The future of Globalisation in the age of Trump and Xi

Executive summary

Amid the rise of protectionist populism in the West, and escalating conflicts over trade policy and the future of technology, it has become fashionable to claim that globalisation’s days are numbered. To provide a deeper understanding of the current state and probable evolution of globalisation, we have built a proprietary Aberdeen Standard Investments (ASI) Globalisation Index incorporating its trade, capital, human and informational dimensions.

With the aid of this new tool we identify three tectonic shifts in the nature of globalisation that will have significant macroeconomic and market implications over the next decade and beyond. The first is that although at the aggregate level there has been only a moderate slowdown in the pace of globalisation over the past decade, there has been a more profound shift in its composition. In particular the contributions of goods trade and capital market integration, the traditional engines of cross-border linkages, have slowed significantly since the crisis while growth in the human and information-related aspects has continued apace. This brings the promise of a vastly different form of globalisation.

Next, our analysis indicates that changes in the political and policy landscape are amplifying the slowdown in globalisation’s traditional drivers. At the heart of this development is the deteriorating relationship between the US and China. However, the broader issue is the lack of consensus about how to design a new governance model for international institutions that is both democratically sustainable and capable of supporting the changing nature of globalisation.

Finally, we identify a shift in the balance of power in global trading relationships. China has become the world’s largest exporter of manufactured goods. Emerging markets (EMs) now account for a larger share of global activity than developed markets (DMs). A world where Asian economies account for the bulk of global activity, and where economic and institutional leadership comes more from Asia, is also one where Asia will have a bigger influence on the global economic and financial cycle and the rules of the game will be written with less of a Western bias.

Our base case is that these three meta-trends will continue over the next decade. However, we also use the ASI Globalisation Index to identify a number of alternative scenarios for the next phase of globalisation, identifying waymarks and potential qualitative impacts. Our scenario analysis implies that the risks are tilted towards slower globalisation and more fragmentation in the international system. But there are also upside risks if politicians can harness technological advances in a way that benefits the many rather than the few.

Our analysis has significant implications for economies and markets over the longer term. The continuation of the slow aggregate pace of globalisation will help keep potential economic and earnings growth lower than pre-crisis norms as it weighs on the commercialisation and diffusion of technological progress. That in turn should help sustain lower real interest rates and lower aggregate equity returns.

At a more granular level, slower goods trade and capital market integration relative to human and informational integration will tilt the relative winners from future globalisation away from ‘super manufacturing trading’ economies and multinationals reliant on global goods value chains, towards more domestically oriented, service based economies and firms. Importantly, the changing composition of globalisation implies greater dispersion in performance at the country and company level, creating greater opportunities for active investors.

Finally, a world in which strategic conflict between the US and China becomes more common, countries will increasingly be forced to choose to selectively align themselves to competing power blocs. This will increase the likelihood that the global trading and regulatory system fragments into competing regional blocs. As previous correlation and relationship structures break down investors will need to adapt and innovate both in terms of investment approaches and client outcomes.

 

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Authors

Govinda Finn,
Japan and Developed Asia Economist

Jeremy Lawson,
Chief Economist and Head of ASI Research Institute

Yashaswini Dunga,
Analyst

Abigail Watt,
Senior Statistical Analyst

 

Introduction
 

Chapter 1

The post-war world has been heavily shaped by the forces of globalisation (see Table 1). It is widely accepted as having contributed positively to a range of economic and market outcomes. It has raised potential growth rates, increased average equity returns, lowered inflation and facilitated technological innovation. It has also helped lift hundreds of millions of people out of extreme poverty.

Table 1 - Globalisation – A force to be reckoned with

Globalisation has contributed to:
Higher global potential growth as countries have been better able to pursue their own comparative advantage.
Acceleration in the transfer of technology and know-how and rapid catch-up growth among less-developed economies.
Unbundling of the different stages of production through the creation of global supply chains, raising intra-industry trade and supporting the shift of manufacturing activity to emerging markets.
A weaker relationship between inflation and the domestic output gap; and an increased impact of ‘global’ slack on inflation as well as the global economic and financial cycle on domestic activity.
A more even distribution of income between the developed countries and early and medium stage entrants to global markets; and a less even distribution of income between those economies and late stage entrants to global markets.
A less even distribution of income within the advanced economies as the benefits have flowed disproportionally to the top of the income distribution.
A greater amplitude of economic and financial ‘shocks’, increasing market volatility and correlations.
Higher earnings potential and an upward trend in the advanced economies’ corporate profit share, in turn supporting equity returns.
Increased constraints on local economic, financial and political institutions as capital has become more mobile and global institutions have played a growing role in governance and regulation.
Source: ASIRI (as of 2019)

However, the gains from globalisation have not been evenly shared. It has benefited emerging economies more than developed economies and the owners of capital in the developed economies more than labour. Western workers in previously protected labour-intensive manufacturing jobs have been hit particularly hard. It has also boosted profit margins more for firms that could unbundle their supply chains across borders than firms more dependent on domestic factors of production.

Despite widespread acceptance of globalisation’s strong influence on the world we live in, globalisation analysis is still hampered by weaknesses and inconsistencies in how it is defined. This undermines our ability to understand the economic and market consequences of shifts in the nature of globalisation and to assess the investment implications. It also hampers our capacity to generate useful policy conclusions.

To help advance analysis on this topic we developed a transparent ASI Globalisation Index based on a clear and comprehensive definition of globalisation that we can track at the aggregate and sub-component level. We then use this framework to assess the pace and drivers of globalisation over multiple decades, showing how the nature of globalisation has changed since the financial crisis.

Next we develop forward looking scenarios for the future of globalisation drawing on the key economic, financial, political, policy and technological drivers. Finally, we outline the investment implications of our conclusions.

 
 

What is globalisation?
 

Chapter 2

The most familiar and studied source of international interconnectivity is the flow of goods and services across borders. A narrow definition of globalisation based on international flows of goods and services is intuitive. It also has attractive characteristics related to data availability when tracking globalisation over multiple decades.

However, a narrow, trade-based definition is insufficient to capture the multiple interrelated dimensions of globalisation. We therefore prefer a broader definition that understands globalisation as a process ‘that erodes national boundaries, integrating national economies, cultures, technology, and producing complex relations of mutual interdependence’ (Norris, 2000). Our broad definition incorporates stocks and flows of trade, capital, people, technology and information, as well as the proliferation of institutions that regulate and facilitate them. We focus on both the total effects as well as the effects of its constituent parts, while recognising their interdependence (Lang and Tavares, 2018).

