The changing face of trade in a digital world

BY Joy Macknight – TheBanker.com

The way goods and services are traded internationally is changing, fuelled by the globalisation and digitalisation of supply and distribution chains. Are free-trade deals still fit for purpose in a hyperconnected world? Joy Macknight investigates. 

The future of free-trade agreements (FTAs) has been called into question by recent political developments – most notably the UK’s vote to leave the EU and, as a result, the single market, arguably the deepest regional trade agreement (RTA) in history.

In addition, US president Donald Trump’s executive order to abandon the recently agreed Trans-Pacific Partnership (TPP), his disparaging opinion of the North American Free Trade Agreement (Nafta) and his ‘America first’ rhetoric have raised the spectre of protectionism and the possibility of future trade wars.

Concern about where such developments will lead spurred an “unprecedented” focus on free trade at the World Economic Forum (WEF) in January, according to Natalie Blyth, global head of trade and receivables finance at HSBC. “Political and business leaders had a mea culpa moment in Davos. We realised that as an industry we haven’t articulated arguments in defence of free trade; we have allowed rhetoric to rule fact,” she said at a recent HSBC webinar entitled ‘A new era of trade’.

Boost to trade

Ms Blyth highlighted the estimated $1000bn boost to world trade that the multilateral Trade Facilitation Agreement (TFA), which the World Trade Organisation (WTO) concluded among 108 countries in 2013, is predicted to bring now that the final few members have completed ratification. “The TFA is expected to reduce the cost of trading internationally by 14%,” she said.

But headline-grabbing political events are not the only headwinds facing global trade. The International Monetary Fund (IMF) reports that trade in goods and services has decelerated since 2012, with growth of just over 3% a year. “Between 1985 and 2007, real world trade grew on average twice as fast as global gross domestic product, whereas over the past four years it has barely kept pace,” the IMF said in its October 2016 World Economic Outlook.

The report found three contributing factors: an overall weakness in economic activity, a slowdown in investment growth and a decline in the growth of global value chains.

The next level of globalisation

While a slowdown in global trade has led many observers to postulate the end of globalisation, McKinsey Global Institute (MGI) argues that globalisation has instead entered a new era defined by “data flows that transmit information, ideas and innovation”. MGI estimates that cross-border data flows have grown 45 times larger since 2005 and are expected to post another ninefold increase by 2020.

According to MGI’s March 2016 report ‘Digital globalisation: The new era of global flows’, digitalisation has introduced three new phenomena that are changing the face of globalisation. These are: large-scale internet platforms, which are driving down the cost of cross-border transactions; purely digital goods and services that are now traded virtually and instantly; and the addition of ‘digital wrappers’, which are enhancing the value of traditional products.

“Global flows of data primarily consist of information, searches, communications, transactions, video and intracompany traffic. They underpin and enable virtually every other kind of cross-border flow. Container ships still move products to markets around the world, but now customers order them online, track their movement using RFID [radio-frequency identification] codes, and pay for them via digital transactions,” says the report.

Electronic commerce (e-commerce) platforms such as Amazon, Alibaba, Flipkart and Rakuten are large contributors to these flows. MGI estimates that 360 million people participate in cross-border e-commerce on digital platforms; already 12% of the global goods trade is cross-border e-commerce. Through these platforms, small and medium-sized enterprises can source and distribute goods and services internationally, which previously only large multi-nationals could do.

The digital effect on services

Trade in services has significantly benefited from digital globalisation – MGI estimates that digitally deliverable services have more than doubled over the past decade, reaching $2400bn in 2014.

“And to think that my 1990s textbooks said services were not tradable across borders, while now more than half of all services trade is carried by the internet,” says Hosuk Lee-Makiyama, director at the European Centre for International Political Economy, a policy research think-tank.

“Today it is possible to trade all types of services internationally – from taxi rides to professional consultants – and outsource everything from simple coding to medical examinations or entire back-office functions. Everything relies on a digital infrastructure,” he adds.

Advanced economies accounted for 81% of total digitally deliverable service exports in 2014, with India and the Philippines the only emerging economies ranked in the top 10 net exporters of such services, according to MGI.

The WTO recently released a research handbook on trade in services, which looks at the role of trade in services in a digital era. It also rejuvenated its work programme on e-commerce, which covers issues such as access to telecommunications technologies, public internet and mobile commerce.

Speaking at the handbook’s launch in January, WTO director-general Roberto Azevêdo reported that trade in services, when measured in value-added terms, now accounts for almost 50% of world trade – more than either manufacturing or agriculture. In addition, two-thirds of world foreign direct investment is now in the services sector.

Mr Azevêdo said: “Despite all of this, trade in services is sometimes regarded as an emerging issue, or something that is only of interest to some countries. This view simply doesn’t reflect the reality today. It seems that we need to update our trade policy software.”

Is it a good or a service?

