Trade Clusters

William Alan Reinsch

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This week’s column is brought to you courtesy of the World Trade Organization (WTO) and a conversation I had with Ed Gresser of the Progressive Policy Institute. The WTO recently published its annual trade report, this year titled, World Trade Report 2023 - Re-globalization for a secure, inclusive and sustainable future. This is always a very useful report packed with interesting information and factoids. This year, Ed pointed out one particular conclusion—the growth of trade within geopolitical blocs and the decline of trade across blocs. This excerpt from page 32 of the WTO report summarizes the situation:

"The analysis shows that despite reaching record highs recently, since July 2018 bilateral trade in goods between China and the United States grew on average much more slowly than the trade of each economy with other partners (Blanga-Gubbay and Rubínová, 2023). On a broader scale, there are the first signs of trade reorientation along geopolitical lines, indicating a shift towards friend-shoring. . . . As a result, goods trade flows between hypothetical geopolitical “blocs” have grown 4-6 per cent more slowly than trade within these blocs (Blanga-Gubbay and Rubínová, 2023). . . . FDI flowing to and from emerging and developing economies is substantially lower for more geopolitically distant partners (IMF, 2023). . . . Fragmentation in FDI along geopolitical lines could therefore be a sign that similar developments may occur in global trade flows in the future."

This is an interesting twist in the argument over whether or not the world is de-globalizing. It appears that we may not be de-globalizing as much as we are “clustering,” to use Ed’s phrase, into blocs of more or less like-minded parties, suggesting that trade is following politics.

Some of this is driven by government policy. Russia’s invasion of Ukraine has effectively divided the world politically into three blocs—those supporting Russia, those supporting the West, and those trying to stay out of the fight. The sanctions and export controls put into effect by the Western powers have clearly reoriented trade away from the Russia bloc, including China, and toward members of the Western group as those countries seek to support their colleagues affected by the cutoff of Russian trade, including energy.

But it also seems that some of this change is due to companies simply reassessing the risk of doing business in difficult countries that have become more hostile in recent years. China, for example, has been sending decidedly mixed messages, verbally welcoming trade and investment while simultaneously raiding Western corporate offices, harassing companies and not letting their executives leave the country. Under those circumstances it is no surprise that companies are looking for more sympathetic locations.

When U.S. companies consider where to invest, they usually search for countries that operate according to rule of law, maintain policy stability, and have a commercial dispute resolution process that is transparent, objective, and efficient. (An exception is companies in the natural resource sector which naturally are forced to invest where the resources are.) These are not black or white criteria—they exist on a sliding scale—but countries that score low on that scale find attracting Western investment more difficult.

Trading or investing in countries that do not maintain high standards in those areas is becoming more difficult, and the increased visibility and activists’ scrutiny of government actions that fall short force companies to respond more quickly than in the past. Thus, it does not come as a surprise to see trade and investment moving in the direction of like-minded countries.

That is also a reminder of President Biden’s comments about the ongoing battle between democracies and autocracies. In the past, economics and politics were often considered separate, and the world was comfortable doing business with others that did not share their values or priorities, as long as it was good business. However, that began changing some years ago as both the right and left flanks of U.S. politics began to take values into account when making economic policy (although they often did not agree on which countries were falling short). We are now in a situation where this is common, and we see it reflected in the WTO data.

It remains to be seen whether political clustering will persist and whether it will ultimately end up dividing the world into two or more blocs, each of which has very little to do with the others. That would be a blow to globalization, but at this point it seems to be more a case of simply changing partners.