Allianz Global Investors Essay On International Trade, Finance, And Investment Matters.

The UK's Domestic Economy and Financial Markets

As a junior consultant working in the international investment organization- Allianz Global Investor, I am preparing this report on international trade, finance, and investment matters. Hence, this report involves analysis of the way financial market work to distribute capital in both the domestic economy and the international economy for the purposes of investment, trade, and development.

Allianz Global Investors is the leading active asset manager with around seven hundred investment professionals in twenty-three offices all across the world and managing around EUR 647 billion in the assets for the families, individuals, and the institutions (Allianzgi.com. 2022). The UK as a domestic country offers a strong and a business-friendly environment to trade, expand and to invest. It is a mature and high-spending consumer market, and liberal and open economy, having a regulatory environment that is business-friendly. On the other hand, the international market- US is the dominant and leading country when it comes to trade and investment, compared to any other nations. The diversity of the US as an international country market are what truly allows the businesses of all nations and industries to thrive (Selectusa.gov. 2022).

Domestic economy is referred as an economy in the system as per which trade, money, and industry of a nation are organized. The domestic economic situation of a country plays important role in the growth and development of a nation (Solmaz and Sanjani 2015).

 

Figure 1: The UK’s GDP (Worldbank.org. 2022).

The UK is the domestic economy. This country is the six largest countries in the world. Trade has long been significant for the economy of the UK. However, this country faces the issues of unemployment, high corruption, and political instability over the past few years. The UK continues to be among the largest economy of the world that is independent, highly developed, and international trading economy (Chadha et al. 2016). Over the past few years, the GDP of the country has increased at an unbelievable rate. The GDP of the UK has increased by 0.9% in 2021, which is more than the level of pre-covid-19 in 2020 by 0.7%. The country’s GNP from 1955-2021, has been around 189,373.88 GBP m that have increased to around 580080 GBP m in the third quarter of 2021 (Worldbank.org. 2022). The inflation rate of the UK is at its highest since the last 30 years, having an increase to the 5.4 percent in the past twelve months (BBC News. 2022).

 

Figure 2: Inflation Rate of the UK (BBC News. 2022).

International economics is referred to the study of international forces, which influences an economy’s domestic conditions and help in shaping the economic relationship. An international market is the system of trading goods & services outside the domestic country of the seller. The US is still considered as the world’s biggest services’ exporter. It is believed that the US globally competitive service industries, immensely benefit from the opportunities abroad (Schellenberg, Harker and Jafari 2018).

Financial market is referred as a market in which financial securities and derivatives are traded by the people at low transaction costs. It comprises the bond market, the money market, the derivative market, and the ownership market (Madura 2020). The country’s financial market comprises of both primary market and secondary market; where the main actors involved in the primary market are entities, financial institutions, and investment banks; and the main actors involved in the secondary market are sellers and buyers, and the investment banks. The primary market comprises equity and debt market; and secondary market comprises issued bonds and shares’ sales and trading. The different kinds of financial market comprise money market, capital market, derivatives market, and commodity market. In an economy, money is created by the banks (Frederic 2021). The central bank of a country ensure that the economy of a nation continues to be healthy and money is circulated smoothly. It is considered to be the apex bank, which provides banking and financial services for the government of its nation and the recommended banks. It issues currency and sets the rates of interest on bonds and loans (Valdez and Molyneux 2015).

International Economics and the US Market

The UK’s central bank is BoE, which helps in managing the operations of market through buying and selling the government-owned things for changing the availability of the banking system’s money amount. The central bank is responsible for managing the gold and money reserves of the UK on the behalf of government, quantitative easing, and printing money. Further, the government and central banks of the UK uses fiscal policy and monetary policy to keeping the stable economic growth, low inflation, and low unemployment (Miranda-Agrippino and Rey 2020). In the times of the covid-19, when the crisis caused major social and economic disruption, the BoE helped in supporting the UK’s economy through preventing the damage to the economy. It reduced the interest rates by 0.1% in 2 stages. It helped the business to continue their operations by making payment to their employees and suppliers (Bankofengland.co.uk. 2022). Fiscal policy continues to play significant role in minimizing the impact of the disruption caused by the crisis with the help of supporting businesses and households (Jordà and Taylor 2016).

