Deglobalization, Deleveraging, And Decarbonization: 3 New Realities For Investors In 2023
Deglobalization, Deleveraging, And Decarbonization: 3 New Realities For Investors In 2023
?It is quite natural to know and ask ourselves what 2023 has in store. Annual predictions are not reliable so spare If we the short-term crystal ball. ?If anything some certainty is that three decades-long trends are undergoing reversals. And the new realities undergoing have started to raise important questions for investors.
Deglobalization
For most of the past 50 years, globalization has been the wind in the sails of companies and investors with a multinational footprint. The KOF Swiss Economic Institute tracks globalization and shows a remarkable and steady rise in globalization over the last several decades. From 1970 to 2019,?the?de jure?globalization index nearly doubled spurred by China’s gradual opening to western business, the fall of the Iron Curtain, the rise of the BRICS nations, and a broad openness to free trade. However, those tailwinds have inclined, and businesses are taking note. 2022 was a year of major geopolitical events, starting with the Russian invasion of Ukraine and ending with Xi Jinping winning a third term amid an economic slowdown in China. Throughout, the ongoing recovery from COVID-19 has underscored an environment of uncertainty and caution. As such, the push to reconfigure supply chains through onshoring or “friend-shoring” has grown for many companies. Even if COVID-19 becomes less disruptive or current tensions are resolved, it is hard to see how those trends reverse in the near term.
?Investors should ask themselves:???????? Is my portfolio built on the assumption of an increasingly connected world? How much exposure do I have to know global hot spots? What less-known global hot spots could cause my portfolio trouble? What would the impact be on my portfolio if China raises tensions with Taiwan, stops buying Treasuries, or institutes strict capital controls?
Deleveraging
Over the same several decades, interest rates have fallen consistently. In 1981, the effective Fed Funds rate peaked at 19%.?Early in 2022, it was essentially zero, following a long and fairly constant downward trend. When leverage has little to no cost, both investors and companies tend to use a lot of it. Now, as the Fed raises rates, we are seeing which firms are strong and which are weak. As Warren Buffett put it, “Only when the tide goes out do you discover who's been swimming naked.” The sudden panic within the crypto industry, precipitated by the collapse of FTX, is just one example of the issues of deleveraging, and the process is only getting started. Investors should ask themselves: What investments do I hold that have only worked because of a lower-rate environment? Am I relying on a “Fed put” or pursuing a moral hazard with the expectation of getting bailed out? ?What primary or secondary exposure do I have to crypto?
Decarbonization
Over these same decades, we’ve used carbon with abandon as emissions came with little to no direct cost to the user. The IEA shows that?global energy-related CO2 emissions doubled between the late 1970s oil shock and 2019?before coming down during the pandemic. When the effects of climate change have been building for years, the investment world has by and large just invested to the challenge as the financial impacts become clearer. And climate change is becoming part of company strategy: many companies have set climate goals, including science-based net-zero targets. They are asking their suppliers about their emissions and the emissions in their supply chains, offering greener products and services, and opting for lower-emission shipping and distribution. In the war for talent, being a sustainable company is increasingly critical. The highlight on sustainability means that companies of all types are considering how to decarbonize their operations – simply because it is good business, and because it will make them more competitive in the future. For investors, considering sustainability in making portfolio decisions goes well beyond choosing green bonds over regular bonds or making net zero portfolio commitments themselves. Not recognizing this move could be a fatal mistake, especially for long-term investors.
Investors should ask themselves:
Which companies will be winners in a decarbonizing world? Do I own them? Do I own the losers? How would my portfolio perform with a real or hypothetical carbon price? Am I invested in companies or countries that can survive the impacts of serious climate change? Am I invested in those that cannot? As an investor, these three new realities raise serious questions about the ways portfolios are constructed to meet long-term goals. Every January brings uncertainty about how the next year will unfold; this one brings uncertainty about how the next decades will unfold. For long-term investors, it’s time to recognize that deglobalization, deleveraging, and decarbonization are here to stay.
?GEO-ECONOMICS?IS AFFECTING ECONOMIES, INDUSTRIES, AND GLOBAL ISSUES
Following nearly a century of globalization, successive global shocks from time to time and the movement to face climate change appear to be turning critical factors. 'Globalization' following the 2008 financial crisis may be turning into deglobalization. But some regions and sectors are deglobalizing faster than others. In response to COVID-19, Russia’s war with Ukraine, and climate change, governments and global companies are seeking security and resilience over the benefits of global value chains. There are strong signals that the era of globalization is coming to an end, analysis by research analysts at?Barclays Corporate and Investment Bank?suggests. The sentiment is turning towards deglobalization. The rise of globalization was never entirely smooth or assured. The reduction of global trade that was bookended by the two world wars was followed by 60 years of increased globalization. This included the hyper-globalization period from 1990 to 2008. However, the 2008 financial crisis, trade wars, disenfranchised middle classes in developed economies, and rising concerns about over-reliance on trade with single partners led to a period of relatively stagnant "globalization”. Since the end of the second world war, globalization has surged — but that era may be coming to an end. Macro History Database. Data 1960 onwards for World from IMG and World Bank, Barclays Research. Today, "slowbalisation" appears to be moving towards deglobalization. Recent disruptions to global value chains such as the COVID-19 pandemic, the war in Ukraine, growing ideological differences, and the green transition have prompted governments and corporations to reconsider external dependencies. They are looking closer to home and to trusted partners for more resilient growth models. This sentiment is transcending media headlines and political posturing and is becoming part of the general corporate narrative. According to Barclays’ Investment Sciences team, a small but notable fraction of 4% of corporate transcripts mentioned onshoring in 2022. Striking, when this has been under 1% prior to the pandemic.
