. Trade finance and the guarantee facilities that

come with it in many Western countries are undeniably important drivers behind trade as they reduce risk. Therefore, reductions in trade finance can have a significant effect on trade growth. This is especially the case for emerging markets in Asia where trade finance is relatively important. A recent survey of developing country suppliers reveals that access to trade finance is one of the key obstacles for them to participate in global value chains (table 6).

Both surveys and academic literature suggest that disruptions to trade finance have economically significant effects on global trade volumes. A report

Figure 24. Investment and FDI in developing economies, in % of GDP

Data Sources: UNCTAD and IMF WEO; ING Global Markets Research

_ Investments (LHS) _ Inward foreign direct investment �ows (RHS)

Investment and FDI in developing economies; % of GDP

As

% o

f G

DP





● Other

0%

7%

14%

21%

28%

35%

0%

1%

2%

3%

4%

5%Investments (LHS)

Inward foreign direct investment �ows (RHS)

20132011200920072005200320011999199719951993199119891987198519831981

25.5%

0.86%

3.77%

3.89%

2.84%

31.5%

2.22%

Table 6. Barriers hindering participation in value chains

Developing country suppliers

Difficulties connecting developing country suppliers to value chains

Transportation costs and delays 42%

Access to trade finance 40%

Customs procedures 36%

Import duties 23%

Supply chain governance 23%

Source: World Trade Report (2014); ING Global Markets Research


published by the BIS (2014) claims that trade finance could have accounted for one fifth of the drop in trade volumes in the three quarters following the Lehman bankruptcy (Figure 25). The sub prime crisis in the US led to a liquidity crisis in developed economies because it was unclear which banks were hit. All banks became risk averse and held on tightly to their own means of liquidity. This liquidity preference made it very hard to obtain trade finance.

However, after the first couple of quarters of the financial crisis access to trade finance seems to have been a less important bottleneck for trade. This is partly because the liquidity crisis eased following money market operations by central banks and with some governments stepping in with (extra) guarantees for export financing. A survey of global lending conditions revealed that demand increases above supply increases had been limited up to 2012 and that supply has started outpacing demand since, resulting in more trade financing being involved in trade (figure 26). Trade finance has increased by 200% over 2007-2013 while trade has grown by only 50% over the same period (BIS, 2014). The more active role that regional banks started to play in trade finance has also helped to diminish the scarcity of supply of trade finance from large transnational banks (BIS, 2014).

The costs of trade finance don’t seem to have been a major bottleneck either. The low official interest rates increasingly prevalent over the last couple of years have translated into lower costs of trade finance. Together with ongoing government guarantees, this has helped to keep trade going, also to more risk prone countries. Once official interest rates become less accommodative the opposite will happen. Absolute interest rates will rise

Figure 25. Contribution of lack of trade finance to trade decline, Q4 2008-Q2 2015

Source: BIS; ING Global Markets Research





● Other

_ GDP _ Trade �nance _ Other factors ● Trade

-25

-20

-15

-10

-5

0Trade

Other factors

Trade �nance

GDP

EMEsAdvanced economiesAllEMEsAdvanced economiesAll-25

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0

Advanced economiesAll

Imports Exports

● ● ●

●

●

●

and put upward pressure on costs of trade finance. But given the current extremely low level of official interest rates, we don’t expect the costs of trade finance to rise quickly to levels that would hurt trade significantly.

Looking at the years to come, we don’t expect that the supply of trade finance will return to being a bottleneck for trade growth. After all, even one year after the liquidity crisis in 2008/2009 world trade was able to show growth of 15%.

Summing up: The reductions in supply of trade finance were responsible for one fifth of the collapse in international trade directly after the outbreak of the financial crisis. However, the availability of trade finance has improved over recent years. Therefore, we cannot contribute a significant proportion of the

recent slowdown in trade to developments in trade finance. We do not expect trade finance to be a major bottleneck for trade in years to come.

g. Innovations and tradeInnovations have lowered trade costs spectacularly in the past. For example, the invention of the telegraph, telephone, jet engines, containerization and the ICT- revolution, all had a huge impact on world trade. Currently work is being done to further reduce the transport costs of trade. For example, making containers much lighter using composite material can be a new stimulus for world trade. This would resolve the problem that when container ships sail home they are loaded with empty containers that weigh two tones each. Lightweight foldable containers would, by lowering


transport costs, stimulate world trade. Also the ICT revolution hasn’t reached all countries fully. Some countries, including India, have below average internet penetration which means above average costs of trade formalities. Consequently, ICT will continue to stimulate trade in the years to come.