We prefer a broader definition that understands globalisation as a process ‘that erodes national boundaries, integrating national economies, cultures, technology, and producing complex relations of mutual interdependence.

How do you measure globalisation?

To capture the complex and evolutionary nature of globalisation we have developed a composite indicator that is influenced by both the CRGR Globalisation Index (Lockwood and Redoano, 2005); and the ETH Zurich Institute’s KOF Globalisation Index (Gygli, Haelg and Sturm, 2018).

Our analysis began by identifying the core elements that we considered most relevant to our definition of globalisation. We then sought to identify a dataset that met two key criteria: 1) sufficient sample size to track variables over multiple decades; and 2) diverse enough to capture the most important elements of our preferred broader definition.

It was quickly apparent that there was a trade-off between these two criteria. A narrow, trade-based measure offered a considerable advantage in terms of the consistency and historic availability of data. However, a broader definition was more closely aligned to our understanding of globalisation. This led us to produce both a narrow index, which captured the entire post-war period, and a more comprehensive broad index, available from the mid-1990s.

Our narrow measure of globalisation is based on changes in international trade connectivity. It utilises variables that capture developments in trade policy as well as volume of goods traded. All variables are standardised to allow for comparability over time and we also smooth the variables to better capture long-term trends.

Our broad measure of globalisation includes data across all four core sub-components. It incorporates the same trade data as for our narrow index as well as data to represent the other core elements: capital, information and people (see Table 2). The rationale is as follows:

  • Capital: Cross-border financial connectivity is a critical aspect of globalisation, with more open capital markets associated with higher total factor productivity, while also increasing the transmission of financial shocks to the real economy. We capture this element of globalisation through FDI flows, banks’ external claims on all sectors and the Chinn-Ito Financial Openness Index.
  • Information: Global information flows have grown rapidly over the past two decades and are estimated to generate more economic value than global goods trade (McKinsey Global Institute, 2016). Information globalisation is not just an economic phenomenon; it has also had a profound effect on cultural and political developments. Consequently, it is attracting increasing regulatory attention. The variables used in the information sub-index focus on access to technology and information as well as innovation.
  • People: The international movement of people is fundamental to global economic development, with consequences for factor endowments, trade patterns, and the transfer of technology and culture. It also influences political perceptions of the benefits of globalisation. Here we focus on changes in the stock of migrants as well as tourism flows.

For our broad measure, we created four sub-indices representing the different drivers of globalisation. Again the data was standardised and de-trended. Each variable is equally weighted in its respective sub index and each sub index enters the final globalisation index with a 25% weighting (see Table 2). Please refer to the Technical Appendix for more details.

Table 2 – The variables in the Broad ASI Globalisation Index

Scroll left and right to view the full table
Broad ASI Globalisation Index
Sub index Composition
Trade Weight in overall index Variable Source Weight
0.25 Trade as % GDP World Bank 0.25
Average tariff rate Clemens and Williamson 0.25*
Regional Trade Agreements Clemens and Williamson 0.25
New WTO members WTO/ Clemens and Williamson 0.25
Capital 0.25 Banks external claims on all countries (y/y %) Bank of International Settlements 0.3
Foreign Direct Investment stock ( % global GDP) Chinn- Ito Financial openness index 0.3
UNCTAD PSU 0.3
Information 0.25 Non-resident patent applications World bank 0.2
Non-resident trade mark applications World bank 0.2
Individuals using the internet ( as % population) International telecommunication Union 0.2
Mobile phone subscribers World bank 0.2
GFCF: Intellectual property products investments OECD 0.2
People 0.25 Migrant Stock OECD 0.5
Tourist arrivals World Bank 0.5
*Enters with a negative sign
Source: ASIRI (as of 2019)
 
We prefer a broader definition that understands globalisation as a process ‘that erodes national boundaries, integrating national economies, cultures, technology, and producing complex relations of mutual interdependence.'
 

What does the ASI
Globalisation Index tell us?

Chapter 3

Chart 1 shows the evolution of our narrow index, which is available back to 1965. The narrow index allows us to identify three main phases of trade globalisation over the past 55 years.

These are:

  1. A first phase (that actually began soon after the end of World War II) of moderate globalisation that lasted until the early 1980s;
  2. A second phase of ‘hyper globalisation’ that followed the first phase after a brief interregnum in the early 1980s and lasts until the financial crisis; and
  3. The post-crisis phase, in which the pace of integration has slowed significantly relative to the hyper globalisation period and earlier moderate period.
The slowing of cross-border integration of trade and capital, which was at the heart of the ‘old economy’ globalisation, is the primary driver for claims the globalisation era is coming to an end.

Chart 1: The three stages of post-war globalisation

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Source: ASIRI (as of 2019, based on latest data availability)

The narrow index also allows us to identify short aberrations from the overall trend. The most noticeable occurred in the early 1980s when a severe recession, a significant appreciation of the dollar and increasing foreign competition from Japanese and European firms led President Reagan to pass a number of protectionist measures.

However, rather than undermining globalisation over the longer term, this period was swiftly followed by an accelerated or hyper-globalisation. This partly reflected a shift in policy priorities - the Reagan administration played a leading role in the Uruguay Round of multilateral trade negotiations in 1986 that lowered global tariffs and created the World Trade Organization. And then in 1988, the Administration passed the U.S.-Canada Free Trade Agreement, which was expanded to include Mexico and renamed the North American Free Trade Agreement. More importantly, it reflected changes in technology, trade costs and industrial organisation that we discuss in more detail in Chart 2.

Chart 2: A falling trade and capital contribution to globalisation

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*Data points for 2018 (excluding Banks external claims) have been extrapolated based on recent trend
Source: Aberdeen Standard Investments (as of 2019)

A second downturn in the narrow index can be observed in the aftermath of the global financial crisis. The magnitude and nature of the crisis severely disrupted trade and capital flows and although there has been a modest subsequent recovery, there are no signs of a return to the pre-crisis trend. Indeed, in the wake of the recent US-China trade and technology dispute, the ratio of trade to GDP has begun falling again.

To investigate this further we turn to our broader ASI Globalisation Index, which allows us to dig more deeply into the drivers during the latter stages of the ‘hyper-globalisation’ phase and the ‘post-crisis’ phase. Chart 2 shows the contribution of each sub-index to the annual change in the broad index.