Deglobalization isn't completely global
While M&A (Mergers & Acquisitions) and jobs data suggest that deglobalization is occurring, it is not happening uniformly across the planet. Increased onshoring of jobs is taking place primarily in Asia. Domestic employment is also increasing US and Europe, but this appears to balance local resignations, and the net trend in both regions is still towards globalization, albeit among more junior roles. Barclays also found evidence that fewer announced M&A deals have been completed recently than historical patterns would suggest. Moreover, deals between target firms in Europe and North America are less likely to succeed when the acquirer is outside these regions, especially for target firms in industries such as advanced technology, finance, and retail. On the other hand, deals targeting firms in, for example, consumer staples, are more likely to succeed. Similarly, the slowdown of M&A activity may not be caused solely by macroeconomic trends, but also by regulatory concerns, as the European Commission and the UK antitrust authority increase scrutiny on deals. The slowdown of M&A activity may not be caused solely by macroeconomic trends, but also by regulatory concerns.?
DEGLOBALIZATION AND THE GREEN
Energy is a key sector to watch in terms of both globalization and deglobalization. The common incentive for nations to address climate change has been a major source of globalized cooperation in recent years. Yet the mechanics of the green transition itself also necessitate a more local focus. The push towards a long-term increase in the share of energy coming from renewables is being driven by the reduction of carbon-intensive transportation infrastructure and carbon pricing mechanisms acting as de facto tariffs. Rising concerns about energy security and fossil fuel pricing volatility have also heightened interest in domestic renewables .\Energy is a key sector to watch in terms of both globalization and deglobalization.?Image:?IEA\However, as the green transition is a global challenge, Barclays suggests it still needs a globalized approach — one that complements local and regional solutions. Although the rise of renewables will fundamentally reshape fossil fuel trade flows, the green transition will have to be supported by the minerals industry which will be used to build its infrastructure. This will result in the increased trade integration of mineral-endowed countries. The era of globalization may be coming to an end. What replaces it remains to be seen, but it is clear that the global cooperation crisis, trade wars, alienated middle classes in developed economies, and rising concerns about over-reliance on trade with single partners led to a period of relatively stagnant "slowbalisation".
The time for transformational change and intergenerational leadership is now – here’s how we get there
The sluggish pace of around 1.6% in 2023?as financial conditions tighten, the winter aggravates China’s COVID policy and Europe’s natural gas problems persist.?The global economy?is not at?imminent?risk of sliding into recession,?as the sharp decline in inflation helps promote growth, but the J.P.?Morgan Research baseline view assumes a U.S. recession is likely before the end of 2023. In the first half of 2023,?the S&P 500 is expected to re-test the lows of 2022, but a pivot from the Fed could drive an asset recovery later in the year,?pushing the S&P 500 to 4,200 by year-end.
There is mixed news for equity markets and more broadly risky asset classes in 2023. The good news is that central banks will likely be forced to pivot and signal cutting interest rates sometime next year, which should result in a sustained recovery of asset prices and subsequently the economy by the end of 2023. The bad news is that in order for that pivot to happen, we will need to see a combination of more economic weakness, an increase in unemployment, market volatility, a decline in levels of risky assets, and a fall in inflation. All of these are likely to cause or coincide with downside risk in the near term.
?What is the Forecast for Global Economic Growth?
2022 was a shocking year. Against the historic volatility and uncertainty of 2020 and 2021 — which saw the deepest global downturn on record, followed by the strongest rebound — 2022 growth outcomes were far more stable. But this year has been remarkably turbulent, with the global economy hit by multiple adverse shocks — from supply and demand issues spilling into labor markets and a third major wave of COVID-19 to Russia’s invasion of Ukraine.
Ushering toward 2023, the monetary policy tightening drag is building, and central banks are on the march. Of the 31 countries J.P.?Morgan Research tracks, 28 have raised rates. There is likely more to come. Based on its current guidance, the Federal Reserve (Fed) will have delivered a cumulative adjustment of close to 500 basis points (bp) on rates through the first quarter of 2023. Central bank activity is clouding the outlook for next year somewhat as the Fed, followed by other major central banks, is expected to pause hikes by the end of the first quarter of 2023.?
?GDP growth in 2023 (% change annualized)
Global GDP growth in 2023 is forecast to climb by 1.6%. Developed Market growth is forecast at 0.8%, U.S. growth is forecast at 1%, Euro Area growth is projected to come in at 0.2%, China’s economy is forecast to grow 4.0% and Emerging Market growth is forecast at 2.9% in 2023.
The substantial rise in borrowing costs is already depressing housing activity and the sharp climb in the U.S. dollar is likely weighing on U.S. corporate profit margins. There are also increasing signs that credit conditions are tightening broadly. Tremors emanating from Emerging Market (EM) low-income commodity importers, U.K. pension funds, and the U.S. crypto sector are not unrelated: they signal that rapidly tightening financial conditions generate stress that could spill over in ways that threaten macroeconomic stability. “With the winter set to aggravate China’s COVID problems and Europe’s natural gas crisis, the global growth outlook remains depressed, but we do not see the global economy at imminent risk of sliding into recession in early 2023. The financial conditions drag is being cushioned by a fading of supply chain and commodity price shocks,” said Bruce Kasman, Head of Economic and Policy Research at J.P.?Morgan. Global consumer price index (CPI) inflation is on track to slow toward 3.5% in early 2023 after approaching 10% in the second half of 2022.
“Circumstances warrant considering a range of scenarios. The dominant event across different scenarios presented is a U.S. recession…but the timing of this break, the path of Fed policy, and the reverberations for the rest of the world vary,” added Kasman.
