Why have we been thinking about this?  Because globalisation has lost momentum over the past decade.  This is evident when looking at the Trade Openness Ratio, which represents world trade as a proportion of global GDP.  This metric has been trending downwards since the Global Financial Crisis (see Exhibit 1).  There are also other measures that support the slowbalisation phenomena – decreasing global bank loans, foreign direct investments and multinationals’ market share.

There are a few factors that could be blamed for the slowdown in globalisation.  The most important is that most of the economic gains from lower costs had been reached.  Transport costs have declined since the 1960s due to greater efficiencies and better technologies.  As a result, international trade became a lot more profitable.  Now, and for the last decade or so, transport prices have been rising on the back of rising fuel prices, which has massively decreased the profitability of international trade.

The improvements in technology is also a factor in its own right.  There was a lot of offshore manufacturing taking place.  US and European companies had an incentive to utilise cheap labour in low-cost countries to significantly reduce their input costs.  However, manufacturing became more automated and labour costs as a proportion of total costs fell.  There is now a reliance on more skilled and technologically able workers over cheap and plentiful.  This has meant that companies have begun to move their operations back onshore, which has reduced the need for goods to be transported around the world.  It’s also worth noting that there has been a clear shift from manufacturing to services.  As incomes rise, we have tended to spend more on services, which can’t be imported, than on goods.

The last factor to blame is trade wars.  The assumption is that tariffs generally fall. Trump, however, ignited a trade war when the US implemented trade tariffs on a number of Chinese goods.  China retaliated and there has been a lot of back and forth since then.  Even today, Biden is considering more tariffs for China.  It’s not only tariffs but even various trading blocs that are increasing regulations and requirements, which is discouraging global trade.

Shocks accelerating the end of traditional globalisation

While the ‘slowbalisation’ trend has been playing out for a while now, we believe it has accelerated on the back of the Covid-19 pandemic.  Even as the world is coming out of this pandemic, the Russian invasion of Ukraine is only likely to further accelerate this trend, as is the rise of ESG.

Covid-19 completely halted international travel.  Supply chains were wrecked.  Foreign direct investments plummeted.  If there ever was a cause of the collapse of global integration, it was this.  Nearly every developed country was in a recession and it was clear that the loss of international travel impacted trade, which led to product shortages.  Global leaders clearly realised that the negative aftershocks of the pandemic may not have been as bad if there was less global dependency (think semiconductors and energy).  And it’s clear that in realisation of this, many leaders are looking to reduce this dependency.

And if that didn’t convince them to take note, the Russian war with Ukraine should.  Russia is a key supplier of oil, gas and other commodities like palladium and wheat, particularly to Europe and Africa.  The war has caused the price of these commodities to skyrocket, and it’s impacting the general populations and the economy, with inflation becoming much more sticky and the likelihood of growth to suffer.  There is the added factor that transport costs will rise with oil prices and that will further deter international trade.

Alongside these issues, new pandemic-related shutdowns have recently been implemented in China, as the case count has picked up again.  This is only going to continue to impact global supply chains and again, force leaders to accelerate the move to decrease their dependency on other nations and focus on more regional strategies.

Last of all is the importance and rise of ESG.  It is mainly the E and S factors that are likely to contribute the greatest to ‘slowbalisation’.  Environmental concerns have the largest impact given the increased focus on carbon neutrality for many nations.  This could mean a reduction in global trade due to the negative environmental implications of transporting goods.  Also, consumers are now choosing to purchase locally produced goods and food and are willing to pay a premium for it, which has shifted the focus of many firms to local production.

The S also plays a part, particularly when it comes to the reduction in companies outsourcing labour (India, China, Bangladesh, etc.).  Companies have too much reputational risk on the line these days with respect to poor working conditions, which is another reason why they are choosing to re-shore production.

What does a new era of globalisation look like?

It is clear that globalisation in its traditional sense, i.e. when referring to manufacturing, is declining.  This is likely to continue and could lead to various trading blocks that are more localised, e.g. China on its own, Russia on its own, a more divided Europe, etc. What is apparent is that, unlike all those years ago, these decisions will be politically driven rather than for the good of the economy.

Moreover, leaders have realised that greater independence is necessary.  This will drive more localised production.  The war between Russia and Ukraine has also highlighted how nations will need to increase their energy independence and enhance their national defence capabilities, including cyber security.

Having said this, globalisation is not dead quite yet.  It is still occurring, but in different ways.  Rather than global growth being propped up by international trade, we are now seeing a rise in the integration from an idea, technology and service perspective.  This is where the new era of globalisation will take place, and it presents a lot of investment opportunities.

Is a “new era of globalisation” investable?

In a word, yes. Just looking at how things will change, there will be a clear need of increased spending on national defence and cyber security.  This will present opportunities in public companies that are involved in the value chains within these industries.  Additionally, the focus on energy independence will lead to more spending on energy, and in particular, renewable energy.  There will also be a focus on developing new and innovative energy sources, which will result in opportunities in this space across private equity and infrastructure.

Where there might generally be less opportunities (or an opportunity to short) is in traditional goods-focused businesses, as a decline in globalisation will likely increase costs, which will ultimately impact share prices.  This may also give way to the fall of the multinational. Further, the resulting increase in prices is likely to mean long-term inflation will be at marginally higher levels than it has been in recent decades, which will provide additional opportunities and threats.

Chirag Jasani

25 March 2022