The challenges to globalisation

Security becomes more important than free trade when you cannot trust all the traders. As divisions between the west, Russia, and China entrench, globalisation is on the retreat.

| 7 min read

As the central banks reflect on why they failed to control inflation in the US and Europe, they are tempted to blame supply interruptions and the retreat from globalisation.

It is true that the Covid-9 lockdowns disrupted supply and helped create shortages as we emerged from lockdowns. Labour markets on both sides of the Atlantic lost potential employees, driving up the cost of labour. A knock-on effect of this was reduced capacity in leisure, hospitality, travel and entertainment as businesses reopened, allowing higher prices.

The Russian invasion of Ukraine reduced the supply of gas and oil to European markets, adding to the price pressures on fossil fuels just as the world economy needed more energy. The Russian blockade of Ukrainian food ready for export drove grain prices higher. Changing western attitudes to both Russia and China has led to policies designed to find sources that can supply important items closer to home.

Whilst all of this is part of the background to the great inflation we now see, it is important to remember that the authorities were following very loose policies, borrowing large sums of money to increase demand and keeping interest rates very low through their extraordinary monetary policies. These, too, are an important part of the story.

Peak globalisation?

The first twenty years of the current century were the high crest of a wave of globalisation. In the second half of that period, an era of low-interest rates was ushered in following the credit and banking excesses of the 2005-8 period. Because the commercial banks were made to live with regulatory demands for more capital and cash relative to their loans, the authorities were able to keep rates very low without creating another inflationary burst – aside from the obvious bubble forming in the valuation of the bonds central banks bought to keep interest rates low.

The dash to globalisation speeded up with the December 2001 entry of China into full membership of the World Trade Organisation. China was given asymmetric terms, allowing it fairly-free access to advanced country consumers, whilst having the ability to protect its own home market.

China took full advantage, expanding the economy very rapidly with exports of manufactured goods and high levels of investment spearheading the growth. Chinese GDP shot up from around $1.3 trillion annually to $17.4 trillion in two decades, a thirteenfold increase. Over this period, China moved up the value chain, producing more sophisticated and complex products. It started sub-contracting parts of the manufacturing task to lower-cost countries. Many argued that the good value and scale of output of Chinese goods was a main driver of lower inflation globally. The West came to rely on regular arrivals of container ships bearing cheap goods from Shanghai.

The high priests of international specialisation approved of China becoming the world’s factory.

China became the main disrupter of more national and regional patterns of trade, asserting itself to become one of the largest trade partners of many countries, despite the massive distances involved in some trade. This, in turn, fostered more international relationships. China bought up important raw material reserves or helped finance their development. It sought to develop Hong Kong as one of the larger global stock and bond markets, to improve transport facilities from China to Europe through the Belt and Road initiatives, and to catch up with US technology in the crucial digital area.

The high priests of international specialisation approved of China becoming the world’s factory as the US claimed pre-eminence in digital-technology-based companies and showed how the internet could transform news, media, entertainment, remote learning and online business. Advanced countries settled into providing more services, with some seeking manufacturing success based on good technology and strong branding. Germany did well in the expensive car market. France and Italy maintained their positions in selected consumer areas, with some strong world brands. Countries needed to find a niche and reinforce their advantages.

The rise of the populist

This started to change with the election of President Trump. Markets were worried by his more-aggressive approach to trade and his challenge to China. He claimed China was a trade cheat, taking advantage of the one-sided WTO arrangements, and acquiring technology from others by questionable means.

The US establishment, including Mr Trump’s Democrat rivals, agreed with him that China was now competing unfairly. They backed his idea that the US need to make more for itself, reducing dependence on the containers from China that arrived full of imports. The disruptions caused by Covid-19 added to the questions over US/China trade first started by the Trump tariffs.

China’s celebration of a major alliance with Vladimir Putin’s Russia on the eve of the invasion of Ukraine speeded up the loss of trust by the west and led more to want to reduce western dependence. Getting China out of supply chains for sensitive technology that could be used in defence equipment or was thought important to national security became part of the policy agenda.

The Ukraine war speeded up the need to get Russia out of most supply chains. Wide-ranging sanctions were introduced as the west wanted to end any dependence on Russian supply for sensitive items. This spread into a wish to end all buying of Russian energy to starve Russia of cash to pay for the war, and to widespread bans on banking activity from Russia into western systems.

What is different is policy direction and intent.

The truth is that today, the world still has a very integrated economy in many respects. The delayed or disrupted container ships from China still bring crucial supplies to Europe and the US. Russian gas still fuels German factories and heats European homes. Ukrainian food is needed by Middle Eastern countries that rely on it. Large global companies still try to run businesses in a wide variety of different countries and political systems and still deliver products and services that need inputs from several countries in the process.

What is different is policy direction and intent. Many western countries are now looking to reduce their dependence on Russia and China. Many are planning greater self-reliance, seeking to attract new investment closer to home.

Economic theory tells us that specialising more and trading more promotes more growth and prosperity. More countries now see the dangers of relying on sources of supply that may be used against them as part of some wider trade war or political battle. Security becomes more important than free trade when you cannot trust all the traders.

Investors need to consider the risks in global sourcing and the costs of doing more in safe countries, as governments seek to chart a new course away from full globalisation. We are entering a world of more subsidies, bans, regulations, taxes and controls as governments seek to affect outcomes in the marketplace that business competition used to settle.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

The challenges to globalisation

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