Category Archives: Publications

November – Trade Outlook

A Pivotal Meeting – A Closer look at US – China Trade

On the verge of their summit, Presidents Xi and Trump could not be in more different places. President Xi has become the champion of globalisation and a world order at which China is centre-stage. The National Congress of the Communist Party of China confirmed his leadership of the country for at least the next five years with no clear successor. By incorporating Xi’s philosophy to make China great into its constitution, the Party elevated Xi to the same status as Mao Tse-tung and Deng Xiaoping. China’s One Belt One Road policy, alongside its promotion of trade at the WTO means it is has become the focus, not just for trade between emerging economies in the Southern hemisphere, but also a pivot around which trade power is shifting from West to East.

In contrast, Donald Trump travels to Asia on the tide of economic nationalism and isolationism. His anti-trade rhetoric is, at best, damaging many of the multi-lateral structures that have been central to the way in which globalisation, such as the North America Free Trade Area, the EU, and, most recently, the Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP). Trump’s discussion with Xi will focus on reducing, even eliminating, China’s trade surplus with the US (Figure 1). This trade surplus is nothing new, but has been widening since the mid 1990’s when China’s market first started to open up; Microsoft, for example, moved into the market around 1996. In 1996 China’s imports from the US were 27% of their exports to the US. This peaked at 35% in 2013, but the gap has been narrowing since and now stands at 31%.

Figure 1:          Value of Chinese Trade with the US ($US bn), 1996-2018 (2017-18 forecast)

Source:            Equant Analytics, 2017

Indeed, it is possible to argue that Chinese exports to the US are a function of the globalisation of US electronics companies. Figure 2 shows the top five Chinese export sectors to the US in 2016 and projected for 2017. The first two, electrical machinery and equipment and components and machinery include mobile phones, washing machines, semiconductors and computers. Clearly, they inherently contain intellectual property which is a key focus for the discussions between the two leaders. These sectors also dwarf trade between the two countries in other sectors which actually might reflect more closely a pattern of trade between an emerging economy and a developed one: furniture, toys and clothing. Top US exports to China include the catch-all “Commodities Not Elsewhere Specified” which proxies well for oil and arms trade, and aerospace. Most of the top export sectors from the US to China show slight declines between 2016 and 2017 except aerospace.

Figure 2:          Value of China’s top five export and import sectors with the US (US$ bn), 2016 & 2017

Source:            Equant Analytics 2017

President Trump’s mantra since his election has been “America first” and most recently his actions in relation to Canada’s Bombardier were directly to support Boeing. In his discussions with President Xi, therefore, it is likely that aerospace could also be a key part of the trade negotiations (Figure 3). For example, exports of large aircraft were worth US$ 124 billion in 2016 and exports of large and smaller helicopters are projected to grow at 24.6% and 11.1% between 2017 and 2018.

Figure 3:          Chinese imports of aircraft from the US, 2016-17 and 2017-18 compared (year on year change, %)

Source:            Equant Analytics, 2017

In spite of all this, between China and the US it is clear who is in the weaker position. Perhaps because the US is realising that the period of globalisation up to around 2014 tilted trade, indeed economic power, towards emerging economies like South Korea and China, President Trump is now fighting a rear-guard action to maintain the central role in global trade that US companies have historically played. Using China’s trade in arms and ammunition as an example; China’s exports have grown at an annualised rate of 6% since 2009 while its imports have shrunk by 20% annually. Its imports are now just 2.5% of its exports in this sector. This tells its own story: while the US assumed it had global trade power leadership, it can no longer take this for granted. Globalisation and trade power is pivoting towards China. Trump’s meeting with Xi may merely confirm this as inevitable.

October – Trade Outlook

The aftermath of Germany’s election: how does trade help?

Germany’s election at the end of September was predicted to be dull. Angela Merkel was to be re-elected, possibly on a larger share of the vote, and the country would be able to focus on defining its role at the heart of a re-generated Europe. In the end, the Alternative für Deutschland won 12.6% of the share of the vote – the largest share of parliamentary representation of any extreme right wing party since the World War II. Germany’s parliament is now divided between six parties and the centre right CDU-CSU and the centre left SPD parties have been given a warning by voters that “business as usual” is not enough. Their votes shrank to 36% and just over 20% respectively.

Inevitably there will be a period of domestic uncertainty. The SPD has already stated that it would not be part of a new Grand Coalition. This leaves Angela Merkel the complex task of forming a “Jamaica” coalition of the CDU-CSU, the liberal FDP and the Greens (so called because the colours are those of the Jamaican flag). This will not be an easy process. There are rumours, following the departure of Wolfgang Schäuble from the Finance Ministry that this post is being left open as a negotiating tool for Angela Merkel as she starts discussions with the other two parties.

However, it is possible that trade offers a solution to at least one of Germany’s persistent problems: under-investment in some of the infrastructures in the country that are weak and that may have contributed to the sense of social as well as economic exclusion that the voters in the eastern regions exhibited. In 2016 Germany posted its largest trade surplus ever at some USD 230 bn – 15% higher than China’s at USD 200 bn (Figure 1). Germany’s budget surplus, to which the trade surplus contributes, was EUR 18.6 bn in the first half of 2017. Much of this surplus has been achieved through its adherence to stringent, and well-documented, austerity measures. But even in Germany economists and politicians alike are beginning to worry that the surplus is unsustainable: the broadband and road infrastructures in the country are under-invested, for example, and some fiscal stimulus would further boost the European economy.

