The world of trade has moved on and Trump’s tariffs are targeting yesterday’s challenges, not today’s

Once upon a time, trade was simple. Poor people in poor countries produced food and raw materials cheaply, and sold them to the rich western economies concentrated in Europe and the United States, who transformed them into finished products that were used or consumed by their own rich populations.

A few luxury consumer goods trickled back to the elites in the poor countries, but most exports back to poor countries were capital equipment needed to extract raw materials.

It was called comparative advantage, and most in the West assumed it was the natural order of things. Supply chains were short and simple. Raw materials were bundled onto a ship in Country A and delivered to manufacturers in Country B. Clever consumer goods produced in Country B were then either consumed by affluent consumers nearby, or bundled back onto ships as finished goods to be sold to elites in Country A.

But then, back in the 1970s, something changed. Improvements in transport and communications enabled western manufacturers to keep their prices down by shifting labour-intensive, low-paying work to poor countries. It meant more complicated supply chains, but it kept consumers in the rich markets happy. China was in the thick of this, and was key to providing the developing world’s “deflationary gift” to western consumers.

This shift was at the heart of “globalisation”, and was the driver of an extraordinary couple of decades of massive trade growth. Walmart made millions of American consumers happy, and millions of jobs were created in the poor world – in particular, China. Most of these were horribly low-paying, but they seeded local consumer economies that have since grown steadily.

Also sown were the seeds of western anxiety about loss of jobs, from which you can draw a straight line to US President Donald Trump, his “Make American Great Again” tariff war with China and the mercantilist trade negotiations planned in Washington this week.

But there is awkward news for these negotiators: the world of trade has moved on. Supply chains and globalisation are being re-engineered in front of our eyes, and these transformative changes are magnificently captured in a new report from the McKinsey Global Institute, “Globalisation in transition: the future of trade and value chains”.

In sum, trade is becoming less important. Those long and complicated international supply chains are shortening. And as a rising share of global consumption shifts to developing economies – in particular, China – domestic supply chains inside these developing economies are becoming longer.

Instead of just capturing the poorly paid low skill bits of the supply chain, countries such as China have begun to capture higher skill, high-value-adding and, most important, higher paying segments of the supply chain. This has lifted wages, and lifted millions into the consuming middle classes. It is no longer the exclusive privilege of the rich West to fill their homes with comfort giving “stuff”.

Research by Homi Kharas at the Brookings Institute says the global middle class has expanded to 3.2 billion people. McKinsey’s own research suggests the developing world’s share of consumption worldwide has jumped from 19 per cent in 1995 to 38 per cent in 2017, and will reach 51 per cent by 2030. They say global consumption in 2030 will reach US$106 trillion – twice the current level.

As more of what gets made in China gets consumed in China, so inevitably the importance of exports declines, along with the length and complexity of multinational supply chains. McKinsey calculates that China exports just 9 per cent of its total output today compared with 17 per cent back in 2007.

To emphasise that this is not just a China story, McKinsey notes that back in 2002, India exported 35 per cent of the garments and textiles it produced, but this had fallen to 17 per cent by 2017. Rising affluence at home means their garment makers can sell more of their garments in India, instead of relying so heavily on exporting to the rich West.

This rising consumer power also inevitably means developing economies such as China, India or Indonesia are becoming increasingly important end markets for manufacturers in the West. McKinsey recounts that in 1995, only 3 per cent of exports from advanced economies went to China. But by 2017, this had risen to 12 per cent. In dollar terms, that was a jump from US$130 billion to US$1.2 trillion. Today, China is the world’s largest market for automobiles and smartphones, consumes 40 per cent of the world’s textiles and apparel, and 38 per cent of all computers and electronics.

As with domestic consumption, so with China’s importance as a producer. McKinsey calculates that by 2017, China accounted for just under half of the world’s output of glass, cement and ceramics, textiles and apparel, and electrical machinery. It accounted for 41 per cent of computers and electronics, and even 28 per cent of automobiles. No wonder global supply chains are morphing.

This massive structural shift also means China’s reliance on exports has declined sharply. From a peak in 2005, when exports accounted for more than 20 per cent of goods produced, exports today account for less than 10 per cent. At the same time, imported intermediate goods have shrunk as a proportion of total goods output from 9 per cent to 4 per cent.

“China remains the world’s largest importer and exporter of goods,” McKinsey says. “But in relative terms, its focus on building domestic supply chains and vertically integrated industries has dampened the scope of the trading opportunities foreign companies once envisioned.”

Hence the frustration of so many western companies focused on building a market presence in China’s increasingly affluent consumer economy.

The message to Trump is clear: focusing on tariffs on goods trade may feel good politically, but targets yesterday’s challenges, not today’s. Most urgently, western companies need better access to competitive opportunities in China’s market.

Also clear is the message to Chinese President Xi Jinping: as China’s consumer economy grows, and its manufacturers become more mature and sophisticated, the justification for infant industry protection is less and less valid. If Xi is truly committed to multilateralism, the market should be opened quickly and soon – not just to American companies, but on a level playing field basis to all.

David Dodwell researches and writes about global, regional and Hong Kong challenges from a Hong Kong point of view