The UK is considered as the most innovative, dynamic, and sophisticated country and centre of finance. This country has the oldest and most advanced financial market. The UK is highly preferred by the financial institutions and investors to invest because of the unparalleled capital and capability concentration. It is considered as the world’s sixth major economy in respect of the GDP, and ranked at third position in terms of the global equity market share after US and Japan. The UK is also known for having largest derivative market for off-exchange derivatives, and have the world’s largest forex market (Langfield, Liu and Ota 2014).

However, the growth and development of the US economy has been highly affected by the two major uncertain events, which are the GFC 2008 and an outbreak of the covid-19 crisis. Although the financial and banking crises differed in their severity level in the different countries, the UK’s economy was severely impacted. For coping with such uncertain events, the government and central banks took various measures and used the tool of fiscal and monetary policies to recover the economies of the nation (Zhang, Hu and Ji 2020).

The UK have almost three hundred commercial banks, which assist in offering the banking services such as making deposits and offering loans at the competitive interest rates. A commercial bank is the financial institution, which is engaged in making commercial loans and issuing transaction deposits (Jaber and Al-khawaldeh 2014). Further, a bond market helps in providing the investors with the extensive options of investment, particularly the Euro-dollar market in Europe is the market, where lending and borrowing of the world’s key currencies take place. In addition, the UK is known for the best place for the international FX market. Over the past few years, the UK has able to maintained its dominant place for the FX trading (Batsaikhan, Kalcik and Schoenmaker 2017).

 

Figure 3: Largest Stock Indices and their Respective Market Cap (Statista. 2022).

There are more than 60 stock exchanges across the world, of which the most dominant stock exchanges across the world are of the UK, US, and the Asian stock exchanges. These market helps the companies to raise high amount of the funds in comparison to holding simultaneous holding of the funds in the different indices by the investors. The NASDAQ, Shanghai, and the NYSE are the world’s leading stock exchanges. The US-based NASDAQ is known to be the largest and oldest stock indices, having the market capitalization of $24.07 trillion (Dennison 2018). The China-based Shanghai stock indices is also among the major stock indices after NASDAQ and NYSE, having the total market capitalization of about $7.77 trillion. Lastly, the US based NYSE is the largest among the other stock indices, having the market cap of about $28.2 trillion. The European stock exchange- Euronext come after all these three major indices, with the market cap of about $7.38 trillion (Statista. 2022).

Financial Markets, Fiscal Policies, and Monetary Policies

In case of derivative market, the LSE offers different derivative markets. A derivative is referred as the contract that exist between the two different parties, which derives value from the its underlying asset. The primary LSE’s derivative segment is the “Curve Global Markets”.  London is at dominant position in the derivatives’ multi-trillion-dollar world market (Londonstockexchange.com. 2022). Further, in case of the non-banking financial institutions, it can be said that these institutions have substantially seen immense growth internationally after the GFC, and hence, at present, it accounts for about half of the world’s financial assets. It is referred as the institution, which offers financial services such as banking, but they actually do not have the banking licenses, therefore, these institutions cannot accept the deposits (Milic 2021). The NBFC comprises an extensive amount of the entities, having varied business models that include various types of the investment funds, such as it is claimed that the NBFC have increased by about sixty percent after 2015 till present, and in the third quarter of 2020, it accounts for $7.5 trillion. The banks of the EU have cross-border exposures to NBFI, for instance, securitization vehicles, financial companies, funds of investment, having about sixty percent of exposures to the entities that is external to the EU (Emter, Killeen and McQuade 2022).

Capital allocation is referred as a distribution process of the organizations’ financial resources with the motive of enhancing the long-term financial stability and value creation of an entity, and assist in providing good returns to the providers of the risk capital. In the financial market, domestic economy enables capital allocation. The country’s financial market functions mainly through an interaction between the seller and buyer that assists in determining the prices of assets being traded. This helps in providing a sign of the allocation of funds in the domestic economy that is based on the demand and supply with the help of mechanism, which is referred as price discovery process (Gopinath et al. 2017).