Stock Market Outlook
After a year of macroeconomic and geopolitical shocks, investors responded by derating the S&P 500 price-to-earnings (P/E) ratio as much as seven times, while some speculative growth segments crashed 70-80% from highs. Although fundamentals have been resilient throughout these shocks, this year’s constructive growth backdrop is not expected to persist in 2023. Fundamentals will likely deteriorate as financial conditions continue to tighten and monetary policy turns even more restrictive. The economy is also likely to enter a mild recession, with the labor market contracting and the unemployment rate rising to around 5%. “Consumers with a cushion of savings from lockdown have mostly exhausted their post-COVID excess cash and for the first time are getting hit by a broadening negative wealth effect from all assets simultaneously — whether that’s housing, bonds, equities, alternative/private investments or crypto,” said Dubravko Lakos-Bujas, Global Head of Equity Macro Research at J.P.?Morgan. “This proverbial snowball should continue to gain momentum next year as consumers and corporates more meaningfully cut discretionary spending and capital investments.”?“In the first half of 2023, we expect the S&P 500 to re-test the lows of 2022 as the Fed overtightens into weaker fundamentals. This sell-off combined with disinflation, rising unemployment, and declining corporate sentiment should be enough for the Fed to start signaling a pivot, pushing the?S&P 500 to 4,200 by year-end 2023. Against this backdrop of these factors, J.P.?Morgan Research is reducing its below consensus 2023 S&P 500 earnings per share (EPS) of $225 to $205 due to weaker demand and pricing power, further margin compression, and lower buyback activity. The upside and downside to this base case will largely depend on the depth and length of the recession and the speed of the Fed’s counter-response. Market volatility is also set to remain elevated (with the Volatility Index or VIX averaging around 25). “In the first half of 2023, we expect the S&P 500 to re-test the lows of 2022 as the Fed overtightens into weaker fundamentals. This sell-off combined with disinflation, rising unemployment, and declining corporate sentiment should be enough for the Fed to start signaling a pivot, subsequently driving an asset recovery and pushing the S&P 500 to 4,200 by year-end 2023,” said Lakos-Bujas. The convergence between the U.S. and international markets should continue next year, both on a USD and local currency basis. The S&P 500 risk-reward relative to other regions remains unattractive. Continental European equities have a likely recession to negotiate and geopolitical tail risks, but the eurozone has never been this attractively priced versus the U.S. Japan should be relatively resilient due to solid corporate earnings from the economy’s reopening, attractive valuation, and smaller inflation risk compared with other markets. “Within developed markets, the U.K. is still our top pick. As for EM, its recovery is mostly linked to China. Tactically, the Asia reopening trade led by China is overdue and the activity hurdle rate is very easy, with further policy support likely. We expect around 17% upside for China by the end of 2023,” said Mislav Matejka, Head of?European and Global Equity Strategy at J.P.?Morgan.
Commodities Outlook
Entering 2022, the view was the global oil market would remain tight but balanced, with Brent averaging $90 per barrel (bbl.) for the year. With the?onset of the war in Ukraine, J.P.?Morgan Research opted to raise its 2022 average Brent price to $104/bbl. and 2023 price to $98/bbl., with prices peaking in the second quarter of 2022 at $114/bbl. “After maintaining our price view for eight months, we now opt to shave $8 off our 2023 price projections, on our expectations that Russian production will fully normalize to pre-war levels by mid-2023. Despite more pessimistic expectations for balances over the next few months, we find the underlying trends in the oil market supportive and expect the global Brent benchmark price to average $90/bbl. in 2023 and $98/bbl. in 2024,” said Natasha Kuneva, Head of Global Commodities Strategy at J.P.?Morgan. Commodity price forecasts for 2023, with Brent averaging $90 per barrel, WTI averaging $83 and gold averaging $1,860 in the fourth quarter of 2023.???
There are strong reasons to expect a relatively robust 1.3 million barrels per day (mbd) of oil demand growth next year, despite expectations for the global economy to expand at a sub-par 1.5% pace in 2023.?There is still substantial room for a cyclical rebound, driven by a continued normalization of demand for mobility fuels like gasoline, diesel, and jet fuel to pre-COVID levels. “Our forecast of a $90 Brent in 2023 centers on the view that the OPEC+ alliance (Organization of the Petroleum Exporting Countries and allies) will do the heavy lifting to keep markets balanced next year,” added Kaneva. On the structural side, the expansion of the world’s oil supply growth is expected to slow in 2024, reviving the need for OPEC’s crude.?Growth from U.S. shale producers, traditionally the most responsive to changing market conditions, is expected to more than halve from 1.1-1.2 mbd this year and next to 0.5 mbd in 2024. For base metals, 2023 will be a transitional year, with prices once again re-testing the lows approached earlier this year around mid-2023. “After bottoming over mid-year, a more sustained recovery in base metals prices is set to unfold in the last few months of the year,” said Greg Shearer, Head of Base and Precious Metals Strategy at J.P.?Morgan. Relative to base metals, the outlook for precious metals is more positive, with all but palladium expected to end 2023 higher. With the Fed on pause, decreasing U.S. real yields will drive the bullish outlook for gold and silver prices over the latter half of 2023. Gold prices are forecast to push up to an average of $1,860 per troy ounce in the fourth quarter of 2023. “Even with a bullish baseline gold and silver forecast, we think the risk is skewed to the upside in 2023. A harder-than-expected economic landing in the U.S. would not only attract additional safe-haven buying, but the rally could become supercharged by more dramatic decreases in yields if the Fed more rapidly unwinds tighter fiscal policy,” added Shearer.?
