15 August 2018

The future of trade: preparing for radical change

This article was written by David Olsson 

For the last few months, the financial markets have been on edge as investors, politicians and business owners gauge the likelihood of a global trade war. Whether the situation with the United States and China escalates or not, we are moving into a new era for trade policy – which will have profound implications for Australian companies.

In this update we highlight five broad themes that we think should be on the agenda of boards and senior leadership teams of Australian companies, and offer some strategies to navigate a rapidly evolving and more fragmented global market place.

Trade policy is now a business risk

Australian companies have learned in the past how to deal with a wide range of trade risks—including exchange rates fluctuations, supply chain interruptions and occasional political risks (notably with live cattle and sheep exports).

But until now, there had never been a real need to address global trade policy as a business risk. The potential that current trade tensions escalate further - with adverse effects on confidence, asset prices, trade flows and investment - is the greatest near-term threat to global growth.  

For Australia, the concern is that while our interests will be directly and seriously impacted, there is little we can do to influence the conduct or outcome of negotiations between the US and China other than to ensure Australia’s economic, security and trade policy settings are adjusted for the likelihood that an even more turbulent international environment awaits us.

For businesses, new and heightened risks include reconfigured trade and investment linkages, disruption of supply chains, cyber risks and trade disputes.

Assessing and mitigating these risks will require careful horizon scanning and preparedness.  Understanding economic uncertainty, geo-political conditions, the impact of trade policies, the regulatory environment and management of cross-border relationships are now priority items for all boards and senior leadership teams.

It is only when armed with these understandings that businesses will be equipped to identify available choices and trade-offs and convert that intelligence into actionable business initiatives.

Trade agreements unlock doors of opportunity

Promoting international trade has always been important to Australia’s economy, providing access to a wider range of goods and services, fostering job creation, spurring innovation, attracting foreign investment, stimulating competition and allowing the nation to focus on areas of comparative advantage. 

For the past two decades (particularly more recently), Australia has advocated strongly for trade liberalisation and has been expanding its trade policy agenda with multilateral, plurilateral, regional and bilateral trade agreements (together FTAs) in key export markets.

By 2030, Australia should have preferential trade deals in place with Asia’s five largest economies (China, Japan, India, South Korea and Indonesia), along with new bilateral agreements with the United Kingdom and the European Union and the much anticipated Comprehensive and Progressive Agreement for Trans-Pacific Partnership (TPP-11) and the Regional Co-operation Partnership Agreement (RCEP).

The importance of these agreements to Australian business cannot be underestimated.

Once ratified by parliament, an FTA is a legally binding treaty to liberalise access by Australian companies to another country’s markets for goods, services and investment. Importantly, the newer FTAs and TPP-11 go beyond traditional tariff reductions to cover areas such as services, intellectual property, investment, e-commerce, labour and the environment.

Beyond these bilateral negotiations, Australia is also leading efforts to settle terms of the Trade in Services Agreement (TiSA), a multi-lateral agreement the objective of which is to strengthen rules and improve market access for trade in services. More precisely, the agreement addresses discriminatory barriers to cross-border trade in services, provides a more predictable investment environment for service suppliers, and improves the mobility of services providers.

Taken together, these FTAs deepen and diversify access by Australian companies to global markets for both goods and services, encourage business confidence and support international investment.

But that global connectedness brings with it new risks and uncertainties. Against a backdrop of deepening protectionist sentiment, trade disputes could spread rapidly as retaliatory moves spread along global value chains.

While there is some evidence of a breakdown in trust and an erosion of respect for global norms designed resolve disputes, the extensive web of FTAs that Australia has negotiated in recent times – complete with dispute resolution mechanisms - are likely to act as a buffer for Australian companies.  

The message though is clear. Companies that do not understand FTAs put themselves at risk of not being able to reach full growth potential and increased pressure from competitors. It has never been more important for businesses to understand in detail how FTAs can shape their international growth plans and benefit their businesses.

Trade in services growing strongly

The Australian economy has undergone many structural changes over time. One of the most pronounced changes has been the transition away from a goods and commodity-producing economy towards a more services-oriented economy. Australians are producing more services, consuming more services and trading more services with other economies than ever before.

This bodes well for a nation that is seeking to broaden and deepen its export markets. But much of the recent talk around trade risks has overlooked the critical dependency that the services sector has on factors affecting competitiveness in the Australian domestic economy generally. Investment in human capital, digital infrastructure, efficient and flexible domestic regulation and connectedness with international markets (including open cross-border flow of data, visa facilitation and mutual recognition agreements) are key to the success of service companies operating internationally.

