When macroeconomics and global supply chains collide

Global trade and its many supply chains are continually subject to shifts in economic conditions, geopolitical regimes, and demographics. Anticipating these changes is essential for companies that depend on their supply chains to adapt and thrive. Several global macroeconomic and demographic trends have emerged recently that are affecting trade flows and have the potential to disrupt those supply chains.

Chief among them is the slowdown of emerging market growth. A number of emerging markets have experienced a rapid deterioration in their economic performance over the last few years. There are four reasons for this slowdown. First, the hyper-globalization of the last 20 years is over, replaced by a more modest and perhaps sustainable growth path. Second, the related surge in commodity prices, known as the commodity super cycle, has come to an end for now. Third, emerging markets no longer have access to credit at historically low rates. And fourth, global trade liberalization has not made much progress recently.

As a consequence, life for supply chain executives is becoming more complicated. Easy opportunities for cost savings in sourcing materials and labor, and rapid growth in new emerging markets, are harder to come by. Growth will be more incremental in the future and depend on closely monitoring economic and political trends to identify new sourcing and demand opportunities.

The emerging market slowdown

Much has been made of the extraordinary growth of emerging markets-in particular, the BRIC countries (Brazil, Russia, India, and China) during the 2000s-as US and European companies en masse moved manufacturing operations overseas. But during these boom years, many emerging markets failed to institute the necessary structural reforms that would enable them to transition to a slower but more sustainable and stable pace of economic growth.

China is still maintaining relatively strong growth-last year real GDP growth was 7.7% and this year it is projected to be approximately 7.5%-but Brazil, Russia, and India have all entered economic slowdowns. Russia is closely tied to the ups and downs of oil markets and now is being impacted by Western sanctions. India faces a much slower GDP growth rate due to declining fixed investment and factor productivity. Brazil's real GDP growth for 2013 was just 2.5%. The country slipped into recession in the first half of 2014 due to declining investment, the end of the commodity super cycle, and a slowdown in private sector consumption.

As the pace of growth slows for these economies, the biggest impact is felt by the new middle class and the still high number of households living in poverty, which devote a significant proportion of their income to food, housing, and other daily necessities.

India's annual GDP per capita is about $1,500, compared to $6,800 in China and $54,000 in the US. As a result, a national economic slowdown would have a greater impact on the average Indian family's quality of life than the average American or even Chinese family. As growth slows in countries with low personal income per household or low GDP per capita, it feels like a recession.

The result is slowing demand growth for non-essential consumer goods, which will likely continue and perhaps worsen if structural changes are not addressed. If global companies fail to understand the causes of the slowdown in emerging markets and do not correctly forecast the implications, it will adversely impact their businesses. For frontline companies serving these markets, that means a hit to sales and an increase in finished goods inventory.

Further up the supply chain-distributors, wholesalers, manufacturers, and component and materials suppliers-the consequences can be amplified, a phenomenon commonly referred to as the "bull-whip effect." That is, as the shock wave of the slowdown ripples back through the supply chain, the impact on sales, inventory, and manufacturing operations grows.

Western markets struggling

Developed markets are struggling in their own ways. Real GDP growth in the US averaged 3.2% annually between 1980 and 2007. Since the end of the Great Recession in June 2009, the recovery has been anemic, with real GDP growth averaging just 2.2% annually. As a consequence, real median household income has been flat for two years and is now 8% below the 2007 level.

In the European Union, the recovery has been hampered by the two-tiered growth performance of the northern and southern countries. The north is relatively stable economically, while the south is slowly digging out of a deep economic hole. Income inequality between the two tiers is rising.

Declining real median household income, elevated poverty rates, and the rise of income inequality in both the US and Europe have caused a bifurcation of consumer spending patterns. Luxury and discount stores are doing well, while the middle-tier retailers are having a hard time regaining traction.

The combination of the slowdown in emerging markets and stagnation of US and Western European economic performance has slowed world trade growth. While IHS expects global real GDP growth to accelerate in 2014 and 2015, globalization-defined as the share of world imports as a percentage of global GDP-is not expected to follow suit. Instead, globalization will hover around 30%, where it has been since 2010 (see figure below).

Supply and demand balancing

In 2014, China's GDP is expected to represent 13% of global GDP, while the US will account for almost a quarter. However, by 2024 China and the US are likely to be even at about 20% each, which is expected to balance global production more uniformly between East and West.

It is likely that US consumers will still claim the highest percentage share of global consumption for the next few years, but emerging market consumers are closing the gap. The rise of China's consumer class is likely to propel its economy to a much greater share of global consumption over the next six to eight years, fueled by accumulating wealth and an increasing number of middle-income households. In fact, IHS expects consumption in the BRICs to surpass Western Europe by 2019 and the US by 2020.

On a per capita basis, China and other emerging markets have a long way to go to catch up with the advanced economies, but the signs of their increasing influence are clear. In 2004, Chinese consumers were responsible for only 4% of global consumer spending. By 2014, they are likely to account for 8% and, by 2024, 15%. This means that the Chinese consumer's share of global private consumption will have increased by nearly a factor of four in two decades.

By contrast, American consumer spending is expected to decline from 33% of global GDP in 2004 to 28% in 2014 and to less than 20% a decade later. Consumer spending in Western Europe peaked in 2004 at nearly 18% and continues to decline. IHS predicts that by 2020, US and Western European consumer spending combined will account for only 24% of world GDP, down considerably from 38% in 2002. As the disparity in production and consumption between emerging markets and the West diminishes, these levels will come into relative balance (see figure below).

