Dec 15 2020
As I mentioned in my previous newsletters (check out part 1 and part 2 if you haven't already), there is much more to untangle on the growth and globalization of service trade. My objective is to identify opportunities during this prolonged period of COVID-19 entropy, not simply chart a course away from the obvious risks.
You will notice that I reference a few reports (all available in public domain) throughout this installment. I lean on these quite heavily, and if you are serious about business potential, I suggest that you take a look at them. Some are quite long and detailed but well-indexed. I understand digesting this material can be tedious, but success does not come without effort.
And no worries, I am not running adrift of exuding my own perspectives. I’m just stirring the pot and grappling to make sense of the many pieces of the puzzle scattered before us ... a grain of salt is required.
Beware! Official Data is Often Misleading
There are a variety of shortcomings in the collection and processing of international trade data – here’s a good summary.
A key issue has to do with the supply chain involved in the manufacture and shipment of tradable goods. Consider Apple’s iPhone …
The most valuable components that comprise an iPhone, the touch-screen display, memory chips, and microprocessors, are designed and manufactured by companies from America, Japan, Germany, and Korea, by companies like Intel, Sony, and Samsung.
Apple buys the components and ships them to China for assembly, with very little local value-add there. The factories that assemble iPhones are owned by companies based in Taiwan and include the behemoth Foxconn. The actual value-chain contribution by China is less than 5% according to several estimates, although the entire cost of the device is booked as China’s imports to the US and exaggerates the trade imbalance! China gets heaps of low-paying jobs, while the profits flow to other countries.
In short, with many products, particularly high-tech, merchandise trade data can be easily misconstrued since basic value-add principles are often not applied. This can lead to poor business decisions.
Plus, broad targeted tariff policies can be counterproductive by harming, not supporting, national interests, such as home-country employment and profits.
Statisticians also face numerous challenges in classifying and measuring international trade in services. Often, the distinction between a good and a service is vague. The digital streaming of a film from a platform based in another country is counted as trade in services, whereas a film stored on an imported DVD is considered trade in goods.
So, if your organization is internationally exposed, the devil is indeed in the details. The concept of value-added, locations of production, and ultimate end-markets need to be assessed.
Understanding the Fundamentals of International Service Trade
For those of you interested, I recommend looking at the World Trade Organization’s 2019 annual Trade report, “The Future of Trade in Services.” This relies on an experimental dataset, developed by the WTO, called Trade in Services by Modes of Supply (TISMOS). Great stuff.
This dataset captures services supplied through the four modes of supply categorized in the WTO General Agreement on Trade in Services. The report defines, with excellent examples, these four modes:
Mode 1 Cross-Border Supply: Where services are supplied from one country to another nation, when neither a consumer nor a producer leaves their domicile and only the service itself crosses a border. Examples include services provided by phone, fax, or electronic means, such as medical diagnosis, legal advice, financial services, reports, video, or other digital media. This resembles goods trade where, in these examples, “shipment” is telephonic or via the internet rather than cargo vessels.
Mode 2 Consumption Abroad: Where services are provided within a country to a consumer that is a resident of another nation. For example, persons traveling to another country and consume services locally, like spending at theatres, restaurants, or for medical treatment. Students educated abroad are another example. Mode 2 also covers instances where the services are related to the property of the consumer while overseas (think of ship repair). Obviously, in this mode many subsegments are devoid of hard data, indicating that WTO estimates are clearly in play. If you have not guessed, tourism accounts for more than 60% of the value in mode 2.
Mode 3 Commercial Presence: These define services supplied through a physical commercial presence in another country. It often involves creating an affiliate company in a foreign country to serve the local market. A noteworthy example is a foreign bank setting up operations overseas. This can also be related to a sourcing out of manufacturing when service industry support is integral.
Mode 4 Presence of Natural Persons: These are services supplied by individuals of a country through temporary residence in another. Examples include computer services companies stationing employees in another country or a consultancy traveling abroad to provide advisory services to foreign clients.
