The Effects of Digitisation and Automation on Global Trade

The large degree of automation enabled by digitisation changes many ways of our lives. Most importantly it changes how things are being produced – ultimately, this also impacts global trade flows. This blogpost tries to anticipate how the geography of trade will change in the future.

The pattern of global trade depends on the availability and price of production factors. Since automation and digitisation are already changing the prices of the production factors involved, it is only natural that we see a change in global production patterns. While automation is capital-intensive, it reduces the impact of labour costs on the location of production. Digitisation lowers information and communication costs and makes both the capital and the labour part of production more efficient. Bearing in mind these fundamental changes, this essay makes an attempt to identify the most important drivers of production allocation for goods and services and to develop an informed guess what this will imply for global trade flows.

Economic theory has identified three factors that drive global trade flows. Bearing these in mind will help to understand the economic impact of new technologies and the implied changes to trade geography:

Proximity: One of the best predictors of trade flows is Newton’s gravity equation: The force of attraction depends on the mass of two bodies and the distance between them.[1] If one substitutes mass with economic market potential or size, continue to use physical distance and control for a few additional factors such a colonial heritage, common language, etc. and one can obtain a surprisingly accurate prediction of the trade flows (attraction) between two geographical entities, be they countries, regions or cities.
Resource availability: A share of global trade is done in raw materials, which are transported from countries where they are abundant to countries where they are scarce and in demand for consumption. Similarly, technologically highly developed goods and services might be abundant in developed countries and in demand in developing countries, thus leading to trade flows in the other direction.[2]
Comparative advantage: A country enjoys comparative advantage in the production of a certain good, if it is relatively more efficient in producing it than the other. Thus mutual trading partner can specialise in the production of what they are more efficient in producing and are both better off.[3]

In the second half of the 20^th century, important developments have taken place that changed the geography of trade flows. Lower transport costs and the dismantling of most trade restrictions through the GATT and later the WTO meant less friction in international trade. Also, technology and capital as production factors easily moved worldwide. As a result, it was no longer necessary to undertake industrial production in developed countries. Low transport costs, the transferability of technology and capital and the availability of cheap labour in developing countries meant that a substantial share of industrial production was moved away from the developed world. Around the millennium, the conventional wisdom seemed to be that developed countries need to specialise in services as they cannot compete with the low wages in the developing world for industrial production but can exploit their advantage in the skill intensive provision of services.[4]

But automation and digitisation call into question that the division of labour – low-skilled industrial production in the developing world and high-skilled services provision in “industrial” countries – is continuing in the same way as witnessed up to the millennium. Some actually forecast that industrial production is likely to return to the developed world.[5] The next section explores what these arguments are worth.

The Future of Trade in Goods

Increased Proximity of Production and Consumption

The hypothesis of ‘reindustrialisation’ of developed economies is one of the most important aspects of the changes in global production patterns. Basically, it states that industrial production is returning to the developed world: The reason for that is, that most goods can be produced by automated machines and hence labour costs are no longer decisive to determine the location of production. Instead, other factors become more important. Time to market is probably the most important one, since most of the consumption of goods takes place mostly in developed economies. Digitisation enables more specialised or personalised production – for example, the German sportswear producer Adidas offers the possibility of customised running shoes. These are being produced in an automated ‘speedfactory’ in Germany, in order to avoid weeks of shipping between the production site and the retail market.[6] Similar stories could be told about customised production of industrial intermediate products which are increasingly specified to the end user’s needs. These examples also illustrates that the new possibilities of production require a good level of physical and digital infrastructure – both more easily available in the developed world.

It is therefore likely, that industrial production will again increase in the developed world. Emerging economies might also retain some of their production for their increasingly interesting domestic markets. But the developing world is unlikely to remain a centre of production for types of goods that will be expected to be delivered timely to market in the developed world or that are susceptible to a higher degree of personalisation.