The Forecast for Rates and Currencies
Over the past year, the Fed has been forced to tighten aggressively, outpacing every tightening cycle over the last three decades. For 2023, it is no surprise that inflation and Fed rate policy remain top of mind for investors: in the J.P.?Morgan Research 2023 Outlook Survey, respondents ranked these two factors as the most important for U.S. fixed income markets in 2023, followed by U.S. recession risks. With inflation already showing signs of softening, the Fed is expected to deliver a 50bp hike in December, before dialing down the tightening pace further and delivering 25bp hikes at both the February and March meetings. It is expected to pause rate hikes thereafter. “The almost 500bp of expected cumulative hikes is already delivering a commensurate tightening of financial conditions, which we believe will tip the economy into a mild recession later next year. With a slowing in aggregate demand, we project the unemployment rate will rise to 4.3% by the end of next year,” said Jay Barry, Co-Head of U.S. Rates Strategy at J.P.?Morgan.10-year U.S. Treasury yields are expected to fall to 3.4% by the end of 2023 and real yields are expected to decline. Investors expect the Fed to be on hold through early 2024 or beyond. 55% of investors polled by J.P.?Morgan in its 2023 Outlook Survey expect the Fed to be on hold through the first quarter of 2024 or beyond.
2023 should deliver the completion of one of the fastest and most synchronized Developed Market (DM) central bank tightening cycles on record, with most of them expected to be done by the first quarter of 2023. The growth profile will show divergence: the Euro area will likely face a mild recession into late 2022/early 2023, while the U.S. is expected to slide into recession in late 2023.In currency markets, further dollar strength is still expected in 2023, but of a lower magnitude and different composition than in 2022. The Fed pause should give the dollar’s rise a breather. Additionally, unlike in 2022, lower-yielding currencies like the euro are expected to be more insulated as central banks pause hikes and the focus shifts to addressing slowing growth — but this in turn makes high-beta, emerging market currencies more vulnerable. Weak growth outside the U.S. should also remain a pillar of USD strength in 2023. “Some growth signals suggest an improvement outside the U.S., but we are skeptical of the longevity of this theme,” said Meera Chandan, Co-Head of Global FX Strategy at J.P.?Morgan.
Emerging Markets Outlook
At 2.9% in 2023, EM growth looks to remain well below its pre-pandemic trend, slowing modestly from 2022. EM excluding China is expected to slow to a below-trend 1.8% with wide regional divergences. In China, the full-year 2023 growth forecast is 4% year-over-year, where two-quarters of below-trend growth are assumed as the economy loosens COVID restrictions.?The global and U.S. economic cycles will remain the primary drivers for EM assets in 2023. The worst moves for EM risky asset classes are seen in U.S. recessions with large widening in credit spreads and lower equity prices. Dwindling private sector savings will test EM’s ability to withstand continued tightening in global financial conditions and weaker global growth. 2022’s geopolitical stresses remain unresolved and represent two-sided risks for EM in 2023, while some key domestic political events will be followed closely — most notably the elections in Turkey and Argentina.
Disinflation is expected in 2023, but with few rate cuts across EM central banks and focused mostly in Latin America. EM ex-China and Turkey inflation is expected to halve to 4.3% by the end-2023 compared with 7.9% in end-2022.
“Inflation is expected to remain a problem for central banks in roughly half of the core EM countries. Some EM central banks may start easing next year but most look set to keep rates high for longer,” said Luis Oganes, Head of Currencies, Commodities and Emerging Markets Research at J.P.?Morgan.
Obstinately high inflation continued USD strength, and a broader tightening in global financial conditions mean easing cycles are only expected to get underway in Latin America, Czechia, and India. The rest of EM Asia, having lagged behind its EM peers in lifting off, is expected to stay on hold next year. “The global and U.S. economic cycles will remain the primary drivers for EM assets in 2023. The worst moves for EM risky asset classes are seen in U.S. recessions with large widening in credit spreads and lower equity prices. EM has historically followed these patterns and we expect higher risk premia into a U.S. recession, although the moves may be mitigated by the selloff already seen in 2022,” added Oganes.
?Sharp, Long-lasting Slowdown to Hit Developing Countries Hard
2023 global growth to slow to 1.7% from 3% expected six months ago. Global growth is slowing sharply in the face of elevated inflation, higher interest rates, reduced investment, and disruptions caused by Russia’s invasion of Ukraine, according to the World Bank’s latest?Global Economic Prospects?report. Given fragile economic conditions, any new adverse development—such as higher-than-expected inflation, abrupt rises in interest rates to contain it, a resurgence of the COVID-19 pandemic, or escalating geopolitical tensions—could push the global economy into recession. This would mark the first time in more than 80 years that two global recessions have occurred within the same decade. The global economy is projected to grow by 1.7% in 2023 and 2.7% in 2024. The sharp downturn in growth is expected to be widespread, with forecasts in 2023 revised down for 95% of advanced economies and nearly 70% of emerging market and developing economies. Over the next two years, per-capita income growth in emerging markets and developing economies is projected to average 2.8%—a full %age point lower than the 2010-2019 average.?In Sub-Saharan Africa—which accounts for about 60% of the world’s extremely poor—growth in per capita income over 2023-24 is expected to average just 1.2%, a rate that could cause poverty rates to rise, not fall. “The crisis facing development is intensifying as the global growth outlook deteriorates,”?said?World Bank Group President?David Malpass. “Emerging and developing countries are facing a multi-year period of slow growth driven by heavy debt burdens and weak investment as global capital is absorbed by advanced economies faced with extremely high government debt levels and rising interest rates. Weakness in growth and business investment will compound the already-devastating reversals in education, health, poverty, and infrastructure and the increasing demands from climate change.”
Growth in advanced economies is projected to slow from 2.5% in 2022 to 0.5% in 2023. Over the past two decades, slowdowns of this scale have foreshadowed a global recession.?In the United States, growth is forecast to fall to 0.5% in 2023—1.9 %age points below previous forecasts and the weakest performance outside of official recessions since 1970. In 2023, euro-area growth is expected at zero %—a downward revision of 1.9 %age points. In China, growth is projected at 4.3% in 2023—0.9 %age point below previous forecasts.
