The Global Trade Paradigm: Rethinking International Business in the Post-Pandemic World

By Arun Kumar

After World War II, a consensus emerged that increased global trade, with fewer barriers, would be a key element in promoting peace and prosperity around the world.

Leading nations of the world took several initiatives in this direction, starting with the Bretton Woods Conference of 1944, which led to the establishment of the international monetary system, and the 1945 San Francisco Conference, which led to the founding of the United Nations, and then on to the 1951 Treaty of Paris, which established the European Coal and Steel Community-the precursor to the European Union. The impact of free trade, liberal economic policies and the promotion of democracies helped in the economic recovery of war-devastated western Europe, Japan and the Far East.

However, the past decade has been highly turbulent due to economic and political reasons, and the imperfections of the global trade system itself. The COVID-19 pandemic was a black swan that further impacted trade. Thus, today, we witness an increasingly polarized world, where countries are turning inwards.

Will an era of expansion and integration in global trade now change to one of isolation and retreat? How will the power dynamics of major nation-states affect the future of global trade?

In The Global Trade Paradigm, Arun Kumar looks at the global trade ecosystem and the stresses it faces today. Based on considerable research and informed by Kumar's rich experience of more than four decades in multiple sectors, from high technology to government, this book presents ways in which the rapidly evolving forces-geopolitics, nationalism and technology-are reshaping the global trade system.

• Language: English
• Publisher: HarperCollins India
• Release date: Jun 22, 2023
• ISBN: 9789356991453

Arun Kumar

Arun Kumar is vice president and head of research at FundsIndia, one of India's largest digital wealth-management firms. He shares his investment ideas, learnings, mistakes and solutions on his popular blog Eightytwentyinvestor.com.

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Introduction

The Cycles of History

Where do we come from? What are we? Where are we going?

—Paul Gauguin

The history of the world is in many ways the story of trade. In totality, trade has been a primordial factor in the rise of civilizations, and in improving the quality of life globally. The pursuit of trade has driven exploration, cooperation and cultural exchange, social and racial intermingling, as also conflict and conquest. This book attempts to narrate the story of global trade, to survey its broad sweep and its evolution, and its effects on key regions as well as on the world as a whole.

The economics and compulsions of trade have shaped national histories and the fortunes of civilizations. The threads of economics and politics are intertwined and when those are stressed, we see a range of consequences, from wars to treaties. National strategic and commercial imperatives go hand in hand. We stand today at a point when the secular trend of openness and globalization that we have seen—markedly since the World War II, but in fact going back to the beginning of trade—is at an inflection point. Will we see a reversal of this trend or a retreat caused by concerns relating to the security of individual nations, or the resilience of supply chains that businesses and consumers have come to rely on?

The growth of trade has, in the main, driven greater employment and higher incomes and living standards. Countries have looked at exports to enhance employment; just look at the phenomenal exports-driven growth of China or the East Asian ‘tigers’. Trade has advanced prosperity around the world. Trade has also promoted travel and connected peoples together, creating a culturally richer world.

Over the last almost eight decades, the global economic recovery following the Second World War was based on a broad consensus that centred on free trade, liberal economic policies and the promotion of democracies. This consensus helped a war-devastated Western Europe, Japan and the Far East recover.

For over four decades after the War, the world was multi-polar in terms of military and political alliances, though the erstwhile Soviet Union was never strong enough economically or technologically to challenge the dominance of the West when it came to trade. China under Mao Zedong had shut itself off from market forces, following statist policies, often with disastrous results. The rise of China since then, with dramatically higher living standards and economic and military capabilities, has transformed it into a global player with economic and military strength.

Even as China’s expansive and aggressive approach towards economic leadership was rising, and partly in reaction to it, under President Trump the United States (US) turned sharply inward. Similarly, across the Atlantic, the United Kingdom (UK) left the European Union (EU). Isolationist forces are rising in many European countries posing challenges to liberal leaders like President Macron. With the retirement of Chancellor Angela Merkel and Prime Minister Shinzo Abe, the Western alliance (of which Japan is also a prominent member) lost long-standing leaders with vision and wisdom.

For most of history, international trade was confined to bilateral exchanges. A transformative change has been the rise of global value chains (GVCs) driven by various factors including advances in technology as well as in logistics and infrastructure—underpinned by the imperatives of comparative advantage. Core to this story today is the central position of China. The pandemic, coupled with geopolitical tensions, added urgency to the concern among countries and corporations that there was a disproportionate dependence on China for critical parts of supply chains—from electronics to pharmaceuticals. Thus, there is a recognition today that redundancy and resilience in supply chains are critical as never before. A consequence is that global corporations are creating alternative trusted nodes in their supply chains. Vietnam has been a big beneficiary of this tilt away from China; and increasingly, India shows promise to become a consequential and trusted node.