Figure 1:          Germany’s trade with the world, selected years, 1996-2016 (USD m)

Source:            Equant Analytics, 2017

Germany is to some extent a victim of its own success. The Hartz reforms in the 1990s and aggressive austerity in the wake of reunification provided the country with a more flexible labour market alongside lower government borrowing than any of its European counterparts. But Germany has also been hugely successful in its main economic focus – trade. Its goods are competitive abroad and its supply chains extend throughout Europe and beyond.

Yet this causes political problems in terms of its foreign relations. Throughout his presidency so far Donald Trump has branded Germany and its surplus as “bad, very bad” in his tweets. He has attributed Germany’s success in exporting to the US as a product of the under-valuation of the Euro that has enabled Germany’s manufacturers to price their goods advantageously in overseas market undermining, for example, American manufacturers. The size of Germany’s trade surplus with the US, and the fact that it has widened since the introduction of the euro (in 1999) is a function both of this and of the fact that Germany’s products compete on quality as well (Figure 2).

Figure 2:          Germany’s trade with the United States, 1996-2016 (USD m)

Source:            Equant Analytics, 2017

But while Germany does export successfully to the biggest countries in the world, among them China and the US, it also operates its supply chains across Europe. In other words, the budget surplus may create distortions, particularly in weaker European countries, but it also helps fuel growth in those very same countries. The automotive sector is the best example: Figure 3 shows the projected annualised growth of German cars and components for its top five import and export partners. It shows how car and component imports from the likes of the Czech Republic and Hungary are predicted to grow to 2020 more quickly than from the US, France or Spain while exports of cars and components from Germany are growing at a slower or similar pace.

 

Germany’s top five import partners

Germany’s top five export partners

Czech Republic

5.1%

United States

2.9%

Spain

3.2%

United Kingdom

4.3%

France

-1.1%

China

1.9%

United States

3.0%

France

-0.5%

Hungary

5.4%

Spain

1.1%


Figure 3:          Projected annual growth of Germany’s top five import and export partners in the automotive sector, 2016-2020

Source:            Equant Analytics, 2017

Germany’s surpluses tell the story of its success in adjusting to two major shocks: its reunification and the global financial crisis. The process has been tough on many Germans, particularly those in the eastern regions and this was reflected in the recent election result. However, Germany is not about to become less domestically stable. It may enter a period of self-reflection, and this is not necessarily a good thing while geopolitical uncertainties are rife. But the AfD and die Linke (the extremist left party) account for just over 21% of the vote between them. Populism in Germany, as with other countries in Europe, has been driven by a sense of economic and social exclusion, largely in the eastern regions of Germany and catalysed by Angela Merkel’s controversial response to the migrant crisis in 2015. To some extent it would be possible to argue that the rise of extremism, because it is so predominantly in the east, is a function of the last nearly 30 years since reunification. Where in other countries populism is a function of exclusion from globalisation, in Germany it is driven by a sense of exclusion from Germany’s second “economic miracle”.

Angela Merkel will realise that this domestic uncertainty is dangerous. Using the surplus to focus on some of the problems of under-investment, including suitable structures to integrate the large numbers of immigrants, will undoubtedly help. It is unlikely that the trade surplus will diminish any time soon – Germany is too competitive for that. But with the trade surplus comes influence, particularly in foreign policy terms. In the run up to the election, Germany’s voters seemed very aware of the responsibility that they had in providing the stability at the heart of Europe in what seem to be turbulent times. The Chancellor’s challenge now is to convert that responsibility into policy.

 

“The Weaponization of Trade: the Great Unbalancing of Politics and Economics” 
Rebecca Harding and Jack Harding.

October 25th 2017 * 170pp paperback *£9.99
ISBN 978-1-907994-72-2

PRE-PUBLICATION ORDERS, WITH FREE UK P+P GO TO: http://londonpublishingpartnership.co.uk/wot-advance-purchase/

 

 

 

 

 

 

 

 

October – Trade Outlook

The aftermath of Germany’s election: how does trade help?

Germany’s election at the end of September was predicted to be dull. Angela Merkel was to be re-elected, possibly on a larger share of the vote, and the country would be able to focus on defining its role at the heart of a re-generated Europe. In the end, the Alternative für Deutschland won 12.6% of the share of the vote – the largest share of parliamentary representation of any extreme right wing party since the World War II. Germany’s parliament is now divided between six parties and the centre right CDU-CSU and the centre left SPD parties have been given a warning by voters that “business as usual” is not enough. Their votes shrank to 36% and just over 20% respectively.

Inevitably there will be a period of domestic uncertainty. The SPD has already stated that it would not be part of a new Grand Coalition. This leaves Angela Merkel the complex task of forming a “Jamaica” coalition of the CDU-CSU, the liberal FDP and the Greens (so called because the colours are those of the Jamaican flag). This will not be an easy process. There are rumours, following the departure of Wolfgang Schäuble from the Finance Ministry that this post is being left open as a negotiating tool for Angela Merkel as she starts discussions with the other two parties.

