Is a greater focus on diversification benefiting world trade?

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Efforts to diversify world trade have been a key area of focus for world leaders at the recent G7 summit. How are such initiatives likely to affect world trade?

Diversification of global trade and supply chains has become a hot topic in recent years. Following a series of economic shocks, from the COVID-19 pandemic shutting down major production centers in China to the Ukraine war illustrating how dependent some countries were on Russian oil and gas for their energy requirements, the need for businesses to have alternative plans in place has become clearer than ever.

This hasn't always been easy to do. For example, one study by McKinsey earlier this year found more than 40 percent of global trade goods rely on three or fewer exporting countries. However, steps are now being made to remedy these issues and build greater security into global supply chains. So what progress is being made and how is it affecting world trade?

WTO highlights importance of diversification

The issue of diversification was on the agenda at the recent G7 summit in Japan, where director-general of the World Trade Organization (WTO) Ngozi Okonjo-Iweala was in attendance. In an interview with CNBC on the sidelines of the event, she stressed the importance of resilience and ensuring the globe is not overly reliant on a limited number of suppliers for key goods. 

Among the industries Ms Okonjo-Iweala highlighted were the pharmaceuticals and high-tech manufacturing sectors. Bottlenecks in these industries in recent years have created major problems, such as a shortage of semiconductors that has had knock-on effects on sectors such as auto manufacturing and difficulties getting COVID-19 vaccines around the world due to export restrictions.

The WTO director-general suggested one way to tackle this would be to focus on building supply chains in developing countries, which would also have the effect of boosting economic growth in these regions.

"Let's reglobalize by situating diversifying industries in these countries," she stated. "We kill two birds with one stone. One is we build global resilience beyond just our neighbors and our friends, because you never know who is your friend. Your friend today [may not be] your friend tomorrow."

G7 leaders look to reduce dependence on China

Several countries have expressed worries about an increasing trend towards protectionism in recent years. For example, the US' Inflation Reduction Act offers major subsidiaries to domestic makers of electric vehicles, which has caused major concern in the EU and led to countermeasures to protect their own industries.

However, one area of agreement among the G7 members in Japan was that steps must be taken to reduce dependence on China. In two official statements, the leaders condemned the "weaponization of economic vulnerabilities" such as Beijing adding trade sanctions to countries it has political disagreements with, and called for the "de-risking" of supply chains.

This follows warnings last month from the Australian government, which has been one of the nations affected by increased tariffs on exports to China. Speaking to Sky News in April, foreign minister Penny Wong urged businesses to look for other sources of goods. She stated: "Making sure we do diversify our export markets is an important part of our national resilience. The government will continue to encourage that because we want to make sure we have diversified export markets."

Among the pledges made at the G7 Summit were efforts to strengthen supply chains for important goods such as minerals and semiconductors, as well as implement multilateral export controls. This would involve nations working together to ensure key technologies, used in military and intelligence, do not end up in the hands of "malicious actors".

New report highlights move towards diversification

While such moves will require a long-term approach, it has already been suggested that moves to increase diversity in global trade are having an impact. For instance, one recent report from ING noted many countries have sought to do this in order to tackle supply chain blockages in recent years - though this is more prevalent in some regions than others.

The report stated: "The US is the main diversification force at the moment. American imports are now a lot more diversified than they were in 2016 and this is mainly driven by a clear trend towards a lower dependency on China for imports."

Europe, meanwhile, remains close to its peak in terms of reliance on China for its imports. However, ING also noted that the diversification trend is likely to accelerate in the EU as well in the coming years due to continued geopolitical concerts, and increased trade barriers with some traditional partners.

These efforts are already having an effect when it comes to easing supply chain pressures, which reached their highest levels in 2021 and 2022. While a drop in demand for goods and increased production capacity have also helped contribute, the report forecast that unless there is another pandemic-sized disruption, the efforts made to boost resilience should help ensure there is no return to the difficulties faced in recent years.