The domestic market of the UK facilitates the financial institutions and the banks to buy and sell funds from each other that contributes to the economic growth (Benigno, Converse and Fornaro 2015). Capital allocation is a main reason for comparatively faster growth of the UK over the past few years. However, economic development of a country not depends on the higher capital accumulation, but with the higher productivity growth, and utilization of the capital in most effective manner (David et al. 2021). The UK is considered as a gateway to the global asset allocation. As per the recent Global Competitiveness Report by the WEF, the UK has been ranked at eight most competitive country to conduct business, and the country continues to maintain its strong historical performance. The UK has a strong competitive advantage on the services trade that is more strongly growing than trade in the goods (Assets.publishing.service.gov.uk. 2022). The GDP of the UK of $2.7 trillion shows the massive international global power this country enjoys, which makes it the fifth largest economy of the world (Jozepa 2021).

Over the past few decades, there has been immense growth in the international flows of capital. The international trade across the globe is much more at present times in comparison to some eras back. The financial market, the international economy facilitates the allocation of capital (Shenkar, Luo and Chi 2014). In the world’s capital market, different investment exchanges are linked to each other that helps the entities to engage in the purchase and sell of the securities on the global level. In the international capital flows, currency plays the most critical role, and it have a potential of shaping the international macro-economic models (Maggiori, Neiman and Schreger 2018).

There are 2 major kinds of capital flow transactions, which are private and official. The official capital flows of the US comprise changes in the reserves of the monetary authorities of the US in foreign exchange, monetary gold, special drawing rights at the IMF, and credit and loans to the foreigners by the government agencies of the US. The private capital flows include direct investments and the portfolio investment undertaken by the foreigners and the US residents abroad in the US (Agbloyor et al. 2014). Further, during the times of crisis and downfall, the US government and Federal Reserve take broad range of the actions to keep the economic condition of the country stable, such as during the covid-19 pandemic, the Federal Reserve took the actions of keeping credit flowing by limiting the economic failure from the crisis (Ozili and Arun 2020). The government have provided extensive fiscal support to protect the households, firms, and vulnerable population. They also use risk management strategies for coping up with such failure, such as hedging (Wessel 2021).

Grounded theory is referred as a way of undertaking the economic research, which purposes to develop the theory and generalization. It includes a set of the procedures to undertake and analyze the case studies- quantitative and qualitative in the comparative and systematic manner. Further, grounded theory explains the less prevalent occurrence of the capital flow in the form of foreign direct investment from the less-developed economies to the wealthier nations (Glavas and Mish 2015).

Ricardian Theory

This theory states that the goods are produced by the countries by using the single factor of the production, mainly labor, which is assumed to be immobile between the countries, but is mobile within the industry with the consistent returns of scale, and the market mainly have perfect competition (Shiozawa, Oka and Tabuchi 2017).  

It is believed that the nation specialized in the production line in which that nation has more comparative advantage in costs in comparison to the other countries, will depend on the imports of the commodities in which that particular nation has cost disadvantages. The main benefit is an ability of manufacturing goods at the lower cost (Gray 2019).

The opportunity cost is the factor used to make choice between the different production choices. It is the benefit that is foregone from making an alternative choice over the others (Agarwal and Gangal 2020).

Investment Treaties Between the States

The investment treaties are mainly settled between the 2 or more than 2 governments (Salacuse 2015). It provides protection to the international investors for the investment from the conduct of host government in treaty violation, such as unequitable and unfair treatment, exploitation, or discrimination. It includes NAFTA, TPP, ECT, or BITs (Oecd.org. 2021).

The Regional Trade Agreements are referred as the important fixture in the foreign trade. It is the treaty signed by two or more than two nations to encourage free goods or services movements across the countries. This has become main mode of the foreign trade negotiation and regulation (Lester, Mercurio and Bartels 2015).

 

Figure 4: World Trade Merchandise Volume from 2015-2022 (Wto.org. 2021).

The WTO is known as the only international trade organization, which is mainly engaged in dealing with the trade rules between the countries. This organization make sure that the trade flows in most easily, independently, and predictably manner (Hopewell 2020). Trade assist in sustaining the growth level, and trade rules stabilizes the world’s economy by discouraging the backward policy measures, and making policy more predictable (Wto.org. 2022). The global trade has been highly impacted because of the covid-19 crisis. However, the growth of the world’s trade is predicted by around 10.8 percent in 2021 and increase of 4.7 percent in 2022 (Wto.org. 2022).

