Technology and politics are changing how the world interacts
Globalisation is a highly contentious issue with many advocates and detractors. Nonetheless, throughout history, free trade has generally been good for prosperity, whereas periods of protectionism, such as those of the Corn Laws and Great Depression, have not.
The UK’s decision to leave the EU, a bloc based on the free movement of goods, services, capital and labour, has been portrayed as a vote against globalisation. This is seen to represent a wider shift: low growth and rising income inequality have resulted in the rise of inward-looking politics and nationalism across the developed world. New populist parties and candidates on the left and right are fuelling the belief that globalisation is not increasing prosperity.
Protectionism is on the rise. Donald Trump has promised to impose a 45% tariff on all Chinese imports, but he is not alone. The World Trade Organisation has warned of a slowdown in trade liberalisation and the number of restrictive measures introduced by its members is rising. Is globalisation, which requires free trade, in retreat?
The rise of globalisation
Globalisation has ebbed and flowed throughout history, but advanced sharply in the modern era. Global trade increased 27-fold between 1950 and 2008 — three times more than global GDP. This was driven by the absence of global conflict, including the end of the Cold War; the integration of emerging markets into the global economy; falling trade costs and technological advances; and even more division of labour. As a result, global trade openness — the ratio of trade to GDP — rose to a record high of 64.3% by 2007—08.
However, minimal growth in trade since the global financial crisis has caused this ratio to decrease (figure 1). In itself, this need not be alarming. Yet there are other signs that globalisation has stalled, such as weaker foreign direct investment flows, the decoupling of the major global economies, currency wars, and populist opposition to free trade and economic migration.
Out-of-step economies, however, are the norm rather than the exception — GDP correlations generally spike during financial crises. Since early 2009, the major economies have slowly decoupled, signalling more normal times rather than the end of globalisation. However, this has coincided with a slowdown in global trade, which is more pertinent.
Slowing international trade growth lowers global economic growth. If this is prolonged, it leads to lower potential growth and lower inflation. A downward shift in global economic growth can increase nationalism, leading to territorial disputes, opposition to immigration and a rise in protectionism.
World trade volumes have not recovered to the pre-financial crisis long-term average
The global financial crisis
Some commentators have blamed the apparent reversal of globalisation on the financial crisis, but some factors were slowing well before 2008. For example, after the Cold War ended, the emergence of lower-cost eastern European economies enabled companies to reorganise their supply chains globally. However, this trend started to decelerate in the 2000s.
In addition, rising incomes in emerging markets relative to developed countries have reduced their labour cost advantage. Sharp falls in the cost of technology, such as robots and 3D printers, have further eroded this cost competitiveness and resulted in ‘reshoring’ to developed countries.
We believe globalisation is changing, rather than reversing. Labour and physical capital were previously considered to be the main engines of growth, but knowledge-based capital has become more important, boosted by technological change and the internet. Trade in services grew to 12.5% of global GDP in 2014, overtaking its pre-crisis peak. A McKinsey Global Institute report from February found that “the world is more connected than ever, but the nature of its connections has changed in a fundamental way. The amount of cross-border bandwidth that is used has grown by 45 times since 2005.”
Globalisation is an extremely complex issue, but in our view reports of its death are greatly exaggerated. We should, however, be vigilant and prepared to challenge the simplistic rhetoric of populist politicians — the 1930s show us where nationalism, protectionism and beggar-thy-neighbour economics can lead.