31 July 2020
7 minute read
By Gerald Moser, London UK, Chief Market Strategist
The pandemic may accelerate the reversion in globalisation seen of late. The trend is likely to partially localise supply chains, alter public spending priorities, increase inflation and hit profit margins. The impact on portfolio allocations may be profound. Finding investments likely to profit from this switch appears key.
Globalisation is not a new phenomenon. Through the past two centuries, there have been periods when the world was “open” for international trade, and other periods during which the world was “closed”. But the past 30 years have seen a level of interconnection, and cross-border trade, never experienced before (see figure 1).
Several factors explain the period of deep globalisation seen since 1990:
However, the latest globalisation cycle probably peaked a few years ago. The growth in trade, which typically only underperforms economic growth in recessionary episodes, has been weaker since the recovery following the 2008/2009 global recession (see figure 2). Part of the shift in the regime is endogenous to the globalisation phenomenon, while policy shifts have played a part.
The increase in globalisation resulted in large parts of the production chain moving from the developed world to elsewhere. With the opening up of large areas, such as China and the former Soviet bloc, companies gained access to a new, deeper pool of cheap labour. From an economic perspective, increased globalisation put downward pressure on inflation as costs of production fell. It also helped to reduce inequality between the developed economies and the emerging ones through a large flow of investments from the former to the latter. But that attractiveness seems to have largely run its course for now.
The difference in the cost of producing goods between developed and emerging markets has narrowed in recent decades. For instance, manufacturing wages in China, Korea and Hong Kong, as a percentage of US wages, have shot up to 60-70% today from 10-20% in 1970 (see figure 3).
The flip-side of shifting unskilled work from the developed to the emerging world has been more inequality in the former.
While the services sector, which generally requires highly skilled workers, has grown in Europe and the US, manufacturing jobs, typically more labour-intensive with a lower skillset required, were moving out of those regions. It contributed partly to the increase in inequality and social tensions seen in the developed world during the period of deep globalisation (see figure 4). More lately, this turn of events resulted in a backlash towards liberal governments and a rise in populist politicians castigating the rise of globalisation and adopting more protectionist policies.
China joining the WTO in 2001 was hailed as a milestone for the world economy. By contrast, the country’s subsequent impressive growth over the past two decades has created tensions and fears, especially in the developed world.
China accounts for 14% of global exports, well ahead of the US and Europe. The nation is now the second largest economy. Its ascent to an economic superpower has been accompanied by much more investment in strategic technologies. The vying for global power between the west and China, and bouts of heightened tensions between the two, is less conducive to international cooperation and globalisation-friendly policies in general (see figure 5).
This year’s COVID-19 pandemic could lead to more protectionism and accelerate the recent reversal of globalisation.
With the world entering containment phases at different times, it exposed how dependent many economies had become on other economies. Indeed, the pandemic has illustrated the potential fragility of supply chains that rely heavily on goods produced abroad to sudden spikes in demand or abrupt stop in production. This economic vulnerability could be a cause for concern when thinking about economic security and lead to an arbitrage in favour of safety over profit when planning supply-chain investments.
While globalisation is receding from extremely elevated levels, a complete reversal of the last 30 years is highly unlikely. The reasons why include the following:
The lower labour costs and tariffs seen in recent decades have contributed to a structural improvement in profit margins. Other elements, such as increased automation and technological developments, also contributed to higher margins, but globalisation cannot be ignored.
The on-shoring of all production is highly unlikely as it would create unsurmountable organisational challenges. And while in certain cases resilience will be preferred over lower costs, for some companies with already low margins, the on-shoring of supply chains is not financially viable.
The most likely short-term effect is more diversified supply sources. For sectors relying heavily on low-skill labour, this seems the most likely outcome. With most of the initial factors which triggered the rise in globalisation in the last 30 years still in place, a full reversal is unlikely.
As a matter of fact, large cooperation treaties are still being signed. For instance, the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, a trade agreement between 11 countries representing around 13% of global gross domestic product, which came into force in December 2018.
“Globalisation reversion” is likely to be more visible in sectors deemed strategically important, such as where the intellectual property is a significant element. For those sectors, which are likely to influence the balance of power over the next decade, policy actions could drive some on-shoring.
Measures such as subsidies, tax incentives, government contracts and foreign investment controls when technology transfer could be involved are all potential incentives states could use to trigger on-shoring. In turn, this could lead to the development of “local champions” in key technologies such as artificial intelligence or 5G.
The new paradigm of globalisation reversion could translate into higher investment, inflation and subsequently higher interest rates. A partial on-shoring of production would mean more investments in research and development and automation to increase productivity and mitigate the additional costs of on-shoring supply chains.
And with the world moving from cooperation and towards more competition between large regional powers, investment in key technologies and infrastructure should continue to ramp up. China has already started large infrastructure investment, notably around its One Belt, One Road initiative. In addition, a potential restriction on free capital circulation could lead to inflation and higher interest rates in a few years.
Globalisation was a strong positive force for equities and bonds, translating into higher corporate margins, weaker inflation and lower interest rates. In a nutshell, it was favourable for financial assets and asset-light companies. Globalisation reversion could lead to outperformance for equities, gold and other commodities as well as infrastructure and other real assets over pure financial and nominal assets such as fixed income.
Strategic sectors such as technology, defence or healthcare are likely to get government support to create domestic organisations that can compete for global leadership. But this could also mean lower market shares, more fragmented sectors and higher barriers to entry.
Since the 1990s, more international cooperation and economic alignment helped to reduce uncertainty in forecasting the economic cycle. But with a weaker globalisation impulse, macro volatility is likely to fluctuate around elevated levels.
The use of trade tariffs and other barriers to entry by governments means that long-term visibility when planning any kind of investment decision is limited. As such, sustained periods of heightened uncertainty should be included into any investment decisions. The use of volatility as an asset class and the need for a well-diversified portfolio to mitigate the uncertainty factor is likely to be more crucial than ever.
The use of volatility as an asset class and the need for a well-diversified portfolio to mitigate the uncertainty factor is likely to be more crucial than ever
The pandemic may be most on investors’ minds for now. But a series of long-term, structural megatrends are likely to have a larger impact. Our investment experts look at the impact globalisation reversion, demographic shifts, building a sustainable world and the pending revolution in “smart” everything may have and how you may profit from them while making a difference to the world.
Barclays Private Bank provides discretionary and advisory investment services, investments to help plan your wealth and for professionals, access to market.
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