From globalisation to regionalisation

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The high cost of transition

Since the collapse of the Soviet Union, the global trading system developed under conditions of overwhelming US economic and strategic dominance. But globalisation itself contributed to a redistribution of economic power. China is the clearest example. Its integration into world markets has helped turn the country from a relatively small economy into one of the central economic powers of the international system. This has created a tension at the centre of the globalisation model. Economic integration was predicated on the idea that increasing interdependence would generate mutual gains. Strategically, however, interdependence could also alter relative power as technologies, supply chains, energy systems, critical minerals and manufacturing capacity acquire a significance beyond their immediate economic value. What had previously been viewed primarily through the lens of efficiency is increasingly viewed through the lens of economic resilience and national security.

The paradox of global interdependence 

Global interdependence has consequently created a paradox: the deeper the integration between major economies, the greater the strategic consequences of that interdependence. This has created a fundamental shift in the global economy. From one organised predominantly around efficiency and integration towards one in which security, resilience and strategic autonomy carry greater weight. That distinction is economically important because resilience and security are rarely free. A production system designed primarily for efficiency tends towards specialisation. Capital and production gravitate towards the locations with comparative advantage. In this system, resources are allocated across competing economic activities and geographical jurisdictions based on the highest value-added outcomes. A system designed increasingly around resilience and security behaves differently. Supply chains may be duplicated, production reshored or moved to trusted trading partners, inventories increased and strategic capacity maintained even where it is not the highest value-added option.

These choices can reduce vulnerability, but they also require additional resources and capital. Five forces capture many of the economic pressures associated with resilience and security: Trade barriers, Reindustrialisation, Artificial intelligence, Debt and Energy security, or TRADE. Trade barriers are typically designed to protect high-cost domestic producers against low-cost international producers. Similarly, reindustrialisation requires economies to build or rebuild productive capacity domestically at cost, or within trusted supply networks, at the expense of low-cost but less trusted suppliers. Artificial intelligence is creating substantial demand for semiconductors, data centres, electricity and digital infrastructure, placing demands on resources throughout the supply chain. The security implications of powerful artificial intelligences mean they have become a new front in the strategic competition between the US and China, increasing the urgency for investment and further exacerbating pressures on the AI supply chain. Energy security requires another major deployment of capital into generation, grids, storage and critical supply chains. At the same time, high levels of government debt constrain the capacity of the public sector to finance these and other competing priorities.

The increased demand for capital drives up its cost

Viewed individually, these are five distinct structural trends. Viewed together, they point towards a broader conclusion: the emerging economic order is likely to require more capital to deliver greater resilience and strategic autonomy. That creates a fundamental tension. Investment requirements are increasing across technology, energy, manufacturing, infrastructure and defence at a time when many governments already carry substantial debt burdens. At the same time, the exceptionally low real interest rates that characterised much of the period following the global financial crisis are now behind us and these five trends themselves are adding pressure to capital markets and interest rates. Hence the TRADE forces are both a symptom and a cause of the transition to a new economic order. As the world needs substantially more investment at a higher cost of capital, the consequences extend beyond the financing of new investment. Higher real interest rates make existing debt more difficult to sustain, raise hurdle rates for new projects and increase the discount rates applied to future cash flows. 

They also create a more demanding environment for asset valuations. The challenge is consequently not simply how to finance a more resilient economic system, but how to reconcile its investment requirements with existing debt burdens, expected returns and sustainable economic growth. But simply responding to these already challenging global trends will not be enough to guarantee a successful investment strategy. Countries differ materially in their demographics, economic growth potential, institutional strength, fiscal positions and exposure to political and economic risk and the countries best positioned to generate future growth will not necessarily be those offering investors the strongest institutions or lowest risks. 

Economic scale and institutional strength remain concentrated heavily among advanced economies, while substantial demographic and prospective growth potential resides across developing economies. As global economic relationships become more strategically influenced and growth becomes more geographically dispersed, the traditional relationship between economic opportunity and investment safety may become less straightforward. For long-term investors, the emerging environment may therefore be characterised not simply by greater fragmentation, but by greater dispersion: between countries, between growth and risk, and between those economies capable of translating investment and technological change into sustained returns and those that cannot.