Sharper Antagonism Between ‘Smart’ and ‘Dumb’ Production

From reindustrialisation of the smart forms of production follows a growing antagonism between specialised, high-tech production discussed in the last section and unspecialised, traditional mass production. The latter is not likely to disappear completely since there will still be categories of products that need no specialisation and where time to market is not decisive. This kind of production is likely to continue in the developing world.

However, the growing antagonism between ‘smart’ and ‘dumb’ production has important economic implications. In the past, the relocation of the production of high-tech goods has also led to a substantial spill over of technical knowhow from the developed to the developing world. This source of technological catching up will no longer be available.

It would also be possible to automate the production of unsophisticated goods. However, automation is costly and requires skilled personnel for supervision and maintenance. Therefore, the production of unsophisticated goods is likely to remain labour intensive and located in the developing world but might in the long-run gradually be replaced by automated factories in the developed world, as automation in the long run can be expected become gradually cheaper and less surveillance intensive.

As a result, the trade flows from the developing to the developed world are likely to decrease in the foreseeable future. The historic opportunities for economic development that the relocation of industrial production has provided are likely to diminish for developing countries intending to use this road of development in the future.

Easier Retail Strategies

Online retail platforms such as Amazon or Alibaba have an important effect of trade. Presently, only a tiny fraction of companies participates in trade with foreign countries. In 2014, 304,000 out of the roughly 7 million firms in the USA exported goods.[7] Statistics for other countries are similar. The reason why only a tiny percentage of firms engages in international trade is that it requires a considerable effort to deal with authorities in the export market, conform to regulations, build a retail network, etc. The emergence of online retail platforms alleviate some of these thresholds to trade, since the need to build up their own retail network abroad, hire staff, etc. no longer exists – it is sufficient to create an account and trade through the platform. This implies that trade through these platforms – and therefore trade flows in general – are likely to increase, as is the number of firms engaging in international trade and the number of productions available to consumers. Increased competition and transparency is also going to result in lower prices which will benefit the consumers. Precondition for successful participation in online retail platforms is – again – a suitable physical and digital infrastructure.

The Role of 3-D Printing

The most disruptive effect on international trade could however result from the widespread use of 3-D printing. 3-D printing is a process in which material is layered up in an automated process until a 3-D structure emerges. This process has first been developed in the 1980s and has since evolved rapidly. 3-D printers are now capable of working with multiple materials such as plastic, concrete or even metal. With 3-D printers becoming increasingly efficient and capable of working with multiple materials, a world would be imaginable where consumers simply download printing plans and print their products on their own printers at home. Except for raw materials and a few non-printable goods, there would hardly be the need for any trade.

The view of this chapter is, however, that this is unlikely to happen in the foreseeable future, if at all. Due to the economies of scale of standardised production – potentially with customisation elements – 3-D printers will be less cost efficient than automated mass production.

That is however not to say that there will be no role for 3-D printing. 3-D printing will play a huge role for goods produced in batch numbers of small n and for goods with a particularly high degree of customisation. In these areas, they are likely to prove more efficient than other means of production. In addition, 3-D printing can play a huge role in the production of spare parts or in remote places where delivery wood take too long.

3-D printing has a negative effect on the volume of trade flows. How large this effect actually is and when it will fully materialise is presently impossible to answer.

The Future of Trade in Services

The conventional wisdom was that most services are globalisation-proof. Since services typically require geographic proximity, it is harder to take advantage of cheaper factor prices elsewhere. While a haircut in Mexico City is certainly cheaper than in New York, nobody would fly in a Mexican barber or visit him down there. For haircuts, this largely remains true. But digitisation has allowed some services to be performed at a location at large geographic distance from where they are commissioned. It was more than a decade ago, that financial firms began to outsource their accounting activities to an Indian subcontractors. This is an example that most business services can indeed be globalised due to improved communication and information sharing via the internet.

