Recent political developments are threatening to send globalisation into reverse. As such, they could have major ramifications over the long run for economic growth and investment markets, writes Michael Grady, senior economist & strategist at Aviva Investors.
The anti-globalisation movement in the West has often been dismissed as little more than a fringe movement. Governments, companies and investors alike did little more than pay lip service to the complaints that came their way.
Indeed, the opening up of the world to freer trade after World War II – through the General Agreement on Tariffs and Trade – accelerated in the 1990s and 2000s. It was almost universally viewed as a key economic policy aimed at increasing comparative advantage (national specialisation), integrating global supply chains and ultimately increasing the wealth of those countries that ‘opened up’. The ‘gains-from-trade’ proposition was largely undisputed in academic and official circles.
Few are taking the anti-globalisation movement so lightly now. In the wake of the UK referendum, and with a growing tide of populism sweeping across North America and Europe, it is clear large segments of the population in many countries feel disenfranchised by globalisation. It is perhaps no surprise that so many, especially in former industrial heartlands in the West, should call into question the benefits of an increasingly integrated economic system they perceive has done nothing for them.
But it begs the question: does this mark the end of globalisation as we know it? And if so, what does it mean both for the world economy and the investment landscape?
In one respect globalisation has actually been in retreat for a number of years. As can be seen in chart 1, trade growth has fallen behind global economic growth since the financial crisis of 2008.
That is in stark contrast to the preceding decades, which saw a period of rapid growth in global trade, in part driven by China joining the World Trade Organisation (WTO) in 2001. In the 18 years leading up to the financial crisis, world trade grew at an annualised rate of 6.5% and economic output at 3.8%. In the eight and a half years since, trade growth has averaged just 1.2% and economic growth 2.9%.
The decline in the growth of trade has had little to do with any anti-globalisation sentiment, however. Rather, it has been the result of first the financial crisis – which among other things led to a sharp contraction in the availability of credit to facilitate trade flows – and then a sharp drop in the growth of trade between emerging economies. In particular, the rebalancing of the Chinese economy away from manufacturing and investment towards consumption has resulted in a sharp slowing in imports of capital goods and components, often sourced from other parts of Asia.
Given the rebalancing of growth in China is seen as an essential element of that country’s economic development, the recent slowdown in global trade growth may be less worrying than it appears. To the extent it reflects the steady transformation of China and other emerging nations into wealthier, more service-based economies, it could help to address some of the global trade imbalances that have built up in recent years.
Looking further ahead, however, there is an obvious risk increasing protectionism will depress global trade, and with it economic growth, further still. As Bill Gross recently claimed, ‘Brexit’ marks “the end of globalisation as we’ve known it”. These fears have been compounded by the direction of the debate in the US Presidential election. The Republican Party’s presidential nominee Donald Trump has argued the economic problems of the US are the result of a leadership class “that worships globalism over Americanism”. On the other side of the political spectrum, Bernie Sanders, in his run for the Democratic Party’s nomination, also railed against free trade.
Despite the rhetoric, politicians are likely to tread warily before resorting to more extreme forms of protectionism. There is an obvious risk that such an approach would lead to retaliation from trade partners, leaving both sides worse off.
That said, support for the policies espoused by Trump, Sanders and others is unlikely to go away in a hurry as it reflects the real economic hardship being felt by those who have lost out in an increasingly globalised world. While numerous empirical studies have shown that increased trade increases the size of the economic pie, they also show that the losers (employees in industries that suffer from increased competition) should be compensated by the winners. A recent academic paper suggests that in the case of the United States, that has not happened.
In their study, the authors claim much of the “received empirical wisdom” about how labour markets adjust to trade shocks has been challenged in light of the massive shifts in world trade induced by China’s emergence as a great economic power.
“Labour-market adjustment to trade shocks is stunningly slow, with … local unemployment rates remaining elevated for a full decade or more after a (trade) shock commences,” the report states.
The authors find that while employment has fallen, as expected, in US industries more exposed to import competition, offsetting employment gains in other industries have yet to materialize. The scale of the difficulties being felt across large swathes of Western societies was starkly demonstrated in a recent report by the think tank of American consultancy McKinsey & Co.
It found that 65% to 70% of households in 25 advanced economies had flat to falling incomes – ignoring the effect of taxes and transfer payments – between 2005 and 2014, up from less than 2% between 1993 and 2005. It is clear policymakers in the West are facing stiff challenges that they need to confront head-on to avoid the risk of more serious social unrest. Among their priorities are likely to be increased spending on re-training and steps to make it easier for workers to relocate.
Most countries have for some time been clamping down increasingly hard on tax avoidance and evasion. But with the imposition of higher taxes on the rich still a political hot potato, it seems likely corporations will bear the brunt of any efforts by countries to lift their total tax haul, especially those headquartered overseas.
As for other investment implications, they are less evident and will take longer to emerge. Nonetheless, it will be important to watch out for any evidence of an increase in protectionism which would favour companies focused on their home marketplaces relative to exporters. This would probably spell particularly bad news for emerging nations’ economies and their currencies since these countries have been the main beneficiaries of freer trade.