Regional trade blocs will become new engine for economic growth

The U.S.-China trade deal President Donald Trump announced on Jan. 15 marks a temporary cease-fire in the trade wars he launched in 2018, but the deal's backdrop — the growing backlash against globalization — will persist, auguring a future where trade within regions becomes a bigger driver of growth, analysts say.

Economists predict Asia will prove resilient in that environment, even as countries such as Japan, South Korea and China have arguably been globalization's biggest winners over the past 60 to 70 years.

The U.S.-China "phase one" deal, which followed a spate of market-roiling U.S. tariff hikes and Chinese counter hikes over the past 18 months, included a Chinese pledge to increase imports of U.S. goods by $200 billion over the next two years and another to purchase $40 billion to $50 billion of agricultural goods each year.

A White House news release touched, in passing, on more intractable trade disputes, saying China also agreed, for the first time, to "end its practice of forcing foreign companies to transfer their technology to Chinese companies in order to gain market access." It went on to assert that China "will address numerous long-standing intellectual property concerns in the areas of trade secrets, trademarks, enforcement against private and counterfeit goods, and more."

With Mr. Trump facing a Nov. 3 election for a second four-year presidential term, analysts say politics was a key driver for both the timing of the deal and its details.

The deal suggests Mr. Trump wants to "put the trade war on the back burner until after the election" to focus on fighting the Democrats for now rather than the Chinese," said Keith Wade, London-based chief economist with Schroders PLC.

That could spell an "11-month quiet period" even if the deal looks to be more like a "short-term truce (than) a sustainable peace," said Eoin Murray, head of investment with London-based Hermes Investment Management.

International trade veterans, meanwhile, called the deal's targets for Chinese purchases of U.S. goods and services very aggressive, leading some to predict the trade ceasefire could prove short-lived.

"The agreement commits China to ramp up its purchases to approximately $560 billion over the next two years — a whopping 55% increase," wrote Gary Clyde Hufbauer, non-resident senior fellow with the Peterson Institute for International Economics, Washington, in a Jan. 15 blog posting.

That leaves "a lot of potential for disappointment" and room for divergent views on what the Chinese think they're agreeing to and what the U.S. expects, said Daniel Morris, London-based senior investment strategist with BNP Paribas Asset Management.

In the event China fails to deliver on its commitments, Mr. Morris said the question will be whether Mr. Trump returns to boosting tariffs — betting that the political advantages of standing up to China will outweigh any fallout for the economy or markets in an election year. Trade-related developments could easily make 2020 "as volatile as last year," he predicted.

Govinda Finn, Singapore-based Japan and developed Asia economist with Aberdeen Standard Investments, called such a move unlikely. Even if those "big splash" headline figures prove "almost impossible" to achieve, it's not clear Mr. Trump will have political incentives to take a hard line response, said Mr. Finn, adding that an increase of $50 billion in U.S. imports in 2020 might be enough to keep the deal on track.

Jean-Louis Nakamura, chief investment officer, Asia-Pacific with Lombard Odier Investment Managers and CEO of the firm's Hong Kong office, agreed, saying the U.S. administration will present the deal as a victory, making it less likely it will move to restart a trade war with China before the election.

In that sense the phase one deal's main takeaway for investors is not what it includes but its implicit promise of no further escalation of bilateral trade tensions through November, Mr. Nakamura said. If Mr. Trump is re-elected, there's every reason to expect him to quickly rejoin the battle with China, Mr. Nakamura said.

Analysts were quick to point out that the phase one deal can hardly be seen as a victory for free trade.

The prospect is for no further escalation of tariffs this year but no de-escalation either, said Mr. Hufbauer in a Jan. 15 interview, noting that the U.S. continues to maintain tariffs on $360 billion of imports from China.

From a global trade standpoint, the deal is "taking away a headwind but not creating a tailwind," agreed Erik Weisman, a Boston-based chief economist and portfolio manager with MFS Investment Management. With much of the tariffs the U.S. slapped on China remaining in place, "we're still in a worse place in terms of the global economy relative to 18 months ago," he said.

Mr. Hufbauer's Jan. 15 blog post called the phase-one deal a sign that the U.S. is opting for "complete immersion" in the managed trade pool. Market price signals as the ultimate arbiter of what gets produced where "are out, quantitative commitments are in," he wrote.

Analysts say the broader story behind the U.S.-China trade brouhaha is the dramatic loss of support in recent years — among U.S. policymakers and citizens alike — for free-trade principles more generally and globalization in particular.

In the U.S., "there are no free traders left, or at least not very vocal ones," Mr. Hufbauer said, noting that Mr. Trump's approach to trade politics "has permeated the whole political landscape" — Democrats and Republicans alike.

Mr. Nakamura said those politicians are simply channeling the growing ranks of people in developed countries who no longer believe the loss of manufacturing jobs that results from throwing one's doors open to global trade is more than compensated for by growth in the number of better paying jobs in the service sector.

Some analysts hold out hope the backlash can be contained.