Digitalisation also begins to blur the difference between goods and services. Pascal Lamy, former WTO director-general and current president emeritus at Jacques Delors Institute, says new technologies such as 3D printing have the potential to transform how and where goods such as electronics, auto parts, machinery and medical instruments are produced. It also calls into question their classification as goods.

“For example, instead of ordering a car part from a distributor, it is becoming possible for me to fix my car with a part made by a 3D printer. Instead of buying a spare part – which might be manufactured elsewhere and imported, thereby increasing the volume of trade – I am effectively importing an electronic file, which moves it from a good to a service,” he says. The ability to 3D print goods could also potentially restructure global supply chains, effectively eliminating the need for production in intermediary countries.

Ken Ash, director of trade and agriculture at the Organisation for Economic Co-operation and Development (OECD), agrees with Mr Lee-Makiyama and Mr Lamy. “Services are becoming increasingly tradable and much more embedded in manufacturing products. As we begin to unpack the value of products that cross borders into goods as opposed to services, the role of services trade in our economies becomes clearer,” he says.

Measuring and analysing digital trade flows is an area that the OECD, the WTO and other international organisations are currently working on, he adds, but it is early days. “The metrics are invisible. There is no customs data on digital flows, for example,” says Mr Ash.

Modernising FTAs

In light of the profound changes occurring in global trade, many are debating the usefulness of FTAs, spurred on by Mr Trump’s pledge to rewrite Nafta. Like the three-country agreement enacted in 1994, many FTAs were drafted before the existence of the internet and digitalisation.

“Trade agreements are not fit for purpose,” says Henrik von Scheel, one of the leading authorities on national and corporate competitiveness, and the architect behind the digital agenda for Germany and Europe, which ignited the global digital wave.

“We are standing in front of the biggest technology revolution that will fundamentally change every aspect of our lives – how we work, consume, everything. Neither nations nor companies are geared up for the scope, complexity and what it will take to transform.” Mr von Scheel predicts that existing trade agreements will disappear in the next five years.

David Hennah, head of trade and supply chain finance at business management consultant and financial software firm Misys, also believes the world is trapped in the legacy of ‘old world’ trade agreements. To address this, Misys recently launched the World Trade Board, which brings together the world of trade policy, trade finance and financial technology (fintech) companies to examine how best to leverage the power of digitalisation.

The MGI report recommends that any new trade negotiations should address issues surrounding cross-border data flows. “Even as governments try to create the right enabling environments for technology to fuel growth, digitisation is handing them a host of entirely new policy challenges,” it says. “Many digital firms have innovative business models that existing regulatory structures never considered. The digital economy evolves so rapidly that regulators have to take a test-and-learn approach to keep up with the pace of innovation.”

Playing catch-up

Mr Lee-Makiyama believes many new trade deals are attempting to catch up with digital developments. “The most advanced rules on e-commerce, for example, are in the TPP. The US may have withdrawn from [the agreement], but the language it employs has set a new standard for all future trade deals,” he says, citing the EU-Japan FTA as an example.

The TPP contains rules around spam, privacy and, most importantly, data localisation, whereby data must be physically situated in the same country where it originated. “Recent agreements have focused on reducing restrictions around data localisation. Many developing countries impose them believing it creates low-end data processing and data hosting jobs, whereas the EU believes data localisation is necessary for privacy protection,” says Mr Lee-Makiyama.

Mr Ash also sees an evolution in FTAs, pointing to the plurilateral Trade in Services Agreement (TiSA), a treaty currently being negotiated by 23 WTO members, including the EU and the US, that aims to liberalise the worldwide trade of services such as banking, healthcare and transport. It could be made part of the WTO once enough WTO members join.

“We have seen a shift towards more progressive, comprehensive, modern trade agreements with provisions that address things which 20 years ago might not have even been considered trade. TiSA, for example, attempts to cover more of the constraints to services trade than previously picked up in multilateral or regional efforts,” says Mr Ash.

Trade agreements are now encompassing a much wider scope than previously, adds Milagros Miranda Rojas, special adviser on WTO and international trade law at Norton Rose Fulbright, which recently launched a trade treaty practice. “Not only do modern FTAs cover digital trade in goods and services but also sustainable development, environmental and labour issues,” she says. “There has been an evolution in the agreements, which later plugs into regulations that parties need to enact to abide by the agreements.”

Likewise, Mr Ash points to numerous RTAs that are deeper and more ambitious, and include intellectual property, regulatory co-operation and other areas where countries are trying to find ways to create a more predictable environment for cross-border business.

Barriers to trade

The overarching purpose of FTAs is to achieve trade liberalisation. In a services-led environment, obstacles to trade are very different, as historically goods and services have been treated differently. Whereas the biggest barriers to trade in goods are usually tariffs incurred when moving goods across borders, this is not the case with services, which face more non-tariff barriers such as regulations, operating licences and standards.

“The digitalisation trend doesn’t change the need for trade agreements, but it does change the focus as to potential barriers to market access,” says Norton Rose Fulbright partner Mark Simpson, who specialises in anti-trust and competition issues.

