By Walter Kemmsies
Patterns of trade flows and economic activity continue to be erratic as the United States and Europe struggle to recover against a backdrop of uncertainty about government policies. However, these patterns also reflect changes in the structure of the world economy.
It is likely that economic trends, which in the last decade resulted in severe imbalances, will be quite different when the recovery gains traction. The process of adjustment to new trends creates new and unfamiliar patterns of economic activity.
Nonetheless, the industries and regions that are likely to lead economic growth and trade flows as the global business cycle evolves are predictable if the structural changes are correctly identified. It is important to focus on these potential longer term regional and industry leaders while navigating the remaining stretch of the long economic recovery in order to be well positioned over the long term.
Industries and regions that lead growth in a business cycle tend to do so because of a change in the economic environment. For example, the deregulation of the telecommunications industry resulted in an investment boom in the information and communications sector, which led economic growth in the 1990s. Unusually low interest rates during the long recovery from the 2001 recession instigated a boom in the residential real estate market, which led economic and trade growth in the 2000s.
To identify the leading industries and regions in this cycle it helps to list potential changes in the economic environment that are likely to prevail throughout the next business cycle. These come in at least four flavors:
Mature industrialized nations have aging populations. Since older people spend more on services than on goods, sales of consumer goods are likely to grow faster in emerging markets with younger populations. However, younger workers generally earn less than their older counterparts. For companies to tap into fast-growing emerging consumer markets, they need low production costs. Thus, factories moved to emerging markets. Early on there was spare production capacity that was used to export to developed economies. China rode a long period of high export growth and the United States developed a large trade deficit. However, China’s export growth should slow as wages have risen there so that its factories’ output can be increasingly absorbed by its domestic market.
Rising production costs in China is motivating manufacturers to shift production to other low cost locations with fast-growing consumer markets, like India and Mexico. Going forward, China’s share of U.S. imports is likely to decline.
Government policy —
For a very long time the United States has subsidized consumption instead of production. Other countries supported domestic production by investing in infrastructure and increased their exports. Recent research indicates that U.S. exports are constrained by inadequate freight movement infrastructure. It isn’t surprising that the United States developed a trade deficit as imports of goods grew faster than exports.
There are other policy initiatives that could impact trade. China’s latest 5 Year Plan emphasizes development of domestic consumer markets. China’s consumer policy and high growth in emerging markets indicate demand for goods that the United States can export competitively is growing. If the United States focuses on freight movement infrastructure investments, exports could grow faster than imports. However, the United States could lose out to other countries if it does not move quickly because other countries are already launching policy efforts to improve their freight movement infrastructure.
Manufacturing in the United States is increasingly automated. This means the contribution of labor to total production cost has been declining. Since the cost of borrowing money in the United States is lower than in most emerging markets, companies that wish to repatriate or increase production in the United States would be more likely to do so if it can be automated. Given the improvements in industrial robotics and the relatively lower cost of raw materials, such as natural gas, manufacturing could increase in the United States over the long run. This could result in faster export growth and slower import growth.
Resource availability —
Over the last 10 years emerging market economies have become larger consumers of energy and other commodities than developed economies. Higher growth of energy consumption in emerging markets relative to mature economies is likely to continue as household incomes and automobile sales continue to grow. This requires increased production of oil, natural gas and coal. To reduce fuel costs, some segments of transportation are shifting to natural gas. Many companies with fleets of vehicles that travel within a confined area, such as garbage trucks, are already shifting to natural gas. Even long-haul trucking is beginning to do this. Many companies are investing in natural gas fuel stations to accommodate this trend. Ocean carriers are also investigating the possibility of changing fuel sources to lower costs and meet tighter air emission standards.
A review of the four categories of structural change drivers indicates that agricultural, energy and high-end capital goods are likely to lead growth of U.S. exports; growth of U.S. consumer goods imports is likely to be lower compared to the last decade; and Mexico’s and India’s shares of U.S. imported goods may increase at the expense of China.
No one has a crystal ball, so some of these trends might not hold up, however, the world is changing and the best thing to do at this point is not look back in order to identify the drivers of change and benefit from them. Furthermore, to account for the uncertainties about the drivers of the cycle, it is advisable to engage in scenario-based planning.
Kemmsies is chief economist of Moffatt & Nichol, a marine infrastructure engineering firm. He can be reached at (212) 768-7454, or by e-mail.