The US has been, since World War II, the undisputed leader in global trade. Through that period, the country has been a driving force for global trade openness; however, recent years have seen this role becoming muted. One way to measure openness is to divide the total of imports and exports by the gross domestic product (GDP) of the country; the higher the ratio, the greater the integration into global trade. For the world in total, this ratio increased from 38.8 per cent of world GDP in 1990 to 60.8 per cent in 2008. However, US trade as a share of its GDP rose more slowly than that of other countries even despite a significant rise from 19.8 per cent in 1990 to 29.9 per cent in 2008. The gap between global and US trade openness, which was 30.9 percentage points in 2008, expanded to 34 points in 2019.

The challenger in global trade is of course China. The rise of China after Deng Xiaoping’s ascent opened a new chapter in global trade flows. Not only has China emerged as the world’s factory, but its technological and financial prowess is now challenging the West in almost every sphere. Today, under Xi Jinping, China is using all the levers under its control—trade, economic and increasingly military—to aggressively assert its ascendency as a global power.

Harking back to the days of the Silk Route, China had been a pioneer in trade and had over the centuries seen the opening and closing of its economy. In the fifteenth century, China mounted major naval expeditions under Admiral Zheng He, until the Ming emperor decided to withdraw inward. Four hundred years later, the Western powers forced the gates of China open following the Opium Wars. A hundred years later, following the rise of Mao Zedong, China again turned inward for a period of thirty years. And then, under the leadership of Deng Xiaoping, China began to open up to the world with a momentum that quickly seemed inexorable.

The US-led alliance is therefore not as united in confronting the challenge posed by China as it was during the days of the Cold War. China is a different kind of an opponent, as compared to the erstwhile Soviet Union. With the Union of Soviet Socialist Republics (USSR), the challenge was mainly military and political. The Western powers had inconsequential trade and economic ties with it. The West’s economic and trade interests are so closely tied with those of China that these ties have attained a level of critical mutual interdependence. This means that to compete with and to contain China, which is a declared goal of President Biden’s foreign policy, the US-led alliance will need a whole new roadmap.

The leading trade power during the nineteenth and early twentieth centuries had been the UK. Britannia had ruled the waves, both to trade and to colonize. These two interests had worked in tandem; the English East India Company had gone to India to trade and stayed to rule as well. The UK’s primacy in trade continued until World War II, following which the US, Germany, Japan and China became major players diminishing Britain’s relative share. In 2016, in a dramatic move that came to be known as Brexit, the UK withdrew from the EU. Brexit, along with the fractious presidency of Donald Trump, has been a precursor of similar movements around the world to draw inward and away from multilateralism.

Europe, after centuries of division and reconfiguration, has focused on economic integration with the creation of the EU. Currently, united Europe, even without the UK, constitutes a formidable force, both economically and technologically. Since World War II, Western Europe has historically been politically aligned with the US. However, a temporary dent may have been created with China’s economic overtures to some European countries over the last ten years, evidenced by their collaboration in the Belt and Road Initiative (BRI) and the Asian Infrastructure Investment Bank. But the recent developments in the Ukraine have brought the Western nations closer together.

The Indian and Pacific Oceans and their littoral nations, large and small, are today attracting the greatest attention among trade strategists. The strategic importance of this area has led to their conflation in the minds of leaders in the region as the Indo-Pacific. The region has become a key strategic theatre of the globe, both in terms of national security and trade possibilities. The creation of the Quad, bringing together the US, Australia, Japan and India, to work together on many objectives including freedom of navigation, is a potentially important development.

This coming together is a response to China’s assertive actions both strategic, such as in the South China Sea, as also its economic moves under the aegis of the BRI. The Quad also signals a convergence of economic and strategic interests, a trend that seems set to increase, as evidenced by the recent spike in geopolitical tensions, notably in Russia–Ukraine, and in China–Taiwan.

India, a country that in ancient times had been a centre of commerce, with its spices and textiles in demand over the then known world, is raising its game in the trade arena. The country has been responding to the dynamically evolving geo-economics situation where it is seen as a ‘friend-shoring location’, a trusted node in global supply chains as corporations the world over seek to create redundant sources of supply. Seeking to increase the share of manufacturing in global supply chains, the country has devised incentive programmes that are well-received. India has also been pursuing trade agreements with a vigour not previously seen. We should expect to see India rising as a trade power over the coming decades.

