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How did we go from 30 years of globalisation to deglobalisation?
The global economy is undergoing a regime shift as it moves slowly, but inexorably, from free trade to trading blocs. What is the genesis of this change? To answer the question, we must turn back the clock 37 years to the fall of the Berlin Wall. The world was a very different place in 1989. The US, which is now the largest debtor in the world, had virtually no net foreign debt at all. The world’s second largest economy, China, was then an insignificant economy at only 2% of global GDP. The world was less global. The Cold War had divided the world between the democratic countries and the communist countries, with trade severely restricted between the two blocs. Measures of globalisation, such as that of the KOF Swiss Economic Institute’s Globalisation Index, record low levels of globalisation back in 1989. In addition, these measures had been fairly static over the previous two decades.
However, things were about to change. Following the collapse of the USSR, the US emerged unchallenged as the world’s military and economic powerhouse. As well as taking over as the world’s policeman, the US rolled out its free-trade oriented approach to the economy and by 1995, the WTO had been established, preparing the ground for the integration of China and many other previously communist-bloc countries into the global economy. Coinciding with a change of regime in China and a shift away from the collectivism of Mao towards a more market oriented structure, Chinese policy makers embarked on an export-oriented growth model specialising in low value-added manufacturing, exploiting their extremely cheap cost of labour. The China model was followed by a number of other East Asian economies and as a result, the region emerged as the world’s factory for low value add manufacturing. Rather than resist this development, many developed countries, such as the US, UK and Australia, took advantage of cheap imports of manufactured goods and redirected domestic resources away from their local manufacturing industry towards higher value-adding industries. In the case of the US, resources were re-routed to high-tech industries and the rise of Silicon Valley was the result. In the case of Australia, a 25-year development of the resource industry was undertaken. By 2010, the KOF Index had increased by 60%.
The flood of cheap manufactured goods from East Asia exerted powerful downward pressure on global inflation, allowing central banks in developed economies to keep interest rates at historically low levels. In the US, this disinflationary impulse was reinforced by China’s recycling of its rising trade surpluses into US government bonds, which helped suppress bond yields while limiting upward pressure on the renminbi and preserving China’s export competitiveness. Together, low inflation and abundant foreign capital lowered the cost of capital, financed the US transition toward technology, supported major rallies in risk assets and underpinned strong growth in US consumer spending. More broadly, the period from 1990 to 2020 was an exceptional era in human history. In 1990, around 44% of the world’s population lived in extreme poverty; by 2020, that share had fallen to just 13%, the lowest percentage on record. Alongside the US, China was one of the great beneficiaries of this era. Its economy grew into the world’s second largest, lifting its share of global GDP from around 2% in 1990 to about 17% today. China then used its high savings rate to fund an increasingly ambitious industrial policy focused on higher value-added manufacturing and technology, in part to avoid the “middle-income trap” that can leave developing economies stranded in low-value-added production.
However, the period was not without its shortcomings. The enormous wealth generated in the US was not evenly distributed across the population, leading to a sharp widening of inequality. The pull of high and rising standards of living in developed countries led to an acceleration of migration into the US and Europe at a rate that challenged the population’s consensus over immigration. And the hollowing out of manufacturing industries in developed economies led to a sense of being left behind by sections of the population whose world had abruptly changed for the worse. The upshot of these developments was a shift to the right in the politics of many developed countries that came to prominence on the back of anti-globalisation and anti-immigration policies. But perhaps the most threatening development, from the point of view of global geopolitical stability, was the rise in the economic power and reach of China, to the point where China challenges the economic (if not yet the military) hegemony of the US. This galvanised both sides of US politics into a fundamentally anti-China position, which has been prosecuted by both Trump Administrations and the Biden Administration.
Where are we now? There has been a clear pull-back in globalisation – both in terms of economics and politics. The economic pull back is most visible in the rise of international trade barriers, which culminated in Trump Administration’s Liberation Day tariff announcements. But the pull back extends beyond protectionism. It includes the reshoring of supply chains, the weaponisation of energy and the attempted monopoly of critical inputs to the supply chain. Politically, it is the emphasis on security rather than economic co-operation in international relations and the pushback on immigration. It has led to a blowout in government indebtedness as policy makers pander to their constituency with tax concessions and handouts and as governments increase expenditure on defence. The outturn of these symptoms of deglobalisation are higher rates of inflation, higher interest rates and higher costs of capital. To date, the negative consequences of higher inflation, interest rates and capital costs have been covered by the AI uplift. If AI is successful in delivering the payoff that justifies the investment that has been made in the technology, then possibly, the AI thematic can continue to offset the headwinds to economies and markets arising from the forces of deglobalisation. If not, the global economy and global markets will be exposed to the full force of deglobalisation.