The evolution of the sub-components of our broad index during this period tells us important things about the changing nature of globalisation. First, developments in trade and capital flows have been the primary driver of the aggregate slowdown in the post-crisis period. The disappointment has reflected the magnitude of the disruption but also the sub-trend recovery in the intervening decade. We believe that the slowing of cross-border integration of trade and capital, which was at the heart of the ‘old economy’ globalisation, is the primary driver for claims the globalisation era is coming to an end.

Our Globalisation Index reveals another important trend. Information and people flows have been far less disrupted by the crisis, with some components actually accelerating. The resilience of these flows raises the prospect of an era of ‘new economy’ globalisation with technology facilitating cross-border flows of information and people at its heart. This conclusion comes with a heavy caveat. Proponents on ‘new economy’ globalisation have a considerably more challenging job to mobilise resources than their predecessors. Not only is there is an ongoing backlash against the perceived failures of globalisation in the West, there is much less consensus for building international governance architecture to expand and regulate data and people flows.

 
The slowing of cross-border integration of trade and capital, which was at the heart of the ‘old economy’ globalisation, is the primary driver for claims the globalisation era is coming to an end.
 

The Global Financial Crisis
(GFC) as a turning point

Chapter 4

Our initial analysis showed that there are larger changes in the composition of globalisation than its overall pace. To better understand these compositional shifts, we delve further into ASI Globalisation Index, examining the evolution of sub-indices and their underlying variables in more detail (see Table 3).

1. Slowing trade flows

The most significant change in this period occurred in our trade variables. A deep literature has emerged looking at explanations for the recent slowdown in global trade growth focusing on the slower post-crisis economic expansion compared with the previous two decades; compositional changes in growth – particularly lower capital intensity - may have reduced its income elasticity; a loss of momentum due to the earlier one-off integration of China and central/eastern European economies into the global economy; and policy changes that have served to limit trade growth.

While the growth of internet users will eventually slow, increasing access to information will have a huge bearing on the future of globalisation.

Table 3: The changing drivers of globalisation

  1998 to 2007 2011 to 2017
Yearly change in sub index TRADE 0.086 0.030
Contribution to change in subindex Trade % of GDP(3 yr avg ) 0.030 0.003
Average tariff rate 0.012 0.003
Regional Trade agreements 0.030 0.012
New WTO members 0.014 0.012
Yearly change in sub index PEOPLE 0.130 0.212
Contribution to change in subindex Migrant stock 0.056 0.087
Tourism 0.074 0.125
Yearly change in sub index CAPITAL 0.145 0.044
Yearly change in sub index Banks' External Claims on All Sectors in All Countries (Y/Y %, EOP, Bil.US$) 0.056 0.014
Foreign Direct Investment: Total Stock (% of GDP, Mil.US$) 0.049 0.038
Chinn- Ito Index 0.039 -0.007
Yearly change in sub index INFORMATION 0.122 0.161
Contribution to change in subindex Nonresident patent application (US,EU, Japan) 0.028 0.024
Individuals using the Internet (% of population) 0.024 0.039
Nonresident trademark applications 0.017 0.036
GFCF: Intellectual property products investments 0.031 0.039
Mobile phone subscribers 0.023 0.023
red = contribution in highlighted period less than other period,
green = contribution in highlighted period higher than other period
Source: ASIRI (as of 2018)

Our trade variables help to shed new light on this issue. While declining average tariff rates as well as the entry of new participants into the global trading system through WTO membership and new regional trade agreements made a moderate contribution to globalisation in the pre-crisis period, and that contribution has declined since the crisis, the biggest shift has been in global trade as a share of GDP. This rapidly accelerated before the crisis and has slowed sharply since.

Why such a large change in the growth of trade as a share of GDP in an environment where the other variables in our index were changing more slowly? In our view this can be best explained by a concurrent shift in trade costs, technology and industrial organisation (see Box 1 for more detail).

Consistent with our trade variables, recent evidence suggests the impetus for expanding global value chains (GVC) has been fading. Foreign value-added in trade – the imported goods and services incorporated in a country’s exports, and a key measure of the importance of GVCs – appears to have peaked after two decades of continuous increases (see Chart 3). Research suggests that the marginal gains from falling trade costs have also levelled off while international wage gaps, particularly in the industrial sector, have declined.

Chart 3: Breaking the global value chain

Source: Johnson and Nogeura (2016), OECD TIVA and ADB MRIO

2. Slowing capital flows

Capital flow and openness indicators have mirrored the pattern in the trade variables. Pre-crisis, external bank claims and Foreign Direct Investment (FDI) flows were both growing rapidly while most countries were liberalising their capital control regimes. After the crisis, bank claims in particular decelerated rapidly as the crisis itself and the regulatory response to it, led institutions to scale back on their international exposures.

This reflects the double-edged nature of capital flows. While they have helped facilitate and fund higher economic growth, insufficient management and regulation of these flows have proved highly disruptive. Indeed, our preferred measure of financial openness – the Chinn-Ito Index - points to a noticeable post-crisis shift in policy.

A more restrictive regulatory environment post-crisis is consistent with work published by the IMF[1] that shows the pattern of capital controls used by countries in different income groups across time. On average, capital controls on both inflows and outflows were being removed pre-2008 but have increased post the crisis, especially in high income countries (see Chart 4).

FDI flows have also made a more modest contribution to the ASI Globalisation Index in the post-crisis period. Attempts to explain this structural slowdown include technological shifts that are prompting firms to increasingly adopt asset-light forms of overseas operations. In addition, the slowdown of GVC proliferation is also likely to be having an effect. Finally, the UNCTAD’s World Investment Report (2018) points to a persistent decline in returns on FDI, with the global average falling to 6.7% in 2017 from 8.1% in 2012.

Chart 4: Capital controls becoming more prevalent

Inflows

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Outflows

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Source: Fernández, Klein, Rebucci, Schindler and Uribe (2016) "Capital Control Measures: A New Dataset"

3. Changing information and technology drivers

Although the aggregate picture for information flows has been positive, we have seen a divergence of performance in variables’ contribution to globalisation pre- and post-financial crisis.

The biggest improvement in terms of overall contribution has come from internet users as a share of the population, while non-resident patent registration has seen the biggest fall. While the growth of internet users will eventually slow, increasing access to information will have a huge bearing on the future of globalisation - particularly the ability to deliver services and labour across borders - as will the advent of 5G telecommunications and the more widespread application of artificial intelligence, robotics and the internet of things.