However, it is possible that trade offers a solution to at least one of Germany’s persistent problems: under-investment in some of the infrastructures in the country that are weak and that may have contributed to the sense of social as well as economic exclusion that the voters in the eastern regions exhibited. In 2016 Germany posted its largest trade surplus ever at some US$300bn – nearly a third higher than China’s at US$200bn (Figure1). Germany’s budget surplus, to which the trade surplus contributes, was €18.6bn in the first half of 2017. Much of this surplus has been achieved through its adherence to stringent, and well-documented, austerity measures. But even in Germany economists and politicians alike are beginning to worry that the surplus is unsustainable: the broadband and road infrastructures in the country are under-invested, for example, and some fiscal stimulus would further boost the European economy.

 

Figure 1:          Germany’s trade with the world, 1996-2016 (US$m)

Source:            Equant Analytics, 2017

Germany is to some extent a victim of its own success. The Hartz reforms in the 1990s and aggressive austerity in the wake of reunification provided the country with a more flexible labour market alongside lower government borrowing than any of its European counterparts. But Germany has also been hugely successful in its main economic focus – trade. Its goods are competitive abroad and its supply chains extend throughout Europe and beyond.

Yet this causes political problems in terms of its foreign relations. Throughout his presidency so far Donald Trump has branded Germany and its surplus as “bad, very bad” in his tweets. He has attributed Germany’s success in exporting to the US as a product of the under-valuation of the Euro that has enabled Germany’s manufacturers to price their goods advantageously in overseas market undermining, for example, American manufacturers. The size of Germany’s trade surplus with the US, and the fact that it has widened since the introduction of the euro is a function both of this and of the fact that Germany’s products compete on quality as well (Figure 2).

 

Figure 2:          Germany’s trade with the United States, 1996-2016 (US$m)

Source:            Equant Analytics, 2017

But while Germany does export successfully to the biggest countries in the world, among them China and the US, it also operates its supply chains across Europe. In other words, the budget surplus may create distortions, particularly in weaker European countries, but it also helps fuel growth in those very same countries. The automotive sector is the best example: Figure 3 shows the projected annualised growth of German cars and components for its top five import and export partners. It shows how car and component imports from the likes of the Czech Republic and Hungary are predicted to grow to 2020 more quickly than from the US, France or Spain while exports of cars and components from Germany are growing at a slower or similar pace.

Germany’s top five import partners

5.1%    Czech Republic

3.2%    Spain

-1.1%   France

3.0%    USA

5.4%    Hungary

Germany’s top five export partners

2.9%    USA

4.3%    UK

1.9%    China

-0.5%   France

1.1%    Spain

Figure 3:          Projected annual growth of Germany’s top five import and export partners in the automotive sector, 2016-2020

Source:            Equant Analytics, 2017

Germany’s surpluses tell the story of its success in adjusting to two major shocks: its reunification and the global financial crisis. The process has been tough on many Germans, particularly those in the eastern regions and this was reflected in the recent election result. However, Germany is not about to become less domestically stable. It may enter a period of self-reflection, and this is not necessarily a good thing while geopolitical uncertainties are rife. But the AfD and die Linke (the extremist left party) account for just over 21% of the vote between them. Populism in Germany, as with other countries in Europe, has been driven by a sense of economic and social exclusion, largely in the eastern regions of Germany and catalysed by Angela Merkel’s controversial response to the migrant crisis in 2015. To some extent it would be possible to argue that the rise of extremism, because it is so predominantly in the east, is a function of the last nearly 30 years since reunification. Where in other countries populism is a function of exclusion from globalisation, in Germany it is driven by a sense of exclusion from Germany’s second “economic miracle”.

Angela Merkel will realise that this domestic uncertainty is dangerous. Using the surplus to focus on some of the problems of under-investment, including suitable structures to integrate the large numbers of immigrants, will undoubtedly help. It is unlikely that the trade surplus will diminish any time soon – Germany is too competitive for that. But with the trade surplus comes influence, particularly in foreign policy terms. In the run up to the election, Germany’s voters seemed very aware of the responsibility that they had in providing the stability at the heart of Europe in what seem to be turbulent times. The Chancellor’s challenge now is to convert that responsibility into policy.

 

“The Weaponization of Trade: the Great Unbalancing of Politics and Economics” 
Rebecca Harding and Jack Harding.

October 25th 2017 * 170pp paperback *£9.99
ISBN 978-1-907994-72-2

PRE-PUBLICATION ORDERS, WITH FREE UK P+P GO TO: http://londonpublishingpartnership.co.uk/wot-advance-purchase/

 

 

 

September – Trade Outlook

Trade Wars: Why the US must think before it acts

There are times when it is helpful for a nation’s leaders to think carefully about the consequences of their statements. North Korea tested an H-bomb capable of being fitted to an Inter-continental ballistic missile on the 3rd September. Without any exaggeration, this is a momentous time for the world’s security. North Korea is playing with both China’s will to intervene substantively and the US’s will unilaterally to start a major war on the Korean peninsula. China is keen to avoid any action that will result in a stream of refugees coming across the border from North Korea. The US, despite statements from President Trump that any aggression by North Korea will be met with “fire and fury” will be reluctant to avoid full-scale conflict because of the risk of retaliation.

So this has become a Trade War. On the 3rd September, President Trump tweeted, “The United States is considering in addition to other options, stopping all trade with any other country doing business with North Korea.” This is a bold statement targeted, of course, at China which accounts for around 85% of North Korea’s trade value. Since Steve Bannon’s statement in August 2017 that the US is effectively fighting a trade war with China, the statement could be interpreted as simply a desire to take on China’s relationship with North Korea and its trade surplus with the US at the same time.