When one looks out to the next fifty years, the sleeping giant is Africa. With a population that is equal to India’s, but with a land area that can accommodate the US, China and India—and still have room for many European countries and Mexico—the continent will become a major driver of global growth and trade. For this to happen, poor logistics and trade boundaries must be overcome. Major moves are being made in terms of opening trade and interconnectivity on the continent.

My engagement with issues of international trade and business was deepened when President Barack Obama appointed me to a senior role in his administration. Working under the leadership of Commerce Secretary Penny Pritzker, I was the lead official to enhance exports and market access for US businesses as well as attract FDI into the country.

As assistant secretary of commerce for global markets and director general of the US and Foreign Commercial Service, I was chief executive of a bureau with professionals in 78 countries and all the 50 states of the union, about 2,000 people located in over 200 locations. My interactions with foreign and US government and business leaders brought home, in a real way, the opportunities that international trade held for job creation and higher incomes for people around the world—and the political challenges that often obstruct the achievement of such potential.

My ringside seat in bilateral and multilateral forums, from the US–India Strategic and Commercial Dialogue to the US Africa Business Forum, leading commercial dialogues with countries as diverse as France and Indonesia, or trade missions in geographies as different as Turkey, Mozambique and Chile, and interactions with government and business leaders in some forty countries that I visited—brought home vividly the variety of compulsions that countries face and the pathways that have brought them to where they are today.

It struck me from these conversations that the story of international trade is at its core a human story, of aspirations that have led in the long term to higher living standards but have, along the way, seen heart-rending suffering and exploitation. It is a story of cycles, of countries opening up the world, expanding their reach using military muscle or other means of getting their way, and of retreating. It is a story of alliances and animosities that change over time. We are today at a critical point of such a cycle. Will the global trade paradigm of expansion and integration now change to one of isolation and retreat? How will the world respond to this situation of strategic discomfort with reliance on global supply chains that countries and corporations cannot control? How will strategic and economic considerations play together?

1

Global Value Chains: Uneasy Interdependence

There are nine million bicycles in Beijing

That’s a fact

It’s a thing we can’t deny

— Katie Melua¹

Where does a bicycle come from? You could own a bike made by a company in the US (Trek, Cannondale, Scott, Specialized) or one from Taiwan (Giant, Merida), Italy (Bianchi), Japan (Fuji) or Switzerland (BMC). It is almost certain, though, that the various components of the cycle have been sourced from different countries. The saddle may have come from Italy, the frame and wheels from China, the brakes from Malaysia and pedals from Japan. Similarly, the iPhone has a global supplier ecosystem: gold and tin mined in Africa, rare earths extracted in China, chips fabricated in Taiwan, packaged and tested in the Philippines, with the final assembly in China, Taiwan or India. Apple, in its disclosures, lists 200 companies (the list spans thirty-three pages) spread across forty-three countries in six continents as its suppliers.

What applies to bicycles and smartphones is equally valid for clothes, shoes, furniture, cars, and almost every industrial product. Welcome to GVCs, a force so powerful that not only has it transformed global trade, but arguably, also human existence. This transformation has occurred in just three decades. The GVCs are now such a powerful phenomenon that states and leaders are becoming wary of their power, seriously worried about the diminution of sovereign economic power that can be a consequence of GVCs.

Economist Adam Smith noted that humans have an intrinsic ‘propensity to truck, barter, and exchange one thing for another’.² Some 5,000 years ago, in the third millennium BCE, the Sumerians in modern-day Iraq and the Harappans in the Indian subcontinent traded spices, textiles, ivory and precious metals. The establishment of the Silk Routes around 200 BCE, linking East, Southeast and South Asia to Persia, the Arabian peninsula, East Africa and southern Europe, became a central nervous system for trade flows, in what can be perceived as one of the first waves of globalization. European attempts to find an alternative to the land-based Silk Routes led to the expeditions of sailors like Vasco da Gama and Christopher Columbus, resulting in the colonization of Africa, Asia and the Americas (Columbus, of course, was attempting to reach India by sailing west!)

GVCs and Their Impact

Global trade progressed on settled lines for centuries after, purveying high-value goods like silk, textiles, ivory and pepper, while the Industrial Revolution in Europe spawned new products and recalibrated global trade currents.

Everything, however, changed radically after the end of the Cold War in 1991. The first change was an increasing embrace of the concept of globalization, which held that a world with fewer barriers to the movement of trade, capital and people would be beneficial for everybody. The second was the transformation that various economic and political forces engendered in Europe and Asia. Deng Xiaoping, who came to power in China in 1977 after Mao Zedong’s death in 1976, steered the country towards a free-market-oriented economic policy—‘Socialism with Chinese characteristics’, as he called it.