The US economy is fueled by the abundant natural resources, high productivity, and a well-developed infrastructure. It grew 5.7 percent in 2021, which is strongest since 1984 (Kenourgios and Dimitriou 2014). The real GDP grew at the yearly rate of 7% in the Q4 of the year 2021. The US operates as a free market economy in the business services and consumer goods. The GDP of the country is $23.9 trillion in the 4^th quarter of 2021. Trade is quite critical for the prosperity of the US, as it helps in fueling economic growth, raising living standards, supporting employment, and assisting the citizens with the affordable goods & services (Pao, Chen and Li 2015). The US is considered as the world’s largest exporter. In 2019, the goods and services’ exports of the US totaled around $2.5 trillion, and the imports totaled around $3.1 trillion, which resulted in the total deficit of $616.4 billion that is down 1.8 percent from 2018 and 19.1 percent from all-time high level reported in 2006 (Sgp.fas.org. 2020).

 

Figure 5: US Trade (Sgp.fas.org. 2020).

The US interest rate is likely to be 0.50 percent by the Q1 2022 end. In the long-run, the US Federal Funds rate is expected to trend over 1.75% in the year 2023 (Tradingeconomics.com. 2022).

 

Figure 6: US Fed Funds Rate (Tradingeconomics.com. 2022).

The competitive advantage of the US stems from its continuing innovative practices as a country. For instance, the US entities are known for bringing the products to the market at much more efficient pace compared to what many other countries can do (Slaughter and Taylor 2015). The US has quite mature market for the government bonds. Since the market is highly developed, the US is having a comparative advantage in the government-based financial instruments. It is because of this reason, the US exports them to the investors across the globe (Harrigan and DiGuardo 2017). In 2020, the US was ranked as the 25^th least corrupt nation out of the 180 nations ranked, reduced from 18^th since the year 2016. This ranking place the US between Bhutan that is at 24 position and Chile that is at 26^th position on the corrupt practices in the government and the other institutions (Runde and Metzger 2020).

The position of the FDI in the US increased $187.2 billion to the amount of $4.63 trilling at the year-end of 2020 from the amount of $4.44 trillion at the 2019 year-end. Hence, this increase mainly shows a $119.2 b growth in the position from Europe, particularly Germany (Bea.gov. 2022). Further, in case of employment, the US rate of employment stood at 58.4 percent (Statista. 2022). The threat of stagflation is haunting the United States, since inflation continues to stay strong and the economic growth slows down. It is mainly because of the covid-19 impact. However, the analysts believes that the US economies are still set to improve better in the coming years (Robertson 2021).

 

Figure 7: The Employment Rate of the US (Statista. 2022).

 

Figure 8: Consumer Price Index Inflation (Tradingeconomics.com. 2021).

In the US, agriculture is the major industry, which generated around $374 billion in revenue in 2018, after adjusted for inflation. It contributed $1.055 trillion to the US GDP in 2020, a 5.0% share (Ers.usda.gov. 2022).

Political stability assists leaders in the other nations and entities determine their policies towards the countries, including direct investment level into the nation. Over the past few years, various nations have become less vulnerable, while the US has become quite less stable. This nation is among the twenty states, which have seen the highest rise in percentage in relative fragility over the last ten years (Calder 2021). Although the US is stable as per some of the political, economic, and social measurement, the year 2020 has seen some major drop in the index labels because of the recession, pandemic, political turmoil and protests (Nationalgeographic.com. 2022).

The trade policies and investment system’s implementation by the US comprises the WTO agreements that forms the multi-lateral bedrock of the US trade policy, its tariff rate quotas, tariffs, 5 preferential trade programs, 14 reciprocal FTAs, 48 bilateral investment treaties, 51 trade and investment framework agreements, trade and development programs, a program of trade agreement enforcement, the trade remedies, actions affecting imports such as customs regulations, measures affecting exports such as exports promotion, and sector programs such ad subsidies to agriculture. The US has FTAs in effect with twenty nations. Further, the US has been a member nation of the WTO since 1995, and also a member nation of the GATT since 1948 (Guides.loc.gov. 2022).

There has been the major impact of the industrialization in the US. The industrial revolt has resulted in the greater wealth as well as larger population in Europe and in the US. The major challenges of the industrialization in the US are unemployment due to the automation, possible social and income inequality gap widening (Opoku and Boachie 2020).

