Globalization will not disappear, it will change

In the wake of the pandemic, slowing growth, high inflation and conflict-induced disruptions in Ukraine are driving a shift in industrial production and distribution.

Key points

  • The world’s growing political fragmentation and supply chain disruptions raise the question of ongoing ‘de-globalization’
  • In the wake of the pandemic, slowing growth, high inflation and conflict-induced disruptions in Ukraine are driving a shift in industrial production and distribution
  • We observe the emergence of a new production model to face the new geopolitical realities and the costs
  • Investors should consider both sectoral and geographic factors when actively managing equity portfolios.

Last week, on the occasion of the World Economic Forum, which brings together business leaders and political leaders each year in Davos, “de-globalization” was at the heart of the debates. Is the world becoming more insular and multipolar as economies grapple with supply chain disruptions, inflationary shortages, China’s zero Covid strategy and conflict in Ukraine? We believe that the process of globalization will not stop, it will evolve.

If one views globalization as a process that stimulates continued growth and improves living standards, one could argue that a period of de-globalization is underway. Indeed, it is tempting to see a setback in globalization in the face of rising political nationalism, the departure of hundreds of Western companies from the Russian market, the absence of major new trade agreements and the continued imposition of tariffs between China and the United States.

The world has already been there. Appearing for the first time in the aftermath of the great financial crisis, the term “de-globalization” was considered at the time as a consequence of the slowdown in global growth. However, globalization did not start with the invention of the shipping container in the 1950s, the end of the Cold War, or China’s joining the World Trade Organization (WTO) in 2001. It is it is a process of secular evolution, which neither the pandemic, nor the latest anti-Covid measures decreed in China, nor the war in Ukraine will put an end to.

The raw materials, production, distribution and delivery network that we took for granted before the pandemic has been shaken by labor and component shortages. The absence of masks, and then the competition between countries for the purchase of vaccines, underlined our dependence on imports and the supply of goods from around the world, as well as the need to make them cross borders without delay. The manufacturing industry, which in recent decades had developed the “just-in-time” system, is moving to “just-in-case” production in order to avoid disruptions in supply chains.

As New York Times columnist Thomas L. Friedman said in Davos last week, globalization is not a one-way process. Over the past fourteen years, it has not only been economic and geopolitical, but also fueled by consumers and their growing ability to communicate, compare their experiences across borders and regions and thus stimulate demand. In this light, globalization includes the means by which trade and technology can better connect the world and make it more interdependent. In this context, globalization will not disappear, it will evolve.

Multilateral remodeling

The world is becoming increasingly multipolar and blocs are beginning to coalesce around like-minded business partners, in a process dubbed “friend-shoring”. The most visible block is that formed by the United States, the European Union and their allies, which quickly deployed a series of sanctions against Russia. Equally visible is the non-aligned group, comprising Brazil, India, South Africa and China, which are unwilling – or unable – to sever their ties with Russia. Nevertheless, it should be emphasized that the most important long-term bilateral relationship remains the competition between the United States and China.

The era of ambitious multilateral agreements to facilitate global and regional trade seems to be over. The General Agreement on Tariffs and Trade (GATT) dates from 1947, ASEAN from 1961, Mercosur from 1991 and 1994, NAFTA from 1992 and the WTO from 1995. In some cases, this network of trade agreements are being revised, even dismantled; Britain voted in favor of Brexit in 2016, the Trump administration withdrew the United States from the Trans-Pacific Partnership (TPP) in 2017, renegotiated an agreement with Mexico and Canada in 2018 and blocked the process of settling disputes. WTO disputes in December 2019. However, last week the Biden administration signed the Indo-Pacific Economic Framework with 13 countries and which includes labor standards and e-commerce provisions, but which, like the TPP before it, excludes China.

Prior to the current inflation crisis, labor shortages and Covid-induced disruptions created a shortage of shipping containers. The prices of the latter jumped from around USD 1,500 in February 2020 to over USD 10,300 in September 2021. At USD 7,768 in April, they remain much higher than before the pandemic.

