Businesses eyeing U.S. expansion must be vigilant about future policy

A decade on from the financial crisis a degree of calm has descended, with every major economy in the world predicted to grow.

Christine Lagarde, Managing Director of the IMF, has insisted that this is 'the perfect opportunity... to repair the roof'. As the latest World Economic Outlook report puts it: ‘Policymakers should seize this opportunity to bolster growth, make it more durable, and equip their governments better to counter the next downturn.’

The picture is supported by strong international trade data, showing that the number of regional trade agreements doubled between 2007 and 2017, while the recovery in trade seen last year as a result of the global economic recovery has continued into 2018. What’s more, the World Trade Organization expects merchandise trade growth to remain strong in 2018 and 2019 following the largest increase in six years in 2017. Last year’s 4.7% growth remains firmly above the post-crisis average, albeit below the average 4.8% seen since 1990.

Geopolitical risk is inherent in trade.

This is exactly the type of environment in which businesses look to expand their trading and operational footprint across the globe. But companies must remain vigilant. ‘Geopolitical risk is inherent in trade,’ says Lillian Labbat, Global Head of Trade Credit and Political Risk for Zurich Insurance Group. ‘When firms export or set up operations across borders, they are exposed to varying levels of risk: political risk, credit risk, embargo, contract frustration and business interruption’.

And a real-life example of these risks is currently threatening to undermine not only businesses’ plans but global growth as a whole. The U.S. administration is reviewing longstanding trade agreements, tax and regulatory systems and defense treaties are being renegotiated, transformed or potentially renounced. IMF chief Lagarde has warned that countries must avoid trade protectionism, in particular, in order to ensure global prosperity.

Three scenarios for future US policy

President Trump has insisted that the U.S. is “open for business” but question marks and concerns have been enough to rattle global markets.

Zurich, in collaboration with the Atlantic Council think tank and Ernst & Young LLP, has published a new report entitled Border vs. Barriers. Navigating uncertainty in the U.S. business environment, identifying three distinct scenarios of future U.S. policy. The report focuses on the implications of these scenarios for businesses, enabling organizations to manage the risks more effectively.

Isolationism

Isolationism is defined as a country voluntarily abstaining from security or economic-related politics when it could otherwise have significant global influence or control. Isolationism could be realized if protectionist politicians gain U.S. voters’ favor by promising a response to fears over wage stagnation, falling standards of living and growing inequality.

But while there may appear to be short-term advantages to protecting national industries, there could be long-term damage.

History has shown that through protectionism you lose your competitiveness.

‘If you have a market with sufficient or even attractive domestic demand to support a specific sector, such as agriculture, there is a kind of logic when a Government believes it can protect certain domestic jobs and companies,’ says Jean-Pierre Krause, Zurich’s Global Head of Risk Engineering. ‘But in the long run history has shown that through protectionism you lose your competitiveness in the export market due to higher prices for intermediate products. Even worse, the protected industries lose their innovation and productivity.’

‘At some point your nation will be so far behind everyone else even your local companies will realize it's better to look abroad for quality and value.

‘This difficulty generally arises when politicians are making policies simply because they appeal to voters, rather than because they also make commercial sense over the long term.’

Then there are the consequences of imposing protectionist measures, with retaliatory sanctions potentially wiping out any benefits.

‘When applying scenario thinking, then the domino effect is a definite risk, especially when there is retaliation by trading partners,’ adds Mr Krause. ‘Look at what has happened between the U.S. and China this year. President Trump spoke about introducing tariffs to protect the American aluminum industry. China then made the same threat to U.S. soybean exports.’

‘Half of all U.S. soybean exports go to China, so the implications are significant. International markets are so complex it is incredibly difficult to predict what will happen and every country has vulnerability that the trading partners could exploit.’

Extrapolate this type of example out over an entire economy and the effects could be significant. Using IMF growth forecasts, the Borders vs Barriers report predicts that the Isolationist scenario could generate a loss of $1.5 trillion of cumulative nominal U.S. GDP between 2017 and 2022.