We are already witnessing a fracturing of internet-related information flows, with new barriers emerging in critical areas including digital rights and privacy. The former is fundamentally an issue of governance with lines of demarcation between the US open-internet model and China’s cyber-sovereignty model. Despite dominating bourses in both China and the US, direct competition between Google, Facebook and Amazon in the US and Baidu, WeChat and Alibaba is limited by the different governance regimes in which they operate (see Chart 5). The same cannot be said for telecommunication infrastructure firms with the US actions against Huawei highlighting the risks when direct competition occurs. On the latter, a fragmentation is also underway. The EU has exerted its own credentials by demanding restrictions on firms that do not provide adequate privacy protection – adding a new complexity to the global digital ecosystem.

Chart 5: Private sector divided

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Source: Ranking Digital Rights (as of 2019)

Turning to non-resident patent applications, the modest decline here is at odds with the rapid acceleration in overall patent applications globally. How can we explain this? The biggest contribution to patent growth globally has come from China and its desire to become a larger centre for innovation. However, in our view non-resident patent applications offer a better guide to true innovation rates as many of the patent applications emanating from China do not hold up under stricter international standards.

Decelerating patent application rates, together with evidence that the efficiency of R&D spending is declining, are not just matters for globalisation, they are also signifiers of the structural nature of weaker global productivity growth over the past decade.

4. People movement on the increase

As for people movement, the rate of increase in migrant stocks and tourism flows has increased since the GFC. The continued growth in the migration stock is worthy of particular attention. Migration has traditionally been driven by a wide range of economic, social and physical forces which are divided into both push and pull factors.

While falling poverty levels and higher living standards in less-developed economies may have reduced the push incentives for economic migration, evidence suggests that it is the middle class - the main beneficiaries of the development process - in developing countries that tend to migrate to traditional settlement countries like the US, Canada and UK.

In addition, the GFC helped propel increased migrant flows within Europe as unemployed workers sought employment in less affected economies. Meanwhile conflicts continue to play an important role in driving migrant flows, with the Syrian crisis and the resultant influx into continental Europe a poignant recent example.

Increased migrant flows are now generating a political backlash in the developed economies (See chart 6). Election surveys suggest that immigration concerns regarding migration policies have pushed some political parties to the extremes in Europe and the immigration issue also played a prominent role in the UK’s EU referendum, the 2016 presidential election and the recent EU elections. Although migration flows have not reacted significantly yet, this may be the next globalisation domino to fall.

Chart 6: Greater urgency on immigration

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Source: Euro Barometer, as of November 2018
 
While the growth of internet users will eventually slow, increasing access to information will have a huge bearing on the future of globalisation.

Box 1: Drivers of pre-crisis hyper globalisation and the post-crisis trade slowdown

Data constraints prevented us from directly capturing trade costs, Global value chains(GVC’s) and intra industry trade (IIT) in the ASI Globalisation Index. However, they have played a critical role in globalisation dynamics over the past two decades.

Trade agreements under the WTO system, built on principles of reciprocity and non-discrimination, ensured a simultaneous lowering of tariffs and policy barriers across multiple countries. The fall in tariffs was part of the broad based fall in costs (see Chart A), which comprise not only of freight costs and time costs but also policy barriers, information costs and contract enforcement costs.

Across income groups, trading costs tend to be highest for low income countries. High trading costs can essentially nullify a country’s comparative advantage by making its exports uncompetitive. Thus, it is low and middle income countries that stand to gain on the trade front by continuing to reduce trade costs and improving trade facilitation logistics (Chart B).

Chart A: The post-war fall in trade costs

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Source: Transaction costs - OECD economic outlook (2007)

Chart B: Logistics performance Index

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Source: World Bank, as of 2018

The hyper globalisation period saw trade costs moderate from previously high levels, thus triggering a reorganisation of industrial supply chains, with firm location increasingly driven by cost arbitrage and market access. Expansion of global value chains (GVCs) meant that factors of production had to shift as well - capital mobility across borders took off in the hyper globalisation period. Labour mobility also increased, both across as well as within borders.

GVC participation is concentrated in industries which could “unbundle” production into distinct sequential processes. Typically these have been light and heavy manufacturing industries. With production processes split across borders, countries began importing and exporting intermediate goods within the same industry category. Rather than country specialisation, producers sought to exploit economies of scale within industries, focusing on product subsets and categories.

GVC expansion allowed developing countries to integrate into global production processes at different levels of value added activities. Further, domestic firms in these countries were recipients of significant “knowledge spill overs” and foreign direct investment inflows. Participation in GVC’s created positive spill overs which were crucial for developing economy’s looking to catch up to global income levels and technology frontiers.

Post GFC, there has been some important shifts in the trade factors underpinning ‘hyper-globalisation’. A fall of share of intermediate goods as % of total exports for major trading countries points to an atrophying of value chain expansion (Chart C). This is a part of the reason why the contribution of the trade sub-index to aggregate globalisation has declined. Furthermore, trade costs for key industrial sectors are no longer falling.

Chart C: Value chain stagnation

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Source: OECD, ASIRI ( as of 2017)

That does not mean that GVCs will no longer be important. In the first leg of GVC expansion, the centre of production was the global north and developing economies were peripheral. As the global trading order stands now, China is no longer at the periphery and many developing countries are looking to upgrade their position in the global trading order. Some will gain because of trade complementarities while others will move further into the periphery.

The scope for low and middle income countries to extract further gains by continuing to reduce trade costs and improving trade facilitation logistics remains high (Chart B). With traditional incentives for GVC expansion running out of steam, continuous improvement in trade facilitation is needed to keep the globalisation engine running.

 

Taking Stock
 

Chapter 5

Given their pro-cyclicality, a lower contribution to globalisation from trade and capital flows since the crisis was to be expected. However, our compositional analysis suggests that cyclical factors do not alone explain the slowdown, with a range of structural drivers also playing an important role. This is worthy of investor attention as the investment returns from investing in the ‘super manufacturing trading’ economies and multinationals making use of global value chains may be permanently lower than their pre-crisis averages.

However, while the winners of ‘old globalisation’ may underperform relative to history, the compositional shifts also create opportunities. The resilience of information and people flows raises the prospect of a new and vastly different form of globalisation. The long-term benefits of, as well as the dislocation associated with, this technology-led ‘new globalisation’ risk being overlooked amid the more immediate risk of trade wars.

We prefer a broader definition that understands globalisation as a process ‘that erodes national boundaries, integrating national economies, cultures, technology, and producing complex relations of mutual interdependence.

Indeed, we believe our broad definition of globalisation and accompanying indices serve to highlight a critical flaw in the globalisation analysis to date. While much has been done to quantify the magnitude and persistency of the post-GFC slowdown in international trade, and to a lesser extent capital flows, analysis on the growth of information and people flows has been neglected.