President Trump should be wary what he wishes for. Apart from China, North Korea’s top ten trade partners (imports and exports) include, Russia, India, the Philippines, Singapore, Chile, Germany, Hong Kong, Indonesia, Switzerland and Mexico. China itself exports around $US 2.8bn into North Korea and other countries are substantially smaller. Russia, for example, imports just $US 68m and India some $US 54m. For many other countries the amounts are in the low millions. However, if the President’s words are to be taken at face value, then all of these countries should be included. Taken together and including China, these countries accounted for nearly 48% of the US’s total trade of $US 3.9 trillion in 2016 (Figure 1).

 

 

Figure 1:          Value of US trade for North Korea’s top 22 trading partners ($US bn)

Source:            Equant Analytics, 2017

Of greater interest is the sectors that would be affected by trading with countries that “do business” with North Korea. Mexico is a major player in the US’s electronics, automotive and machinery and components sectors and, of course, in oil. But its trade with North Korea is small, as is the trade of many other countries with North Korea. It makes sense to look just at China and how its key sectors are interwoven into strategic sectors for the US (Figure 2).

This chart in itself depicts the frustration that the US has with China’s dominance of its trade. US supply chains, are irretrievably interwoven with China. For example, many of the imports from China in Electrical Equipment and Machinery are intermediate manufactured goods, nevertheless, these goods are part of other supply chains, for example in automotives or aerospace.

 

Figure 2:          US trade with China in non-oil strategic sectors ($US million 2016)

Source:            Equant Analytics, 2017

 Quite apart from any impact that the decision to stop trading with all those nations that have trade with North Korea, there is a sense in which any sanctions, or sanctions-like move, is counter-productive. North Korea, it seems, already has nuclear launch capacity and this is not a new phenomenon. The trend started in 2008 in nuclear-related dual-use goods and, during the process of Kim Jong Un’s accession, imports of propulsion equipment started to increase (Figure 3).

 

Figure 3           Value of North Korea’s trade in selected dual-use goods, 1996-1997, $USm)

Source             Equant Analytics, 2017

There are already signs that North Korea is winning the deterrence war. Their calculation is that both China and the US are “paper tigers”: they can bluster, but in the end there is little that they can materially do. There are no clear diplomatic or military answers – all have unimaginable consequences and are therefore likely to be avoided if possible. Accepting North Korea as a nuclear power will be a tough pill for the US to swallow and again is unlikely without some form of diplomatic ‘victory.’

But what is absolutely clear is that economics solutions may well be equally as unimaginable. Loose words in military terms may increase the risk of miscalculation and war as a result. Equal discipline should be applied to the use of language in economic and trade terms. Ending trade with countries who do business with North Korea is impractical and would be an act of assured economic destruction for the US itself. Maybe this is the ultimate deterrence against a trade war with China as well; weaponizing trade cannot be the way forward.

“The Weaponization of Trade: the great unbalancing of politics and economics,” by Rebecca Harding and Jack Harding will be published on the 25th October by London Publishing Partnership. Click here to find out more and to pre-order a copy.

August – Trade Outlook

What does a US trade war with Russia mean?

Just as the world thought it was safe to go on holiday, at the beginning of August President Trump signed legislation to place severe sanctions on Russia because of their alleged interference in the US Presidential elections. At the same time, he declared the legislation to be “seriously flawed” and “unconstitutional.” Russia’s Prime Minister, Dmitry Medvedev responded on Facebook, that the action was, “the declaration of a fully-fledged trade war” against Russia and would damage US-Russian relations for years to come. More than this, he also stated, “The US establishment fully outwitted Trump… the Trump administration has shown its total weakness by handing over executive power in the ‘most humiliating way.’ ”[i] President Trump’s response? To tweet “Our relationship with Russia is at an all-time and very dangerous low. You can thank Congress, the same people that can’t even give us HCare!”[ii]

Escalation of tension

The politics of the escalation of tensions between the US and Russia clearly matter, but do the economics? From a US perspective it may appear not. Russia is not a top-ten import or export partner of the country. Its US$ 32bn of trade is less than 1% of the total value of US trade of US$ 3.9tn and has been falling since sanctions against Russia were first imposed in 2014 (Figure 1). Some of this may also be due to the collapse in oil prices between 2014 and 2015. A momentum-based projection into 2017 suggests that the increase in both imports and exports between 2015 and 2016 is unlikely to continue.

 

The trade between US and Russia between 1996 and 2017

Figure 1: US trade with Russia, 1996-2017, US$ bn (2017 projection)
Source: Equant Analytics 2017

What does the US Export to Russia?

US exports to Russia are predominantly in aircraft and aerospace (Figure 2). It accounted for US$ 3.2bn in 2016 and this was nearly double the second largest export sector, machinery and components, which includes computers and data storage. In every year since 2011, and in spite of sanctions against Russia, US exports in aircraft have grown by just over one third. This is admittedly from a relatively small base but it does demonstrate the fact that there is activity in what is both a highly politically sensitive and strategic sector for the US. On the basis of a momentum projection into 2017, it might be expected that exports would grow by a further 8%. This represents a lost value of around US$ 256m, which is small in the grand scheme of US exports. Although it represents a sector-specific loss, Russia is a relatively small export destination and does not feature in the US’s top ten biggest market in this sector.