On the other hand innovations like 3D printing and robotics can reduce trade. For the time being, the quality, reliability and costs of 3D printing are unfavorable compared to production along standardised assembly lines. Nevertheless, this can change and then the effect on trade could become noticeable.

3D printing could lead to more local production and thereby diminish cross border trade, especially for business-to-business production. 3D is useful within the trend towards customization of products and production of smaller series. Because of the fact that many companies demand that their suppliers supply a broad spectrum of goods to them, of which only a couple are needed frequently, many suppliers have substantial stocking costs. Once the extra costs of 3D- printing become less than the cost of stocking large quantities, local instant production with 3D printers becomes an interesting alternative for mass production. Once this is the case, it will push cross border trade down because mass production often takes place in one country, from which products are exported to the customer.

For business-to-consumer production it will be more difficult for 3D printing to have a large impact. This end of the market is very competitive, with low value added per item, making it very sensitive to the relatively high costs of 3D printing. It can influence niche markets, for example sneakers and clothes, where consumers might

Figure 26. Demand and supply of trade finance

* Demand and supply conditions as indicated in the IIF Emerging Markets Bank Lending Conditions Survey. Values above 50 indicate improving conditions while

values below 50 indicate deteriorating conditions.

Source: BIS; ING Global Markets Research





● Other

_ Supply of trade �nance _ Global funding conditions _ Demand for trade �nance

20

30

40

50

60

70

2010 2011 2012 2013

be prepared to pay a higher price for unique customised items instead of mass produced standard items. But the macro-effects of this will probably not be significant.

Robotics can lead to a further substitution of labour by capital. If robots make the input of labour unnecessary, low cost countries lose their competitive edge. For the time being this is not the case on a large scale. The car industry has been using robots for a long time and nevertheless has been offshoring a lot of production

during the past two decades. Stil, robotics can potentially bring back earlier offshored production.

Summing up: At the same time that potentially trade reducing innovations are arising, like 3D printing and robotics, there are other innovations in the making, like container innovations, that will stimulate trade growth. And many countries haven’t fully reaped the fruits of the ICT revolution yet.


h) Geographical division of tradeThe share of developing economies in world trade has been rising since the start of the 1990s, at the expense of developed economies (figure 27). Nowadays developing countries are responsible for almost half of world trade, compared to little over a quarter at the beginning of the 1990s. This trend in trade follows the trend in GDP shares. Due to much higher economic growth, the share of developing economies in world GDP has risen to 40%, from 24% in 1980, according to WTO figures. Especially Asia has shown impressive growth in GDP and trade, with China leading the way.

The rise of developing economies has not only increased the size of world trade but has also contributed to the rise of the ratio of world trade to world GDP. This

Figure 27. Share in world trade of developed and developing countries

ING Global Markets Research; Data Source: UNCTAD, IMF

_ Developed trade _ Developing trade


_ Real world production growth_ Average growth of world production0%

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ratio rose from 20% in 1990 to 30% in 2008, mainly thanks to the rise of the trade to GDP ratios in most developing countries since the start of the 1990s.

The financial crisis put this development on hold. It caused a sharp drop in the ratio in 2009 (figure 10). In 2010 however the trade ratio recovered to a large extent, but has decreased slightly afterwards. The medium and long term outlook for the ratio of world trade to world GDP will depend to a significant extent on developments in developing countries.

Although some BRIC countries are currently showing a growth slowdown (China) or are in recession (Russia and Brazil), the expectation still is that developing markets on average will grow faster than developed economies. This will happen not only over the medium term but also in the short run. For 2015 and 2016 the IMF expects the emerging economies and other developing countries to grow almost twice as fast as the advanced economies. This means that the weight of developing countries in world GDP and world trade will increase further.

Besides differences between regions in economic growth, differences in the composition of demand will also influence the growth of trade. As an example, ageing in developed countries leads to rising demand for health services. Although health tourism is on the rise, health services are still not much traded across borders. So, ageing puts downward pressure on the import intensity in developed economies. On the other hand, most emerging markets and other developing countries have young populations. With economic growth the middle classes in these countries will (continue) to rise in size. The middle classes tend

to have a large demand for consumer durables like mobile phones and other communication products, cars, and luxury goods. These consumer durables are over represented in cross border trade So, the rise of the middle classes in developing economies will put upward pressure on their import ratios.

