Canada’s best chances for trade growth may not be in China: McKinsey
Escalating diplomatic tensions with Beijing have at least temporarily poured cold water on Ottawa’s long-held desire to deepen trade ties with China.
But that may not be as big a setback as it seems, a new report suggests.
As automation curbs the hunt for cheap labour, Asian countries consume more of what they produce and manufacturers locate closer to their customers, Canada’s best trade opportunities are likely to be found outside China’s vast economy — and in some instances, much closer to home, according to researchers at the McKinsey Global Institute.
“Our data certainly shows that China won’t provide as much opportunity to Canada as other parts of the world,” said Susan Lund, a partner at the institute and one of the researchers on the report. “China has a very competitive and vibrant set of companies that are now satisfying the needs of its domestic value chains. But that doesn’t mean there aren’t a lot of other opportunities for Canada. There are.”
Ottawa’s ongoing attempts to broaden trade with China have been derailed by a series of incidents — the most recent being the arrest of senior Huawei executive Meng Wanzhou in Vancouver at the request of the United States, which is seeking her extradition. The move infuriated China, which has since detained two Canadians and sentenced a third to death in apparent retaliation.
In a call with reporters Sunday, Minister of Trade Diversification Jim Carr acknowledged that Canada’s relationship with China is “going through a tough period.” However, “many relationships have been established already and over time and as we work through this difficult moment, those relationships may broaden and pick up,” he said.
While Canada can’t ignore the world’s second-largest economy, which will remain an important export market for agricultural products and resources, broader shifts in global trade suggest the best chances to broaden exports may be elsewhere, Lund said.
Indeed, as companies shift their priorities away from cheap labour and toward automation, research and development and maximizing the speed at which their products reach consumers, goods value chains that once sprawled out globally are “regionalizing,” the report finds.
Such shifts favour advanced countries such as Canada, where an educated workforce, free trade deals with other nations and a location on the doorstep of the world’s largest consumer economy are all advantages, Lund said.
“That trade is becoming more regional is now par for the course in our view,” said Lund, whose team drew their conclusions from a study of value chains in 23 industries in 43 countries between 1995 and 2017. “Automation and artificial intelligence means the search for lower wages around the world is becoming a lot less important in all value chains. That means there are new opportunities to produce in advanced economies like Canada and the U.S. So we would expect countries to focus a lot more on their regions.”
Though U.S. President Donald Trump’s tariff wars may have quickened this shift, they didn’t cause it. The transition can be traced back the mid-2000s — a turning point that was “obscured” by the Great Recession — when the share of goods traded across borders began to shrink, the report finds. Between 2007 and 2017, exports from goods-producing value chains as a share of gross output declined to 22.5 per cent from 28.1 per cent, even as output and trade continued to increase in absolute terms. Meanwhile, trade intensity in services soared.
To some extent, Canada has lagged this trend although it hasn’t escaped it, according to McKinsey. Trade intensity in goods — a measure of the share of products exported — was 48 per cent in 2017, a decline of 4 percentage points since 2007 though still above most large advanced economies. And in most sectors, both exports and output of goods declined, with the most significant drops in trade intensity in computers, electronics and machinery equipment.
Not surprisingly, the global shift toward regional goods value chains is largely being driven by China and other large emerging economies, where consumers are buying more of what domestic value chains make and where local firms are capable of supplying more of their needs — making them less reliant on imported intermediate goods. Indeed, China exported 17 per cent of what it produced in 2007 but only 9 per cent in 2017, according to McKinsey.
Meantime, “speed to market is becoming a key battleground, and many companies are localizing supply chains for better coordination,” the report states.
A case point, Lund says, is Adidas. The German athletic wear giant that has typically outsourced production of shoes and apparel to low-wage southeast Asian countries now has automated “speed factories” in both Germany and Atlanta that use very little labour, waste less material and produce much more quickly.
It follows that as goods trade regionalizes, Canada’s renegotiated NAFTA deal will become ever more important. Free trade deals will also emerge as a key advantage as the share of global services trade skyrockets — growing as much as 60 per cent faster than goods, by McKinsey’s estimation.
Canada runs a deficit in services trade, making this a key area of opportunity — though again, not with China — Lund said.
“Services trade is the future but not with that market in particular,” she said “And again that’s because China is increasingly filling it’s own needs.
China has also been accused of unfairly restricting access to foreign competitors — a key source of tension in its current trade dispute with the U.S.
But that doesn’t mean there aren’t other nations where Canadian companies could thrive, Lund said, pointing to NAFTA and Canada’s new free trade deals with Europe (the Comprehensive Economic Trade Agreement) and the Asia Pacific countries (Comprehensive and Progressive Agreement for Trans-Pacific Partnership) as key advantages in the future.
“These are long-term trends, of course,” she said. “It’s not like things will shift overnight, but this is definitely the direction things are going. We can see the momentum.”