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Weekly global economic update

What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.

Yet, the reality is that globalization was already under threat prior to this crisis. The United States had launched a trade war against China and others, starting in 2016, that led to the highest effective US tariff rates since the 1930s. China, too, despite giving lip service to the benefits of globalization, imposed restrictions on cross-border capital flows and encouraged greater autarky in the production of goods. Populist ideology grew in popularity in multiple countries, offering a counterpoint to the argument for globalization. Populist parties, leaders, and ballot initiatives performed well in such disparate places as the United Kingdom, France, Spain, Italy, Turkey, Mexico, and Argentina. 

Yet, despite the populist backlash against globalization, supply chains based on high speed and low cost continued to thrive, even in the face of higher tariffs and restrictions on cross-border investment. Instead, it was the pandemic, and now the war in Ukraine, that accelerated interest in reducing concentration in supply chains. Thus, we have seen numerous global companies attempt to diversify their supply chains even at the cost of reducing efficiency. The goal has been redundancy and resilience. 

Now, a great debate is under way as to whether globalization has reversed. Some observers say that companies will continue to seek to protect the viability of supply chains, in part by creating regionalized as opposed to global supply chains, and in part by returning some processes to the home market. At a recent meeting in Silicon Valley, I heard several executives of local technology companies agree that technology supply chains are rapidly becoming regionalized. Larry Fink, CEO of Blackstone, said that “the Russian invasion of Ukraine has put an end to the globalization we have experienced over the last three decades.” 

Meanwhile, the most critically important country in global supply chains remains China. And China is evidently being careful not to run afoul of Western sanctions on Russia. Chinese companies recognize their massive dependence on the United States and Europe as opposed to Russia. Yet, many global companies are wary of excessive dependence on China. They see risk that China could become subject to new sanctions by the West, either through interaction with Russia or because of its own geopolitical actions. They likely see risk that the Chinese government’s focus on boosting the fortunes of state-owned enterprises will put private sector actors at a competitive disadvantage. And they likely worry that, with onerous demographics and rising wages, China will lose its competitive edge from a labor arbitrage perspective. Thus, a kind of deglobalization, at least relative to China, is under way.

On the other hand, the benefits of globalization have not disappeared. In a competitive global economy, companies will still have an incentive to seek the lowest costs and greatest speed. It could be that the shift toward diversification is merely a bump in the road, meant to address risks previously not seen. It could be that globalization will survive, especially once the pandemic and the war in Ukraine are both in the rearview mirror. 

In any event, if deglobalization takes place, or even if globalization decelerates, there will be some consequences. It could lead to higher costs of production, thereby leading to higher prices for end consumers and declining real purchasing power. This shift away from efficiency could also be inflationary, especially if the shift related to the war leads to serious efforts to replace products produced in Russia and Ukraine. The current turmoil in global food markets, due to an expected shortage of Ukraine/Russia grain and fertilizer, is a good example. 

In the realm of technology, deglobalization could hamper innovation, especially if symbiotic relationships between companies in various countries are broken. Slower innovation means slower productivity growth and, consequently, slower economic growth. The challenge going forward, then, will be for companies and governments to achieve the right balance between efficiency and risk mitigation. Governments are likely to err on the side of reducing efficiency, especially if their goal is to protect existing jobs from dislocation and encourage reshoring of manufacturing jobs. Some governments, especially the United States, have lately placed an emphasis on producing things at home. 

Finally, some countries might benefit if companies seek to diversify away from China. Regionalization of supply chains could mean more investment in Mexico to service the US market, more investment in Southeast Asia to service Japan and other affluent countries in Asia, and more investment in Eastern Europe to service Western Europe. Thus, deglobalization could entail a redistribution of the benefits of globalization.  

 

Deloitte Global Economist Network

 

The Deloitte Global Economist Network is a diverse group of economists that produce relevant, interesting and thought-provoking content for external and internal audiences. The Network’s industry and economics expertise allows us to bring sophisticated analysis to complex industry-based questions. Publications range from in-depth reports and thought leadership examining critical issues to executive briefs aimed at keeping Deloitte’s top management and partners abreast of topical issues.

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Cover image by: Sylvia Chang