Trump’s trade war could create more sustainable supply chains

July 11, 2019 13:09
China’s Belt and Road Initiative is creating a network of new options for rail transport between China and Western Europe that will prompt reconsideration of supply chains by some companies. Photo: Reuters

After decades dominated by globalization, trade is being reconfigured as a result of geopolitical, technological and other changes. Sustainability could be a big winner from this process.

US President Donald Trump is not generally known to be a friend of sustainability. His administration’s rejection of the Paris Agreement on climate change typifies an approach to climate change that veers between apathy and denial, for instance. But it’s possible that Trump’s trade policies – aimed at increasing US industrial output and reducing the US trade deficit (most especially with China) – could accelerate trends already underway, potentially improving the sustainability of supply chains.

Although there’s plenty of rhetoric and posturing, the trade war between the US and China is having real consequences.

Last year, about US$250 billion of US imports were covered by tariffs and similar retaliatory measures were put in place by China.

The impact on world trade is small but not insignificant: approximately 2-3 percent of world merchandise trade is now affected by trade war tariffs. But it comes on top of a more general slowdown in trade growth which is taking place because of changes in global value chains.

From the 1990s onwards, global supply chains became increasingly fragmented as multinational corporations took advantage of offshoring to lower their costs.

Globalization meant that trade grew as much as two times faster than GDP growth during this period as intermediate goods shipping increased and supply chains grew ever longer. But since 2011 (the latest data only extends to 2016), global value chains have stopped growing.

One explanation is the fragmentation of existing value chains. in world trade is coming from new value chains, hence the limitation in scale. However, there is also anecdotal evidence that supply chains have consolidated in the last few years.

Wages in parts of China have now reached CEE levels, which are close to those in parts of the US and higher than those in Mexico. That is prompting some corporates to reconsider their supply chains, especially with new options and lower costs associated with automation and robotisation.

Corporate choices

For companies reassessing their supply chains in the light of trade developments, there are two possible choices.

One option is to move production to other (still distant) cheaper locations. These may be further inland in China (although this can increase logistics costs) or other countries. Chinese value-added in the gross exports of Vietnam, Thailand, and Mexico has increased significantly in recent years, indicating a shift of assembly activities from China towards these countries.

Some companies may speed up this relocation because of the trade war in order to take advantage of production in countries that are not subject to tariffs.

In January 2019, Pegatron and Foxconn, two major electronic contracting companies, announced expanded production capacity in Vietnam, India and Indonesia.

The other option is to onshore production or create regional, rather than global, supply chains. The option of shortening supply chains, could have positive implications for sustainability.

The trade war may be an additional driver in this development, though it is too soon to say. More certain is the pressure being put on China’s competitiveness by rising wages.

The increased use of automation and robots, which will lower the cost of production in high-wage economies such as the US, are likely to intensify this trend in the medium term.

Nevertheless, any decision to move production away from China will be based on many factors. While China may no longer be as competitive on wages, there are still vast economies of scale and access to the huge and rapidly growing Chinese domestic market, which is increasingly important for global companies.

Moreover, the decision by Alibaba, which now sells consumer products in Europe, to open a warehouse in Belgium indicates that production in China will continue to make sense in some circumstances. For lower-value products, such as those sold by Alibaba, it makes sense to manufacture cheaply overseas, ship by sea, and maintain stock in Europe for rapid delivery.

Other industries have different priorities. In fashion, for instance, Turkey has become the preferred manufacturing location because fashion seasons and lead times are short and manufacturing close to consumer markets enables companies to restock current lines quickly and react rapidly to changing consumer tastes – shipping takes about three extra weeks from China.

While sustainability might be fairly low on the priority list for the fast-fashion retailers that manufacture in Turkey rather than China, these short supply chains nonetheless also improve sustainability.

The BRI effect

The increasing scope of China’s Belt and Road Initiative (BRI), a huge infrastructure and trade plan, will also change trade dynamics in ways that could boost sustainability.

The BRI is creating a network of new options for rail transport between China and Western Europe that will prompt reconsideration of supply chains by some companies.

Rail is roughly twice as fast as shipping, which will make it important for time-sensitive products. Crucially, it is significantly cheaper than air transport, not least because of sizeable subsidies from the government to help it grow.

Although it is not a primary consideration at the current time, CO2 emissions for rail freight between China and Northwest Europe can be 20 times lower than air freight. Compliance with the Paris Agreement is therefore likely to ensure that rail carries more freight in the future.

For consumer products priced at more than 3 euros (US$3.36) per kilo, rail is a more attractive option for freight. Rail could be especially valuable in connecting deep inland destinations in the two continents.

In logistics, price and speed are generally most important given tight margins. But as carbon tariffs are introduced around the world as a result of the Paris Agreement and prices rise from the current 20 euros per ton, CO2 emissions could become an important component in supply chain deliberations.

Currently, China, unlike the European Union, does not have a carbon tax. However, as a signatory to the Paris Agreement, such measures could be introduced in the future, with implications for transport costs.

Furthermore, growing awareness of sustainability among consumers in the coming years could prompt companies to prioritize rail freight over air.

As the circular economy becomes more prevalent and we move to reuse raw materials such as metals, there will also be an impact on global trade. ING's analysis anticipates a regionalization of supply chains as circular economy trade is most effective within a radius of about 200 to 300 kilometers.”

Rico Luman, Senior Economist of ING Bank is the co-author of this article.

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Economist, International Trade Analysis of ING Bank