How global trade shifts affect Malta

The sooner we get our act together, the better it will be.

As the global economy adjusts to persistent economic and geopolitical pressures and disruptions, the familiar routes that have hitherto defined the world trade map are being redrawn and trade blocs are playing a greater role. In addition, overall global trade is growing at a slower rate than the world economy, a fundamental shift away from the trend of trade-led globalism that has been prevalent since the end of the Cold War.  In fact, world trade in goods is forecast to grow at 2.8% per year, on average, through 2032, compared with an estimated 3.1% growth rate for global GDP in the same period.

The emergence and growing prominence of trade blocs (lately the expanded BRICS) is having a dampening effect on traditionally deep and fast-growing trade lanes such as China-US and China-EU.  The brakes on such lanes began with President Trump’s trade tariffs   ̶   continued by President Biden  ̶  and the increasingly cool economic relations between the EU and China.  Five emerging global trade dynamics will characterise the world in the coming decade, according to a new Boston Consulting Group (BCG) analysis.

How does all this affect Malta?   Undoubtedly, negatively.  Malta’s economy is very open to trade, showing one of the highest openness ratios in the world and the highest in the EU.  In 2022, our trade to GDP ratio was 324.63%,  up 1.59% on 2021.  By comparison, Cyprus   ̶   the second most open economy in the region  ̶  had a ratio of 142%.  For a normal economy, one would look at Spain, with an 80% ratio.

In 2022 over 58% of Malta’s trade in goods (excluding ships and aircraft stores) was conducted with European countries (of which 45% with the EU), just over 9% with the United States and Canada combined (NAFTA), and just under 22% with Asia (of which China, India, and South Korea combined accounted for just below 8%).  The concentration of our trade can also be seen from the fact that almost 58% of our trade is conducted with just 11 countries.

An interesting analysis of our trade in goods and services through the use of a gravity model by Reuben Ellul, a principal economist at the Central Bank of Malta, showed that, on average for every 10% increase in distance, exports and imports fall by 11.2% and 7.5% respectively.  In times when shipping and insurance costs go through the roof   ̶   as is happening right now with the attacks on shipping in the Red Sea   ̶  this assumes greater importance.  But a set of other variables which include culture and incomes was also noticeable.

Ellul also found a statistically significant and positive impact on trade when Malta became a member of trade blocks, mostly when we signed an association agreement with the EEC and then as a full member of the EU.  

A retreat from globalisation

The increasing attacks on trade and the multilateral system mean a retreat from globalisation.  Policymakers in some of the world’s largest economies are making choices to halt further international integration and, in several instances, to embrace protectionist or nationalist policies.  Meanwhile, global trade is still growing, but this could well be because it responds with a delay to changes in the policy environment.

Globalisation and open trade are universally acknowledged to have contributed to great economic achievements.  Extreme poverty was dramatically reduced while standards of living, as measured by income per capita, increased across the world.  Consumers gained access to an extraordinary variety of goods at affordable prices.  The free flow of electronics enabled the tech and social media revolution, including new entertainment possibilities.  Declining prices of air travel spurred an astronomic rise in travel, exposing people to new cultures and ideas.

I could go on and on.  But lurking beneath the surface were tensions building towards a backlash.   Again, I can only mention the more important ones.  One was competition from low-wage countries which led to the ravaging of manufacturing in some countries (Malta included) and led to high unemployment.  Another was that a small section of the populations of developed countries became super rich while others were left behind.

Populist politicians, and even economists who did not believe in the open trade model, exploited these trends to label many trade patterns as “unfair” and to militate for a re-domestication of industries that had abandoned the developed countries for lower-wage countries with lower labour standards and government subsidies. 

The Covid pandemic and the resulting logistic shortages were then exploited by protectionist-minded politicians and special interest groups to emphasise that national security required less dependence on off-shore manufacturing.  As if this wasn’t enough, the Ukraine war and trade sanctions associated with it dealt globalisation another blow.  Finally, a group of emerging countries declared they were fed up with unfavourable terms of trade and decided to set up their own trading blocs.

The new world trade order

World trade volume today is roughly 45 times the level recorded in the Fifties, while world trade values have ballooned by almost 400 times from 1950 levels. If one looks at more recent periods, between 1995 and 2007, the volume of global cross-border trade had grown on average by 7.3% per year, with a peak of over 12%. Since 2012 however, we have seen much lower annual growth rates.  Based on International Monetary Fund estimates, the long-term growth rate halved from 2008 to 2020, reaching only 3.4% per year on average.