Excluding China, growth in emerging markets and developing economies is expected to decelerate from 3.8% in 2022 to 2.7% in 2023, reflecting significantly weaker external demand compounded by high inflation, currency depreciation, tighter financing conditions, and other domestic headwinds. By the end of 2024, GDP levels in emerging and developing economies will be roughly 6% below the levels expected before the pandemic.?Although global inflation is expected to moderate, it will remain above pre-pandemic levels. The report offers the first comprehensive assessment of the medium-term outlook for investment growth in emerging markets and developing economies.?Over the 2022-2024 period, gross investment in these economies is likely to grow by about 3.5% on average—less than half the rate that prevailed in the previous two decades. The report lays out a menu of options for policymakers to accelerate investment growth.” Subdued investment is a serious concern because it is associated with weak productivity and trade and dampens overall economic prospects. Without strong and sustained investment growth, it is simply impossible to make meaningful progress in achieving broader development and climate-related goals,”?said?Ayhan Kose,?Director of the World Bank’s Prospects Group.?“National policies to boost investment growth need to be tailored to country circumstances but they always start with establishing sound fiscal and monetary policy frameworks and undertaking comprehensive reforms in the investment climate.”
The report also sheds light on the dilemma of 37 small states—countries with a population of 1.5 million or less. These states suffered a sharper COVID-19 recession and a much weaker rebound than other economies, partly because of prolonged disruptions to tourism. In 2020, economic output in small states fell by more than 11%— seven times the decline in other emerging and developing economies. The report finds that small states often experience disaster-related losses that average roughly 5% of GDP per year. This creates severe obstacles to economic development. Policymakers in small states can improve long-term growth prospects by bolstering resilience to climate change, fostering effective economic diversification, and improving government efficiency.?The report calls upon the global community to assist small states by maintaining the flow of official assistance to support climate-change adaptation and help restore debt sustainability.
?How globalization is changing
??Rerouting relationships.?Multinational companies have spent decades investing in supply chains that span the globe. Now, amid shifting geopolitical tensions, organizations are revisiting their relationships with suppliers as they focus on safety and on diversifying their economic ties. World trade accounts for 57% of overall economic activity, down from a high of 61% in 2008. As companies reroute export and supply chain pathways, this has resulted in strengthened ties with some countries and reduced reliance on others.?[WSJ]
??Global melting pot.?Some economists believe that globalization peaked in 2007, before declining in the face of the global financial crisis, populist politics, the pandemic, and war. But the global success of some K-pop groups shows that cultural globalization is unstoppable—there’s no winding back the blending of Western and Asian cultures. Moreover, one US economist points to an increase in cross-border trade in services as evidence that globalization is continuing.?[Bloomberg]
“Multinationals play an outsize role in global flows. They are responsible for about 30% of trade, 60% of exports, and 82% of exports of knowledge-intensive goods.”
??According to research by White and colleagues, globalization is evolving, rather than fracturing. Flows representing knowledge and know-how, such as intellectual property and data, and flows of services and international students are now growing faster than the flows of goods. The world remains interdependent. In fact, “every region in the world depends on another significant region for at least 25% of a flow it values most,” White says. For instance, resource-rich regions of the world depend on other regions to import manufactured goods, while manufacturing centers depend on others for food and other resources. Listen to the podcast for more ways?globalization could continue to progress?in the coming years.
?How our interconnected world is changing
?What’s the fate of globalization? New research breaks down changes in the global flows that bind us together—and what those changes mean for our collective future. Globalization isn’t going away,?but it is changing, according to?recent research?from the McKinsey Global Institute (MGI).?Pundits and other public figures have errored and predicted the demise of globalization for what seems like years. Now, given the war in Ukraine and other disruptions, many are once again sounding its death knell.
The flows of goods, the real tangible stuff, have leveled off after nearly 20-plus years of growing at twice the rate of GDP. But the flow of goods kept pace with GDP and even rose a little bit, surprisingly, in the past couple of years. Since GDP has been growing, that means actual ties have gotten stronger. One of the most striking findings from this research was that flows representing knowledge and know-how, such as IP and data, and flows of services and international students have accelerated and are now growing faster than the flow of goods. Flows of data grew by more than 40 % per annum over the past ten years.?The fact that certain goods are growing slower than other types of flows shows this shift in our economy and what’s most important to the way the economy functions. It comes on the back of a long history of different factors that influence growth and shifts in the way patterns work. What’s happening, in part, is that a variety of countries are producing more domestically—first and foremost China. That has been driving a lot of the flow down. The top line is, every region in the world depends on another significant region for at least 25 % of the flow it values most. In general, regions that are manufacturing regions—Europe, Asia–Pacific, and China, if we look at it on its own because it’s such a large economy—depend very strongly on the rest of the world for resources: food to some degree, but real energy and minerals of different sorts. For examples:
In general, regions that are manufacturing regions depend very strongly on the rest of the world for resources: food to some degree, but real energy and minerals. China imports over 25 % of its minerals, from places as far-flung as Brazil, Chile, and South Africa. China imports energy, particularly in the form of oil from the Middle East and Russia. Europe is emblematic of these forms of dependency on energy. It was dependent on Russia for over 50?% of its energy, but now that has drastically changed. In some other regions of the world—places that are resource-rich, like the Middle East, sub-Saharan Africa, and Latin America—those places are highly dependent on the rest of the world for their manufactured goods. Well over half the world’s population lives in those places. They import well over 50 % of their electronics and similar amounts of their pharmaceuticals. They are highly dependent on other parts of the world for things that are really quite critical to the development and for modern life. North America is a slightly dissimilar one. We don’t have any single spot of quite as great a dependency, at least at the broad category level. We import close to 25 % of what we use in net value terms across the spectrum, both resources and of manufactured goods. This doesn’t yet speak of data and IP, where, for example, the US and Europe are fairly significant producers/exporters. A country like China is a very large consumer of IP.