By the end of the Cold War, China was ideally positioned to benefit from the coming wave of globalization. India followed in 1991, when it began a move away from its statist thinking on economic policy and embarked on a series of bold reforms, accelerating its integration with the global economy. The fall of the Berlin Wall and Reunification of Germany was followed by the signing of the Maastricht Treaty in 1992, creating the world’s single largest Free Trade Area—the EU. This project, four decades in the making, began with the creation of the European Coal and Steel Community in 1952. The Treaty of Rome that followed in 1957 formed a customs union called the European Economic Community (EEC). The Maastricht Treaty further enhanced this integration and allowed for the admission of new members, especially from countries in Eastern Europe, which had been part of the Soviet Union.

A critical factor in changing the dynamics of trade was the Uruguay Round of negotiations under the General Agreement on Tariffs and Trade (GATT). This project had been in the making for over four and a half decades, starting in 1947 soon after World War II. The Uruguay Round began in 1986 and after eight years of arduous negotiations (and much acrimony between rich and developing nations), an agreement was signed in 1994. This led to significant across-the-board tariff cuts, provisions for the protection of intellectual property and the Marrakesh Agreement signed by 123 nations to create the World Trade Organization (WTO), a global watchdog for international trade.

These developments have led to an unprecedented change in how global enterprises and economies are organized. The process had already started with the setting up of manufacturing plants by multinational corporations (MNCs) in the so-called ‘Tiger Economies’ of East and Southeast Asia (the appellation comes from the rapid leaps they took in the 1980s). The entry of China, India and eastern Europe into the global system and the formation of the EU considerably accelerated these changes. Attracted by the enormous potential of the two billion-plus populations of China and India, MNCs entered these markets.

Thus, a concatenation of forces led to the creation of global value chains as we know them today: the creation of a stable policy and regulatory ecosystem for governing global trade under the aegis of the WTO, the pressure on firms to optimize their operations, leading to a search for low-cost locations where core competencies resided best; the falling costs and improving convenience of global transportation of goods led by containerization; and the discovery of new consumer markets for established firms.

The impact of GVCs is reflected in the steep growth in merchandise trade. According to the WTO, international merchandise trade rose from about US$3.5 trillion in 1990 to approximately US$6.5 trillion in 2000. In the last twenty years, it has tripled to more than US$19.5 trillion (as in 2018). The World Bank’s World Development Report 2020 (WDR 2020) noted that the share of GVCs in global trade peaked at more than 55 per cent in 2008, the year of the global financial crisis. While it has dipped since then, GVCs still make up nearly half of all international trade.

Global value chains lead to significant productivity and income gains for two important reasons. The first is the diffusion of technology, as domestic firms gain technical know-how from their foreign partners. The second is the element of hyper-specialization. This means that local firms no longer need to master the entire manufacturing process. Such firms or even countries can specialize in tasks.

Though production processes in GVCs are generally more capital-intensive, research shows that the overall effect on employment is positive. In Ethiopia, for example, firms that participated in GVCs employed 39 per cent more workers compared to non-GVC-participant enterprises. Equally significantly, the new GVC-led economic activities pull workers out of less productive tasks and into more productive manufacturing jobs. Since participation in GVCs leads to faster employment growth and higher incomes than conventional trade, it also has a significant impact on reducing poverty. According to studies, 1 per cent increase in GVC participation tends to boost a nation’s per capita income by a similar proportion. This is five times greater than the income gain from participating in standard trade. According to the WDR 2020:

A 10 per cent increase in the level of GVC participation is estimated to increase average productivity by close to 1.6 per cent and per capita GDP by 11–14 per cent—or much more than the two per cent income gain from increasing trade in products fully produced in one country by a comparable amount.

Empirical evidence suggests that within three years of joining a manufacturing GVC, a country is more than 20 per cent richer on a per capita basis, the report adds.

Bangladesh’s experience showcases these positive effects of GVCs. In 1988, the country’s exports of apparel and footwear formed a minuscule proportion of the global trade in these goods. Since then, it has participated in GVCs and its exports of these two products have grown 18 per cent year-on-year. In 2019, Bangladesh was the third-largest exporter of apparel and footwear, accounting for over 7 per cent of global trade, behind only China and Vietnam. This sector now accounts for 89 per cent of the nation’s exports, 14 per cent of its GDP, and employs over 3.6 million workers, over half of whom are women. The country is now moving into exports of plastic and leather goods, the second-largest export category. During this process, the share of agriculture in the country’s GDP by 2016 had dropped to 38 per cent (70 per cent in 1988). Similarly, the percentage of the population in extreme poverty dropped dramatically from 44 per cent to 15 per cent. This movement of population from agriculture to other sectors of the economy is an intrinsic effect of participation in GVCs. Thus, the progress of Bangladesh has become a celebrated case study in the beneficial impacts of participating in GVCs.

