Is globalization over?

The trend may have peaked, but we don’t think it’s ending.

Globalization means many things–migration, the exchange of ideas and culture, and trade and cross-border capital flows, to name a few. Increased trade tensions, especially between the US and China, have shined the spotlight on the topic and raised the questions, “Is the end of globalization at hand?” and “What are the implications for investors?”

Here, we define globalization narrowly to mean trade in goods and services and suggest that the dramatic rise in global trade flows (especially manufactured goods) witnessed over the past three decades may have reached its zenith. We argue that this is not a new phenomenon or related only to recent trade tensions, but rather the continuation of a trend underway since the global financial crisis of 2007-2009.

If globalization has been waning for years, what is the worry?

We think these trends may have far-reaching implications for global growth potential and especially for emerging market economies (EMs) and their existing growth models. The globalization and export-oriented growth models of many EMs have been credited as key contributors to rapid growth in per capita incomes in EMs, especially following China’s accession to the World Trade Organization in 2001. Of course, these externally based models have been accompanied by better domestic macroeconomic management too, including the deepening and opening of domestic financial markets, increased competition, and perhaps more importantly, an increase in foreign direct investment (FDI) that has transferred technology to EMs and improved productivity. These developments have helped lift millions out of poverty and increased the potential growth of the world economy, led by EMs (Figure 1). Reinforced by a dramatic decline in transportation and communications costs, the rise of global value chains (GVC) has led to the segmentation of the manufacturing process in which production is allocated to various countries based on cost minimization.

Figure 1: Export growth and per capita income

Source: Our World in Data, 2019.

Downward trend in foreign direct investment and trade

However, since the global financial crisis, we have seen a discernible downward trend in FDI flows to EMs and global trade in general. FDI to EMs has plateaued in recent years and the world is now trading less for each unit of GDP it produces than it did before the financial crisis. We attribute this secular decline in “trade elasticity” to several factors:

  • The composition of world gross domestic product (GDP) is changing, led by China’s rebalancing away from investment toward consumption, but also due to globally weaker investment since the financial crisis. Because investment tends to have a larger import content than private consumption and government spending, trade flows are also weaker.
  • The second culprit appears to be slower expansion of GVCs. This may be partly due to natural limits to the fragmentation that can be achieved in GVCs. After a point, quality control concerns, logistical and transportation costs probably make it disadvantageous to further break down production chains. A second reason often cited for slower GVC expansion is China’s move up the value-added chain. As Chinese technology has improved, the share of foreign value added in its exports has declined since the 2000s. This development is not limited to China. It has been observed on a global scale as technology diffusion has increased domestic capabilities (Figure 2).
  • In addition to these broader trends, potential saturation in two key trade and GVC-heavy sectors–electronics and autos–are also contributing to slower trade flows as a percent of global GDP. At the end of 2018, there were already 105 mobile phone subscriptions for each 100 people in the world (Figure 3), and the dramatic technological improvement since the first smartphones were launched appears to have leveled off. This is reflected in declining sales growth figures for mobile smartphones since 2013. In the auto sector, global demand for motor vehicles is cooling off, a result partly of the removal of purchase incentives in China and other economies, global attempts to decarbonize and the attainment of peak demand in advanced economies.

Figure 2: Global value chain participation

Source: United Nations Conference on Trade and Development, data from 12/31/90 to 12/31/18

Figure 3: World mobile phone subscriptions per 100 people

Source: World Bank, data from 12/31/80 to 12/31/18

What do these trends mean for global growth and EMs going forward?

We may be reaching the limits of the export-led growth models of the past century. Historical experience suggests that, as countries grow, the goods sector becomes a smaller and smaller share of the economy, in terms of output and employment. Once the basic needs for goods are met, consumer expenditures tend to transition to services. Consumers may need a house, essential durables such as televisions and refrigerators, and maybe a car or two. But with development, as these needs are met, consumers begin to focus more on services–better health care and education for their children and more sophisticated financial services, for example.

What does this mean for emerging markets? First, demand coming from advanced economies may not be what it used to be. As the demand for highly traded goods such autos and electronics is satiated, export growth may be limited. Second, there is only so much growth that can be generated externally and EMs may need to increasingly generate growth domestically. Finally, emerging market economies are following in the footsteps of advanced economies as their focus shifts from the consumption of goods to services.

Can emerging market economies grow without relying on exports?

We believe the answer is a qualified yes. It is true that the world’s most successful growth models, such as South Korea and Japan, were based on exports. A broader market allows larger scale investment and rapid income growth. But most important for long-term growth is productivity growth, achieved through more physical and human capital, and greater efficiency. After all, the global economy is a closed one and yet we have expanded productivity since the industrial revolution.

Despite this optimistic note for the long-run, current trade tensions and trade policy uncertainty are disrupting existing growth models and production structures and require painful adjustments. Decisions on investment and their locations require longer-term policy visibility than is currently available. We, therefore, expect continued softness in global fixed investment with a negative impact on potential global growth.

In the short-term, trade diversion away from the US and China to avoid tariffs may create relative winners and losers for certain products. However, we see bigger risks lurking in the current uncertain environment. Despite expectations of a first stage deal with China, we think geopolitical issues extend beyond mere trade in goods. These broader issues could lead to technological de-coupling and the regionalization of technology and trade, with significant negative implications for potential global growth.

Important Information

Credit image: NASA/Unsplash

The global value chain (GVC) describes the people and activities involved in the production of a good or service and its supply, distribution, and post-sales activities (also known as the supply chain) when activities must be coordinated across geographies.

Trade elasticity refers to the sensitivity of global trade to global GDP.

An investment in emerging market countries carries greater risks compared to more developed economies. The opinions referenced above are as of December 17, 2019. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.

Meral Karasulu is Director of Fixed Income Research for the Global Debt team, covering emerging  economies in the Asia-Pacific and Central and Eastern Europe regions.

Ms. Karasulu joined Invesco when the firm combined with OppenheimerFunds in 2019. Prior to joining OppenheimerFunds in 2015, she worked at the International Monetary Fund (IMF), where she served in a number of capacities over her 17-year tenure. In her last role at the IMF, she served as a deputy division chief in the Asia Pacific department. Over the course of her tenure, Ms. Karasulu has covered a range of advanced, emerging  and frontier markets including Korea, Australia, Chile, Germany, Netherlands, Mongolia, Myanmar, and Cambodia, focusing on macroeconomic and financial sector issues.

Ms. Karasulu earned a BA degree in economics from Bosphorus University, Turkey, and a PhD in economics, with a specialty in international macroeconomics and econometric theory, from Boston College.

Turgut Kisinbay is a Director of Fixed Income Research on the Global Debt team, covering developed market economies as well as emerging economies in Central Europe. In his role, he provides views on the economy, interest and exchange rates, and risk factors of the economies under his coverage.

Dr. Kisinbay joined Invesco in 2019 when the firm combined with OppenheimerFunds. Before joining OppenheimerFunds in 2011, Dr. Kisinbay was an economist at the International Monetary Fund (IMF) for nine years, specializing on monetary policy. He is a data science enthusiast, and his work on forecasting asset price volatility and business cycles has been published in academic journals.

Dr. Kisinbay earned a BA degree in economics from Bogazici University in Istanbul, Turkey, as well as an MA and a PhD in economics from McGill University in Montreal, Canada.

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