?This is quite striking. We asked how many workers in regions outside North America serve North American demand. And we asked the same question for Europe. It turns out that 60?million people in regions outside North America serve North American demand, and in Europe, the corresponding number is 50 million. These numbers are very substantial versus the working populations in those countries. So, when you consider how much of what North Americans or Europeans are consuming could be produced onshore, by onshore labor, the answer is not even remotely close to those sorts of numbers—at least given the means of production or the way services are delivered today and the role people play in that. Flows related to knowledge and know-how. Knowledge services that have historically grown more slowly than manufactured goods and resources, with increased global connection over time, have flipped over the past ten years. Professional services, such as engineering services, are among those more traditional trade flows that have been growing fastest, at about 6 % a year, versus resources, which have slowed to just around two %. Anything that involves real know-how—engineering, but also providing, say, call center support—is in that category.
The flows of IP are growing even faster. Now, IP is tricky because accounting for it is a very tricky thing to do. But it roughly looks at the flows of the fun stuff. In the report, we talk about?Squid Game, but IP also includes movies, streaming platforms, music, and any sort of cultural elements that we consume. It’s also important to consider flows of patents and ideas and the way countries or companies will use ideas or know-how developed in one country to help what they do broadly across the world. Those flows have been growing at roughly 6 % per year as well. There are data flows—the flows of packets of data. For example, if we were in different countries while conducting this interview there would be a flow between us. There are also flows linked to our ever-expanding use of the cloud and data localization. Data transfer is happening swiftly. The flow of international students has also been rising. That was mightily interrupted by the pandemic, for reasons I don’t need to belabor, but these flows seem to be rebounding. It’s important to consider the degree to which those will jump back on their accelerated growth trajectory.
There’s some variation, but many flows were remarkably resilient—resilient in a way that’s a bit counter to the general narrative about what happened during the pandemic. The flows of resources and manufactured goods jumped reasonably significantly in 2020 and 2021, both to levels of about 6 % per year on an annualized basis. To some degree, what was happening is that cross-border flows stepped in to replace interrupted domestic production. Flows from Asia came in, for example, to the US or to Europe. We’ve seen some flows go in reverse directions. There were a bunch of interruptions in domestic production, which was quite surprising. Flows of capital also jumped quite a lot as people needed to shift the way they were financing themselves. Multinationals needed to shift the way they were financing themselves. Some were moving liquidity to different parts of the world under times of financial stress. But those jumped to levels of growth in the tens of digits from what had actually been reversed growth for the past ten years. All those things jumped. IP jumped a little bit; data remained high. So, these flows have been remarkably resilient.
The good and bad news about resource concentration
?From the global perspective, there are some products that truly originate in only a few places in the world, and all of us across the globe are dependent on those few places for our supply. Iron ore is quite concentrated, and cobalt is concentrated in the DRC [Democratic Republic of the Congo]. The second type of concentration is viewed from the standpoint of an individual country. Lucia, you talked about Europe and gas dependency, for example, Germany was getting gas from only a very concentrated set of sources. These are places where, for a variety of reasons, countries have built up dependencies on just a small number of other countries for one reason, the cost of trade. People have made decisions based on economic factors. Another reason is regional preference. Not all goods are created equal, even if they fall into the same category. The third reason is preferential trade agreements between different countries or other forms of tariffs or taxes that shape the way flows occur. We’re in a world in which suddenly people are realizing they have to contemplate the consequences associated with concentration—not of suppliers, but of the country of origin from which they’re buying things.
It’s not always a bad thing. But there are a lot of considerations to make that involve costs, involve geopolitical relationships, involve the role that various countries want to play themselves, how they’re thinking about development, and how they’re thinking about their workforces. All those things have to be part of the mix. Imagine three or four different countries, each with three trading partners, and they’re largely different trading partners. Swapping off who’s supplied by whom is a huge problem of coordination.
Evolution of new global supply chains
?Broadly speaking, there are four categories of potential evolution. Semiconductors are most prominent in public discussion. Electronics, more broadly, is one of the fastest-moving value chains since 1995, with 21 %age points of share movement per decade. Pharmaceuticals and the mining of critical minerals are other examples. And they will be part of what shifts the way that flows traverse the globe. Second category: is textiles and apparel. This category is not as sensitive in a geopolitical sense as some of the things said above. This category is one where you actually do have new hub creation right now. Consumer electronics, and other forms of electric equipment that aren’t particularly sensitive, possibly fall in that category too. Third category: is IT services and financial intermediation or professional services. That will reconfigure the ways in which services flow. Fourth and finally, there’s the stuff that’s just going to be steady—food and beverages, paper and printing. There’s no particular reason to expect that there are strong forcing mechanisms that will change the way those things are flowing across the world right now. They’re things that have remained relatively steady for the past ten or more years.
