Many countries have begun to think about trade diversification. After all, one of the reasons for Brexit was to allow the UK to trade more freely with the world other than the EU. This is partly because policy makers are raising concerns regarding the risks, largely political, arising from overly concentrating trade and investment on a small number of trading partners. We argue that trade in services may offer better opportunities for trade diversification than traditional trade in goods. However, we posit that facilitating trade in services not only requires supportive regulation, but more importantly strong global cities that serve as hubs for international services trade.

Canada represents an interesting example of our argument. In recent years, the country has expressed interest in reducing its dependence on trade with the US. Reflecting the priority attached to this goal of trade diversification, Canada has now appointed a Minister of International Trade Diversification and is pursuing trade agreements with more distant partners, including the Comprehensive Economic and Trade Agreement (CETA) between Canada and the European Union (EU), and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) between Canada and 10 other countries in the Asia-Pacific region.

Indeed, the various countries that have ratified the CPTPP have stated as one objective the ambition to develop diverse and more distant trade and investment partners in the face of the rise of China, and the possibility of becoming overly dependent on that market. These activities parallel the UK efforts to geographically diversify its trading partners as a consequence of Brexit. Trade Secretary Liam Fox interprets his remit as identifying and ultimately signing new trade deals, and in 2017 suggested that the British government will immediately agree 40 free trade deals with other non-EU countries the minute Britain leaves the European Union.

An implicit assumption underlying these actions is that distance is now less of a barrier to trade, a phenomenon which has favoured the concentration of trade to close neighbours, because technology has lowered transportation and communication costs, and that trade deals can overcome the remaining costs of distance.

But is this entirely true? Can nations move away from their traditional trading partnerships – typically based on geographic proximity – in favour of new nations located further afield? Our research grappled with these considerations of proximity and distance in matters of trade, particularly as they pertain to Canada and the UK.

Our Canada-UK collaboration – comprising researchers from the LSE and Simon Fraser University’s Beedie School of Business – surveyed recent academic and practitioner data and publications on trade and foreign direct investment (FDI) flows in order to assess the role of distance. We conclude that if you are trading in goods, physical distance still matters. Moreover, the evidence suggests that trade agreements between distant countries may not be sufficient to offset the costs of distance.

This isn’t true for all forms of distant trade, however. Our research findings showed a very different result for trade in services. Services trade includes a list of heterogeneous direct activities such as professional business services, education and tourism, but also includes indirect trade in services resulting from services such as research and design that are embedded in final products or are traded within companies. Indirect trade in services has increased over time, as global value chains (GVCs) have become more dispersed. One example is the global dispersion of research activities by multinational firms. When Google creates a tech hub in Toronto, it effectively exports that knowledge to other Google subsidiaries around the world. Distance matters less for the global movement of these services, particularly when they are knowledge-intensive and digital. Thus, it is not surprising that evidence suggests that trade in services, direct and indirect, is growing faster than trade in goods.

Although it is true that trade in services is less affected by geographic distance, there is evidence that it is more affected by other measures of distance. International business scholars have identified a series of more general distance measures including cultural and regulatory distance between countries. These are sometimes referred to as CAGE distance, which accounts for cultural, administrative and economic differences between trading nations in addition to geographic distance. For example, commonalities along several of these dimensions have facilitated exchanges of various types among Commonwealth countries, despite the vast geographic distances that separate them. However, in general, because trade in services involves the movement of people along with knowledge and capital, these social, political, and economic dimensions take on a heightened role and can inhibit trade in services. Trade agreements now seek to minimise these costs by including specific clauses with respect to trade in services, but these have proved difficult to negotiate because they require a higher degree of regulatory alignment, which can be politically controversial.

Thus, the evidence suggests that the impact of distance on trade depends on the nature of what is being traded (goods or services), and how one measures distance. We then asked whether it matters where distance is measured from. This seems an obvious question since when one talks about trade one mostly thinks of countries. However, we found that the majority of trade in services, particularly knowledge-intensive services, in fact originates in, and is traded with, a relatively small number of international metropolitan regions, sometimes referred to as global cities. Most trade in services, it turns out, happens between cities rather than between countries.

While there is no one particular definition of a global city, it is clear that in order to understand the nature of trade in services and the policies that might encourage them, one must understand what global cities do and how they do it. It turns out that global cities essentially limit the impact of CAGE distance. Cities provide sophisticated communication, education and transportation infrastructures, and the cosmopolitan values that attract and retain talent. That’s why it’s generally easier to move people and services between global hubs such as London, Toronto, New York and Hong Kong. However, the decentralised nature of global value chains means that it is not only the largest cities that are global. Smaller cities can establish specific niches as global centres for research and design.

Global cities not only attract knowledge-intensive service firms, they have the capacity to spawn the kinds of companies that will become global exporters of services. The important lesson to be drawn from cities is that they draw attention to the links between innovative activity and internationalisation, while at the same time they blur the policy distinction between innovation and trade policy. Policies that promote innovation are not entirely separate from those that promote diversified trade. When countries help their global cities to foster knowledge-based activities they will also promote diversified trade in services.

At the same time, cities themselves undertake trade and promotion activities that in principle complement those of the national government. In talking to city-based investment and trade promotion agencies, we learned that cities have developed sophisticated strategies to identify and promote trade and investment opportunities, typically with other cities around the globe. However, these activities are not always coordinated with national diversification strategies. Canada has created Invest in Canada, in part to fill this role, but its mandate is focused primarily on investment attraction.

Cities have not been central to public policy discussions on trade growth and diversification, which has centred in large measure on trade agreements between countries. We suggest that while trade agreements between countries are important, the role of cities in driving trade in services has not been fully appreciated.

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Notes:

  • This blog post appeared first on LSE’s Department of Management blog.
  • The post gives the views of its authors, not the position of LSE Business Review or the London School of Economics.
  • Featured image by 12019, under a Pixabay licence
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Saul Estrin is professor of management and founding head of the department of management at LSE. His areas of research are emerging markets, with a particular focus on entrepreneurship and international business issues. Professor Estrin has published more than one hundred papers in scholarly journals as well as numerous chapters and reports. He is co-author of the policy brief on FIRES-reform strategy for the UK.

 

Daniel M. Shapiro is professor of global business strategy at the Beedie School of Business, Simon Fraser University. He is also co-editor of the Multinational Business Review and co-director of the Jack Austin Centre for Asia Pacific Business Studies. He has published five books and monographs and some 100 scholarly articles on international business and strategy, corporate ownership and governance, foreign investment and MNEs, industrial structure, and various aspects of public policy.