Globalization 4.0

Rising discontent among citizens around the world has led some to repudiate global integration. Will the world go back to raising walls between nations?

Globalization—the broad trend toward freer worldwide movement of goods, capital and labor—has created new opportunities and increased global wealth, yet it has also increased poverty and pollution. For the past few years, economics observers have increasingly been saying globalization has peaked.

“It’s partly the overhang of the financial crisis,” says Simon McAdam, a global economist at Capital Economics, noting how the crisis dried up trade credit markets in the short term and made banks more cautious about lending longer term. He believes that globalization has peaked and is at present stalled, but “it’s not like we’re going into a massive reverse.”

Economic and political elites, who have mostly benefited from globalization, have been slow to awaken to its problems—that is, until the dual political shocks of 2016, when Britons demanded to leave the European Union and Donald Trump was elected US president, partly on an anti-globalization platform.

“Historically, globalization has produced advantages in terms of development and economic growth,” says Davide Furceri, deputy chief of the Development Macroeconomic Division in the IMF Research Department, “but it also had some negative distributional effects.”

Financial-software company Finastra became concerned enough to initiate the World Trade Board (WTB), with the stated goal of “shaping the future and being an enabling force for global trade, inclusion and prosperity.” Finastra CEO and WTB chair Simon Paris says, “I worry a lot as a citizen, as a businessman with a vested interest in trade, that this is a harmful downward spiral.”

Roiling protests from Spain and Lebanon to India and Bolivia continue to make the point: Many citizens are unhappy with the status quo. “Whether it’s Hong Kong, Santiago de Chile or Paris, you see this growing civil unrest,” says Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch. “A lot of it can be tied to inequality.”

I worry a lot as a citizen, as a businessman with a vested interest in trade, that this is a harmful downward spiral.

Simon Paris , Finastra CEO and WTB chair.

The world has never been as connected as it is today, yet globalization has never been so unpopular. But is it true that worldwide economic integration has peaked? “Globalization is at an inflection point,” says Demetrios Papademetriou, a distinguished fellow at the Migration Policy Institute, a think tank in Washington, DC. “It could go either way.”

Some countries seem to be pulling back already. Trade growth has leveled off since 2010, and global foreign direct investment flows fell 23% in the first half of 2019 from the last half of 2018, according to Unctad.

“I have been talking about peak globalization for several years, as a result of economic changes,” says Paul Donovan, chief economist at UBS Global Wealth Management. “Mercantile trade volumes as a share of real GDP—which is the best concept of globalization in real terms—have been stagnant for some time and are now slowly starting to turn down.”

Still, globally, exports of goods and services remain near the historic high of 30% of GDP. “I do not know whether we are seeing the death of globalization, but I certainly think we are seeing changes in globalization,” says Hartnett. “I think, really, what peak globalization means is that the momentum toward free trade [and] free movement of goods, services, capital and labor as a method to raise prosperity and living standards across the world has stopped.”

McAdam points to structural trends working against further global integration. Tariff rates, for example, were brought down by GATT and the Uruguay talks in the 1990s to 2%. Supply chains were offshored. “But you can only fragment supply chains once,” he says, and tariffs can’t be cut much further, either.

Economists generally agree that the slowdown in trade expansion isn’t simply due to policy decisions—the actions of the “tariff man,” as US President Donald Trump has called himself—or any individual or government.

The Downsides

The central critiques of globalism touch on many issues. Immigration, for example, both legal and illegal, has become a flashpoint across Europe as well as in the US, with immigrants blamed for taking jobs from locals and for costs to the host country for immigrants’ use of social services. In a different vein, the Panama Papers and other investigations have revealed legal and illegal shenanigans on the part of the world’s wealthiest individuals, aided and abetted by bankers and even governments. Repeated instances of corporate failure to respect privacy and safeguard citizen data—whether through negligence or willful misuse—further stoke flames of rage against giant multinationals, as do inversions and other corporate schemes to avoid paying taxes.

“Of course there were drawbacks to globalization, like the loss of income for negatively affected segments of the population in advanced economies, in sectors and areas where jobs were lost to foreign competition,” says Fabio Ghironi, Paul F. Glaser Professor of Economics the University of Washington in Seattle. “The failure of domestic policies to correct these problems is a big part of the story here.”

The single greatest source of rage against increased trade and connectivity stems from job losses. In recent decades, as companies moved production to countries where labor was cheaper, unemployment rose in many developed economies. Economists dismissed labor’s concerns, insisting the impact of higher trade would be modest. Some, such as influential New York Times economics columnist and Nobel laureate Paul Krugman, would years later admit they got it wrong.

A 2016 US study, The China Shock: Learning from Labor Market Adjustment to Large Changes in Trade, analyzed the impact of the massive rise in imports from China in the 1990s, for example, and found that local labor markets were hit hard and slow to recover. Wages remained depressed and unemployment rates stayed high for at least a full decade after the start of the “China trade shock,” according to David Autor, economics professor at the Massachusetts Institute of Technology and co-author of the study with David Dorn and Gordon Hanson. “Exposed workers experience greater job churning and reduced lifetime income,” they explain.