Global flows are necessary for a net-zero transition
There is no way we move rapidly toward a net-zero transition without global flows. There are certain things about global flows that are tricky from a net-zero perspective. It costs carbon to ship things and move things a long way. But in order for net zero to be attainable, we need to make sure that energy-generating technologies and fuels are able to flow across the world. Energy-generating technologies include both the minerals that underpin the construction of those technologies and the actual manufacturing. So, in the first category, think nickel and lithium. In the second category, think about the actual manufacturing of solar panels. The minerals themselves are processed in only a few countries around the world. So people are going to have to move from one place to another. Maybe the world could have broader diversification of such things, but on average, the timeline from discovering a mineral to being able to produce it at scale is well in excess of 16 years. If we want to move fast, we have the luxury to move things across the world. Meeting cost curves for manufacturing at scale and in locations where you have at least some established presence is going to be important. The final element that’s crucial with respect to net zero is cross-border capital flows. It’s really important that developing countries are able to finance shifts in the way that energy is produced and consumed in their countries, which means they may have to both spend more, at least as a ratio of GDP and have less ability to spend, given other forms of development imperative.
Multinationals and global resilience
?The first thing that needs to be recognized is that major MNCs play an outsize role in global flows today. Multinationals are responsible for about 30 % of trade. They’re responsible for 60 % of exports and 82 % of exports of knowledge-intensive goods. So they disproportionately drive flows, especially the ones associated with knowledge. And therefore, they’re going to be the center of managing for their own resilience, but also in a collective sense, for the resilience of the world.
The future of global flows
The world we live in right now is highly dependent on flows. Will those flows reconfigure and shift? Yes, absolutely. They have in the past, and they will in the future.?If you look along regional lines, individual regions can’t be independent. If you just start to play with what sorts of decoupling of regions would be possible, you see very quickly that it’s not something you can do. Now, is it possible that you would get groups of countries that become more strongly interconnected among themselves and less strongly connected with others? Absolutely. It’s possible to move in that direction. The question becomes, is there an actual decoupling, or do you just have a shift in degree? As with most things in the world, the answer tends toward the shift in degree rather than an abrupt or sharp true change or decoupling.?To some degree, if the company is self-sufficient, no need to become more resilient.” On the other hand, all of a sudden you depend on yourself for everything, and that’s a point of vulnerability in the same way that getting it only from one other person would be a problem. There are a whole host of reasons some degree of regionalization might help. You’ve got things closer to you. But dependency just on a few sets of people, whether or not they’re in your region, means you’ve got a dependency on just a few points of potential weaknesses rather than a broad web, which in general is a more resilient and robust structure.
?CONCLUSION
Based on the above one is forecasting and another supporting globalization. Russia’s invasion of Ukraine has put geopolitical risk?front of mind for corporate leaders. That could see deglobalization determine M&A priorities. Boards in the US and Europe have?two strategic concerns in a turbulent world —?diversifying?supply chains,?and allocating capital away from riskier markets and?toward what they will see as the relative political and economic safe haven of the US. And whether they make cars or smartphones, companies are reassessing their reliance on China. This would amount to an unwinding of the trends in corporate activity in recent years. Instead of deals being hatched to enter new territories or product areas,?the focus could shift to more selective acquisitions, with a focus on buying key?suppliers. Meanwhile, inflationary pressure will be a spur to?striking conventional cost-cutting mergers in regions close to home. Alongside this de-globalization will be a financial priority: de-leveraging. Investors have been rewarding companies for keeping debt?under control and that’s unlikely to change anytime soon. True, the pharmaceutical majors need to do M&A to replenish their drug pipelines. But the main, bold, debt-funded megadeals that take companies in adventurous directions are likely to be the exception.
For private equity, 2023 must surely bring a reckoning. The seizing up of the leveraged-loan market ended the deal boom in 2022. Hereon, the acute challenge won’t be resurrecting deals, it’ll be keeping afloat those buyouts of yesteryear that can’t cope with cost inflation and weakening demand from their customers.
Combine those dynamics?with?the demands of servicing high debts, and the year ahead looks set to test buyout firms’ willingness to support portfolio companies when the prospect?of earning any kind of return recedes. Businesses that succumbed to private equity bids toward the end of the boom —?when buyers more likely paid high prices that required lofty borrowing — may be the first to go awry. There is one scenario where the buyout industry could start making new investments:?a?staggered recovery in the debt and equity markets. If leveraged finance ungums first, without lifting stock valuations, that would enable buyout barons to go bottom fishing. Conversely, a?bounce-back in the equity market would be a trigger for initial public offerings. ?CVC Capital Partners taking the opportunity to revive the trend of buyouts firms going public. From the year behind us: ?Can’t Just Take a Russian Oligarch’s London Townhouse:?Reforms will help the government challenge their source of wealth. But will this lead to more assets being seized? Bankers Had Their Crisis. Now It’s Lawyers’ Turn:?Russia’s invasion of Ukraine demands a rethinking of how England’s legal profession conducts itself.
Gen Z, Millennials, and Gen X All Basically Agree on WFH:?Support for hybrid working is high across demographics. But bosses should ask why —?and address the reasons. Pound Slump Makes the FTSE 100 One Big Dumpster Dive: Mid-sized UK stocks attracted private equity attention in 2021. In 2022, corporate bidders had?an even bigger pool to play in.?Deriding Women’s Complaints on Equal Pay Is Costly:?BNP’s penalty for discriminating against a female banker was elevated by its mishandling of her concerns. Banks should heed the warning.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Chris Hughes is a Bloomberg Opinion columnist covering deals. Previously, he worked for Reuters Breakingviews, the Financial Times, and the Independent newspaper. Even when the forces of deglobalization are present, parallel forces of globalization, staggered and truncated, are at work in the world system.”Rising nationalism and protectionism, territorial aggrandizement by Russia and China, and the return of Cold War tensions in new forms have prompted predictions that the intensified globalization of the post–Cold War era is coming to an end, beset by atavistic forces. Historically, patterns of “two steps forward, one step back” (or vice versa) have often produced geopolitical convulsions, preceded by domestic conflicts cleverly used by political leaders who engineer social revolutions and wage war on their neighbors. But the world order needs to deteriorate much further, as it did in the 1930s before countries will jettison globalization altogether. Although the patterns we see today show many tendencies toward deglobalization, the globalization process has not yet completely broken down. Parallel trends in this ongoing process will continue, and a new form of “truncated globalization” may be emerging even amid the backlash underway in some regions. The deterioration of global market forces could produce more state regulation and control, in a reaction not unlike Austro-Hungarian economist Karl Polanyi’s concept of “double movements,” whereby the rise of the power of markets prompted demands for greater social protection. No country can confront contemporary global and national challenges single-handedly. States are taking steps to burnish their nationalist credentials, often in the form of economic protectionism and national industrial production, particularly in the high-tech sector. But they are also promoting globalization in one way or another. The capacity of anti-globalization forces and actors to fundamentally upset the globalization process may be overstated.
