Globalisation is a useful prism through which to examine both longer term economic, market and technological developments. Our analysis, which captures the drivers of globalisation across all of its important dimensions, suggests that we currently stand at somewhat of an inflection point.
Although we expect globalisation - as broadly defined to capture its trade, capital, people and information elements – to continue, the relative importance of those drivers and the regional leadership of the institutions that help propel globalisation forward is undergoing tectonic changes. The days when goods and capital market integration were the primary drivers are over; as are the days where governments could ignore the distributional consequences of globalisation or where the US could dominate the global institutional and regulatory landscape relatively unopposed.
Gaining access to the winners will require greater precision in investment selection, with research-led, active decision-making likely to be rewarded.
What comes next is uncertain, but a more prominent role for information and services seems assured, as does a greater influence for China and other large emerging economies as they continue to grow in relative economic importance and seek political influence to match. While it is not inevitable that this transition gives rise to greater conflict, particularly between the US and China the early signs are that greater fragmentation of the international system is the most likely outcome.
These tectonic shifts have important investment implications. The first is that a world in which globalisation continues to grow much more slowly than in the past, average global productivity and potential growth will also remain more modest. This, in conjunction with high global debt levels will keep real risk free interest rates low compared with longer-term norms.
In response, the policy balance must shift away from monetary policy, which has done much of the heavy lifting post-crisis but is yielding diminishing marginal returns, to structural reforms and growth-enhancing fiscal policy. Importantly, we call for greater focus on sustainable ‘green’ fiscal policies that tackle the redistribution and environmental challenges the world faces without detracting from potential growth.
The second is that we also face the prospect of lower average corporate earnings growth and thus equity returns. For a given level of interest rates, productivity growth is the key to sustained equity returns. Slower globalisation amid fewer opportunities for unbundling supply chains and more policy emphasis on redistributing income from capital to income, imply that it will be harder to grow aggregate margins over the longer-term while also raising the possibility that the long ascent of margins may even reverse.
The third is that there will likely be big changes in the investment opportunity set across firms and countries. The hyper-globalisation era was an especially large boon to the companies and countries that could best exploit the growth of global value chains in manufactured goods. In that world, having a small domestic market, or a concentrated resource endowment, was not a barrier to growth because open borders enlarged the opportunity set.
Looking forward that path to catch-up growth will be harder to come by as the return to large domestic markets and pools of skilled services and technology workers will increase, as will the benefit of having a strong indigenous culture of innovation as opposed to buying that innovation in the open market. Investors will need to think carefully about which firms and countries are best placed to benefit from a more services and technology oriented form of globalisation and which will struggle to adapt. Gaining access to the winners will require greater precision in investment selection, with research-led, active decision-making likely to be rewarded.
The fourth is that the premia investors require when investing in risky assets may increase. A core element of our thesis is that the world is becoming much more fragmented, both within countries and between them. It is feasible that the world will eventually separate into a dollar bloc, a renminbi bloc and bloc of countries that attempt to straddle the two. This will be particularly difficult for those countries that have developed especially close economic ties with China but still rely on the US-led alliance system to guarantee their security.
That in turn will make cooperation harder to come by, make it more difficult to manage the cross-border dimension of crises when they arise and make the world generally less predictable. With uncertainty elevated and more scope for shocks, risk appetite may be structurally lower and the hurdle rate for productive investment higher. The correlation structure of asset prices is also likely to change in this environment.
Data Appendix: ASI Globalisation Index
The aim of the index is to capture movement in variables that are affected by and symptomatic of globalisation. The variables chosen are representative of four different categories of variables.
3 year averages have been taken for all variables to smooth over year to year volatility. All variables are standardised so as to ensure a common unit of measurement.
Once standardised we aggregate the variables first into sub-indices based on equal weightings and then each sub index enters the final globalisation index with a weighting of 0.25.
The tariff rate variable enters the index with a negative weighting. The negative weight captures the adverse effect increasing tariff rates have on globalisation.
Variables like trade as % GDP, FDI as % GDP and Banks external claims are subject to cyclicality i.e. they have strong co-movement with global growth. To overcome this issue we could either de trend the data using a filter or take a moving average which reduces the volatility of the series. For the purpose of this index we have used moving averages. The averaging makes sure we have a smooth index but at the same time we capture the movements in trade or FDI caused by a strong/ weak growth environment.
Narrow & Broad index
For the narrow index we’ve only used variables that have a history going back till 1960. For the broader index we have used a combination of 14 variables which better capture the multi-dimensional nature of globalisation.
De jure v de facto
The split between de jure and de facto was undertaken to understand whether the policy measures that are meant to facilitate trade have retraced some of the advances made during the periods of healthy globalisation growth. The de jure index is comprised of average tariff rate, regional trade agreements, new WTO members and the Chinn ito index.
Within the de jure and de facto indices each variable has been weighted equally.
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