Of course, the rise of China as a global economic powerhouse is a stellar example of the catalytic powers of GVCs. This has led to an estimated 300 million workers migrating from the rural areas to urban and peri-urban production centres. These migratory trends are not just in China, but have also led to an aspirational migration of skilled people across the globe. According to the United Nations (UN), sometime in 2007, the share of people living in urban areas globally exceeded 50 per cent of the total global population; today, it is estimated that this share stands at about 55 per cent. Global migration has also been on the rise in the three decades, and over a third of residents in several major cities—London, New York, Los Angeles, Toronto and Singapore, to name a few—are foreign-born. Several of the largest corporations in the world, especially in the technology sector, are today headed by immigrants. Think of Satya Nadella of Microsoft or Sundar Pichai of Alphabet/Google (both of Indian origin), Israeli-born Safra Catz of Oracle, Ukraine-born Jan Koum who co-founded WhatsApp, and South Africa-born Elon Musk, to name just a few.

Another key aspect associated with the spread of GVCs is the relatively free movement of capital, especially FDI. Most developing countries, when GVCs started evolving—and these included China—did not have the savings required to invest in global-scale plants. It was FDI that helped mitigate this savings–investment imbalance as MNCs either invested directly by setting up their plants, bought local producers or entered into joint ventures. Beyond bridging the savings–investment gap, FDI also led to technology transfer to local manufacturers and the improvement of human capital as companies set up facilities to train workers. The enhanced activity from FDI also improved the host government’s tax revenues, which could then be reinvested in developing social infrastructure.

According to the United Nations Conference on Trade and Development (UNCTAD), in 1990 the total FDI worldwide stood at US$200 billion. By 2007—the year before the global financial crisis—it had grown ninefold to US$1.8 trillion. However, the last decade has seen a steady dip, with FDI flows dropping to US$1.5 trillion in 2021. Despite this dip, the change in the fortunes of several countries, in terms of their foreign exchange reserves, has been nothing short of incredible. According to the International Monetary Fund (IMF), China (along with Hong Kong) has forex reserves of over US$3.4 trillion. India—whose balance of payments crisis and near bankruptcy forced it to liberalize its economy in the early 1990s—had garnered reserves of over US$500 billion by October 2022, its highest ever.

The movement of FDI is best captured in two stories, both from India. In 2007, two young Indian entrepreneurs, inspired by Amazon, launched Flipkart, a website selling books. When Flipkart branched off into e-retailing other products, its founders—to escape India’s (then) restrictive e-commerce laws—incorporated a company in Singapore, which attracted private equity capital from investors like US-based Tiger Global and Japan’s SoftBank. In 2018, the US retail giant Walmart acquired Flipkart for US$18 billion. In effect, a US-based company had acquired a Singapore-based firm founded by two Indians, with all its business in India—in a deal that benefited most significantly, the US- and Japan-based investors!

The second story relates to Reliance Jio Platforms, founded by Mukesh Ambani. Reliance Jio is the largest telecom operator in India—a distinction it achieved within three years of its launch—with over 388 million subscribers. In eight weeks, between April and June 2020, the company raised US$13.5 billion of private equity investments in ten separate deals from investors. This happened when the country was under the world’s most stringent COVID-19, lockdown. To put the number in context, in 2019 India’s entire start-up ecosystem had attracted US$14.5 billion in FDI.

The beneficial economic, social and cultural impact of GVCs is clear to see. Since 1990, global GDP rose from about US$47 trillion (adjusted for inflation and expressed US$ at 2011 prices) to US$108 trillion in 2015. In 2018, World Bank Group President Jim Yong Kim said, ‘Over the last twenty-five years, more than a billion people have lifted themselves out of extreme poverty, and the global poverty rate is now lower than it has ever been in recorded history.’³ It is indeed, as Mr Kim said, ‘one of the greatest human achievements of our time’.

Butterfly Effect

Global value chains by their very nature—with every production process broken down into hundreds of subassemblies scattered across countries and continents—are among the most complex systems invented by humans. For the value chain to work smoothly, all these components need to function efficiently. Adding to the complexity, over the last three decades, as GVCs have flourished, managements—under ever-increasing pressure to improve quarterly numbers—have adopted the ‘Just-in-Time’ principle of supply-chain management. While this has helped them reduce inventory and working capital costs, they have sacrificed resiliency for efficiency in the process.

Chaos theory, the science behind complex systems, tells us that the more complex a system gets,