These changing international trade, production, and consumption patterns have several implications for global supply chain managers. First, the relative decrease in the US consumer's importance to global trade will serve to reduce production volatility. As global producers become less reliant on one market, they will be able to spread market risk around the world in a more balanced way.

Second, the major trading blocs are becoming increasingly connected and their performance correlated. As retailers struggle for market share in the West, the growth of the middle classes in China and India has also slowed. A strategy that considers relative growth opportunities across multiple markets will enable global corporations to maximize their market opportunities.

Evidence of the relative importance of emerging markets abounds. Some computer manufacturers launch their products in emerging markets before the US. Some American automobile manufacturers have been introducing new models in Asia before they hit the US market. Even Hollywood has responded to the production and consumption balancing by releasing some films in emerging markets prior to their US launch. Demography has spoken

In the late 1970s and early 1980s, many demographers and economists were asking whether it would be possible to prevent the world's population from reaching 25 billion by the end of the 21st century. Current estimates now project a world population of around 10 billion by 2050 with little increase thereafter. This slowing of the world's population growth will lead to an uneven slowing in the global economy.

The reason for the population growth slowdown is falling fertility rates. Globally, women and families are choosing to have fewer children than in the past. This is because as a country urbanizes and industrializes, the need for large families to work the farm decreases. Approximately 70% of all nations have child-bearing rates below or approaching the replacement level in developed countries of 2.1 children per woman. Coupled with longer life expectancies, this effect is turning the traditional population pyramid on its head.

Some regions are seeing a particularly strong aging effect (see figure below). In China, for example, the one-child policy, coupled with increasing urbanization, has taken a toll on population growth. In Japan, the working-age population has started to shrink because of the aging of the overall population. Since 2006, the number of deaths in Japan has outpaced the number of births. And in Central and Eastern Europe, population growth rates are close to 0% and expected to remain there for the foreseeable future.

Declining population growth and increased urbanization have implications for trade and supply chains as well. Increasing levels of urbanization and the emergence of megacities will require increased productivity of the food supply chain. They will also necessitate improvements in both intra- and inter-city logistics. This effect is pronounced in China, where increased urbanization and an aging population combine with a large and growing middle class. In most developed countries, urbanization stabilized last century, but emerging markets are catching up. The global urbanization rate surpassed 50% sometime between 2000 and 2004 (see figures below).

Who's next?

Nations that show promise in terms of their end-use or sourcing potential are emerging. Chief among the contenders are Mexico and Vietnam. Mexico's increased competitiveness is helping the country regain its share of US imports at China's expense. In 2001, China's entry into the WTO caused a major shift in trade as China quickly outpaced Mexico in exports to the US. Between 2001 and 2005, Mexico's share of US imports of manufactured goods fell from 12.1% to 10.4%, while China's share rose from 11% to 19.2%. But Mexico staged a comeback in 2005. By 2009, China's share of US manufactured goods imports leveled off at around 26%, while Mexico's share grew to 13% by 2013.

There are several reasons for Mexico's rebound. First and foremost is its proximity to the US. The relatively stronger US recovery after the Great Recession benefited Mexico disproportionately. The relatively high cost of ocean shipping compared to that of an improved north-south transportation infrastructure between the US and Mexico was a contributing factor as well.

Mexico's diligent observance of the principles of the 1992 North American Free Trade Agreement (NAFTA) and its adherence to international standards of intellectual property rights have also been factors. And as China's middle class grows, wage inflation in its manufacturing sector is outpacing that of many competing emerging markets, including Mexico.

China can no longer boast the same cost advantages that allowed it to become a dominant player in global manufacturing. Not only are labor costs rising, but there is growing concern about broader macroeconomic and political risks, such as civil instability, shadow banking, a real estate bubble, and military adventurism. These factors have ignited a reassessment by Western companies of their reliance on China.

This concern is helping to drive growth in Vietnam, China's southern neighbor. The country has been a member of the WTO since 2007 and its manufacturing wages are roughly half those paid in China. These advantages have triggered a recent surge in manufacturing foreign direct investment and led to a tenfold increase in the value of Vietnam's merchandise exports since 2000, with shipments in 2014 expected to hit $150 billion.

The African continent, and especially the sub-Saharan region, has been another surprise winner as demographics shift. Improving social and economic fundamentals in many African nations have placed the continent on many multinationals' radar screens. IHS forecasts that between 2013 and 2017, sub-Saharan African economies are likely to outpace every major regional economic bloc except China in real GDP growth and projects that the region will lead the world in population growth.

All the social metrics are pointing in the right direction for Africa. Improving health outcomes and strengthening civil society are responsible for an improving development picture. HIV infections and infant mortality rates are falling, while life expectancies and enrollment rates for primary school all the way through college are on the rise. From the late 1980s to the early 1990s, few African nations were considered a democracy; today, the vast majority of the 55 African states enjoy some form of multi-party democracy.

The long arc of changing global production and consumption patterns should have generally positive implications for global supply chains. On the consumption side of the equation, a more regionally balanced demand for goods around the world reduces dependence on any one market and lowers overall supply chain risk. Likewise, on the production side, the emergence of viable regional manufacturing centers-in Asia, the Americas, Africa, and elsewhere-will distribute and perhaps minimize the risks for downstream manufacturers, distributors, suppliers, and other members of the global supply chain.

Jr. Chris G. Christopher Director of US Macroeconomics and Global Consumer Markets, IHS Economics
Connect with Chris on LinkedIn

David Deull , US economist, IHS Economics
Connect with David on LinkedIn