While the old world of trade was based on protection, the new world is based on precaution, according to Mr Lamy. “The new name of the game to open trade is not how to reduce obstacles, but how to harmonise and converge in terms of regulations and standards. This creates new issues related to deeper integration because most non-direct measures are related to risk. Risk sits on a scale between good and bad; and such scales are dependent on culture, religion, philosophy and so on,” he says.

“This change also reshuffles the old debate between bilateral, plurilateral and multilateral agreements,” he adds. While arguing that multilateral agreements are the best way forward, he admits that if an agreement addresses a precautionary measure then a multilateral standard will take a longer time to develop.

“Precaution can only be harmonised – or the differences can only be reduced – by starting from the highest level of precaution and moving all parties upwards. No one will reduce precaution for the sake of opening trade. That is a big difference, and for some time – in the absence of proper international system of standards for precaution – this will be done bilaterally,” he says.

Is multilateralism dead?

Mr Lamy’s remarks draw attention to a corresponding debate: should multilateral negotiations be foregone in favour of direct country-to-country talks? Both the UK and US governments have indicated their intent to forge new bilateral agreements out of the ashes of the European single market and Nafta, respectively.

Multilateralism has its challenges, according to Mr Ash. While he believes that the WTO is central to a well-functioning rules-based multilateral trading system, he points to the mismatch between members’ expectations and the progress made by the WTO’s Doha round, for example.

“When countries looked at what was set out in 2001 and then at what was accomplished after 15 years of negotiations, there is some concern that the multilateral approach is slower than many would like it to be. So then logically they move to alternatives, which is why many have looked at regional agreements,” says Mr Ash.

However, as Douglas Lippoldt, senior trade economist at HSBC Global Research, pointed out during the aforementioned webinar, bilateralism is not well aligned with advances in global trade. “Today, companies are taking advantage of the liberalised trading environment that globalisation opened up. They are sourcing from diverse suppliers, selling into multiple markets and benefiting from economies of scale. Bilateralism only liberalises one trade corridor,” he said.

Not everyone has abandoned multilateralism. While the TPP may be unravelling, other FTAs are moving ahead including the TFA and TiSA. In addition, China continues to push forward the Free Trade Area of the Asia Pacific and the Regional Comprehensive Economic Partnership. Unexpectedly for some, Chinese president Xi Jinping emerged as the biggest proponent of free trade, globalisation and multilateralism at the WEF in January.

In light of Brexit

Mr von Scheel believes that the triggering of Article 50, scheduled for the end of March, gives the UK an opportunity to differentiate itself and enter into new trade agreements that are in its best interest. But success will depend on the UK’s ability to leverage digital developments that will increase its productivity level and eventually drive transformational growth, he adds.

“In order to compete with the European nations, the UK needs to increase productivity and GDP,” says Mr von Scheel. “To do this it needs to plan long term and invest in the right things. Policy-makers need to come together with industry leaders and develop a national strategy to define the national competitiveness of the UK industry in future.”

His specific recommendations include encouraging companies to adopt smart economic models, smarter manufacturing, smart healthcare and smart cities. “This will increase the level of productivity in the UK so it can produce smarter and better by utilising technology, algorithms, data and so on. That is an investment the UK government needs to make in companies and universities, in legislation and policy, in order to make it easier for entrepreneurs to grow up,” he says.

The UK government’s ‘Building our industrial strategy’ green paper, published in January, goes some way to doing just that. It lays out plans for supporting business growth, developing skills and cultivating world-leading sectors. To this end, the government has committed to increase investment in science, research and innovation by £4.7bn ($5.84bn).

But part of the UK government’s trade policy must also be about ensuring market access for ‘national champion’ industries, such as financial services. Norton Rose Fulbright’s Mr Simpson believes access for services is going to be just as important as access for manufacturing. “Although there are no tariffs on services, companies must have the right to conduct business in another jurisdiction,” he says.

He gives the example of India, a country with 1 billion people, a fast-growing economy and rising average incomes but with strict regulatory requirements, such as local ownership laws, which act as obstacles to UK services businesses exploring opportunities there.

India was one of the first countries on UK prime minister Theresa May’s ‘post-Brexit’ trade tour, hailed as the start of a new, tighter relationship between the two countries. However, the UK government’s subsequent refusal to reform tough visa restrictions for Indian nationals to study and work in the UK has become an area of contention.

Clearly, freedom of movement is an important part of current free-trade negotiations, but something that both the UK and the US want to curtail. However, digitalisation might also be able to address this issue.

The MGI report highlights how digital platforms offer individuals new ways to learn, collaborate, acquire new skills and gain employment. For example, through digital platforms such as Freelancer.com and Upwork, some 44 million people around the world find freelance work, effectively breaking down borders and creating a more global labour market.


Joy Macknight is a UK-based Deputy Editor at The Banker.