It makes sense to distinguish between digitally tradable services – which includes most business services – and services that are not digitally tradable. With the latter, no much is going to change – unless these services lend themselves to automation (imagine a robo-barber). But digitally tradable services – accounting, research and development, legal services – will come under stronger competition as it is technically possible to outsource them to low-cost countries. This can be an important source of economic growth for developing and emerging economies, provided they have strong digital infrastructure and human capital. It is however important to note, that there are strong legal protections of some services, as well as other barriers to services trade. This becomes particularly apparent in the area of legal services which remain in many areas protected by enshrined requirements – both against outsourcing and automation. Most importantly, these are entry requirements for the legal profession and personal liability that may be unlikely to be conferred to machines. While many legal services could in fact be automated or outsourced, requirements that these services be carried out by a human being in a given country protect legal professionals. Still, especially in the English speaking world, due to the linguistic and legal heritage of colonialism, competition for legal services is likely to increase substantially once the barriers to trade are being relaxed.

While for a long term the expectation was that services would not be traded globally on a significant scale, we know now that this is no longer due. The net flows of trade in services are likely to go from the developing world to the developed world, as there is a large availability of human capital at low cost there. This is likely to put well-remunerated professions under pressure that have not yet felt the rising global competition. The globalisation of industrial production has put the traditional working classes in the developed world under pressure. Now this pressure will reach the middle and even upper classes. However, it also provides anyone with important opportunities as they too have access to a much larger market as services can potentially be offered worldwide. As we know from manufacturing, it remains possible to sell high-quality products for a high price in a global economy. The same might apply to services.

Conclusion

This chapter attempted to identify the most important drivers of trade flows in the future. Almost everything described here is already happening but likely to gain further traction of the next decade or more. What would trade look like in 2030? Here is an attempt to characterise the main developments:

Developed countries will re-industrialise by bringing the production of high-tech production and highly customised production back, in order to be able to provide them to the market more timely. These plants are however likely to be almost completely automated. There might be a positive effect on jobs growth due to the need of maintenance and surveillance of these production plants.
Through online trading platforms more firms will be able to participate in international trade and sell their products to a larger market. Consumers have access to more products which are subject to more intense price competition.
Trade in services, especially business services, will become more global and more competitive. Relaxing non-tariff barriers to services provision will become an important subject in international trade negotiations. Emerging and developing economies can use services trade to compensate for the loss in high-tech production, provided they have sufficiently well-developed human capital and a digital infrastructure.

What does this mean for international trade flows? Trade in raw materials is likely to increase but trade in manufactured goods likely to decline. Trade in services will increase, and the share of emerging economies in this kind of trade will increase. Of course, the amount of exchanged data will increase with trade in services. Should 3-D printing become a widely used production technology, this will further amplify the above described tendencies.

[1] A gravity model was first employed (Tinbergen 1962) in order to explain international trade flows.

[2] Factor endowments drive trade flows through exogenously determining comparative advantage in the widely used trade model by (Ohlin 1967)

[3] The concept of comparative was first forwarded by (Ricardo 1817)

[4] A nice illustration of this thinking is (OECD 2000) which argued: “There is considerable variation across OECD countries in the extent to which they have experienced rapid development of high-growth service industries. This, in turn, has been influenced by major differences in underlying policy conditions. In the United States, there has been extensive restructuring of existing firms which have reorganised their activities around their core competencies and outsourced a wide range of service-related activities, as well as numerous start-ups of service companies.” (p. 4)

[5] E.g. (Shih 2013)

[6] (rtr 2016)

[7] Department of Commerce, 2016

Literature

Department of Commerce – International Trade Administration. “US Export Fact Sheet.” Washington DC, 2016.

OECD. The Service Economy. Paris: OECD, 2000.

Ohlin, Bertil. “Interregional and International Trade.” Harvard Economic Studies, 1967.

Ricardo, David. On The Principles of Political Economy and Taxation. London: John Murray, 1817.

rtr. “Produktion stückweise wieder “Made in Germany”.” Wirtschaftswoche, 24 05 2016.

Shih, Willy. “The Re-Industrialization of the United States?” Wirtschaftspolitische Blätter, 2013: 297-312.

Tinbergen, Jan. Shaping the World Economy: Suggestions for an International Economic Policy. New York: The Twentieth Century Fund, 1962.