Photo © Ake Ngiamsangua Via Canva.com
The term ‘global supply chains’ first came to the attention of the world during the Covid-19 crisis. The media started reporting that disruptions to global supply chains were causing economic problems. What this means is that so much of what people buy or enjoy is the end of a chain of supply. Or, more accurately, chains of supply.
The obvious example is an iPhone. Whilst it is designed in the US, most but not all of its components come from 17 companies based in mostly in Japan, China, Switzerland, Taiwan, Germany and the US. The phones themselves are assembled in China. The chains of supply are drawn together in China and then other chains of supply take the phone all over the world.
This exemplifies globalisation. But what happens if globalisation slows down?
Globalisation, supply chains and investment
One of the core themes that First Samuel incorporates in clients’ Australian shares sub-portfolios is the changing nature of global supply chains. In an interesting article by Macquarie Equities last month, we noted a simple chart showing global trade evolution over the past 60 years.
Source: Macquarie
As we move past the disruptions of covid, we can see that in the first half of 2024 global merchandised trade had stagnated. The pattern of diminishing trade flows as a % of GDP, that has been the dominant theme since the GFC, has returned.
Macquarie notes, “whereas for two decades to 2011, merchandise trade grew at 1.6x GDP; the intensity has since meaningfully dropped to below 0.8x.”
Why?
The reason for the fall is multi-factorial and must be included in the fundamental analysis of economic policy.
For 20 years, the economic textbook dominated. Countries were inclined to pursue only industrial policies that supported industries with strong “comparative advantage” (the ability to produce a particular good or service at a lower opportunity cost than its trading partners).
But real life is more complicated than textbooks, and China’s industrial policies follow different rules from those of the rest of the world. Luckily, Australia benefited from its capacity to mine scarce materials for Chinese-dominated global markets but was disadvantaged in most other spheres.
Since the GFC, the global reaction, including from the US since 2016, has included tariff and non-tariff measures to halt the expansion of trade. The natural limits of Chinese growth, combined with some areas of their economy failing to generate globally relevant products, have stalled the rise.
Will trade continue to decline?
So, will global trade intensity continue to decline? We concur with Macquarie’s summary, for four reasons.
1. Industrial intervention
Industrial interventions continued to rise, especially in China, US and Europe. But increasingly, even in countries such as Australia that has previously devoted itself to “pure” economics we see the emergence of industrial policies and directed investment.
Source: globaltraderalert.org, First Samuel
2. Technology
Technology simplifies supply chains and shifts economics away from many industrial products. The global response to the dumping of Chinese EVs over the next decade will be a fascinating component of the global trade outcome.
The lead China has taken in production, sales and pricing of EV, (sales shown below) is now extreme.
China now leads in EV sales
Source: iea.org, global EV Outlook 2024.
3. ‘Friend-shoring’
As countries such as Australia continue to respond to a combination of aging and excess financialisaton of their economy (household debt, government spending and deep use of insurance), the requirement to deepen local supply chains and undertake friend-shoring grows. Friend-shoring is recreating supply chains to include more trade and production benefits to allied countries.
Instead of opting for the lowest cost, firms increasingly select partners in a group of geographically closer countries and/or those that align politically, economically, and socially. The formation of the EU (embryonically in 1951) was the forerunner of friend-shoring
4. Service exports
It is possible that the evolution of service exports may display lower trade intensity. We understand that as economies grow in wealth, the inclination to visit Italy and the Leaning Tower of Pisa grows. At some point, however, consumers look for other local, more personalised or perhaps more unique services. Perhaps Pisa loses some lustre simply due to number of people visiting?
So, who wins?
In a world of declining trade, faced with higher levels of protectionism, the countries that will be advantaged will be those:
- with large young populations; or
- small countries with the most friends, especially friends without aging problems
The solution for others will be to increase localisation and protectionism until the next global growth driver emerges.
Where is Australia placed in such an environment?
At first glance, it could appear that we would again favour the circumstances of 1996-2008. After all, our terms-of-trade-induced income growth and declining global interest rates were sensational for house prices, real incomes, and the retirement prospects of an entire generation of Baby Boomers.
From now on, our advantages will be more nuanced.
In part, we are likely to retain the advantages of high volumes of mining output, regardless of the price we receive for iron ore and other products. We also benefit from a range of catch-up infrastructure development and education infrastructure. Wisely, Australia has also used the past 30 years to increase our investment in global businesses through the Future Fund and our superannuation regime.
But the textbook disappears at this point, and hence the following becomes core economic policy:
- alignment with India
- developing our own industrial policies
- taking advantage of US protectionism in the Inflation Reduction Act
- deepening our industrial connections with neighbours
- investing in the geographically sensitive regions of Papua New Guinea and the Pacific
Building a less interest rate-sensitive household sector, especially one that generates wealth in non-housing assets, and managing intergenerational wealth will also be critical.
Q: How is this reflected in our clients’ Australian shares sub-portfolios?
A: Very widely.
We own companies with deep local supply chains, either those assisted by a duopoly structure such as Woolworths or specifically local due to the nature of service such as Cleanaway (waste collection). We own Seven Group, which not only owns Boral for the ongoing building task but also companies such as Coates, which gets the advantage of cheap goods from China as inventory but works in a domestic market that is strengthened by friend shoring. We own Macquarie Group, which seeks to benefit from both local markets and the infrastructure investment needs of most of our allies.
We own domestic production in biosecurity-protected and food-related industries such as Bega Cheese and Inghams. In mining, we concentrate on future materials (copper and lithium) and businesses that benefit from volume growth, including Imdex and Emeco.
We own industrial properties in our property sub-portfolios, which benefit from local supply chain development.
Finally, in the medium term, as this transition away from the pure advantages of high prices from traded goods evolves, the role of government is likely to remain elevated. High government spending supports Medicare-related medical services and labour support services for a company like Ventia.
Takeaway
The world is changing faster than most investors understand. The ramifications of the change in globalisation patterns are subtle. First Samuel instils in its portfolio construction the two enduring keys to managing change: diversification and agile thinking.
If you have any questions or want to know more, please contact your Private Client Advisor or get in touch.
The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.