So, what segments are most prevalent? Check out Figure 1. Does this surprise you?
Figure 1: Commercial Presence and Cross Border Supply Dominate
Source: WTO 2019 Report
A few observations:
Mode 1 is benefiting from the digital revolution. No stopping this train; just a question of who can win the global tech-war or what a geopolitical truce might look like (more in later chapters).
Mode 2 has been thriving largely owing to global tourism, with obvious COVID-19 setbacks, but a post-COVID-19 recovery is percolating. The principal demographic catalyst is aging populations in wealthy nations, that include travel-loving vacationers.
Mode 3 is old school, with corporate affiliates establishing a physical commercial presence offshore. Recall my discussion of foreign direct investment from my last newsletter. Global politics and national sovereignty/security issues will determine the path going forward. (Stay tuned for future episodes.)
Mode 4 is small and fragmented. If there are niche opportunities here, they are out of my radar screen.
Service Trade Trends, Opportunities and Risks
According to TISMOS, global trade in commercial services totaled US$13.3 trillion in 2017, the latest year data was available. As a result of the pandemic, the peak-to-trough world trade in services is estimated to have plummeted by 23% by mid-2020.
Particularly beleaguered are modes 2 and 4 that are heavily reliant on international travel. Nonetheless, service trade has grown at an average yearly rate of 5.4% during the 2005-2017 period, significantly swifter than the 4.6% annual clip reported for goods trade.
As the service industry is expected to flourish worldwide in coming years, there are clearly business opportunities on the horizon.
From a sectoral viewpoint, trade in distribution services (wholesale and retail) dominate, but as a mature industry, its annual growth rate, although healthy, is comparatively slow as depicted in Figures 2 and 3. Walmart’s international presence is an example. By the way, I gave a seminar at their Bentonville, Arkansas headquarters a few years back. Interesting place.
The financial service sector is the second most prominent, dedicated to lubricating the global flow of goods and service trade. The ongoing maturation of developing economies suggest that robust growth will continue.
Cross border regulatory risks, an ongoing tug-of-war, concern me. This has as much to do with foreign portfolio investment than foreign direct investment; the former being mostly involved in equity/bond markets with the later encompassing stuff like establishing a physical presence overseas akin to building factories. Again, more on this in future episodes.
Both world trade in financial services and distribution services result via an overseas commercial presence, or mode 3 as defined above. But with the palpable drift towards e-finance and e-commerce, we should expect migration from mode 3 to mode 1, cross-border supply. Keep this in mind.
Telecommunications, Computer, and Audio-Visual
Not far behind are the telecommunications, computer, and audio-visual cluster. This fast-growing sector will likely overtake distribution and financial sector service trade at some junction. This broad sector employs many STEM (science, technology, engineering, and math) workers so herein lie opportunities for training and education and risks associated with falling behind the curve. I will delve deeper in this arena in forthcoming newsletters since many sensitive issues are brewing in the world of geopolitics.
Transportation and Tourism
Rounding out the top-five are transportation and tourism. These are closely linked with the movement of goods, services, and people. Although the pandemic has encumbered these sectors, hope has rekindled considering substantial progress on COVID-19 vaccines.
Figure 2: Distribution, Financial and High-Tech Service Trade Lead the Way
Source: WTO 2019 Report
Figure 3: Strong Growth Reported for Top Service Sectors
Source: WTO 2019 Report
Finally, of the other interesting sectors I identified while exploring the WTO data, many are STEM-related. Most are comparatively small but growing. Niches of opportunities!
Several caught my eye: professional, intellectual property-related, research and development, and healthcare services.
Where We Are Going from Here?
There is much more of this tapestry to triangulate. Geopolitics, including the possible reemergence of trading blocs that encompass national security issues; supply chain (global value chain) matters; and the related fate and future of multilateral trade agreements.
It is all about business opportunities and assessing risks.
Happy Holidays! See you in the New Year.