As a consequence, companies will need not only business models that allow them to be competitive in a domestic Australian context but will also need to become increasingly adept at calibrating their responses to an uncertain trade environment across divergent political and legal systems.

By way of example, given the important role that supply chains play in export business models, and their potential for disruption, companies should be undertaking a critical review of  all aspects of their supply chains, including the impact of tariffs and other trade barriers and their ability to comply with a more complex regulatory and legal environment, including around privacy, modern slavery and anti-corruption.

Trade goes digital

The way the world trades is changing. Global trade no longer occurs only through physical highways. Instead, invisible data highways are rapidly becoming the new road and shipping routes and cloud storage the new shipping containers and warehouses. On-line platforms are replacing intermediaries to export goods and services.

The importance of digital trade to the Australian economy has been reflected by the inclusion of e-commerce provisions in nine of Australia’s 10 existing FTAs. The nature of these provisions has evolved over time, with earlier FTAs focussing on paperless trading, protection of online consumers, and excluding electronic transmissions from customs duties. More recent FTAs have also included provisions concerning the protection of personal information, cross border data flows, disclosure of source code and location of computing facilities.

A sound and predictable legal, regulatory and standards framework is fundamental to promoting investment in, and use of, digital technology. Within Australia, businesses are benefiting from years of sound policy and industry development work to develop frameworks that are sufficiently flexible to accommodate rapid changes in technologies, while also protecting consumers’ interests. The work done in relation to areas such as block chain, smart contracts, fintech, open banking, AI, data protection, e-commerce and IP protection goes a long way to addressing trade barriers and strengthening trust in digital trade and developing international standards. 

To draw together and coordinate activities currently undertaken by government, industry and the wider community, the Australian Government will be launching, later this year, its national Digital Economy Strategy. Trade issues, particularly digitally-enabled trade, will be an important component of that strategy. This document will be essential reading for all looking to expand into offshore markets.

For Australian businesses the opportunity to use technology to leverage Australia’s worldwide reputational advantages as a producer of high quality products and innovative services is immense. Digital technologies are an enabler of innovation - they allow companies to scale up quickly, collaborate, become part of new eco-systems, access global platforms and gain better access to markets, financing, labour, skills, as well as new services and products.

Central to the ability of companies to do this is the extent of familiarity with the technologies involved, and the extent of collaboration and preparedness in grasping opportunities and combatting evolving threats. Leadership in, investment in, and use of, digital technologies should be prioritised to drive growth directly and inspire others.

Global governance in transition

The world is moving towards an inflection point in the governance institutions for global trade. The post-World War Two western-led trade system, centred around the World Trade Organisation (WTO), has worked well for decades, but  is now under stress – in part due to China’s rise, but also from globalisation, automation, information technology and changing public perceptions.

The Trump Administration is withdrawing its support for the WTO and as much as China has benefited from the current global governance rules and institutions, China is now adjusting to an international system that was developed in its absence, and in which it feels that it has little ability to influence. This shift in attitude has spurred China to push forward with alternative regional institutions. Both the Belt & Road Initiative (BRI) and the Asian Infrastructure Investment Bank (AIIB) can be seen in this light.

That places the world in very uncertain times. At this stage there appears to be no common interest in building a global governance system that accommodates China’s legitimate interests, but that also preserves the foundations of a rules-based international order that is respectful of universal rights and freedoms.

The familiar model of a single economic pole around the US and a single system of governance is, by default, being replaced by a multipolar, diverse world. As a consequence, companies will have to deal with a multiplicity of governance organisations and rules and technologies.

Most likely, the emergence of a decentralised governance system will lead to the introduction of new rules that are more complex and volatile. They will include local and regional rules that strike a balance between national and political interests and global economic logic. These rules will be influenced by new institutions, whose decisions are guided more by country and regional interests than by global concerns.

Moreover the influence of individual governments on financial flows and competitive rules is increasing as a result of the direct acquisition of private companies, investments by sovereign wealth funds and loans and subsidies for the development of high priority domestic industries. Businesses have to prepare for the possibility of working more with Chinese businesses and capital.

Conclusion

Global trade and investment is under the spotlight as governments around the world recalibrate their approaches in response to the effects of globalisation, technological advances and geo-political risks. 

The precise contours of the evolving global trading system are still unfolding, but it is clear that the old approaches for successfully engaging the world will not provide the best opportunities for sustained growth.

Australian businesses now need to re-evaluate their business strategies, their familiarity with new technologies, and their collaboration plans to ensure they prosper in this new era of trade and investment uncertainty.


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