Responding to Trump: International Trade Diversification

Two key long-term responses have been commonly advocated to the threat of a very damaging US-CA tariff war, a threat that still remains despite a 30-day pause. These are? trade diversification and internal trade reform. I thought I would dust off some reports on these topics that I authored and share some key thoughts. Part 1 is on international trade diversification. Part 2 will be on internal (interprovincial) trade reform.

Part 1: International trade diversification

People talk about trade diversification as if it were as simple as managing your investment portfolio – you just simply call your broker and move your business to the UK, EU, Asia or whichever market you choose. International trade development is far from being that simple.

It often takes years to develop a new market requiring considerable upfront cost. For example, it requires finding effective, trusted local partners to work with; understanding the legal, business and cultural context of the market you are entering; and adjusting your products or services to meet the requirements of the local market. Policymakers need to understand the work and risks involved - do firms have the scale, capacity and competitiveness to do this?

Portfolio theory, however, does provide two useful principles firms and policymakers should incorporate into their decision making:

1)????? Both risk and return must be considered. If, for example, non-US markets provide lower returns (growth or profit margins), perhaps due to sluggish markets or higher distribution or marketing costs, this must be weighed against the potential benefit of not having as many eggs in the US basket.

2)????? The overall risk of an export portfolio depends upon three factors:

a.????? The riskiness of individual markets (e.g., US vs China vs the EU)

b.????? The relative importance (weight or share) of sales in each market

c.????? The correlation between these markets. For example, a global recession would cause demand to fall in both the US and EU. Disruption to the Suez Canal will affect trade flows to and from all Asian markets. The threat of US tariffs is only one type of risk. Businesses should think through the multiple sources of risk to their trade portfolio and which risks they want to minimize.

Here are some practical takeaways from my chapter on diversity in our 2001 trade book:

1.???? Clarify your goal or objective. What are you trying to achieve? For example, are you trying to increase total export revenues, reduce the dependence on one market (e.g., US), or reduce the overall volatility of your export revenues?

2.???? Check your strategy – will it achieve your objective? Increasing diversity may not reduce the overall risk of an export portfolio – especially if you are moving to a low return, high risk market that is highly correlated with the US.

3.???? Compare risks and returns. Balance expected growth and profitability with different risks. Your new non-US market may reduce your profit margins and slow your export revenue growth. What trade offs are you willing to make?

4.???? Count the cost. Examine the feasibility and costs of entering a new market. Get help as required.

5.????? Consider alternative strategies. Market diversification may not always be the best way to reduce risk. Setting up in the US and serving US clients from there may be a wise move from a business perspective, even though this advances President Trump’s goal.

This, by the way, is a huge risk for Canada’s economy if we cannot ensure a safe, secure cross-border trading environment. We will lose investment and jobs from Canadian and international firms to the US market. Ensuring we are investment attractive is key to mitigate this risk. One part of this is ensuring free trade within Canada. This is the subject of my next instalment.

To read the full article see Chaundy, David, “Export Diversity in Atlantic Canada,” Chapter 3 in Chaundy, David ed. (2001), Atlantic Canada’s International Trade in the Post-FTA Era. Halifax: Atlantic Provinces Economic Council.