The end of globalisation - Capital Economics
Global Economics

The end of globalisation

Global Economics Update
Written by Vicky Redwood

Globalisation has peaked. It may stall over the next decade, but a period of de-globalisation is increasingly likely. If this is driven by new technologies, it will not be bad for the world economy. But it could take a more malign, policy-driven, form. If we are right that the trade war reflects China’s strategic threat to the US, then some form of decoupling is inevitable – which will have an adverse effect on global GDP.

  • Globalisation has peaked. It may stall over the next decade, but a period of de-globalisation is increasingly likely. If this is driven by new technologies, it will not be bad for the world economy. But it could take a more malign, policy-driven, form. If we are right that the trade war reflects China’s strategic threat to the US, then some form of decoupling is inevitable – which will have an adverse effect on global GDP. (This Update summarises a series of reports that we have written, which can be found here.)
  • The current wave of globalisation has been underway since the early 1990s, driven – like previous waves – by both technology and policy. Automation has enabled the fragmentation of supply chains, digital technologies have boosted services trade and the internet has reduced communication costs. Meanwhile, policymakers across both advanced and emerging economies have promoted openness to trade and capital flows. But globalisation now seems to have hit a wall. Trade of goods and services, as well as capital flows, have levelled off as a share of GDP. This occurred well before the trade war began. (See Chart 1.)
  • It is possible that this is just a temporary hiatus and that an unforeseen technological breakthrough will trigger a new wave of globalisation. But such waves are rare. In fact, there are several reasons – even before we consider the trade war – why globalisation has peaked. First, all the major steps to integrate the global system have been taken. Second, advanced manufacturing techniques mean that the location of manufacturing no longer hinges on where labour costs are cheapest. Third, complex supply chains have reached their limit. Fourth, China is unlikely to open up its capital markets significantly.
  • Reaching the peak of globalisation is not necessarily a cause for alarm for the world economy. On the contrary; the technological developments that are partly driving these trends will boost productivity growth and widen consumer choice. That said, given that the most common development path begins with labour-intensive manufacturing in sectors such as textiles, life for the poorest countries will become more difficult. This will add to the structural headwinds already facing emerging markets.
  • What’s more, a more malign form of policy-driven de-globalisation – where cross-border trade and capital flows fall as a share of GDP – is looking increasingly likely. In the past, it is policy which has caused globalisation to roll back. While the first wave of globalisation ground to a halt during World War One, it was definitively ended by the protectionism of the 1930s. And the second wave drew to a close after the Nixon shock of 1971 which was followed by Reagan’s trade restraint policies.

Chart : World Exports of Goods & Services (As a % of GDP)

Sources: WTO, Capital Economics

  • The current most likely course of policy rollback is the trade war between the US and China. This trade war, in and of itself, is not actually that big a deal, given that trade between the US and China accounts for only 3% of total world goods trade. But it is a symptom of more fundamental factors in the relationship between China and the West. China’s emergence as a strategic competitor means that some form of push-back was inevitable, whoever the US president happened to be.
  • What’s more, there is a risk that the trade war is the start of a broader backlash against globalisation that goes beyond just the US and China. After all, globalisation has undermined the power of national governments and been blamed for rising inequality, multinational tax avoidance and unwanted migration.
  • There are various forms that de-globalisation could take, including the break-up of the world economy into competing regional blocs or the widespread imposition of tariffs between individual countries.
  • In most scenarios, the effects for the world as a whole would be negative, but manageable. (See Table 1.) A modest degree of regionalisation would not be a big problem given that a lot of trade already takes place between neighbouring countries, and regions would probably be big enough to sustain companies that achieve maximum economies of scale. Meanwhile, we estimate that a trade war in which every country levied import tariffs of 25% would knock 4% off global GDP by 2030 – significant, but not devastating.
  • Indeed, the implications of protectionism for the world economy over the next decade or so would probably be small compared to the much larger challenges posed by demographics, stubbornly low productivity growth and the impotence of monetary policy.
  • However, the one de-globalisation scenario that is especially concerning is a deep split between China- and US-led economic blocs, in which case economic growth and stability could be seriously endangered. Admittedly, it seems unlikely that trade and investment flows between the West and China would be dramatically cut back, in a repeat of the “Cold War Two” between the US and the Soviet Union. Whereas the Soviet Union was never a major part of the world trading system, it would be extremely difficult to disentangle China from the global economy.
  • However, a mix of restrictions on trade in specific sectors and products seems likely, as does some sort of technological iron curtain. Indeed, the so-called “splinternet” is already here, with China barring Western internet services such as Facebook to limit the flow of information. Concerns about their vulnerability to attack could see Western governments respond with restrictions on Chinese-made hardware too.
  • Whatever happens, de-globalisation would contribute to lower asset returns over the next decade than in the past. (See Table 2.) If a policy-driven reduction in integration slowed economic growth and increased frictions to global financial markets, this effect could be a major drag on returns. But given the starting point of very low bond yields, the drag on equities would not stop them from outperforming bonds, unless de-globalisation took the most severe forms we have discussed.

Table 1: Globalisation Scenarios – Economic Effects

Scenario

Growth

Inflation

R*

Globalisation reaches its natural limits

Mild regionalisation

Global trade war

Extreme regionalisation

↓↓

↓↓

Source: Capital Economics

Table 2: Globalisation Scenarios – Market Effects

Scenario

Bonds

Equities

Commodities

Globalisation reaches its natural limits

Mild regionalisation

Global trade war

Extreme regionalisation

↓↓

↓↓

Source: Capital Economics


Vicky Redwood, Senior Economic Adviser, +44 20 7808 4989, victoria.redwood@capitaleconomics.com