 

the change in US exports to russia in different sectors

Figure 2: US top five largest exports to Russia, Compound Annualised Growth Rate, 2011-2016 and year-on-year projected growth 2016-17 (%)
Source: Equant Analytics, 2017

What does the US Import from Russia?

Just over 52% of the US’s imports from Russia are in oil and gas. It is the US’s fifth largest import partner in this sector but the value of US$ 10.6bn is dwarfed by Canada at over US$ 72bn. Russian oil and gas imports represent just over 4% of US total oil and gas imports and have been falling over the past five years (Figure 3). In fact, the only area to show any substantial increase is fertiliser imports which are projected to grow by 7.9% between 2016 and 2017 but from a low base and a period of five years during which they have declined annually by around 1% each year.

 

change in us imports from russia

Figure 3: US imports from Russia, Compound Annualised Growth Rate, 2011-2016 and year-on-year projected growth 2016-17 (%)
Source: Equant Analytics, 2017

Figure 3 illustrates two things: the US has imposed sanctions on Russian imports progressively over the past five years and the downward trend is likely to continue. But second, and perhaps more importantly, the substantial drop in oil and gas trade with Russia reflects the US growing independence in this sector as its own exports increase and as shale gas production becomes increasingly efficient.

What are the consequences?

So what does this tell us about the importance of a trade war between the two countries? From a US perspective, Russia is another country with whom it has a trade deficit, albeit proportionately small at US$ 6bn in 2016. It has been reducing its imports from Russia and the country is not a major trading partner. In terms of the economics of its own trade, it loses relatively little and is making a strong political point. But equally, the US is not a top ten importer into Russia and is only its sixth largest export destination. Even though this has been driven in the last few years by sanctions and dropping oil prices, it seems that the relationship is economically less important than it is politically.

It is the politics that are the key point here. When leaders of two major countries start declaring a “trade war,” they are raising the stakes. Trade becomes political rather than economic and this is dangerous.

July – Trade Outlook

Three charts to show why the South and East China Seas matter

Japan does not officially have an army, it has a Self Defence Force. So, when it starts sending warships into the South China Seas in an attempt to keep China’s territorial claims in check, it is clear there is a problem. Its Izumo helicopter carrier’s presence is to provide the assurance to the region that it is willing to move into a more proactive military role in the interests of regional security at a time when US interest is at best only focused on North Korea, and at worst, waning. While the US nominally retains its commitment to the “Freedom of Navigation Operations” (Fonops) to provide a base for regional security, its military operations are taking a lower key and not being publicised as they were under the Obama regime. As the US appears to look away, China continues to build and protect what it deems its sovereign and economic rights. China can play a long game without using its military muscle, but the very fact that it is demonstrating its regional influence reinforces the perception that tensions in the region are dangerous.

The region matters to world trade flows and to its energy security. The importance of the South and East China Seas cannot be understated. It is not just a source of geopolitical tension, it is also a major trading route. The countries in the region’s US$ 10.7tn trade accounted for just over 54% of world trade in 2016. More than this, the countries in the South and East China seas account for just over 40% of world oil trade (Figure 1). Any risk of disruption or threat of instability should make markets and commentators alike feel nervous as a result, not just because of the spill-over effects into the global trade system but also because of the region’s strategic importance.

 

Figure 1:  Share of world oil trade for countries in the South and East China Seas area 2016
Source:  Equant Analytics 2017

The region matters to China as well. Trade with the other countries in the South China Seas account for some 51% of China’s trade (Figure 2)

Figure 2:   China’s trade with nations and Hong Kong in the South and East China Seas
Source:  Equant Analytics, 2017

Hong Kong is China’s biggest trading partner in the region at more than twice the value of trade compared with Japan, its second largest trading partner. The regional partners, Indonesia, the Philippines, Malaysia and Vietnam in particular, are important contributors to regional supply chains in electronics and machinery & components meaning that their regional fortunes are intertwined. As China has gone through its economic reform programme of the past few years, it is these regional partners who have had to adjust. But any political instability in the region threatens trade flows within the region as well as between the region and the rest of the world. This impacts China just as much as it does other countries and as a result, China will be keen to ensure that there is no escalation of tensions beyond rhetorical ones simply because it is in its own strategic interest.

China’s strategic interest is evident in the East China Seas through its relationship with North Korea. As sanctions have become more stringent, China’s share of North Korean trade has increased (Figure 3). The momentum projections suggest that this may well stabilise over the next few years but at over 85% of North Korea’s trade, China has a strong strategic leverage over Pyongyang.

Figure 3:   Percentage share of North Korea’s trade accounted for by China (1996 – 2021)
Source:  Equant Analytics, 2017

The US and China have engaged in talks since their Summit in April, not overtly about North Korea – but about trade. Why? President Trump explained this in a tweet on the 11th April: “I explained to the President of China that a trade deal with the US will be far better for them if they solve the North Korean problem!” In other words, trade is a strategic tool to gain influence over North Korea. An explicit “trade war” between the two countries was avoided because of the post Summit “100 day plan” and although the deals struck since then have been modest, they have the effect of diverting global attention away from the region.

