What’s happened?
A growing number of big investors, including bosses at BlackRock, Oaktree Capital Management and Allianz Global Investors, have gone public with predictions that the war in Ukraine will prove an inflection point in the global economy. “The Russian invasion of Ukraine has put an end to the globalisation we have experienced over the last three decades,” wrote Larry Fink, chief executive of the world’s largest asset manager, BlackRock, in his annual letter to shareholders last week. The isolation of Russia from capital markets will promote a trend everywhere towards national independence and hasten the development of rival economic blocs led by the US and China. A world in which cheap offshore manufacturing and smooth global supply chains hold costs down will be replaced by “a large-scale reorientation of supply chains”, and that will be inflationary, says Fink. That implies lower growth and lower returns for investors.
Is Larry Fink right?
One metric that offers a reasonable proxy for “globalisation” is international trade as a share of global GDP. That share surged from 25% in 1970 (World Bank figures) to 50.7% in 2000 and peaked at 61% in 2008. This was an era when Western policymakers believed that trade and investment would bring the world closer together politically. From 1992 to 2008, Russian gas exports grew tenfold. Between 1985 and 2015 Chinese goods exports to the US rose by a factor of 125. And in the 1990s annual global flows of foreign direct investment rose by a factor of six.
So what went wrong?
In the wake of the financial crisis, global trade fell sharply before bouncing back a bit. But it has never again hit that 61% – instead trending lower and falling to 51.6% by 2020. Meanwhile, global flows of long-term investment fell by half between 2016 and 2019. The Ukraine war follows hard on the supply-chain shocks of the US-China trade war, the Covid-19 pandemic, and the semiconductor shortages – all of which have focused attention on supply-chain sovereignty and domestic production. In other words, globalisation has been in retreat for some time, as John Micklethwait and Adrian Wooldridge point out on Bloomberg “But Russia’s invasion of Ukraine marks a bigger and more definitive assault than the previous ones.”
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Why is this retreat happening?
Two main reasons, say Micklethwait and Wooldridge. First, because “geopolitics is definitively moving against globalisation” and towards a world dominated by two or three great trading blocs (an Asian one led by China, perhaps with Russia as its energy supplier; a US-led bloc; and perhaps a third centred on the EU). But just as important is a change in mindset. CEOs now understand they are in a world where political matters trump economic logic. They are recalculating accordingly, shifting from a “just-in-time” mentality to “just-in-case” – by preparing to bring production closer to home in case their foreign plants are cut off, for example. Historians may well decide that “the definitive moment globalisation died was when China, India and South Africa all abstained on the United Nations vote condemning Putin’s invasion”, says Robert Peston in The Spectator.
What will that look like in practice?
Already, French president Emmanuel Macron has committed his country to self-sufficiency in pharmaceuticals. The EU has vowed to wean itself of Russian gas, oil and coal by 2027. Joe Biden has promised to “make sure everything from the deck of an aircraft carrier to the steel on highway guardrails is made in America from beginning to end”. But this “fetishising of domestic manufacturing over advancing crossborder trade in services and networks” is ironic, argues Adam Posen in Foreign Affairs. In fact, it is the latter sectors that have truly advantaged the West over Russia in implementing effective sanctions, and that have deterred Chinese businesses from bailing Russia out. Sadly, the retreat from globalisation will diminish both innovation and the return on capital in the world economy, and “it will do so on every side of the economic divide”, says Posen.
Growth will suffer then?
Yes. It will lead to higher prices for inputs, already seen most dramatically in the oil and gas price surges, but also in soft commodities and metals, as Emma Duncan points out in The Times. Higher input prices push up consumer prices and reduce output, thus hitting employment and wages. The other “source of economic pain will be lower demand, as markets are closed off to each other”. World trade will fall – hurting the global economy, and Britain (an open, trading, service-based economy) more than most. “About 63% of our GDP is traded, compared with 26%, 36% and 49% of America’s, China’s and Russia’s respectively.” Globalisation is in retreat, and we are “going to miss it when it’s gone”.
What can be done?
For policymakers, deglobalisation adds to the fiscal pressure of a low-growth world. Rishi Sunak’s spring statement fiddled with tax rates. But arguably far more important, says James Heywood on CapX, was his promise of a major review of how the tax system creates incentives for investment. That could prove crucial to reinvigorating growth and productivity. Meanwhile, we’ll have to learn to invest in an inflationary environment that compresses multiples and shrinks profits, says asset manager Thomas Friedberger. Investors will have to position themselves to “take advantage of these mega trends: energy transition, cyber security and digitalisation”, he told the FT. Monica Defend, head of the Amundi Institute, suggests a focus on sectors such as energy and defence that will benefit from “strategic autonomy”. Virginie Maisonneuve, of AllianzGI, believes the shift could “drive innovation” by linking renewable energy with artificial intelligence to enhance efficiency, for example.
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