A few years ago it would have seemed bizarre to talk of deglobalisation
But at seven years and counting, we are currently experiencing the longest period of stagnation in the pace of global economic integration in over 70 years.
The ratio of world trade to gross domestic product has remained at just under 60% and foreign direct investment (FDI) flows have declined from a peak of US$1.9 trillion in 2007 to US$1.2 trillion in 2014. Political support across the developed world for what has been the animating project of post-war US and Western foreign policy is waning.
This cooling in support for globalisation is not especially surprising. After all, the benefits of globalisation have not always been evenly spread and a cohort, roughly corresponding to the working class and lower middle class in developed countries, has barely participated in global growth over the last 20 years. Trump’s election further underlines the waning popular support for globalisation, and the extent to which there is nothing natural or inevitable about free trade and integrated economies. They are the result of political choices, and if support for these choices reverses then so will globalisation.
It is true that progress with bilateral trade deals has been a little more successful, but these will only deliver limited global effects. Furthermore, any potential benefits are being more than offset by small scale protectionist policies and legislation from governments favouring their own country’s products over those from abroad. For example, the International Monetary Fund puts the percentage of products (globally) affected by temporary trade barriers at the highest figure ever – approximately 2.5%.
The globalisation trilemma
At the heart of the matter is a threeway trade-off. Professor Dani Rodrik of Harvard University argues that democracy, national sovereignty and global economic integration are mutually incompatible. We can combine any two of the three, but we can never have all three simultaneously and in full. He calls this the ‘impossibility theorem’ of the global economy.
The risks to globalisation are large. Not only have its benefits been intangible to many, but if we want to retain democracy and the nation state, this will ultimately involve some limits on how deeply economies can integrate. Perhaps the world has now reached the maximum level of globalisation compatible with maintaining democratic nation states. But such change really would involve enormous change to our societies and how they function. So while it may be the right antidote, it’s not obvious that the patient would find it palatable.
What’s more, a scaling back of globalisation would almost certainly reduce potential economic growth, given the strong empirical links between global trade and economic growth. Pre-unification East and West Germany are prime examples. While West Germany established itself as a dynamo of global manufacturing, East Germany closed its borders and sank into economic ruin. So what does all this mean for the future of global fixed income markets? Lower potential growth would reduce the equilibrium interest rate (the level of interest consistent with full employment and on-target inflation) as there would be less demand for investment capital, causing less competition for funds and a correspondingly lower interest rate. While longer-term interest rates would be lower, there is a possibility that near-term interest rates would rise more quickly, causing a sell-off in bonds with shorter-dated maturities.
Additionally, higher near-term interest rates as a result of the reduction in global integration would put upward pressure on consumer prices. This is because deglobalisation would boost the bargaining power of labour in the developed world as it no longer has to compete with low-cost workers in the developing world. And while this might seem like good news for workers, it also probably means that central banks would have to push unemployment higher to ensure wage growth is consistent with their inflation target. All in all, the same workers who support deglobalisation to protect their jobs and encourage wage rises could end up worse off.
Globalisation is by no means perfect. Yet tearing it up will make those people who are most disappointed by it poorer. It is unrealistic to expect a solution that is both palatable and effective to miraculously emerge next year. In the meantime, as investors we will be watching closely for any signs of progress. It is simply not a subject that can be ignored.
Luke Bartholomew Investment Manager, Fixed Income - EMEA