The perception of geopolitical risk in the South and East China Seas is not new. In the South China Seas the disputes are territorial and between countries; the role of the US has been to keep the trade route that it represents open in the economic strategic interests of the world. The risks in the East China Seas and Korean Peninsular are as much about strategic influence as they are about trade.

However, a deliberate armed conflict is unlikely as the example of North Korea and the “trade deals” with China show. It is simply too important to the US and the world, in terms of energy security, in terms of trade flows, in terms of economic interests and more generally in terms of national interest and power. Increasingly, the disputes in the region are centred around strategic influence. Trade, or the threat of disruption to trade is the means by which any conflict will be fought: it is a bargaining chip. China knows this and holds increasingly more of the cards as the US looks away.

 

 

 

June – Trade Outlook

Article 50: time to take a strategic look at trade

Almost as soon as the dust settles after the UK election, the Article 50 process to negotiate the UK’s exit from the EU will start. The UK so far has relied on a conciliatory Europe led by a Germany that was genuinely saddened by the loss of its like-minded Anglo-Saxon ally and therefore more likely to drive the bloc towards compromise. The G7 and NATO summits at the end of May, and the inauguration of President Macron have changed all that. Europe is finding a new assertiveness on the global stage. This was articulated by Chancellor Merkel in her Munich speech; she argued that the US and the UK could no longer be relied upon and that Europe must find its own voice to promote its own interests. And while much of the rhetorical anger in the speech may simply be attributed to electioneering, it serves as a wake-up call to the UK. Europe will have its own strategic interests when it starts the negotiations and the UK would do well to be aware of what these are.

Trade is political and this makes it strategic – that is, something that can be used as a tool to promote national or regional interests in economic or foreign policy terms. In this, EU negotiators will be keen to protect Europe’s economic and energy security as well as increasingly focused foreign policy interests.

The EU’s top ten export and import trade flows by sector with the UK are automotives, machinery (including computers), pharmaceuticals, electrical equipment and oil and gas (Figure 1). The top fifteen trade flows by sector add optical, photographic and medical equipment, plastics and aerospace. These are not just the top trade sectors for the EU as a whole; they are also among the top sectors for Germany, France, the Netherlands, Italy, Belgium and the UK.

Given that Europe exports to the UK some 85% more than it imports from the UK, it has been assumed that the cards are stacked in the UK’s favour. However, trade “wars” are reciprocal: one side imposes tougher arrangements and the other retaliates. As these are the top sectors for the UK as well, and as Europe is the UK’s largest export destination for each of these sectors, it will be important to bear in mind that the symbiotic relationship in these sectors are because of Europe-wide supply chains. Everyone will lose without some compromise.

 

Figure 1: Top 15 trade flows by sector between EU and UK (exports and imports, 2016, US$ bn)
Source: Equant Analytics, 2017

The second thing to note is just how concentrated this trade is. The top ten flows account for 53% of Europe’s trade with the UK. Add in plastics, optical and medical equipment and aerospace (the 11th and 12th largest flows and in the top five for Germany, France and Italy) and the top flows account for over 60% of Europe’s trade with the UK (Figure 2).

Again, the dominance of exports to the UK is clear – the top four sectors are all exports to the UK and constitute over 31% of Europe’s trade with the UK. Again, however, the importance of Europe-wide supply chains is critical. The UK is a large export market for German cars and automotive components, but this is because the UK is a major location within Europe for the manufacture of German cars. While this may appear that Germany is more dependent on the UK than the other way around, the UK’s exports of cars to the US has grown at an annualized rate of 9% and to China at an annualized rate of 13% over the past five years. This is not all attributable to German manufacturers, but there is no doubt that this has had an influence.

 

Figure 2:  Share of EU trade with the UK, top fifteen sectors, 2016 (%)
Source: Equant Analytics, 2017

Finally, the EU 27’s trade is 73% correlated with the value of the euro since 1998 suggesting that it is a trade-based currency rather than a speculative one. Its trade with the UK is slightly weaker at 70% but this is still substantial. (Figure 3). The euro is the world’s second largest trade finance currency and its position and strength can therefore be seen as a function of the strength of Europe’s trade. This is a quite distinct function for the euro and explains why Germany in particular has been keen to hold the Eurozone together: the euro’s economic importance is in trade and as supply chains develop across the region, this becomes more rather than less important. Just as is the case for Europe, a stable euro for the UK ensures that prices within the supply chains into which UK businesses are woven are also stable.

 

Figure 3:  EU 27 exports to UK vs euro-usd spot price, 1998-2016
Source:  Equant Analytics, 2017

Elections distort rhetoric and there is anger in Europe about the UK’s bellicose tone which, along with Trump’s visits at the end of May provoked the response from Angela Merkel that former allies could no longer be trusted and that Europe would have to go it alone. The danger is that rhetoric becomes entrenched on both sides after the election in the UK because there is still a long way to go before the German election. This would be a negotiating mistake on the part of the UK. Europe’s and the UK’s trade is almost symbiotic because of the importance of supply chains. Policy makers on both sides would do well to remember this.

May – Trade Outlook

Just how globalised is France?

The French election campaign has raised some important questions: first, what is France’s role in the world, and second how can that role be articulated to its citizens? It is easy to campaign on the back of a view “for” or “against” globalisation. But the reality may well be more complex: to many, globalisation is a threat and it is therefore the next President’s responsibility, to explain why France would do itself great damage by extracting itself from the global, free-trade economy.