Further study of these latter factors is critical as they form the basis of the services economy which dominates output, value added and employment in high-income countries. The OECD estimating 70% of employed labour within its member states in the services sector in 2017, with that number rising to 80% in high-income, industrialised economies. If globalisation is to rejuvenated it will be the integration of services-based industries that will drive the next phase.

Indeed, we think the potential for technology to overcome barriers that have prevented international services trade in the past is being under-estimated. A digital, mobile high-skilled services workforce (see Box 2) would likely transform our understanding of people connectivity. This so-called ‘third unbundling’, where labour services are physically unbundled from labourers, offers potentially larger repercussions than the establishment of global supply chains had on the industrial sector. Likewise, seamless data and digital goods transfers across borders could accelerate service trade growth at a time when it is already outstripping goods trades in both DM and EM markets.

There is an important caveat here. The further integration of people and information flows that will be necessary to underpin this ‘new globalisation’ are naturally more sensitive to cultural, social and political forces than trade and capital have been. Services-led globalisation is likely to be more politicalised as a result. An international political consensus on these issues remains remote, while new barriers to both migration and data and digital flows are rising. Furthermore, people or digital information flows lack a comprehensive global governance framework.

Our analysis indicates we are reaching a critical point in the evolution of globalisation. The challenge of sustaining the benefits of globalisation while managing the disruption from technological-led change is more acute than ever. The onus is on policymakers to respond to that change and deliver the appropriate governance models. Investors have a critical role to play too. We caution against excessive myopia and urge long-term thinking and sustainability as the basis for capital allocation.

 
The long-term benefits of, as well as the dislocation associated with, this technology-led ‘new globalisation’ risk being overlooked amid the more immediate risk of trade wars.

Box 2 – Technological evolution

Technology has the power to transform globalisation. It played a critical role in facilitating the period of hyper-globalisation between 1990-2007, allowing firms to establish global supply chains and facilitate international know-how transfers. This process known as the ‘second unbundling’ had major implications for industrial workforces, with jobs transferred to emerging economies while the DM-EM wage gap declined.

Digital technologies offer service sector firms similar opportunities to coordinate complicated tasks across international borders, allowing them to arbitrage wage differentials in the skilled services sector where the gaps are largest.

To meet this demand, there are already signs that the services work force is reorganising. Tele-migration services – in the form of international freelancers or the ‘human cloud’ – offer a highly skilled and globally mobile workforce that could transform value-chains within the services sector.

High adoption rates and structural revenue growth have supported a string of human-cloud related IPOs in recent months. By revenue, two of the largest three firms in the industry, Lyft and Uber, have listed while a further two of the top five in B2B human capital segment have filed for IPO, Upwork and Axiom.

Importantly, this phenomenon is global with five of the world’s top ten human-cloud firms by revenue based in emerging markets, even if the countries with the two largest presences are the US and China (see Chart A).

Chart A: China playing catch-up

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Source: Staffing Industry Analysts ( as of 2018)

Telecommunications infrastructure is also primed for a major update with the rollout of 5G technology. This is expected to run 100 times faster, with dramatically lower latency rates, facilitating fast and seamless flow of data and digital goods across borders.

5G is expected to unlock new technological innovations from smart infrastructure to autonomous driving. However, plans have hit a major stumbling block as one of the world’s largest telecoms network firm Huawei has been dragged into an increasingly bitter feud over data security. The politics here are complicated – and we deal with it later in this paper – however, the business impact is undoubtedly large. Huawei recently reported it has signed 40 5G contracts across the world. Exclusions on regulatory grounds is likely to cost billions and is estimated to delay the launch of 5G networks by years.

 

The Road Ahead
 

Chapter 6

Defining and documenting the shifting pace of globalisation at an aggregate level, as well as its sub-components, enhances our understanding of its evolution. However, the key to understanding the next stage of globalisation is accurately attributing its deeper more fundamental drivers.

In the second half of this paper, we consider the drivers of changes in the composition in globalisation. We examine the consequences of these changes, both intended and unintended. Finally, we consider the future state of globalisation through scenario analysis. This includes five scenarios for the future of globalisation over the next 5-10 years, along with the waymarks for each scenario and potential qualitative impacts.

Not enough has been done in developed countries to ensure that the gains from globalisation and broader technological change have been widely shared across different income, educational, skill and geographic cohorts.

Failure to live up to its promises

The nature of globalisation that define the pre-crisis world was a consequence of: 1) an acceptance of its income and welfare benefits 2) a belief in its sustainability through continuous structural change. In both of these areas our understanding is changing.

There are few doubts that international linkages have reduced the numbers living in poverty across the globe – a fact that should be celebrated. However, rising global welfare has failed to disguise rising income distribution disparities both within and between countries.

Milanovic and Lakner (2013) have highlighted two sets of relative winners and two sets of relative losers from the era of hyper-globalisation. The biggest winners were those around the median of the global distribution of income. These include the factory workers and their families in the countries that benefitted most from the dramatic reorientation of manufacturing activity from the advanced economies to the emerging economies, particularly China and the other east-Asian economies.

The other winners have been the owners of capital and the very best paid, the so-called ‘one percent’, located mostly in the advanced economies. Not only has the income share of the top 1% increased substantially but they now own over 50% of global wealth according to the Credit Suisse Research Institute Global Wealth Report (2018). The return on capital has exceeded the rate of growth in the economy over the last 20 years, with corporate profits as a share of GDP rising more than 60% from their 1993 low. Highly skilled workers have benefitted too, as their expertise is typically complementary to both technological change and globalisation.

The direct losers have been the semi-skilled lower and middle income workers in the advanced economies, who have either lost their jobs outright, or seen their wages eroded by the treble forces of technological change, domestic deregulation and globalisation. The other set of losers – the world’s very poorest - have not been harmed by globalisation per se, but by virtue of residing in countries outside the global system and where warfare, institutional failure and corruption act as an enormous drag on economic development, have simply not benefited in the way that residents of other emerging and developing countries have.

The most comprehensive cross-country research on the underlying causes of changes in the within country distribution of income has been conducted by the IMF. That research suggests that globalisation has made almost no contribution to rising inequality in the emerging world (Jaunotte, Lall, Papageorgiou, 2008), helping to explain why there has been little backlash against trade liberalisation in these countries.

In the advanced economies the story is more complex. Although globalisation has not been the biggest contributor to higher inequality – greater labour market flexibility, the deepening of financial markets and skill-biased technological advances have jointly been more important – globalisation has played a larger role than had earlier been acknowledged by most economists and policymakers.

