Condivergence: Taking advantage of the New Global Digital Market

This article first appeared in Forum, The Edge Malaysia Weekly, on March 13, 2023 - March 19, 2023.
Condivergence: Taking advantage of the New Global Digital Market
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Forecasting how the global economy and markets will perform in 2023 is getting schizophrenic, with a wide range of possibilities before us. Devising the right economic and technology strategy becomes imperative, not just for nations and businesses but also investors.

After two stellar years in trade from late 2020 to 2022, exports from China shrank 6.8% in the first two months of 2023 compared with last year, marking a fifth consecutive month of negative growth. The financial markets were beginning to worry that the world’s largest merchandise exporter was going to slow after a prolonged Covid-19 lockdown amid a year-long tightening of monetary policy globally. With Europe embroiled in war and the US Federal Reserve still hawkish on interest rates, the bulls and bears were clearly more divided than ever.

Financial returns year to date mirror this confusion. So far, equity markets are up, bond markets are down, and the US Treasury yield curve is inverted, suggesting a recession may be looming later in the year. As US-China tensions rise further, with new restrictive measures being piled onto China, supply chains are being reconfigured, but not without higher costs and risks. Investors fret about the implications these factors may have on future profits.

Bank for International Settlements (BIS) economic counsellor Hyun Song Shin has just disclosed how global trade patterns emphasise the direct relationship that working capital availability has on supply chain growth (BIS Working Paper 1070, January 2023). Decades of globalisation and financialisation resulted in greater liquidity available for global cross-border lending, which peaked in 2007. The lengthening of supply chains requires more financing to cover inventories in transit. Thus, tightening of liquidity has the effect of putting pressure on production chain operations across national borders.

Since the 2007/8 global financial crisis, the share of global goods exports as a portion of gross domestic product (GDP) has continuously fallen from nearly 20% to about 17%. Part of this is a reflection of Western banks that reduced their trade financing after the pain of the crisis. Despite the world’s adoption of a loose monetary policy, the Asian Development Bank estimated the trade financing gap to be as high as 10% of total merchandise exports, or about US$2 trillion. Thus, as overall monetary policy reversed, consistent with Shin’s analysis, impediments to funding would constrict supply chains and global exports will slow down.

Shin warns that “long production chains and offshoring are sustainable only when credit is cheap, and chains that have become overextended are vulnerable to financial shocks that raise the cost of borrowing”. Thus, China’s negative export growth may be a warning of broader consequences of tighter liquidity and of potential supply chain decoupling due to geopolitical tensions. As China is also the world’s largest importer of intermediate goods, regional exports markets will also be hurt, as two-thirds of intermediary exports by Asian countries are essentially regional trade, according to the World Trade Organization (WTO). With Chinese imports declining by 10.2% in January and February this year, effects will be felt in the order books of its exporting neighbours.

A schism in global supply chains may fit the geopolitical strategy of “friend-shoring” production — moving production back on-shore or within allied territories. But raising barriers for products within the existing global trade networks is challenging, since it may take years to shift production and markets. Even a long period of globalisation cannot quickly erode comparative advantages in both physical infrastructure (hardware) or logistics skills (organisational software). Thus, the tensions shaping our world at present are advancing the trade war front to new industries.

We see this happening within the electric vehicle (EV) supply chain. Recognising the importance of this nascent technology, China moved early to secure a commanding position in the industry and came to supply 69% of the world’s lithium-ion batteries by last year, while controlling 64% of the global EV market, according to Caixin magazine. Chinese companies ventured abroad early to secure access to lithium assets around the world in order to control the battery supply chain.

Last year, the US responded.

Under a combination of the Inflation Reduction Act and CHIPS (Creating Helpful Incentives to Produce Semiconductors) and Science Act of 2022, the US launched a mixture of tax incentives, subsidies and industrial policy seeking to aggressively domesticate its own battery, semiconductor and EV supply chain. The CHIPS Act alone may provide as much as US$280 billion in federal aid to help semiconductor companies build their factories and foundries in the US. Other incentives include nudging US-based EV makers towards purchasing materials locally or via partners that the US has free trade agreements with. These are ambitious programmes to rival China, which had already granted more than RMB100 billion in EV subsidies since 2009, reported Caixin. The industrial policy adopted by the US government has also alarmed the European Union, as it fears that European companies may not be on a level playing field against their US counterparts.

The implications of geopolitically motivated investments in key production and supply chains mean that state intervention in markets will distort the normal supply-and-demand dynamics of production. There is real risk of supply overshoots in semiconductors and EVs in the medium term, which will hurt corporate profits. Moreover, countries imposing export restrictions on goods, such as semiconductors, can have an adverse effect on corporate profits as well, since broken supply chains cannot harness economies of scale.

All these suggest that corporate profits may be pressured in the short term in areas of technology production. But this does not mean that there are no opportunities for specialised production. Smart tech companies are already figuring out how to exploit market niches that the giants are not interested in dominating.

One bright spot amid all this is the digital economy. In 2021, the WTO estimated exports of digitally delivered services to have reached US$3.7 trillion. That is equivalent to nearly 4% of world GDP in nominal terms. The Covid-19 pandemic has accelerated the shift of online delivery of knowledge services. This was most obvious in 2020, when lockdowns disrupted physical logistics and trade flows. By comparison, being relatively borderless and untethered from the conventions of supply chains, exports of digital services grew 14% in that period as we sheltered in our homes and relied on our devices more than ever.

Reflecting the fundamental changes in our modern lifestyles, exports of digitally delivered services grew at an average rate of 7.3% a year from 2005 to 2019, outpacing growth in traditional goods exports. Value-added services delivered online reflect a fundamental shift of production (of services) to those markets that have the talent and generous research and development (R&D) to design, produce and deliver creative software and services. Artificial intelligence and the availability of 5G networks and beyond will only accelerate this shift. We have already seen how India and the Philippines have become beneficiaries in the offshoring of software services, owing to their cheaper skilled labour force, which itself is the product of strong investments in STEM (science, technology, engineering and mathematics) education in both countries.

As global manufacturing supply chains begin to fragment, the production of specialised design, testing, support and ancillary services will command a higher value, particularly if these skills aid in manufacturing or improve traditional agriculture and mining production efficiency or sustainability. This creates new opportunities for first-mover emerging markets that devote attention to improving the 3 T’s: technology, tourism (higher-value services) and talent.

Perhaps the stagnant share of global goods exports in the world economy described by Shin can be thought of differently — that we have created a new frontier of globalisation that will help global wealth to grow faster than conventional trade.

The opportunities for Malaysia are therefore in the new digital economy, building on our strengths already in the exports of electronics and engineering, and our comparative advantages in energy, palm oil and tourism. The real challenge in this new era is how to provide investments in talent, technology and creativity, by not only giving access to working capital financing for new firms in this area, but also investing heavily in start-ups that are opening new markets in a fragmented global world.

Tan Sri Andrew Sheng writes on global issues that affect investors. Tan Yi Kai is a Malaysian multi-asset trader based in Hong Kong.

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