France is the fifth largest trading nation in the world with its exports contributing over US$ 600bn in 2016 to the country’s GDP. France is also the fourth most open economy in the G20 measured as the proportion of GDP accounted for by trade at 48% compared to 43% in the UK, for example. While this is not as open as Germany, at 63%, it still shows that trade matters to the French economy and French jobs. More than this, out of France’s 12 largest trade partners, 7 are in Europe (Figure 1), although trade outside of the EU, particularly with the US, China and the UAE is growing more quickly than trade with its European partners.  France’s exports to Germany were worth US$ 80.5bn in 2016 and exports to the US worth US$ 50bn but the growth with the US suggests the gap is not necessarily permanent.

Figure 1:          Projected growth in trade between France and its top partners ordered by size left to right, 2016-2020 (CAGR, %)
Source:           Equant Analytics, 2017

France’s trade with Germany and the US is dominated by aircraft and aerospace. This is France’s largest, and fastest growing, trade sector (Figure 2).

Figure 2:  Projected growth in France’s top trade sectors ordered by size left to right, 2016-2020 (CAGR, %)
Source:  Equant Analytics, 2017

France has strong automotive supply chain relationships with Poland and this is reflected in the fact that imports from Poland are set to grow at an annualised rate of over 3% in the next few years. This also helps to explain why France’s exports of cars and electronic equipment are projected to be either flat or to fall. While beverages and perfumes remain strong growth sectors, their exports are a lot lower in value terms to the French economy, at US$ 18bn for cars and electronic equipment and US$ 16bn for beverages and perfumes compared with US$ 86.4bn contributed by aircraft.

It is in the aircraft and aerospace sector where the real global nature of the French economy can be seen. Given how large this sector is, it is significant that the top trade flows in it are exports to Germany (US$ 20.3bn), imports from Germany (US$ 16.2bn) imports from the US (US$ 13.2bn) and exports to China (US$ 8.3bn). This illustrates just how global this sector is (Figure 3) and, more importantly perhaps, how strong French exports are since all bar four of its top 20 trade flows are exports.

Figure 3: Value of France’s top aircraft and aerospace trade flows by partner, 2016 (US$ bn)
Source:  Equant Analytics, 2017

Trade matters for France and for French jobs given how open the French economy is. French car and consumer electronics manufacturers have taken advantage of cheaper labour in Poland in particular and have built European supply chains, particularly with Poland, to guarantee the competitiveness of their sectors. Aerospace is a more global sector with flows across Germany, the US and China dominating the top five trade flows in this sector. France dominates sectors where globalisation is irreversible. The French election campaign has been fought on the basis of the negative aspects of globalisation through immigration and its weaker power within Europe compared to Germany because of its economic under-performance since the financial crisis. It is the task of the new administration to put globalisation on a positive footing so that the French people feel comfortable with their global as well as their national role in the world.

April – Trade Outlook

What does trade tell us about the oil price? In the first Trade Outlook of 2017, we pointed to a somewhat negative outlook for oil prices. Although analysts at the time saw prices increasing as demand recovered and production stayed at similar levels, based on our trade forecast for oil, we felt that the picture was at best neutral and maybe slightly negative. This was in line with OECD thinking but the World Bank and the EIU at the time were both suggesting that prices would rise.

The reason for the more negative outlook that we had at the time was because of the very high correlation between world trade values and the oil price (Figure 1). This correlation, of 90%, does not tell us how the oil price will move. It simply tells us that it is highly correlated with trade values, which is reasonable since oil is the world’s third largest traded sector with a value of $1.9 trillion in 2015. However, it does tell us that if trade is projected to remain static, then there is a greater likelihood that oil prices will also remain static.

 

Figure 1:  Monthly value of world trade in oil (USDm) vs oil spot price (last price monthly), Jan 2010-Jan 2017
Source:  Equant Analytics, 2017

The trajectory for oil prices since January has been downwards reflecting the flatter pattern in world trade.  Last month highlighted the difficulties of predicting oil prices. In the middle of the month, oil prices had fallen 10% in one week to their lowest level since OPEC cut production in November 2016. In the last week of the month, prices had rallied with the best week so far in 2017. A Reuters poll at the end of March suggested that analysts were not expecting oil prices to rise to $60 a barrel until 2018 at the earliest. But with the trade outlook flat for 2016 and 2017 and growing only slightly into 2017-18, the prediction of $60 a barrel in the near term would appear to be only possible were there an unexpected dose of market hubris! (Figure 2)

Figure 2            Projected growth in total world trade vs world trade in oil year on year (2016-17 and 2017-18)
Source: Equant Analytics 2017

There are two key issues. The first is whether demand is increasing relative to production. As the US increases its output of shale, there is little doubt that the US itself will be able to meet its domestic demand, taking market share from OPEC and non-OPEC aligned producers. This will keep prices flat during the course of the year if this pattern continues and, potentially at least, push prices downwards if the OPEC producers decide to go for an all-out price war when they meet in May. Falling projected global trade in oil suggests that demand will be at best weak relative to prices.

The second is the shift in the patterns of production in the market. This is evident in how trade has grown over the past five years and how it is projected to grow over the next five years (Figure 3).