Indeed, a growing body of research has pointed to competition from low-income countries as a source of deindustrialisation in the developed world. In particular, this work has focused on the emergence of China as the world’s largest exporter of manufactured goods and the impact of higher import competition on labour markets in the US (see, Acemoglu et al., 2016; Autor et al., 2011). The key point is that not enough has been done in the developed countries to ensure that the gains from globalisation and broader technological change have been widely shared across different income, educational, skill and geographic cohorts.

Running out of runway

The second source of discontent with globalisation relates to its level of maturity with some observers pointing to inevitable exhaustion as marginal returns from global integration dwindle. They highlight the considerable gains made in reducing tariff barriers since the signing of the General Agreement on Tariffs and Trade (GATT) in 1948 and argue that creation of the World Trade Organisation (WTO) in 1995 represented the high water mark for multilateral trade liberalisation.

Subsequent WTO negotiations have certainly made more limited progress, incentivising a boom in the negotiation of a web of regional and bilateral trade agreements that have further lowered aggregate barriers to trade, but also diverted trade from non-participating countries and increased the complexity of the global trading system.

One marker of progress is the decline in the world average goods tariff rate. While it fell from close to 10% at the start of the 1980s to below 5%, the average global tariff level has flat lined over the past 15 years (see Chart 7). Indeed, if the tariffs the US and China have recently imposed on one another stick, or even increase, the world average tariff rate is likely to increase in the next iteration of our index.

Chart 7: The tariff floor may be behind us

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Source: Absolute Strategy Research, as of June 2019

While we accept the more limited marginal gains from goods trade liberalisation available, our broader definition of globalisation highlights that this is only one critical aspect. Globalisation usually finds a way to reinvent and reinvigorate itself eventually. The evidence from our analysis of people and information flows suggest this may be the case again, particularly if it facilitates growth in services and digital trade. As discussed earlier, a critical caveat here is whether political and social forces remain supportive or opposed to these developments.

Our analysis of globalisation’s shortcomings highlights the important role for policy and politics in the evolution of globalisation. In the next section we consider these forces in more detail.

 
Not enough has been done in developed countries to ensure that the gains from globalisation and broader technological change have been widely shared across different income, educational, skill and geographic cohorts.
 

What impact has
policy and politics had?

Chapter 7

Until the financial crisis, the common view among policymakers and establishment politicians was that increased inequality was an acceptable price to be paid for stronger economic growth. Those who doubted this logic were mostly pushed to the fringes of political and policy debates. Likewise, attempt to tackle the consensus view on the merit of a market-based approach were aggressively condemned by both international organisations and the US – the world’s leading power.

However, a new narrative has emerged. The financial crisis, combined with the structural changes in the composition and distribution of economic activity in the decades beforehand, as well as rapid change in the social and demographic structure of many western societies, has created a perfect storm for a rise in populist parties and politics (see Chart 8).

Electorates across the advanced economies are becoming more fragmented and increasingly seeking alternatives to mainstream centrist parties.

Chart 8: The rise of populism

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Source: National Sources, ASIRI (as of 2018)

Electorates across the advanced economies are becoming more fragmented and increasingly seeking alternatives to mainstream centrist parties. Even where centrist parties have survived, they have often chosen to ape the policies of their populist rivals, and had more difficulty building effective governing coalitions and legislating policy.

The upshot is that policy uncertainty has increased, which in turn has had meaningful effects on economic and market activity. Polling has also become less accurate, increasing political risk for investors.

Have politicians given up on globalisation?

To quantify the magnitude of the shift in the political and policy environment in the last decade we go back to our Globalisation Index. We categorise the variables in our broad index into de facto variables, which are true in fact even if not officially sanctioned, and de jure variables, which are true in accordance with the law and are officially sanctioned.

By splicing the data along these lines we are able to discern trends that are a direct consequence of policy and legal stipulations and those that are not, instead representing activities or flows that are informed but not defined by policy. Chart 9 highlights that there has indeed been a more material slowing of our de jure globalisation index relative to the de facto index. And while the change has so far been relatively modest, this does not yet reflect the recent protectionist steps taken by the US. It is also important to keep in mind that while the US has been keener to use trade policy as a stick with which to achieve its ends, most other countries are still taking steps to further liberalise trade relations. The decision by the non-US signatories to proceed with the Trans-Pacific Partnership is one sign of this progress but also the way that new regional trade agreements continue to be concluded, albeit more slowly than in the past.

Chart 9 – Growing policy headwinds

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Source: ASIRI (as of 2018)
 
Electorates across the advanced economies are becoming more fragmented and increasingly seeking alternatives to mainstream centrist parties.
 

What action is required?
 

Chapter 8

Of course, an uneven distribution of the benefits and a slowing of trade liberalisation does not necessarily mean globalisation is doomed. The policies to tackle the failings of globalisation are available, while new incentives are needed to ensure the marginal returns remain attractive.

Redistributive polices are specifically designed to tackle inequality. However, it is often assumed there is some kind of necessary trade-off between policies that lift potential growth and policies that reduce the dispersion of gains from that growth. But that is false. Public investments in infrastructure, spending on health and education, as well as appropriately targeted social insurance provision, are all pro-growth and pro-equality. In addition, there is remarkable little evidence that more direct redistributive policies through the tax-transfer system damage growth (Ostry et al, 2014). Instead, redistribution polices may prove growth positive by increasing the stability and extending the economic cycle.

Efforts to establish global governance practices in both data and digital trade as well as in migration need to be accelerated.

As for the diminishing returns argument, our earlier analysis using the ASI Globalisation Index and sub-components highlights that lowering policy barriers to goods trade has been only one aspect of the story of globalisation. Barriers to services trade remain high and a harmonisation of national standards absent. Opening up protected domestic sectors and allowing technology to facilitate services and digital trade may facilitate another supply-chain based acceleration in trade.

In addition, efforts to establish global governance practices in both data and digital trade as well as in migration need to be accelerated. Earlier this year, WTO members gathered to discuss new rules to govern global digital trade and more efforts are required to prevent barriers increasing. These include increasing interoperability, reinforcing the rule of law and enhancing digital rights. However, progress is lagging the pace of digital protectionism and a fragmentation in approach between the United States, Europe and China. Discriminatory actions including US restrictions on firms’ trading with Huawei, a standardisation law which favour domestic firms in China, and digital services tax proposals in Europe have been met with limited international condemnation despite their effects in distorting competition in advanced technology industries and damaging innovation and productivity growth.