Atlanticism

Atlanticism is based on the idea that countries that border the Atlantic Ocean share a similar identity or have overlapping interests. In this scenario, the U.S.’s focus on trade deficits with countries such as China, would be intensified, heightening scrutiny on trade flows and sourcing. Multinationals with production in China or a significant Chinese customer base, for example, would need to consider major restructuring of their business models to address higher barriers of entry and tariffs for any cross-bloc trade.

Good risk management is an essential tool in negotiating these choppy waters, and in this case against isolationist measures targeted at those countries outside the ‘Atlantic’ bloc.

“The biggest challenges that trade wars pose to risk managers concerns their supply chains and the increased costs of supply” says Ms Labbat. “The largest business impacts are increased operating costs and difficulty in accessing skilled and affordable labor and resources. Also, there are increased costs to buyers of goods which results in increased credit and counterparty risks.”

Nick Wildgoose, Global Supply Chain Product Leader for Zurich, points to transparency as a vital tool in mitigating risk.

‘When events force companies to look closely at their supply chains it often turns out they are more like spaghetti than the nice linear structure you might expect,’ he says.

Take steps to ensure you aren’t completely reliant on a single organization.

‘One way of reducing this kind of risk is to increase your supply buffers, though in manufacturing cash flow is so important there is often a lot of resistance to this approach. Besides, even if you know who your tier one suppliers are - and you take steps to ensure you aren’t completely reliant on a single organization or a specific geographical location - they are in turn reliant on materials from a second tier of suppliers.’

‘By the time you reach the third tier most organizations know very little about their supply chains. Addressing this is a major step in terms of mitigating your risk. This is a clear example that where there are risks there are opportunities. If you can see there’s going to be a shortage and you grab the supply before your competitors then you have a big win.’

When investing in a new market, business leaders must consider the potential future risks of operating in that country. Indeed, the economic impact that an Atlanticist scenario could have on U.S. nominal GDP is a cumulative $502 billion loss between 2017 and 2022, according to Zurich’s Borders vs Barriers report.

Internationalism

The third scenario is Internationalism, an open and rules-based world order built on institutionalized cooperation among democracies. It acknowledges a diverse array of global interdependencies that must be managed to sustain economic well-being.

Internationalism would take hold in an environment where the U.S. sees diminishing threats from abroad amid an increasingly strong U.S. economy. In turn, corporate balance sheets would improve and the U.S. maintains its technological advantage in the economy’s largest sectors.

Meanwhile, the globe’s other major economies would be forecast to grow at a significantly slower pace, which would result in them turning inward to address domestic concerns. That would have a knock-on effect on those countries’ ability to extend policy outwards.

It might not, therefore, be a surprise that the Internationalism scenario would, according to the Borders vs Barriers report, see an additional cumulative gain of $505 billion in nominal U.S. GDP. But Zurich’s Krause warns business leaders not to be complacent, even when contemplating the U.S. as an investment destination in such a scenario. ‘It's a case of understanding where are the safe countries you're allowed to deal with,’ says Mr Krause. ‘You must evaluate if there are other suppliers and markets where you can increase your market.’

None of these three scenarios are likely to dominate over the next decade, but certain aspects of each may emerge depending on policymakers, and history teaches us that protectionist policies have clear knock-on effects for nation states. For corporations, understanding the risks of each potential scenario has never been so important.

Key Takeaways:

• Global growth and strong international trade data has created the perfect environment in which businesses look to expand their trading and operational footprint across the globe.
• However, the U.S. administration is reviewing longstanding trade agreements, tax and regulatory systems and defense treaties are being renegotiated, transformed or potentially renounced.
• Zurich, in collaboration with the Atlantic Council think tank and Ernst & Young LLP, have published a new report entitled Border vs. Barriers. Navigating uncertainty in the U.S. business environment, identifying three distinct scenarios of future U.S. policy: Isolationism, Atlanticism and Internationalism
• Protectionism, which could be prevalent in the Isolationist and Atlanticist scenarios, could have short-term advantages in protecting national industries but there could be long-term damage.
• One of the most important things a business can do to protect themselves is to analyze their supply chains in order to strengthen and diversify them.