Figure 3           Selected mineral fuel trade vs electrical energy growth 2010-15 and 2016-21 (CAGR %)
Source             Equant Analytics, 2017

The prospects for growth in each mineral fuel sector is more positive from the second period with 2016 as its base compared to the post-crisis period. However, only trade in petroleum wax, coke and bitumen and bitumen and shale show positive annualized growth and the most substantial projected growth is in the bitumen and shale sector. Although electrical energy’s decline in trade growth is projected to slow, it is still a very small sector compared to other mineral fuel sectors and its improvement does little to suggest that a major change is on its way.

What this suggests is that the oil sector as a whole is likely to dominate for some time to come despite environmental pressures. Demand is growing, but it appears that it will be met by current energy sources rather than new ones. The greatest improvement in trade growth over the two time periods is in bitumen and shale and this corroborates the view that US shale production, increasingly cost effective as it is, is likely to compete favourably in oil markets with crude and refined oil to meet the growth in demand, particularly in the US itself.

 

 

March – Trade Outlook

The stage looks set for the UK to trigger Article 50 as planned by the end of March 2017. This will start the process of negotiating the UK’s way out of the European Union, a process which will be at best difficult. As no-one at this stage knows precisely what the trade arrangements will be after Brexit, and as these arrangements won’t come into place for at least eighteen months, it is a good idea to take a snapshot of where we are now in trade terms  and, indeed, to look at what the future looks like if nothing changes. At the very least, this provides a reference point for that point in the future when we are, well, where we will be.

Figure 1:          Projected annualized average growth of UK trade with global regions, 2016-2020
Source:            Equant Analytics 2017

NOTE:     The projected growth between 2016 and 2020 is based on a momentum forecast only. The momentum forecast is taken from all available data for the UK between 1996 and 2016 (inclusive) to capture cyclical changes in trade and from the last ten years and the last three years to create the forward momentum. The projections are based entirely on the data series and not on assumptions about policy changes or their impact. This note applies to Figures 2 and 3

At first glance the chart shows that although UK exports to the EU 27 and the EU currency area are projected to fall, export growth to the Asia Pacific region (APTA) may be as high as 7.4% annually to 2020. This is a pattern that has been gaining some momentum for the past few years, particularly since the investment of BMW in the UK, which has boosted car exports to China for example. Export trade to the Middle East and North Africa is also projected to grow and much of this is in aerospace and engineering-related supply chains. Trade with North America seems set on a downward path – clearly Theresa May’s recent visit to the US has yet to show through in the projections!

However, two key points about this chart need to be considered before a universally positive conclusion is drawn. First, generally speaking, imports look set to grow faster than exports. Some of this may simply be due to the weakness of sterling making imports more expensive but it does suggest that even on current conditions our exports are not growing fast enough to cater for increases in imports. Imports from the Asia-Pacific region (notably China) are the notable exception but as we export just over half to the Asia Pacific region compared to what we import ($46.6bn compared to $87.5bn) this explains why growth of imports might be slower.

Second, exports to Europe, both the EU27 and the Eurozone are set to decline and the increase in export trade with Asia Pacific, even on current trends, is insufficient to make up for this loss. We project exports to the EU27 to be worth $197.6bn by 2020 while exports to the Asia-Pacific region to be worth around $57.6bn, or just under 30% of the value of European exports by 2020.

The picture of UK trade by sector shows just how integrated into global supply chains our businesses are. For example, the top ten sectors (shown in Figure 2 from left to right by size), also show that generally imports are set to grow more quickly than exports. This may not in itself be a bad thing, because where imports are growing in components, for example, the UK is able to add value through its exports of cars. Certainly for pharmaceuticals the projected annual growth to 2020 of 2.8% is substantially higher than the annualized growth between 2010 and 2015 of 1.2%.

 

Figure 2:          Projected annualized growth for the UK’s top trade sectors, 2016-20 (%)
Source:            Equant Analytics, 2017

However, UK export growth is fragile, even on the basis of current conditions. Projected export growth to 2020 for computing is close to zero, while export growth for automotives is one third of the rate it was in the 2010-2015 period of 6.0%. Exports in electronics, organic chemicals and oil and gas look likely to decline. The obvious exceptions are gold and precious metals and works of art where exports will grow more quickly than imports.

Figure 3:          Projected annualized growth, 2016-2020, for key UK services (%)
Source:            Equant Analytics 2017

The UK runs a trade surplus in services and exports overall look set to grow faster than imports over the next five years. However, the picture is mixed. Travel, transport, intellectual property and insurance are the four service sectors where exports are growing particularly compared to imports but cultural and creative, franchising and licensing and financial services exports are likely to decline on current trends over the next five years. Financial services in particular is an iconic sector for the UK because of its links with employment and the regional economy of London and this negative outlook ahead of Brexit negotiations is important for policy makers to bear in mind.

What this overview shows is the fragility of UK trade generally and exports in particular. Trade is growing quickly with Asia, and some of our top sectors and services look strongly placed ahead of Brexit negotiations. However, the fact that imports are growing quickly has to be seen in a context of an area of globalization. If globalization is thrown into reverse during the course of the next two years, not just because of Brexit but also because of increased protectionism in the rest of the world, especially in the US, this position is increasingly untenable as we return to an era where export strength is equated with national economic strength. While nobody really knows what will happen, any uncertainty will increase the downside risks in the current outlook.