Globalization in the Crosshairs, Again...

Globalization is once again under fire.  In the past, developing nations often complained that the benefits of increased global trade flowed disproportionately to the developed world. Today the shoe is on the other foot. Wide swaths of the American public are reacting favorably to Donald Trump and Bernie Sanders’s proposals to reign in free trade while the recent Brexit vote highlights the growing anger over greater economic integration in Europe.

The most recent anti-globalization movement comes at a curious time. Unemployment levels in the U.S. are at record lows and wage growth is starting to pick up. Global trade too is hardly swamping local trade, with international trade volumes having grown at less than 3% in each of the last four years.

So what is fueling the latest change in sentiment? The anemic economic recovery from the 2008-2009 financial crisis is certainly one factor. For as long as most of us in the developed world can remember, economic growth chugged along at about 3% per year. But since 2008, GDP growth has been more than cut in half (see chart below). This difference is significant. A 3% growth rate is fast enough to both support rising standards of living for existing citizens AND absorb new ones. A 1% growth rate is not. Continued low interest rates inflated the prices of stocks, bonds and real estate – a boon to the wealthy but hardly much help to those with limited financial assets.

In the midst of vast social, technological and economic change, the idea of turning inward can certainly seem appealing. But the costs of moving in this direction can be large indeed. To appreciate why, you need to understand the concept of comparative advantage - a basic tenet of any Econ 101 class. The idea here is that economic growth is maximized when each country produces the things that they are best able to at the lowest cost. The reverse of this approach typically involves implementing high tariffs to protect uncompetitive domestic industries from lower cost imports. The U.S. adoption of such protectionist policies in the wake of World War I and retaliatory measures by our trading partners resulted in an estimated 66% reduction in world trade between 1929 and 1934 and contributed to the Great Depression.

To suggest that free trade is only beneficial, however, is inaccurate. The benefits of global trade – mostly in the form of lower priced goods- are widely dispersed, but the costs are often painfully concentrated in specific industries and communities. Further, comparative advantage is not a static concept; changes in the prices of key inputs as well as technological innovation create a constantly changing list of winners and losers. China is ceding its low cost manufacturing role to Vietnam and Thailand, while here in the U.S. new robotic technology is luring back some previously lost manufacturing jobs. Recent trade policies have clearly not paid enough attention to those on the losing side of the equation. Better support and retraining for displaced workers as well as improving access to university and vocational education would be steps in the right direction.

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The global economy is more interconnected today than at any time in history. Even though global trade has slowed somewhat recently, the flow of digital information between countries - everything from videos to web searches - grew 45 times between 2005 and 2014 according to the McKinsey Global Institute. Efforts to reverse the overall trend toward greater integration would not only be bad economic policy but likely unsuccessful. Better to jump on the bandwagon and focus on making the ride smoother for all involved.

Globalization: Dormant But Not Extinct

In the late 1990s and 2000s up to the financial crisis in 2008, globalization seemed a powerful inexorable force.  The world was becoming more interconnected. Goods, services, capital, and people were moving ever more freely around the globe without regard to borders. The world was getting flatter. Global champions, we were told – whether companies or individuals – could arise from any corner of the globe. Millions in developing economies would rise out of poverty as their economies became tied to developed ones. And the story of China’s astonishing growth seemed to blot out everything around it. 

The trajectory of that narrative, however, changed dramatically with the financial crisis of 2008-09. Economic activity collapsed, and countries withdrew into themselves as they tried to right things at home. Trade in goods and services plunged, and cross-border capital flows and migration slowed. Economists started to talk first about “decoupling” and then about an age of “deglobalization.” In addition, as economies focused inward, there were signs of the world becoming a more fractured and tribal place. Religious and cultural identities started becoming powerful divisive forces, and separatist movements gained momentum.

It is true that hundreds of millions in emerging markets did rise out of poverty thanks to globalization. And China did become the largest or second largest economy in the world, depending on you how you measure.  But the world did not turn out the way we expected in the mid-2000s.  Healthy economic growth in China today is far from inevitable. Two of the other “BRICs” from the early 2000s, Brazil and Russia, are in near-crisis.  And the United States, not China, is the resurgent factory to the world. With its cheap energy and new-found cost competitiveness, the U.S. has been enjoying a surprising manufacturing renaissance.  In a recent International New York Times article, Jan Svenjar of Columbia’s School of International Public Affairs called the U.S. “the most promising emerging market in the world.” In the same article, an executive from Dutch company Royal DSM noted that the company no longer studied where to locate its new plants because it was clear that they would just go to the U.S.

Still, globalization is a matter of degree, not an all-or-nothing phenomenon, and there are recent signs that cross-border activity is coming back to life. Wealth continues to spread to developing economies: the seven richest nations held two-thirds of global income in 1988, but just half by 2010. And while global foreign direct investment is below its 2007 peak of $2 trillion, it did rise 9% last year to $1.45 trillion, with half going to developing nations. Trade remains below pre-crisis levels, but it is expected to rise again slowly as global demand recovers.

Economists Pankaj Ghemawat of NYU’s Stern School and Steven Altman of IESE Business School also found that globalization has been making a comeback in recent years. In their DHL Global Connectedness Index, they used data from 140 countries to measure cross-border movements in trade, information, people, and capital.  They looked both at the depth of cross-border movements (how much activity there was) and the breadth of activity (how many borders were crossed). As the charts on this page show, the volume of cross-border activity is now higher today than pre-crisis times (the depth), but that activity is taking place among fewer places (the breadth). That may not be surprising in a world where economies are in various states of distress or recovery.  Those pockets of the world that are struggling to stabilize their domestic economies or that are in the grip of populist politics that lean against globalization will simply have less capacity for global economic activity.

The zigs and zags of globalization’s course remind us that we seldom know how things will turn out. Few in the mid-2000s would have guessed that the U.S. manufacturing would be born anew, or that China’s growth could look fragile. Likewise, today it can be difficult to imagine how the more distressed economies of the world could recover and re-emerge on the world stage. That suggests that there is a growing case for investors to look outside the U.S. for opportunities. The U.S. recovery is well advanced and that is reflected in its stock market prices. But this is not yet the case in many pockets of Europe and emerging markets, where things may be worth a closer look.