South-South Trade: Rising at Turbo Speed

South-South Trade: Rising at Turbo Speed

What is this trend called South-South trade, how is it growing and what does it mean for Canadian exporters?

The world is living through a dramatic period of economic and geopolitical transformation. What sets it apart from all others? The simple answer is “speed.”

Centuries were once required for global power shifts to occur. Now it’s decades – best seen in the sharp increase in emerging markets in Asia, Latin America and Africa trading with each other in recent years. Given that these countries are mainly in southern locations (except Russia and some surrounding markets), this trend has been nicknamed South-South trade.

The North, by contrast, is broadly defined as the highly industrialized members of the Organisation for Economic Co-operation and Development (OECD), with a few minor exceptions.

To illustrate, the South side’s Emerging 7 – Brazil, Russia, India, China (BRIC), Indonesia, Mexico and Turkey – will generate over half of the world’s economic growth by 2025, compared with just 25 per cent last year. This year, for the first time, Chinese exports to the North will be eclipsed by its South-bound exports. Indeed, China alone now accounts for 40 per cent of South-South trade, and Asia for three-quarters.

By the numbers

Back up just two decades and South-South trade was a low one-digit share of global trade. According to the World Trade Organization, this swelled to more than 16 per cent by 2007 – and to roughly a quarter of global trade by 2010 – a surge aided by the global recession.

Will the South-South Trend Continue?

Three compelling factors point to ongoing momentum in South-South trade in the coming decades:

  1. Technologically, the South can leapfrog over the often dated infrastructure of the North to next-generation systems, enhancing South-South competitiveness and trade potential.
  2. The strength of the South’s financial markets has increased in the wake of the West’s financial crises. But the real motor is the rise of personal incomes. China reports its middle class is growing by Canada’s population every year. India claims it will soon match this pace. Brazil is adding about five million per year, and so on.
  3. There are dozens of new South-South trade initiatives, exemplified by the ratification last fall by India and South Africa of a preferential trade agreement to achieve $15 billion of bilateral trade per year.

Slower growth prospects in the North lead researchers for the Asian Development Bank to project North-North trade shrinking from some 50 per cent to 30 per cent of total global trade by 2030. These economies are boosting their fortunes by engaging in North-South trade, which is growing at a 15 per cent annual clip. Even so, this pales against the consistent 21 per cent annual growth in South-South trade.

As well, South-South outward foreign direct investment rose from 25 per cent of the global total to 34 per cent by 2010. Close to two-thirds of these flows are now to other developing countries, and most are greenfield investments (brand new facilities). The BRIC nations make up 60 per cent of these investments.

Another key sign is the rising penetration of South firms in industries where the North has enjoyed an advantage – such as heavy capital equipment. A 2011 study by the Economist Intelligence Unit observed that OECD countries were feeling the strain from Chinese export competition in 37 industries.

What’s up in the North?

Many northern companies still have a dated approach to emerging market strategy. Traditionally, this has meant locating in emerging markets for access to their natural resources, outsourcing potential, lower-cost labour, and growing consumer and business markets. Increasingly, though, emerging markets are also valuable for their South-South trade potential.

This new trend suggests that international marketing strategy has to increasingly decipher which supply chains offer the best South-bound trade opportunities. The reasoning is simple: why just target the South’s 139 markets individually, when you know that they are becoming increasingly interlinked?

For example, U.S. foreign affiliate sales (FAS) are valued at three times the amount of exports leaving U.S. shores. Similarly, Japan’s FAS are three times its direct exports, and the U.K.’s are five times more.

In Canada, exports to our traditional OECD customers have been flat over the last decade – a disaster for a trading nation. Prospects for improvement remain modest over the long term. According to the OECD, the annual U.S. growth trend in 2013 and beyond is just 2.2 per cent – it’s even less in Europe and Japan.

By contrast, China is expected to see an average of 9 per cent annual growth, while India weighs in at almost 8 per cent, and so do a good chunk of Southeast Asian, Middle Eastern and African economies. Growth data is more modest for Russia and Latin America, with Brazil’s up to 5 per cent and Mexico, 3.5 per cent.

Oh Canada or oh-oh

Canadian Foreign Affiliate Sales (FAS) vs. Direct Exports from Canada

Canadian Foreign Affiliate Sales (FAS) vs. Direct Exports from Canada

Trade is starting to turn around for Canada. Since 2003, the swift currency appreciation has kicked off a simultaneous increase in trade diversification. Our trade to emerging markets grew by more than 10 per cent annually, leading to a jump in the South’s share of our merchandise exports (from 4 to 11 per cent). In other words, we can thank emerging markets for over two-thirds of Canada’s export growth through most of the past decade.

Over the same period, Canadian affiliate sales in emerging countries tripled to 28 per cent of all such foreign sales – while the U.S. share tumbled from two-thirds to half. In 2009, this pattern briefly pushed Canada’s FAS ahead of domestic exports for the first time, before weaker sales from developed markets reversed the rankings in 2010 (see graph).

Still, Canada’s share of our emerging market trade to total exports is low, compared to many other OECD countries, and so is our growth of foreign affiliate sales in the South-South market space.

Whether we are ready or not, new factors – combined with the ongoing high loonie and slow growth in key industrialized markets – will keep on pushing Canadians beyond their trading comfort zones. Like other developed economies, Canada faces an acute labour crunch by 2016. Trade with the South, and their southern supply chains, will enable us to “import” labour without moving it. This in turn offers opportunities for “scarce” and experienced Canadian workers to move farther up the value chain.

South Selling South: 20 Top Traders

Of the top 20 South-South exporters, 14 are from Asia; the others are Brazil (10th), Argentina (14th), Chile (16th), South Africa (17th), Mexico (18th) and Nigeria (20th).

The bottom line: Achieving a steady share of South-South trade will demand a much more aggressive pace of Canadian direct investment abroad than we now see – to the tune of roughly $250 billion by 2020. This would help our companies develop the economies of scale that can keep them globally competitive.

Peter Hall is Vice-President and Chief Economist at EDC. Research contributions were made by Alain Cohen and colleagues in EDC’s Marketing Department.

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