While experts have been predicting a shift away from global trade towards more regionalized patterns, recent data suggest a more skeptical take is in order: An analysis of trade data based on four different regional definition shows a clear trend toward less regionalized trade between 2003 and 2012, and no consistent trend in more recent years. Since 2004, trade flows have generally stretched over longer distances, a trend that increased during the pandemic. Looking forward, while geopolitical tensions, technological trends, and environmental concerns all have the potential to contribute to an increase in trade regionalization, other forces, such as decreased container shipping costs and the ongoing improvement of technologies that ease long-distance transactions, will continue to favor long-distance trade. When deciding whether to regionalize, leaders should focus on the economic fundamentals that have always guided such decisions.
For more than a decade, experts have been predicting a shift to more regionalized trade patterns, as companies adopt nearshoring strategies to produce goods closer to the markets where they will be sold. Many expected Covid-19 to turbocharge this trend.
But recent data suggests a more skeptical take on trade regionalization. Trade flows have stretched out over longer distances, even during the pandemic. While trade regionalization may increase moving forward, we wouldn’t bet on a transformational shift from global to regional business.
The Elusive Evidence of Rising Regionalization
In our DHL Global Connectedness Index 2021 Update report, we track the percentage of world merchandise trade taking place within regions using four different regional definitions: one each from the World Trade Organization (WTO) and United Nations (UN), as well as by continent and within the three macro-regions of Asia-Pacific, EMEA (Europe, Middle East, and Africa), and the Americas.
While there was a clear trend toward less regionalized trade between 2003 and 2012, no consistent trend appears in more recent years. When we use the WTO’s definition, which divides the world into seven regions, we do find an increase in regional trade between 2012 and 2016. But that trend ended in 2016. And if we divide the world up using the other three regional definitions, the rising trend disappears entirely.
Since all region definitions involve subjective judgments, we prefer to focus on a more objective measure of shifts in global trade patterns: the average distance traversed by all trade flows around the world.
If there really was a robust shift toward regionalization, one would expect trade, on average, to take place over shorter distances. But our analysis for the DHL Global Connectedness Index found that trade flows have actually stretched out over longer distances since 2004, albeit with a pause between 2012 and 2018.
The Pandemic Increased Long-Distance Trade
Trade has even traversed longer distances during the Covid-19 pandemic, despite expectations that disruptions would force greater reliance on nearby suppliers. This is because exports grew strongly in Asia to meet growing demand for imported goods in many parts of the world. Therefore, countries far away from Asia imported over longer distances, while countries within Asia itself imported over shorter distances. This overall shift to more long-distance trade advanced even as some buyers did switch to closer suppliers, especially for time-sensitive products. While disruptions to long-distance trade dominated the headlines, short-distance trade was also hampered by pandemic-induced capacity bottlenecks and labor shortages.
The fact that long-distance trade grew more during the pandemic than short-distance trade raises questions about the role of regionalization in strategies for reducing supply-chain risk. Nearshoring and regionalization have many attractions, and they can increase resilience via shorter transit times and reduced cross-region interdependencies.
But long-distance trade can also contribute to resilience. Long-distance trade boosts specialization and scale economies, and there is some evidence that producers were able to ramp up exports faster during the pandemic in countries that supply a large share of global demand for their products.
Regionalization in the Long Run?
Looking forward, geopolitical tensions, technological trends, and environmental concerns all have the potential to contribute to an increase in trade regionalization. So could new trade blocs such as the Regional Comprehensive Economic Partnership (in the Asia-Pacific region) and the African Continental Free Trade Area. And pandemic-induced supply-chain regionalization might gather pace in the coming years, since major reconfigurations take time to execute.
Nonetheless, other forces will continue to favor long-distance trade. These include container shipping costs eventually coming down to more normal levels, the growing share of emerging economies in global trade (they tend to trade over longer distances), and the ongoing improvement of technologies that ease long-distance transactions.
Waning business interest in regionalization, after a spike at the beginning of the pandemic, also reinforces the sense that predictions of a major increase in regional trade could fail to materialize. In an April 2020 survey, 83% of executives said their companies planned on nearshoring to regionalize their supply chains. When the same survey was repeated in March-April 2021, only 23% still said they were planning on nearshoring. Another set of surveys shows that companies have backed off from regionalization and nearshoring plans and instead have embraced other ways of increasing supply chain resilience, such as boosting inventory levels and dual-sourcing raw materials.
The war in Ukraine has given another boost to business interest in regionalization. However, many of the war’s effects, so far, have favored long-distance trade. The European Union, for example, is boosting energy imports from more distant countries to reduce its dependence on Russia. Meanwhile, Russia is trading more with Asia instead of Europe, despite the greater distance from Russia’s major population centers.
The potential for large increases in trade regionalization is also constrained by the fact that trade is already quite regionalized. Using most regional definitions, more than half of world trade happens inside regions, roughly three times the proportion one would expect in a “frictionless” world where distance and cross-country differences did not affect trade patterns. Surprisingly, transportation costs explain less than 30% of the dampening effect of distance on trade. Preferences for similar products in neighboring countries, regional trade agreements, and many other similarities and linkages among proximate countries have long boosted short-distance trade.
Should Your Company Embrace Regionalization?
The main implication of this analysis is that leaders should be skeptical about the assumption that a major regionalization wave is under way. If your company is contemplating regionalization because you expect your customers or suppliers to embrace regional strategies, take a careful look at what actual commitments they are making, since the rhetoric about regionalization may have gotten ahead of the reality.
Ultimately, the main drivers of whether or not a company should regionalize should be the economic fundamentals that have always guided such decisions, most importantly demand patterns and production costs/capabilities.
What is new is the extent to which companies should factor geopolitical tensions into their thinking. The nearshoring trend may fall short of expectations, but what many are starting to call friendshoring or allyshoring could become increasingly important in strategically sensitive industries.
Be especially careful of any supply-chain reconfigurations that could lock in a higher cost structure for your company. Without sustained government support, a company that significantly increases its cost base risks losing business to more efficient competitors. And while the pandemic and the war in Ukraine have put a spotlight on the need for resilience, they have also contributed to a large rise in inflation and strained government budgets. This implies that substantial policy support for relocating supply chains will be limited to the most politically sensitive product categories. Rising pressure to reduce costs will require companies to look near and far for the most efficient and reliable production and sourcing locations.