Hopefully the belief that it's better for two countries to trade than not to can persist, said BNP Paribas' Mr. Morris. The mistake has been in not paying enough attention to those who've gotten hurt by global trade – "your steel worker in Pennsylvania or industrial workers in the north of England, and so on," he said, citing the elections of Mr. Trump in the U.S. and Boris Johnson in the U.K. as "kind of the revenge of the losers from globalization."

Messrs. Trump and Johnson paid attention to those segments of their populations, and "the acknowledgment of the pain and suffering they've gone through was obviously quite powerful," Mr. Morris said. A greater emphasis on compensating the losers of globalization could help sustain global trade growth in the future, he predicted.

For now, though, most analysts see little likelihood of that ongoing shift in popular sentiment reversing.

The willingness of voters in developed countries to accept "an ever-increasing level of openness of their own economies to the rest of the world has stopped and is currently reversing," a trend that could drive trade policy for the next 10 to 15 years, Mr. Nakamura said

Hannah Anderson, Hong Kong-based global market strategist with J.P. Morgan Asset Management, said her optimistic case is that at some point there will be a "reset" and acknowledgment that "trade is how we make the economic pie bigger," but a growing focus on regional trade blocks is a more realistic outlook.

"I think in our lifetimes, the cat's out of the bag," MFS' Mr. Weisman said. It won't be easy to convince those that lost out, and there are large swathes of people in places like the U.S. Midwest, northern Britain and France's farm belt who feel that way, to trust policymakers to get it right this time, he said.

That should make "trade-related disruptions ... the new normal, and not just in America," said Ben Powell, Singapore-based managing director and Asia-Pacific strategist with the BlackRock Investment Institute. "Structural and persistent" tensions between the U.S. and China, meanwhile, will provide incentives for both heavyweights to become more "self-reliant," he said.

That pattern, writ large, will see the globalized world of the past few decades give way to one where the more important driver of growth will be intraregional trade.

There's going to be a slow devolution of globalization, predicted Mr. Weisman. "You're going to see these spheres become more clear: the American sphere, the Chinese sphere, the European sphere. More economic activity will take place within those spheres than across them, relative to the last 20, 30 years," he said.

"Growth in trade will be within regions," Mr. Hufbauer agreed. For example, trade within North America will grow, not because Mr. Trump's makeover of the North America Free Trade Agreement is so good but "because of confidence in investment" and supply chains there.

Concerns about "policy interruption," meanwhile, will result in much less appetite for building the kind of far-flung supply chains that became commonplace in recent decades, he added.

"It will be more and more difficult to achieve or to maintain zones of free trade between economies of very, very different levels of development and very, very different social priorities," Lombard Odier's Mr. Nakamura said.

Analysts point to growing inequality around the world as a wellspring of the anti-globalization backlash, even if other factors, including automation and misguided policy decisions, have been major contributors to that outcome.

A world where growth is more dependent on regional trade would likely be less efficient "but if you wind up living in a world where the global pie is a little bit smaller but the distribution within any given country is a little more even, it might be a preferable world," Mr. Weisman said.

Of course, achieving that outcome would depend on good policy decisions, absent which the result could be lower growth with no offsetting social goods to speak of, he said.

That coming world of stronger intraregional growth will have consequences for corporate profits and macroeconomic factors such as inflation.

For the past few decades, companies have been able to solve almost entirely for one variable — efficiency — which helped their margins and kept price pressures in check, BlackRock's Mr. Powell noted. Increasingly, companies will have to solve for geopolitical "robustness" as well, taking account of the growing political complexities of trade, which should result in "some sacrifice in margin and a resultant reduction in the disinflationary pressure that globalization has driven," he said.

Even though countries in the Asia-Pacific region have been prime beneficiaries of globalization, analysts say they should remain competitive in an environment where intraregional trade becomes the main driver of growth.

While Asia has been the biggest winner from globalization, many of the countries in the region have already reached middle income and to the extent they can tether themselves to the consumption behemoth that is China, they should do well, MFS' Mr. Weisman said.

Mr. Weisman said countries in Africa or South America at an earlier stage of development may feel the loss of the opportunities globalization has provided in recent decades more keenly.

Countries in Asia have reached a level of development where they can invest in the next-stage technologies, positioning themselves to "survive better in this new deglobalized world," Mr. Nakamura said.

Countries in the region, meanwhile, are taking steps to further expand their trading ties.

Just more than a year ago, the 11-nation Comprehensive and Progressive Agreement for Trans-Pacific Partnership, a reconstituted version of the Trans-Pacific Partnership former U.S. President Barack Obama pushed for and Mr. Trump rejected, went into effect after Japan, Singapore, New Zealand, Australia, Mexico and Canada signed on.

And the leaders of the 10 members of the Association of Southeast Asian Nations together with those of Australia, China, Japan, New Zealand and South Korea agreed in November to sign on to the Regional Comprehensive Economic Partnership by early 2020, which they contend would be the world's largest trade pact with more than 3.5 billion people and 30% of global trade.

Regional trade blocs fuel growth