?Globalization is a multilayered process in which economic, technological, social, and political changes lead to the intensification of relations among states and societies, with greater integration across borders. The most significant aspect of this process is the expansion of economic activities beyond national borders as companies spread their operations worldwide, generating manifold growth in global trade and investment. Increased labor mobility and technological diffusion were key manifestations of the intensified globalization that occurred in the aftermath of the Cold War.?Starting in the 1980s, and especially since the early 1990s, the neoliberal ideal of free markets and the associated policy prescriptions known as the “Washington Consensus” became the mantra of many countries. In the globalized world, states’ ability to manage and regulate their economies declined as corporations and other nonstate actors gained more clout. The social dimensions of globalization promoted the notion of global citizenship, while political globalization has resulted in the spread of democracy to all parts of the world. New technologies, especially in the information domain, link corporations, people, and societies in unprecedented ways, cutting across national boundaries. Economic globalization increased the wealth of many countries, especially China and India. It produced a growing middle class in these and many other lower-income nations, adding momentum to globalization with new consumers. It also helped to stabilize inflation in advanced countries. As domestic production costs increased, offshore facilities offered cheaper goods to meet growing consumer demand. Deglobalization is the reverse process. It leads to diminished interaction and integration of national economies. It also brings a reassertion of nationalist policies among states, manifested in increased economic and technological protectionism and cultural atavism.
Did progress reverse?
Augmented globalization was facilitated by the United States' near-unipolar ascendancy during the first two decades of the post–Cold War era. It also reflected the strengthening of the liberal international order, characterized by three core elements: growing economic interdependence, an increasing role for international institutions, and widening democratic space. But recent trends have reversed progress in all three elements. This has raised fears of deglobalization in many quarters, especially among business leaders.
The United States itself has been retrenching and taking nationalist positions, repudiating the globalist policies it once upheld. Increasing protectionism and tariff wars, started by the Trump administration and continued by President Joe Biden, show the rising influence of anti-global forces in Washington. Two recently passed bills, the United States Innovation and Competition Act of 2021 and the America Competes Act of 2022, are intended to boost internal production capabilities and reduce reliance on China, particularly in high-tech fields such as semiconductors, artificial intelligence, quantum computing, biotechnology, and renewable energy development. In October 2022, the Biden administration also imposed export controls to choke off China’s access to advanced semiconductor technology.
?Globalization is not a linear process.
?In geopolitical terms, the relative decline of the United States and the rise of China, as well as the aggressive reassertion of Russian power under Vladimir Putin, have brought fears of a new Cold War dividing the world once again. Some warn that these trends will result in a further reduction in interactions among states, with allies preferred as partners in trade and investment while adversaries are restricted or shunned. This new geopolitical competition, with intense jockeying over great power spheres of influence, is characterized by both hard and soft-balancing coalitions. Hard balancing relies on military alliances and arms buildups, whereas soft balancing mechanisms include restraining a threatening power through international and regional institutions and economic statecraft such as sanctions.
The process of deglobalization has intensified since the global financial crisis of 2008–9 with the protectionist policies adopted in its wake by the United States and other countries. Although concerted efforts by many countries, including the rising powers in the so-called BRICS grouping of five major emerging economies—Brazil, Russia, India, China, and South Africa—helped to dissipate the financial crisis, the trend line has been one of retrenchment by governments and the near collapse of global trade negotiations. The financial crisis was just one of a series of global crises that were aggravated by the failure of states to respond effectively, adding to skepticism about globalization and its benefits in recent years. The biggest challenge has been the COVID-19 pandemic, which engulfed every corner of the world in 2020 and has continued since with the emergence of different variants of the virus. Increased global interconnectivity, largely via growing air travel, spread the virus within months after it was first detected in Wuhan, China.
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Despite some major hiccups, there is no evidence that China has lost its supply chain leadership role for good, even though other countries, including Vietnam, Mexico, and India, have poached some of the businesses. It may take several years to see the extent of the shift of global production facilities out of China and judge whether that portends the end of globalization as we know it—or just re-globalization or truncated globalization in the economic and high-tech spheres. In 2020–21, global trade underwent first a decline and then some resurgence, including an increase in trade with China. FDI has also been picking up momentum. According to the United Nations Conference on Trade and Development, global trade totaled $28.5 trillion in 2021, an increase of over 25 percent from 2020, and up 13 percent from 2019. Global FDI flows sharply rebounded from $929 billion in 2020 to $1.65 trillion in 2021, a 77 percent rise.
These numbers show that economic globalization is here to stay, but its form and content might have been altered to some extent. Increasing regionalization in trade and investment has emerged at a time when global trade talks shepherded by the World Trade Organization are showing little progress. Beijing’s Belt and Road Initiative has created dependency relationships between China and some weak states. But however, debilitating the effect of the debt burden on weaker participants may be, the additional infrastructure projects, and competing ones built by Western interests, in fact, might help extend economic globalization by opening new markets, especially in Africa and Central Asia.