An equally pressing challenge relates to international governance around people flows. While a large body of work exists to support the economics benefits of migration, its sustainability should not be taken for granted. During the 1920s and 1930s migration levels fell noticeably in response to Western government’s enacting restrictive legislation. That trend continued for more than two decades and was a critical contributor to the retreat from globalisation in the interwar period. That era came to an end after the shock of the Second World War brought a more wholesale rethink about international organisations and cooperation.

The post-war consensus on institutions, agreements and principles that emerged out of Bretton Woods is unlikely to materialise in the absence of a major economic or political shock. However, our analysis highlights that the challenges facing the global economy at the current juncture are equally critical. Investors should demand greater urgency. In addition, we urge policymakers to prioritise governance of the engines of ‘new globalisation’ as it will determine the future benefits over many decades.

 
Efforts to establish global governance practices in both data and digital trade as well as in migration need to be accelerated.
 

The China question?
 

Chapter 9

In the next section, we consider the impact of China’s integration into the global economic system in more detail and use this to inform our forward-looking scenario analysis.

International relations scholars identify three different forms and outcomes of interdependence: zero-sum, negative-sum and positive-sum. How should China’s interactions with, and impact on the rest of the world be characterised? The original work on trade theory contends that countries trade with each other because they share different factor endowments and can exploit comparative advantages. This theory underpinned a systematic dismantling of trade barriers in the post-war period. It would also characterise the integration of an additional economy, even one as large as China, as a positive-sum game.

China is seeking to build both economic and institutional architecture that will allow it to continue to deepen its connectivity to the global economy.

Economic theory does recognise the costs of international trade; particularly the role of import competition on jobs, wages and working conditions (Stolper, Samuelson, 1941). High-profile research has from Autor, Dorn & Hanson (2011) argued that import competition, as a result of China’s industrialisation, may have persistently lowered employment rates in the most exposed American communities. However, aspects of that work have been disputed and there is a danger in focusing on too narrow a sub-set of relative losers (Magyari, 2017). Indeed, once we look beyond the US and consider the broader positive spillover effects in both DM and EM economies, it is very difficult to identify the net costs necessary to characterise China’s entry in the global trading system as negative-sum.

Not bad just different

An alternative framework to examine China’s relative importance is through business cycle correlation analysis. Theory is ambiguous on the effects of international linkages on business cycle correlation. The convergence argument is based on the idea that all economies have become more intertwined through trade and finance, which should make the national economic cycles more connected. On the other hand, rising income levels in economies integrating into the global financial and economic system expand domestic markets and reduce dependence on other economies.

We have built a model that seeks to identify patterns in the co-movement of economies across the world, comparing the sensitivity of activity in eight key regions to a global business cycle. The results suggested a u-shape phenomenon with high correlation in the 70s declines in the 80s and 90s before rebounding in the 2010s. Furthermore, the analysis suggests the magnitude of economic shocks has generally increased.

The results were more ambiguous at a country level. Although there was no aggregate trend towards higher business cycle correlations across countries, China stood out as a noticeable exception. In China’s case correlations have increased, especially within EM, consistent with its transition from being a relatively small economy to the second largest economy in the world (see Chart 10). Part of this shift may be explained by an acceleration in the global integration of resources industry driven by prolonged cycle of rising price trends. However, even allowing for this China’s integration into the global economic system is remarkable.

Chart 10: China now an equally important driver of the EM business cycle

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Source: ASIRI (as of 2018)

Recent evidence suggests that this is more than just a trading relationship too. China is seeking to build both economic and institutional architecture that will allow it to continue to deepen its connectivity to the global economy. A new, more outward looking China is courting other nations in the region and beyond through programmes such as the Belt and Road Initiative and the AIIB, while efforts to build a regional trade agreement through the RCEP framework promises to bring China even closer to other economies.

 
China is seeking to build both economic and institutional architecture that will allow it to continue to deepen its connectivity to the global economy.
 

Political leadership
 

Chapter 10

The changing nature of globalisation also raises question about future leadership. The United States’ market-based approach has given it a dominant position in the promotion of international trade and capital linkages. However, our Globalisation Index highlights that in both areas there are signs of a structural slowdown.

In contrast, its pre-eminence on information and people flows is less secure. Competition between the US and China in the area of digital and information architecture has recently crystallised in US actions towards ZTE, Fujian Jinhua and, most importantly, Huawei. The critical point with Huawei is not that it has been banned from US infrastructure, this was long sign-posted, but that it has been listed on the Commerce Department’s Entity List – which effectively bans US suppliers from selling parts and services to Huawei without a license not just in the US but globally.

Competition between the US and China in the area of digital and information architecture has recently crystallised in US actions towards ZTE, Fujian Jinhua and, most importantly, Huawei.

Greater competition may not be the only driver for a decline in the US leadership and influence over globalisation. Dani Rodrik (2011) argues there is a fundamental conflict between economic integration, the nation state and democratic politics. The US certainly appears to be closer to the limit of international economic integration, which impinges on its political and sovereign state, than other nations. In a recent WEF poll, examining support level for international cooperation North America lagged all other regions (see Chart 11).

Chart 11 – Looking beyond borders

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Source: World Economic Forum (as of Jan 2019)

However, a more likely cause is the failure of globalisation to live up to its promises and a further retrenchment is likely in the absence of policies to offset its negative effects. In the same poll, South Asia and East Asia and the Pacific ranked the most supportive regions in terms of international cooperation in the poll. Indeed, China and Asian nations, where the net benefits have been much stronger, are likely to step into that vacuum as confidence in their economic and political power is growing and attitudes to further globalisation are generally more favourable.

Unsurprisingly countries in the region have become more active in pushing forward global and regional architecture in as they seek to position themselves to take over the leadership mantel in these areas.

 
Competition between the US and China in the area of digital and information architecture has recently crystallised in US actions towards ZTE, Fujian Jinhua and, most importantly, Huawei.
 

The future of globalisation
 

Chapter 11

A useful way to think about the likely future evolution of globalisation is through the prism of scenario analysis. In conducting this analysis we think it is important to build our view up on the basis of how we expect the different components of our index to evolve over time under different conditions, avoid simplistic explanations for the changing nature of globalisation over time, and consider the interactions between its different aspects. Table 4 provides a detailed explanation of our five forward-looking scenarios for globalisation, representing compositional shifts, institutional waymarks and implications.