This did not prevent the increase in the commercial value of the goods transported. Since the invention in 1956 of the standardized 20-foot (6.1-meter) long steel shipping container, the volume of world trade has increased 40 times, according to the WTO. As for the value of the goods transported, it is almost 300 times higher. In 2021, the total value of trade in goods reached a record USD 28.5 trillion, an increase of 25% compared to 2020, and 13% compared to 2019. Services reached USD 1.6 trillion in 2021 , a level similar to that of 2019. However, the pace of growth in world trade has slowed since the Great Financial Crisis. While it grew by 6% per year on average after 1945, it has fallen to around 3% per year since 2008. We expect this slowdown to continue, and annual growth is expected to be 1.5% longer. term (see graph 1).

From “just-in-time” to “just in case”

The strength of a chain is only equal to that of its weakest link, the saying goes. As the world becomes more multipolar, industrial supply chains are adapting to protect themselves from disruption. Pre-pandemic cost concerns have shifted to supply and production resilience.

One way to improve this resilience is to move companies towards “dual sourcing” of components and production, manufacturing the same items at two or more sites, and thus creating redundancy. In summary, this trend is to shift from “just-in-time” production to “just in case” manufacturing. The price to pay for supply resilience will be the association of costs with smaller production volumes and potentially higher wages.

Discussions move from the theme of “relocation” in the country of origin, to that of “near-shoring”, which consists of relocating production to a nearby country. But this trend should not be overestimated. If relocations take place, they happen in the background, while many large companies, such as European aircraft manufacturer Airbus, for example, continue to increase their production capacity in China.

Given its strategic importance for electronics, the semiconductor sector is among the most likely to move production sites. China accounts for about a quarter of global semiconductor exports, with Japan and Taiwan together producing a fifth. However, a change of site requires time, as new installations can take three years from commissioning to product delivery.

Microchip shortages have impacted the automotive industry, slowing deliveries, driving up the price of used vehicles and costing an estimated 10% of global sales in 2021. In Europe, this effect on automotive production is expected to escalate. intensify with a further 5% reduction in volumes expected in 2022 due to the war in Ukraine, where a large part of the cabling for this industry is assembled. In the longer term, automakers will need to continue assembly in low-cost economies, such as Ukraine, China, Mexico and North African countries, even if current disruptions continue. At the other end of the price spectrum, certain industrial sectors, such as fashion, are highly standardized with little room for price increases, and therefore no possibility of redirecting production locally.

Globalization is changing as trade adapts to changing geopolitical constraints to meet demand. Therefore, we do not expect major structural consequences for inflation or economic growth as goods find their way to consumers even in the presence of higher trade barriers.

For example, China’s share of global exports has increased, although its volume of direct exports to the United States has declined since 2018, when the two countries began imposing tariffs on their respective imports (see graph 2). The rise in taxes between the United States and China triggered a transfer of production to close or neighboring countries, such as Vietnam, but a radical transformation did not take place.
If customs tariffs never benefit an economy, their impact seems relatively limited. The duties imposed by the previous US administration are estimated to have reduced US gross domestic product growth by 0.2% over the long term. Perhaps more importantly in the near-term fight against rising consumer prices, we estimate that a full tariff reversal would reduce US inflation by around 1.3%.

The move towards regional trading blocs could also challenge the role of the US dollar as the world’s reserve currency. However, the need to trade internationally and the purchasing power of the American consumer have determined the status of the dollar and will continue to support it. As we discussed in a recent article, there is little alternative, so it is hard to see the dollar losing its position as the dominant currency in the world.

Rethinking sector investments

In most sectors, the business reality is one of globally integrated markets, from supply to production and sales. Therefore, companies belonging to a specific industry might have more in common with each other than companies from a particular country or regional index. However, for equities, the dispersion of performance by sector and by region seems at least as large (see charts 3 and 4). Therefore, investors should complement their tactical regional views with thematic and sector views.

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Globalization will not disappear, it will change

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