In recent times, Western outsourcing to Asia has been a source of much handwringing, but the future of trade is heading in a different direction. Due to the rise of robotics and digitization, more goods will be produced closer to home, while certain physical products are already disappearing entirely.
According to Paul Donovan, chief economist at UBS Wealth Management, this means that Asia’s trade model of the last 25 years will lose relevance in the decades ahead. In this interview, he explains the tectonic shift by looking at supply chains, intellectual property, and the race for technology.
Maurits Elen: How important is China’s trade for U.S. inflation?
Paul Donovan: Chinese trade is not that important for U.S. inflation. In the world’s largest economies, inflation is a local issue. About 70 percent of inflation in an advanced economy is local labor costs. A lot happens to a product after it arrives in a country. Storage, moving a product about, advertising, and selling a product are all local labor costs.
China’s impact on global inflation in recent years has been small. On balance, China has probably pushed inflation up. China may have lowered prices for some goods by making them more cheaply. China has also raised the prices for commodities by being an inefficient commodity user. China’s main impact on inflation was to change relative prices. China’s economic model meant commodity prices rose relative to other prices.
China’s role at the end of many supply chains complicates the way China might impact prices in the U.S. and elsewhere. By imposing tariffs, President Trump has not really been taxing U.S. buyers of goods made in China. Instead, he has been taxing U.S. buyers of goods that are partially made in China. China may only make a small part of a product. However if China is the last stage in the supply chain – the postage and packaging department – then there is a risk of a U.S. trade tax. President Trump is not only charging a tax on China, but he is also imposing a trade tax on all the countries that contribute to goods that China puts together. That will of course include U.S. made parts of goods China puts together.
How visible would tariffs on Chinese imports be for U.S. consumers?
Up until now trade taxes have not been especially visible to American shoppers. Taxing washing machines or solar panels is not very visible, because consumers do not buy these things very often and people are unlikely to remember the price of the last washing machine that they bought. If the shopper is not comparing the price before and after a trade tax, they will probably not appreciate that they are paying an additional tax.
Steel and aluminium are not products that people will tend to buy directly. The steel or aluminium that a shopper buys come packaged up in drinks cans or cars. Taxes only affect people if the producer passes the tax on to them. As steel and aluminium are only a small part of the costs that go into things people buy, the changes are not likely to be very visible. The recent aluminium tariffs have added perhaps half a cent to the cost of producing a can of beer.
If the U.S. creates new trade taxes on finished consumer goods that are frequently bought, people may realize that their government is taxing them. An American may not notice a tax on washing machines, but a tax on sports shoes or smartphones is likely to be more obvious.
It is worth noting that companies will work to evade the trade taxes through shifting production. A car company could avoid the taxes on steel imports by shifting production from the U.S. to Canada, for example. Importing a car made with Chinese steel into the U.S. does not incur new trade tariffs. But making a car in the U.S. with Chinese steel does incur new trade tariffs.
You wrote that global trade shows signs of having hit peak trade. How does Asia, the center of global trade, fit within this story?
The trade model of Asia that has succeeded over the past quarter century will not work over the next quarter century. A lot of globalization in the past 25 years was about supply chains becoming longer and more complicated. Simply put, it took more international trades to produce a product. Companies made components in more and more places – the process known as outsourcing.
The rise of robotics means that localizing production is becoming more common nowadays. A factory in Europe fitted with robots can manufacture as cheaply as a factory using low cost labor in Asia. The European factory that produces close to its customers is less likely to have wasted production, as it can almost produce on demand. It becomes more efficient to produce as close to the consumer as possible.
When companies can digitize a product, nobody needs to trade physical products. Ten years ago, people bought music on compact discs. The music itself may have come from the U.K. The compact disk, the case, the plastics, the packaging, the promotional material may have come from Asia. Each part could come from a different country before being packaged together in yet another country. Lots of Asian trade allowed a European consumer to listen to a U.K. band. Now the European consumer does not need Asian trade to listen to music, because no one listens to music on a compact disc any more. Now a European consumer can download or stream the music direct from the U.K band. As such, physical trade has disappeared.
This is not a sudden shift. Rather, this is a change that will take place over the course of the next 10 or 15 years. However, we are already seeing the effects of this. In real terms, global trade has stagnated as a share of global GDP over the past few years, while foreign direct investment has slowed as well.
What will the battle for the future be about?
Trade in the future is likely to be closer to the imperial trade model of 50 years ago than to the trade model of the past 25 years. Trade in commodities will continue. Trade in intellectual property will continue, and expand. Trade in goods is likely to be a lot less common. People will probably still trade certain goods. One example might be luxury brands, where people believe that where a company makes the good adds to the value of the good. However, companies will make most goods close to their customers.
Commodities are unlikely to be the subject of trade conflict. Intellectual property and design are far more likely to be fought about. In a world where companies make things locally, the security of intellectual property is the main worry for a company that wishes to trade.
Technology-wise, how competitive are the U.S. and China? The U.S. and China are in different development stages. Does this change the way technology contributes to productivity?
Technology cannot define productivity on its own. An economy needs a mix of technology and human skills. A country needs to have people who can change to use any new technology. People also need to innovate. Universities and the economy’s private sector need to work closely together. Flexibility and the ability to challenge existing ways of doing things are very important.
China’s growth model has to change. Increasing inputs to increase output will not work. China needs to focus on doing more with less. This requires innovation and productivity. Technology with the right labor flexibility is a key part of this.
I would argue that getting the right technology and labor flexibility matters more to China than to the U.S. But this is not because of China’s stage of development. It is because China is getting older. China faces more serious environmental problems, too. Pollution is causing falling life expectancy, and water shortages have limited economic growth. Technology has an important role to play in helping to solve both of these issues.
Today, the U.S. has a competitive advantage over China. The American culture of independent universities with ties to the economy produces that competitive advantage. The culture where people challenge the existing way of doing things socially, economically, and politically also helps. China is publishing more research on artificial intelligence than the U.S. However, the research is of poorer quality. It is quality, not quantity, that matters.
This interview has been edited for clarity.