A characteristic of the new world trade order will be the growing prominence of trade blocs    ̶   especially North America, the EU, ASEAN countries, and potentially the BRICs   ̶   as production moves closer to end markets (see BCG chart). Blocs are attractive for countries seeking to limit geopolitical friction by trading with entities seen as “friendly” partners, especially where trade agreements exist, such as the EU, USMCA, Comprehensive and Progressive Agreement for Trans-Pacific Partnership, Regional Comprehensive Economic Partnership, and EU-Vietnam Free Trade Agreement.

Under the Biden administration, the US has adopted new industrial policies, with legislation that encourages direct investment in strategic industries such as semiconductors, domestic manufacturing, renewable energy production, and electric vehicle infrastructure and battery technology.  The EU has been dabbling in it as well, but in typical style, with timid and half-hearted efforts.

The net effect of these industrial policies will be to pull investment back to the members of each bloc   ̶   especially for industries deemed critical to national security, like computer chips. Trade between the US and Mexico stands to grow by an impressive $300 billion over the coming decade. The Inflation Reduction Act, for example, goes beyond familiar “Buy American” incentives to encompass a “Buy North American” approach, such as extending the $7,500 credit for electric vehicles with powertrains or battery technology made in the US, Canada, or Mexico.

A fall-off in trade between China and the United States and Europe simply means that trade will move elsewhere.  The beneficiaries will be the ASEAN countries and India as many companies move manufacturing to these economies, both to reduce global supply chain risks and to access new markets. As a result, trade between ASEAN and China will grow a remarkable $616 billion in the coming decade—and trade between ASEAN and both the US and Japan will increase by more than $200 billion. India is forecast to achieve 6.3% average annual trade growth, partly because of this rebalancing of China trade.

One might say: it’s ok then.  But the economics of these shifting trade partners are not that straightforward.   Inevitably, there are going to be trade frictions between different blocs and multilateralism will weaken, with the global market becoming more fragmented. The more cooperative trade environment that enabled companies to build global supply chains in recent decades is quickly being replaced by a more uncertain world characterised by a mix of smaller regional and local supply chains.  This is definitely a sub-optimal solution.

What can Malta do?

Naturally, Malta cannot influence what will happen and is completely at the mercy of the rest of the world, including of the EU, given that a puny country cannot hope to impose anything on anybody.  But that does not mean that we cannot do anything either.

I know that there are several documents floating around and that a number of initiatives are bearing fruit.  What I do not sense is a concerted and ongoing programme to implement the changes that are needed, though I might be wrong. 

In the short term, companies should take several steps to adapt. One would be to strengthen our decision-making capability to insulate supply chains from disruptions as much as possible.  Maltese companies should be assisted to improve resilience by investing in digital tools, such as artificial intelligence, to make them more agile in decision-making and adaptability.  It would also be helpful if a national scheme is set up to build buffer inventories of essential commodities, alternative suppliers are pre-qualified, and contingencies are planned for at-risk supply inputs.

Another one would be to enhance the ability of companies to respond to price volatility and inflation. Strategies can include building resilient pricing, such as by sensing demand shifts earlier and developing dynamic pricing capabilities, strengthening customer relationships and contracting flexibility, and exploring new monetization models, including outcome-based pricing.

A third one would be to make companies more flexible and adaptable by adopting “fractal innovation”.   This would enable them to meet the challenges of a fragmenting global trading landscape.

Turbo-charging risk and cybersecurity capabilities is yet another step.  It involves, for example, helping companies identify security gaps, prioritise security projects and tools, and consider approaches such as a cyber-tool health index, zero-based budgeting, and cyber risk quantification to develop a custom cybersecurity roadmap.  I know that MITA is offering some services in this respect, but I don’t know whether the take-up is substantial.

All this cannot be done by individual companies alone, particularly because most of them are micro enterprises.  It requires a strongly co-ordinated approach by the government, various public entities, and the stakeholders   ̶   including Malta Enterprise, the Malta Development Fund, the National Development and Social Fund, and the commercial banks.  The sooner we get our act together, the better it will be.

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