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Global trade and profitability

Lesson in Course: Market movements (beginner, 7min)

How does trade between countries impact an investment?

Eureka!

What it's about: Some government policies make it easier, and others make it more challenging for companies to do business abroad.

Why it's important: A trade policy can be good for some of our investments but bad for others.

Key takeaway: When trade policies change, look at how a company's ability to operate and profit internationally is affected for insight into how the stock price might change.

Global trade is the flow of goods and services between countries around the world. 

Our economies are inter-connected

Things we use every day are created by an intricate system of trade between nations. To get a sense of how important global trade has become, we only need to look at the cars on the road. 

Cars and global trade

Toyota is a Japanese corporation that produces cars, but the cars aren't made in Japan.

  • Factories in England manufacture the chassis 
  • Production in Whales fabricate the engine
  • Workers in the Czech republic create the seatbelts
  • Chinese factories provide the electronics and wiring
  • French factories provide the headlights
  • Only the tires are made in Japan. 
  • Just before we buy the car at a local dealership, it's assembled at a factory in the United States. 

While our example doesn’t include where the steel, plastics, fabrics, and rubber supplies are sourced to make these parts, it's a clear example of how global trade impacts us today.

Global supply chains keep costs low for consumers

Global trade exists due to country-specific competitive advantages. Each country produces certain goods and services exceptionally well and will trade with other nations for what it can’t make as well or as cheaply. The direction and magnitude of total imports and exports make up our economic health.

What is Exports?

Exports are goods and services that a country sells abroad. 

 Economies and the stock market benefit when countries export more than they import

What is Imports?

Imports are goods and services that a country buys from abroad.

Let's take a look at a few trade policies that impact a country's competitive advantage.

Impact of trade policies on markets

Globalization policies

Businesses have the option to buy supplies and sell goods or services in another country because of globalization. In our example, Toyota is a Japanese company that sources its parts from different countries to sell in the American markets. 

What is Globalization?

The process of businesses and organizations expanding to operate on an international scale

The countries that take advantage of globalization help their economies grow. By being open for trade and business, countries allow a foreign company like Toyota to build infrastructure and jobs where their citizens directly benefit from the circular flow of money from consumers in other countries.

Developing nations worldwide encourage multinational corporations to build factories or open offices by offering tax cuts or lower wages. Consumers worldwide benefit as companies decide to take some of their business offshore. Lower production costs mean cheaper products and increased purchasing power for everyone.

Lower costs result in increased purchases

One of the drawbacks of globalization is that it can lead to large and unequal gains and losses between countries. Even though everyone benefits from lower prices for goods, countries that export more tend to benefit more. A major part of the concern is also that the benefits of trade aren't distributed equally. In the short term, more of it flows to the businesses and wealthy rather than the workers, especially in industries with more competition abroad.

Protectionist policies

Sometimes it's more difficult for businesses to trade internationally because of protectionism. For instance, protectionist policies could make it too expensive for Toyota to sell cars in the U.S.

What is Protectionism?

An economic policy of limiting trade, specifically imports, from other countries

These policies aim to address the concerns of globalization in an effort to protect the businesses and workers in the industries that face more foreign competition. To do this, they often make imports more expensive by using policies like subsidies, tariffs, and import quotas. We see subsidies often used in agricultural industries across the U.S. to help farmers compete with countries that can produce crops at a lower cost. 

America first policies are protective

National security is another reason governments will use these policies, which significantly impact industries like aerospace, advanced electronics, and semi-conductors. Relying on foreign manufacturers would impact a country's defense during war.

What is Subsidy?

Money granted by the government to assist an industry or business so that the price of something can stay low or competitive

What is Tariff?

A tax on foreign-made goods, sometimes applied as a fixed amount for each item or as a percent of its value

What is Import quota?

A trade restriction that sets a physical limit on how much of something can be imported into a country in a given period

Changes to NAFTA

President Trump, in his term, was pro-protectionism to bring businesses back to the U.S. He renegotiated the North American Free Trade Agreement (NAFTA) between Canadian prime minister Justin Trudeau and Mexican president-elect Andrés Manuel López Obrador. Trump threatened tariffs or international taxes on Mexican and Canadian imports unless the countries revised the trade agreement. On Jan. 29, 2020, President Donald Trump signed the United States-Mexico-Canada Agreement (USMCA). The White House estimated it would create 600,000 jobs and add $235 billion to the economy. 

  • The USMCA requires auto companies to manufacture at least 75% of the car's components in Canada, Mexico, or the United States. It was 62.5% previously.
  • Canada must open up its dairy market to U.S. farmers. It will eliminate its complex pricing scheme for Class 6 and 7 products.
  • The USMCA requires Mexican trucks to meet U.S. safety standards before crossing the border.
  • Fourth, the new agreement provides more protection for patents and trademarks. This adopts many of the intellectual property rights negotiated in the Trans-Pacific Partnership abandoned by Trump.
  • U.S. drug companies can sell biological products in Canada and Mexico for up to 10 years before facing generic competition.
  • Companies can no longer use Chapter 19 of NAFTA to resolve disputes with governments. One of the few exceptions is U.S. oil companies. They are concerned Mexico may try to nationalize its oil industry again.

Impact of trade on investments

The supply chain webs created from global trade mean that changes in global trade policies impact our investments. For example, the value of Toyota stock relies on the value of that business. So, protectionist policies that increase the cost for Toyota or make it difficult for it to sell in the U.S. will hurt the company, causing the stock price to fall. However, that same policy would have a positive impact on a U.S. car manufacturer like General Motors.

Body shops would also be affected

In the case of protectionist policies, some companies may benefit in the short term until other countries retaliate with their own protectionist policies. This can lead to trade wars like the one between the U.S. and China. Protectionist tariffs from both sides have hurt domestic businesses, notably in agriculture and silicon chip manufacturing.

We often find that increased globalization positively affects the markets because it reduces costs and leads to increased spending. But, not all investments will benefit. While increased globalization improves overall growth, it can be harmful to domestic industries that aren’t as competitive as others abroad. For example, suppose we are invested in a business that produces something in the United States that can be made better for cheaper elsewhere. In that case, globalization will hurt the profitability of that business and therefore lower the value of our investment.

 

Actionable ideas

When global trade policies change, it's a good idea to stay on top of how they might impact your investments. If you own stock, ask yourself if the changes will help the business grow and become more profitable? Or, will it negatively impact its operations? Will it even affect the company at all? Answers to these questions will impact the value of the business, and therefore its stock price will rise or fall as a result.

 

Supplementary materials

Check out this short video for an overview of how global trade works
https://www.youtube.com/watch?v=HfN8BnRJryQ
Here is a helpful resource for international registration for intellectual property
Read the whole storyhttps://www.thebalance.com/intellectual-property-patents-trademarks-1201095
This article covers some pros and cons of the Trans-Pacific Partnership
https://www.thebalance.com/what-is-the-trans-pacific-partnership-3305581

Glossary

What is Competitive advantage?

Factors that allow a company or country to produce something better or cheaper than anyone else

What is Exports?

Exports are goods and services that a country sells abroad. 

What is Imports?

Imports are goods and services that a country buys from abroad.

What is Globalization?

The process of businesses and organizations expanding to operate on an international scale

What is Protectionism?

An economic policy of limiting trade, specifically imports, from other countries

What is Subsidy?

Money granted by the government to assist an industry or business so that the price of something can stay low or competitive

What is Tariff?

A tax on foreign-made goods, sometimes applied as a fixed amount for each item or as a percent of its value

What is Import quota?

A trade restriction that sets a physical limit on how much of something can be imported into a country in a given period