Although luxury goods from Western countries are very popular with middle classes in emerging countries, demand from consumers and producers in emerging countries in general is increasingly being met by products from other developing countries. This is reflected in the fact that trade between developing countries has risen faster than trade between advanced economies and developing countries. Over 1990- 2011 South-South trade increased from 8% of world trade to 24% (figure 28). Intra-regional trade represents a large and rising percentage of total exports from Asian countries. This share has grown from 42% in 1990 to 52% in 2011, so that it now represents the majority of Asian trade.

The rising share of South-South trade in world exports is also explained by the increasing number of regional trade agreements between southern countries. These account for the majority of new regional trade agreement concluded since 1990. The fact that some elements of these agreements still have to be implemented is another reason to expect more South-South trade in the years to come, with rising trade to GDP ratios in this part of the world.

Summing up: Import intensity of developed economies could stagnate or decline with ageing induced shifts in demand towards non tradables. On the other hand, in developing countries the combination of relatively high economic


growth and catch up demand for tradable consumer goods will stimulate world trade. Given the increasing share in the world economy of developing economies, the later effect will probably dominate in the long run.

i. Product division of trade Agricultural products have seen their share in trade fall steadily over time, from 57% at the beginning of the last century to 12% in 1990, and 9% in 2011, according to the WTO. Manufacturing products’ share on the other hand has risen steeply. This made up 40% of trade in 1900, rising to 70% in 1990 and peaking at 75% in 2000. Fuels and mining products have been on the rise due to higher prices. This resulted in a decline in the share of manufacturing products, to 65% in 2011. The commodity boom is currently in reverse with the sharp decline in the oil price and lower prices for other commodities in place for several years. American import demand for crude oil has been decreasing since its peak of 11.5 million barrels per day in 2004, to below 7 million barrels a day in 2015. This is due to the shale revolution that has put downward pressure on worldwide imports of fuels. Until 2013 world trade in fuels kept rising though because increasing demand in other countries overshadowed the decline in US demand. Currently European demand is picking up, related to the economic recovery, but demand from most emerging markets have been slowing with the cooling of their economies. Because the growth of the world economy is not declining and emerging markets production is relatively energy intensive, world demand for oil in volumes is still on the rise.

As already mentioned, the fast growth of the middle classes in emerging economies means that their demand for imports will make up a larger share in the

Figure 29. Shares of product groups in worldwide export of ‘goods’

ING Global Markets Research; Source: WTO

● Other ● Agricultural Products ● Fuels and mining products ● Iron and Steel ● Chemicals

● Other semi-manufactures ● O�ce and telecom equipment ● Automotive Products ● Textiles ● Clothing

● Industrial Machinery

Industrial Machinery

Clothing

Textiles

Automotive Products

Of�ce and telecom equipment

Other semi-manufactures

Chemicals

Iron and Steel

Fuels and mining products

Agricultural Products

Other


Clothing

Textiles

Automotive Products



Chemicals

Iron and Steel



Other


Clothing

Textiles

Automotive Products



Chemicals

Iron and Steel



Other

● Other

● Agricultural products

● Fuels and mining products

● Iron and steel

● Chemicals

● Other semi-manufactures

● Of�ce and telecom equipment

● Automotive products

● Textiles

● Clothing

● Industrial machinery

1990

29%

12%

14%3%

9%

8%

9%

10%3%

3%

2011

15%

23%

3%11%

6%

10%

7%

2%2%

12%

9%

Figure 28. Shares in world trade by region

ING Global Markets Research; Source: UNCTAD, IMF





● Other

● North-North ● North-South ● South-South ● Unspeci�ed destination

0%

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20112010200920082005200019951990

36%37%40%41%46%50%51%56%

38%38%37%37%37%36%35%33%

24%23%21%20%16%13%12%8%

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200019951990


Figure 30. Share of commercial services in goods and services

ING Global Markets Research; Source: World Trade Report 2014





● Other

0,0

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Oct. 2011-Oct. 2012

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10%

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2011200520001995199019851980

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200520001995199019851980

composition of traded goods and services. This means that the demand for typical middle class consumer goods, such as office and telecom products, will continue to grow fast.

ServicesThe share of services rose until 2005. Since then it has fallen back to the level of 1990 (figure 10).

Thanks to the ICT revolution, live communication with very distant places has become easy and cheap. This has created the possibility for low wage countries such as India to become large suppliers of ICT helpdesk services and accounting services.