Immigration also hurts labor’s bargaining power. “There is increased skepticism in many countries about immigration,” says the Migration Policy Institute’s Papademetriou. “What you see everyone talking about are two things: either illegal immigration or the manner in which people are coming into certain countries.” Mexicans illegally crossing the US border, Hondurans seeking asylum or North African refugees crossing the sea to Europe in leaky boats are visible symbols easily exploited by opportunistic politicians promising draconian solutions.

Still, even legal immigration can suppress wage growth. In the US, the H-1B guest worker program, launched in 1990, has been heavily criticized by academic researchers, employee advocates, a few politicians and many unemployed programmers and developers for contributing to outsourcing and wage suppression. Even Milton Friedman called it a subsidy for corporations, according to a report in Computerworld. Initially set at 65,000 per year, the number of imported workers has been increased again and again through various exemptions, extensions and new laws.

“Policies should mitigate these negative effects via a better redistribution of benefits and also via education and training programs to help displaced workers find new jobs” says the IMF’s Furceri.

The wage issue makes threading the policy needle on international trade pacts especially tricky. NAFTA put both US autoworkers and Mexican corn farmers out of work, although it was good for capital. But when Trump withdrew the US from the Trans-Pacific Partnership (TPP), negotiated under previous administrations, the other countries went ahead without it and suspended 22 of the intellectual-property rules US companies had wanted.

“The result is that the US is in a weaker position—more isolated and with the same problems as before—in its interaction with China,” says Ghironi, who participated in discussions about the TPP treaty at the White House before President Trump’s decision. “The biggest damage for the US is not coming from a lower economic expansion but from the loss of credibility. Trump’s current policy is a U-turn from what the US has done and stood for on the international trade stage since the Bretton Woods Conference in 1944.”

What Next?

BofA’s Hartnett is co-author of a report that identifies the peak of globalization as one of the major topics of the next decade, concluding that local markets and real assets will benefit from the shift. He suggests investment shifts tied to “an environment where globalization has peaked and there is a desire to correct imbalances. “It could be solar companies, as one method to address climate change. It could be global infrastructure plays in areas like utilities,” he says. “Similarly, you probably want to have a lower weight in government bonds, given that we’re going to see a big increase in government borrowing going forward.”

He does see one sector that may lose out if globalization stalls. “If there is one sector that really has been at the forefront of globalization, it is technology,” he says. “I suspect that in the coming 10 years, the tech sector is not going to perform anywhere near as much as it did in the past 10 years.”

If there is one sector that really has been at the forefront of globalization, it is technology,

Michael Hartnett, chief investment strategist at Bank of America.

McAdams of Capital Economics notes that the technologies of the industrial revolution encouraged globalization—the steam engine, telegraph, containerization: “The latest manufacturing techniques, whether 3D printing or robotics, are actually facilitating the re-shoring of activity.” UBS’ Donovan has a similar view. “Automation, robotics and digitization change the economic benefits in favor of more localization and toward smaller and simpler supply chains,” he says. “For example, clothes are made in an automated factory closer to the consumer. Trade in goods and services—everything from raw materials to finished product and intellectual property—has been replaced by downloading: trade in services and intellectual property only.”Finastra CEO Paris argues that software companies do well whether the macro picture is weak or strong. “When things are difficult, people have to cut costs; so they have to automate, and much of what software does is automate business processes,” he explains. “And we tend to do very well when things are very strong and people are investing in growth.”

That’s not necessarily a bad thing. “Overall, I would say the localization of technological change will reduce inefficiencies, both economic and environmental,” says Donovan. “In this sense, it is to be welcomed.”

Some have suggested that civil society and local powers can compensate for federal decisions—or indecision. For example, as the US pulled out of the Paris climate agreement, a consortium of US states led by Washington, California and New York, along with some major US cities and more than 100 corporations, announced that they would maintain their commitments. Likewise, British companies can choose to continue to adhere to EU data protection regulations (GDPR) even after the UK leaves the EU. “The role of private enterprises and municipal and local governments having different views than their federal governments is a very interesting approach,” says Finastra’s Paris. “Maybe that’s the way forward.”

Trade deals surely are not dead, with new deals still being negotiated. Last summer’s EU-Mercosur deal is one example. The US, Canada and Mexico have now signed the successor to the North American Free Trade Agreement (NAFTA), the US-Mexico-Canada Agreement (USMCA), which at time of writing is set to go before the US Congress for ratification. Or consider current talks for the Regional Comprehensive Economic Partnership (RCEP), a proposed trade pact between the 10 countries of the Association of Southeast Asian Nations and their five partners: Australia, China, Japan, South Korea and New Zealand. Yet even in this case, India pulled out due to concerns that cheap Chinese imports would damage domestic producers.

“Many countries still share a strong interest in keeping multilateralism alive and well,” says Ghironi. His worst-case scenario involves other countries in Europe following the UK and US with “Brexit-like choices,” dissolving the EU. “Unless that happens, the losers from the current situation will instead be the United States and the United Kingdom,” he says. “It is hard to see them thriving economically if they remain behind a world that moves forward with integration.”