The international market- US is considered as the world’s largest economy and largest importer and exporter of the goods & services, and the globally competitive service industries, such as IT, telecommunications, energy, banking, and many others, provide immense opportunities for the international trade (Kose et al. 2017). This country has trade relations with around 200 nations, regional associations, and territories across the globe. An access to the location is more in the US. It is quite good place for the investment, and the government regulations are favorable (Bea.gov. 2021).

 

Figure 9: Political Stability Index (TheGlobalEconomy.com. 2021).

When it comes to the international market- the US has had a major fall in the 2020 in terms of the perceived political stability. The US is at 17^th position, while the UK is at 14^th position. The US have failed to be under the top ten politically stable nations. Hence, this political risk in the US may negatively affect all the aspects of the international business (Radu 2020).

The economy of the US grew faster than what was anticipated in the year 2021. An economic growth averaged around 2.3% per year from the mod of 2009 through the year 2019. The US growth of the GDP increased in the Q4, growing at the 6.9 percent annual rate of growth, which is a rise from the growth pace over the past 4 quarters, since the US economy remains recovering itself from the covid-19 impact. Hence, international trade in such country where the market is competitive and opportunistic, will be quite beneficial (Furman and Powell 2022).

The trade policies related challenges in the US includes inconsistency in policies, low labor productivity, and pervasive corruption level. The present key issues that are affecting the trade in the US are increasing tariffs, intellectual property theft, and others (Rivoli 2014).

 

Figure 10: Corruption level of the US (Tradingeconomics.com. 2020).

The corruption has been one of the major problems facing the world, and the US and the is not an exception. This country has been facing the corruption issue since long, which in turn has created numerous challenges for the countries, such as stock market flows, global competitiveness, economic growth. These issues have highly distorted the country’s growth and development (Campante and Do 2014). Due to this reason, the government of this nation has implemented some regulations to act against those issues. The international market of the US scored 69 in 2019 that reduced to 67 points in 2020. This implies that the trade in the US will not be much affected by the corruption (Tradingeconomics.com. 2020).

The international market of the US has free trade agreements with twenty nations, and these FTAs are built on the foundation of the WTO agreements, with stronger and comprehensive disciplines compared to the WTO agreements (Rodrik 2018). For more than sixty years, the US has pursued a trade liberalization policy that seeks open markets as well as expanded international trade based on the assumption that lessening trade barriers helps in creating more jobs, reduced poverty, and advances economic development and reform across the world. The trade policy is the most important part of the US international policy and of huge importance for reasserting leadership of the US. Hence, this will benefit the international trade (Boustany 2020).

Conclusion

Hence, this report concludes that the UK and the US are the world’s dominant financial market. Both these countries’ main financial players are its financial institutions, investments banks, and entities. The financial system of these country plays significant role in the country’s economic growth. The UK and the US government use two main tools i.e., fiscal policy and monetary policy to elevate the nation’s economic growth. For responding to the covid-19 pandemic, BoE (central bank of the UK) has reduced the interest rates and expanded QE. In the international financial market, the US enjoys the leading position. Further, the theory used to discuss regarding the international trade, is the Ricardian model of comparative benefit and opportunity cost. Further, in the economic development and growth of the UK and the US, international trade, FDI, inflation, and agriculture plays the most significant role.

It has been found that the international market of the US provides the best opportunity for the international trade, because of the economic growth, less corruption, and political stability, compared to the domestic nation- UK that is facing significant challenges due to Brexit, corruption, productivity of labor, political instability, and WTO’s trade policies. It is expected that in the coming years, the US will continue to lead the dominant position in the international market in terms of trade and investment. The US must maintain its competitive advantage in terms of the trade and investment, which will make it the most desirable global platform. The US producers have unique access to the largest domestic market of the US.

Therefore, this report recommends that the strong measures should be taken by the UK to lift up the country’s economic growth and development. Following are the main recommendations:

• Encouraging more consumer spending and investment of the business. The country needs to influence its 4 main factors that are technology, human resources, physical resources, and natural resources. These efforts are necessitated because of the covid-19 crisis.
• Moreover, it is suggested that businesses of the UK should make WTO as the part of its long-term strategic planning through creating a thorough insights of the WTO; through engaging WTO with the government; and drawing extensive institutional knowledge regarding the WTO.
• It is recommended to trade in the international market of the US, since the country provides a huge scope of growth and success.
• It is recommended to lower the barriers to entry as well as address the distorted patterns of ownership through the increased competition and business growth of the SMEs.

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