The rise of transnational enterprises and their global value chains has also caused more trade in services, for example in transport and business services. A significant part of these services is exchanged within these transnational enterprises. For example, the payment of royalties within transnational enterprises can be substantial and is booked as services. Two-thirds of

world trade now takes place within multinational companies or with their suppliersBut the influence of the ongoing implementation of ICT inventions is broader than these well known examples. Services that once were non-tradable, including retail sales, medicines or educational courses, have become tradable through e-commerce, e-medicine or e-learning. This development is just starting, with consumers still hesitant about doing cross border business online out of fear that they cannot claim their money back if something goes wrong. But similar fears restricted domestic on line business when it started. So services can be a driver of growth of world trade in the near future, especially if we take into account that import sensitivity of services has risen. Moreover, currently services face relatively high trade barriers compared to commodities and manufacturers. This means that when the various (inter) regional negotiations, of which lowering barriers for trade in services is an important goal, succeed, a considerable impulse should result for world trade that will put upward pressure on the trade to GDP ratio.


IV Conclusions

Some believe that the slowdown of world trade and the decline of the ratio of world trade growth to world GDP growth is here to stay and marks the end of globalization. However, we believe that a significant part of the slowdown is temporary. World trade growth may return to outpace world GDP growth, although not by as much as before the financial crisis. The main driver of the rise of the ratio was the increase of import ratios. Although at a significantly lower pace, we see import ratios rising again because:• In economic upturns, currently expected for 2015

and 2016, the demand for investment goods and consumer durables rises disproportionately. This will cause world trade to rise more than world GDP because durable goods make up 70% of world trade. Based on experiences during earlier periods of recovery, this will push up the ratio of trade growth to GDP growth from 1.0 during 2012- 2014 to 1.2 at the end of 2016.

• This normal cyclical effect for the world economy is reinforced by the European recovery because Europe is more overrepresented in world trade than in earlier periods of economic recovery. Moreover, European business investment has been falling more strongly than usual during the recent downturn. A normalisation of investments will push up world trade growth disproportionately, because investment goods are relatively import sensitive. These effects will push the ratio up another 0.05 percentage point. So, these cyclical effects together wil lift the ratio from 1 to 1.25 at the end of 2016.

Besides these short term cyclical effects we see some medium term and long term structural developments in favour of trade. • Implementation of the Bali agreement on lowering

customs procedures will push up world trade by 4.1% and world GDP by 1.1%. On the assumption that it will take five years to implement this agreement in equal steps (so that the benefits, in terms of the upward effect on trade growth and GDP growth will be spread out equally over this period), the Bali agreement will push up the ratio by 0.14%. This will bring the trade growth to GDP growth ratio close to 1.4 if the economy is still in an upturn (otherwise the cyclical effect will push the ratio down again). Taking into account that the implementations of recent trade agreements has not been fully completed, we forecast the ratio to come close to 1.5 during 2016-2020.

• If negotiations on the Transatlantic and Pacific trade agreements (TTIP and TPP) deliver results that are acceptable for European, American and Asian governments and ultimately parliaments, this will also have an upward effect on global trade in the long run. This will lift the ratio as well. What this means for the medium term (the next five years) is unclear because it is not known when negotiations will be finished and what the outcome will be. - Trade will also be stimulated by continuing

offshoring of production to developing economies. Although reshoring has increased, offshoring will continue to dominate in the years to come because there are many developing

countries that have maintained or improved their attractiveness as production locations, notwithstanding wage cost rises in some of them. Now that business confidence is recovering in most advanced economies ING expects a recovery of their outward FDI. These developments will increase trade in intermediates and thereby lift the ratio of world trade growth to growth of world GDP. Because there are no good quantitative data on the relation between offshoring and trade, the exact effect on the ratio cannot be calculated.

- The spread of trade- and offshore enhancing innovations (such as in ICT and logistics) is far from finished. Some countries, like India, have below average internet penetration which means above average cost of trade formalities. There are no reliable data available to quantify the effect on trade of an optimal spread of these technologies.

- On the downside, the conflict in the Ukraine could still lead to an escalating trade war between the West and Russia, which would be a clear negative for trade since Russia is a significant player in world trade. Harm to trade could also stem from increased exchange rate volatility if the current currency battle escalates.

- In the long run innovations like 3D printing and robotics will be trade diminishing, but in in our view they will not have the scale to seriously push down the growth rate of trade in the short to medium term. Besides, at the same time, trade enhancing innovations like lighter containers are appearing as well.


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World Trade Organization, (2013) World Trade Report-Factors shaping the future of world trade.

World Trade Organization, (2014) World Trade Report-Trade and development: recent trends and the role of the WTO.


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The Future of World Trade_LANDSCAPE DEF (versie die gedrukt is)