Regionalization of trade: more hype than reality?

While experts predict a shift in global trade towards more regionalized patterns, recent data suggests a more skeptical stance is in order: an analysis of trade data based on four different regional definitions shows a clear trend towards less regionalized trade between 2003 and 2012, and no consistent trend in recent years. Since 2004, trade flows have generally spread over longer distances, a trend that has been accentuated during the pandemic. Going forward, while geopolitical tensions, technological trends and environmental concerns all have the potential to contribute to an increase in the regionalization of trade, other forces, such as falling container shipping costs and the continuous improvement of technologies that facilitate long-distance transactions, will continue to promote long-distance trade. When deciding whether or not to regionalize, leaders must focus on the economic fundamentals that have always guided those decisions.

For more than a decade, experts have predicted a shift towards more regionalized business models, with companies adopting proximity strategies to produce goods closer to the markets where they will be sold. Many expected Covid-19 to accelerate this trend.

But recent data suggests a more skeptical view of the regionalization of trade. Trade flows have extended over longer distances, even during the pandemic. Although the regionalization of trade may increase in the future, we would not bet on a transformational shift from global trade to regional trade.

The elusive proof of growing regionalization

In our DHL Global Connectedness Index 2021 Update report, we track the percentage of global merchandise trade taking place in regions using four different regional definitions: one from the World Trade Organization (WTO) and one from the United Nations (UN) , as well as by continent and in the three macro-regions of Asia-Pacific, EMEA (Europe, Middle East and Africa) and the Americas.

While there was a clear tendency to less regionalized trade between 2003 and 2012, no consistent trend appears in recent years. When we use the WTO definition, which divides the world into seven regions, we see an increase in regional trade between 2012 and 2016. But this trend ended in 2016. And if we divide the world using the other three regional definitions, the upward trend disappears entirely.

Since all definitions of regions involve subjective judgments, we prefer to focus on a more objective measure of changes in the pattern of global trade: the average distance traveled by all trade flows in the world.

If there really was a robust shift towards regionalization, one would expect trade, on average, to take place on shorter distances. But our analysis for the DHL Global Connectedness Index found that trade flows actually spanned longer distances since 2004, but with a break between 2012 and 2018.

The pandemic has increased long-distance trade

Trade has even traveled longer distances during the Covid-19 pandemic, despite expectations that the disruptions would force greater reliance on nearby suppliers. Indeed, exports have increased sharply in Asia to meet the growing demand for imported goods in many parts of the world. As a result, countries far from Asia imported over longer distances, while countries in Asia themselves imported over shorter distances. This global shift to longer-distance trade has progressed even as some buyers have shifted to closer suppliers, especially for time-sensitive products. While disruptions to long-distance trade have dominated the headlines, short-distance trade has also been hampered by pandemic-induced capacity bottlenecks and labor shortages.

The fact that long-distance trade has grown more during the pandemic than short-distance trade raises questions about the role of regionalization in supply chain risk reduction strategies. Offshoring and regionalization have many attractions and can increase resilience through shorter transit times and reduced cross-regional interdependencies.

But long-distance trade can also contribute to resilience. Long-distance trade drives specialization and economies of scale, and it appears producers have been able to increase exports faster during the pandemic in countries that supply a significant share of global demand for their products.

Long-term regionalization?

Going forward, geopolitical tensions, technological trends and environmental concerns all have the potential to contribute to an increase in the regionalization of trade. The same would apply to new trading blocs such as the Regional Comprehensive Economic Partnership (in the Asia-Pacific region) and the African Continental Free Trade Area. And pandemic-induced supply chain regionalization could accelerate in the coming years, as major reconfigurations take time to execute.

Nevertheless, other forces will continue to favor long-distance trade. These include container shipping costs eventually returning to more normal levels, the rising share of emerging economies in world trade (they tend to trade over longer distances), and the continued improvement technologies that facilitate long-distance transactions.

The decline in business interest in regionalization, after peaking at the start of the pandemic, also reinforces the feeling that forecasts of a major increase in regional trade may not materialize. In an April 2020 survey, 83% of executives said their companies planned to use offshoring to regionalize their supply chains. When the same survey was repeated in March-April 2021, only 23% still said they were planning nearshoring. Another set of surveys shows that companies have abandoned regionalization and proximity plans and instead embraced other ways to increase supply chain resilience, such as increasing inventory levels and doubling source of raw materials.

The war in Ukraine has given a new impetus to business interest in regionalization. However, many of the effects of the war, so far, have favored long-distance trade. The European Union, for example, is increasing its energy imports from more distant countries to reduce its dependence on Russia. Meanwhile, Russia trades more with Asia than with Europe, despite the greater distance from major Russian population centers.

The potential for significant increases in the regionalization of trade is also limited by the fact that trade is already fairly regionalized. Using most regional definitions, more than half of world trade occurs within regions, about three times the proportion one would expect in a “frictionless” world where distance and differences between countries did not affect the pattern of trade. Surprisingly, transport costs explain less than 30% of the moderating effect of distance on trade. Preferences for similar products in neighboring countries, regional trade agreements and many other similarities and links between close countries have long boosted short-distance trade.

Should your business embrace regionalization?

The main implication of this analysis is that leaders should be skeptical of the assumption that a major wave of regionalization is underway. If your business is considering regionalization because you expect your customers or suppliers to adopt regional strategies, carefully consider the actual commitments they are making, as the rhetoric about regionalization may have preempted reality.

Ultimately, the main drivers of whether or not a company should regionalize should be the economic fundamentals that have always driven those decisions, including demand patterns and production costs/capacities.

What is new is the extent to which companies should incorporate geopolitical tensions into their thinking. The nearshoring trend may fall short of expectations, but what many are beginning to call friendshoring or allyshoring could become increasingly important in strategically sensitive industries.

Pay particular attention to any supply chain reconfiguration that could result in a higher cost structure for your business. Without sustained government support, a company that dramatically increases its cost base risks losing customers to more efficient competitors. And while the pandemic and the war in Ukraine have highlighted the need for resilience, they have also contributed to a sharp rise in inflation and pressure on public budgets. This implies that substantial political support for the relocation of supply chains will be limited to the most politically sensitive product categories. Growing pressure to cut costs will force companies to take a hard look and away from the most efficient and reliable production and supply sites.

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