Table 4 – A critical juncture for globalisation

Scroll left and right to view the full table
Scenario Globalisation index - compositional changes De jure, de facto change Institutional indicators Indicative market implications
Globalisation with less US participation and leadership Trade and capital market integration increases but more slowly than long term average; people and information integration continues around historical averages De jure index increases below trend levels; de facto increases at trend US does not end existing trade deals but no new ones are signed; soft Brexit; China pushed RCEP forward Global potential growth broadly unchanged from current trends; modest damage to US potential growth; US influence over the rest of the world diminishes
Services - lead Globalisation Trade integration increases but more slowly than long term average; capital, people and information integration rises above historical averages De jure index increases at trend; de facto index increases more rapidly than past trend Firms seek to arbitrage service wage costs across international borders; self regulation of internet firms; technological advancements fuel robot globalisation Growth potential higher and international wage disparities narrow. Corporate profit share of income continues to rise.
China lead globalisation Trade and capital market integration more regionally concentrated under status quo;people and information integration remain unchanged De jure index increases below trend; de facto increases above trend RCEP is finalised; Chinese development lending surges; B&R investment grows; China lowers domestic barriers and plays larger multinational role; new DM trade agreements stall Modest improvement in Asian growth and earnings potential relative to DM; new agreements disproportionately benefit China; Chinese lending more likely to be misallocated.
Globalisation Stalls Trade integration begins to decline; capital market and people integration stalls; information integration progresses but more slowly than status quo DE jure index falls; de facto stalls US pulls out of FTA's; TPP and RCEP failure; modest increase in barriers to capital, migration and people flows Global potential growth rates weakens, with super traders hit hardest, goods trade and global supply negatively affected; downward pressure on corporate profit share of income, particularly for multinationals
Globalisation Reverses Trade, capital and people integration all begin to decline; information integration is slowed by greater regulation De jure index falls; de facto falls US dissolves existing FTA's, stops working with WTO, it's tariffs rise substantially, trade wars follow led by China; disorderly Brexit; Great Firewall spreads, substantial new barriers on capital and migration flows Potential economic and earnings growth greatly harmed; recession possible if tariffs rise rapidly; most damaging for open, manufacturing lead economies and multinationals


Source: ASIRI (as of 2018)

More specifically we have taken into account that some of the post-crisis slowdown in globalisation was natural – China’s and other emerging economies’ entry into the global trading system, the large reduction in average goods tariffs and the proliferation of WTO membership could only occur once.

In the absence of policies to address the failure of globalisation to deliver both in terms of income equality and sustainable progress, Western powers in the US and Europe will step back from their leadership role.

In addition, changing perceptions about the benefits of trade, capital and human integration are about more than economics and include concerns about security, sovereignty and other social forces. Finally, slow or inadequate integration of global institutional structures can reduce the efficiency with which globalisation is regulated, amplifying shocks and the resistance to further integration itself.

Fading US influence

The most important takeaway from our work is that the most likely scenario, globalisation with less US participation and leadership, is a continuation of the current status quo in which trade and capital market integration continue to increase but below its longer term average. Information and people components remain more resilient. However, there is neither the technological or institutional governance improvements required to generate an acceleration. The migration component of people flows is an additional source of weakness for ‘new globalisation’ thanks to greater political resistance. Note that trade barriers between the US and China are compatible with this scenario as long as the trade conflict does not extend to a much larger number of trading partners.

In the absence of policies to address the failure of globalisation to deliver both in terms of income equality and sustainable progress, western powers in the US and Europe step back from their leadership role. In contrast, China, which has become a major player in and driver of globalisation and the global business cycle in its own right, continues to play a more active role. This is accompanied by a modest fragmentation of global standards and conventions but no major breakdown in the international system.

Scope for an even larger Chinese role

Our second scenario, regional fragmentation, has China taking a less constructive role towards multinational engagement combined with a US drift akin to scenario one. In this environment, regional cooperation receives greater attention at the expense of the global. The credibility of international institutions and governance decays as a result.

Countries would be faced with a choice to seek to compete based on legacy international standards and practices or to cooperate more closely with the US, China, or Europe. Participation in regional integration will come with trade-offs, with tighter migration controls a feature of the US sphere of influence and cross-border information and capital flows highly regulated in a China-led regionalism. In this scenario, we assume nation states take a pragmatic view selecting areas to cooperate based on self-interest. This may result in a more meaningful fragmentation of the global system. However, differences in political or economic ideology result in competition rather than direct confrontation.

The importance of services

Our third most likely scenario is services led globalisation. In this instance, a re-acceleration of globalisation to its pre-crisis trend would be driven by people and information flows as political and social resistance to globalisation are overcome in developed economies. It would require international service sector integration akin to the horizontal specialisation that occurred in the manufacturing sector beginning in the early 1990s.

We do see scope for globalisation to regain momentum through an unbundling of the services sector and the application of new technologies. This could have a disruptive impact on firms in both the non-manufacturing and manufacturing sector, which has witnessed increasing value-added from manufacturing services and the rewards will be highest for those that are able to reallocate capital most efficiently.

We are certainly mindful of the rise of political and policy forces that may push against globalisation. Our de jure index hints at changes afoot here but any resistance appears to be in its infancy. US political developments have made further trade liberalisation more difficult. However, a greater crystallisation of the political positions is likely to emerge ahead of the 2020 presidential election.

Further slowing in globalisation more likely than re-acceleration

The most likely trigger for our most adverse scenarios of a stalling or reversal in globalisation would be a trade war or another very deep and prolonged global downturn. In the latter case, the politics of globalisation could become even more toxic, with the US and other countries pulling out of existing trade agreements and migration restrictions rising much further. This would act as both an inhibitor to further technological advances and prevent any advances from being properly commercialised and diffused.

Taking the last insight further, there would therefore be further downward pressure on global longer-term potential GDP. The downside risks to earnings are likely to be concentrated in manufacturing and industrial sectors as well as on the consumer side, particularly for goods that are most reliant on supply chains such as autos, consumer electronics/phones etc.

 
In the absence of policies to address the failure of globalisation to deliver both in terms of income equality and sustainable progress, Western powers in the US and Europe will step back from their leadership role.
 

Conclusion and
investment implications

 

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

Methodology

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.

  1. Trade
  2. Capital
  3. People
  4. Information

Transformations

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.

Signs

The tariff rate variable enters the index with a negative weighting. The negative weight captures the adverse effect increasing tariff rates have on globalisation.

Cyclicality

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.

 
Gaining access to the winners will require greater precision in investment selection, with research-led, active decision-making likely to be rewarded.

The views and conclusions expressed in this communication are for general interest only and should not be taken as investment advice or as an invitation to purchase or sell any specific security.

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Risk Warning

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