My Thoughts on the Coronavirus: 7. Shifts on the Horizon

Globalization—a Fragile Web of Interdependency

To minimize production costs and compete more effectively, large enterprises around the world have leveraged the comparative advantages of foreign resources. Since it’s cheaper for companies to produce something offshore and trade, these businesses are pushing specialization and trade across the border. Because this seems like a win-win strategy that boosts the economies on both sides of the trade, it has lead to the rapid globalization of our economy. 

However, globalization is not without cost. The price we pay is that it creates an intricate web of global interdependency. This is normally not an issue. Until Covid19 strikes!

Because most countries will naturally prioritize the health and well-being of their citizens over the production and trade obligation to other countries. So it’s inevitable that most countries will lockdown and restrict mobility in an attempt to contain the epidemic. The result is a broken supply chain, which is arguably the biggest disruption caused by the coronavirus. A pandemic of similar scale is the Spanish flu ~100 years ago, but its impact on the financial market was mild. One reason for this is attributed to the absence of supply chain disruptions due to World War I.

An important lesson from the Spanish flu that I must point out is that saving lives and saving the economy are not mutually exclusive. A study shows cities that took more aggressive containment measures earlier tend to have faster economic recovery and growth afterward. So by saving lives, you are helping the economy. Ironically, a nation that prioritizes the health of its citizens over its economy will come out with a stronger economy. This emphasis of national interest over the economy will surface again in the context of globalization later.

To restructure the supply chains established by globalization is typically so costly that it wouldn’t make economic sense. It’s hard enough just to disentangle that complex web of interdependency, let alone reshaping it without significantly impacting the business of many upstream and downstream companies scattered all over the globe. This is normally a nonstarter. Until Covid19 hits. This pandemic puts the entire supply chain on pause, essentially removings all the interdependencies in a matter of a few months.

We are Great at Optimizing, but Terrible at Balancing

The temporarily shut down of the entire supply chain provides a unique opportunity to restructure it. But how precisely should we rebuild this new supply chain? If I know, I wouldn’t be here! But there are some guiding principles that we should follow. After all, we messed it up the first time. The most important change of mindset is that we must forego the overly simplistic view of purely maximizing efficiency and profit, which is what led us to the current state of “hyper-globalization,” or hyper-interdependency.

A well functioning market needs strong governance to provide regulation, stability, and legitimacy. And these governance bodies are typically institutionalized at the national level through democratic processes. The challenge with globalization is that the market now extends far beyond the nation’s border, where nations have no jurisdiction. So how can this global market be governed? This would require nations to do 1 of 2 things.

1. They can rule in favor of the global economy at the expense of its citizen’s democracy.
2. They can give up their national sovereignty to a stronger governing body with the power to effectively regulate the global market.

Since neither of these options is plausible in a free-market, it’s impossible to create a global market that is as integrated and as efficient as domestic markets. This is known as the Globalization Trilemma, as described in Prof. Dani Rodrik’s seminal work “The Globalization Paradox: Democracy and the Future of the World Economy.”

The problem is that many of our international policies are shaped by the misconception that hyper-globalization is achievable without cost. If we remove enough regulatory barriers and tariffs, everyone benefits. This is what got us into the current situation, where one can argue that perhaps globalization has gone too far.

Rodrik’s Trilemma revealed the hidden costs of globalization and made it explicit. If we continue to globalize and hyper-globalize, we will have to either give up our democracy or our sovereignty eventually. Rather than constantly optimizing for profit and efficiency, we must learn to find the right balance.

Supply Chain Reorganization

So what is the right balance for globalization, and how do we get there? Paradoxically, Rodrik argued that the right level of globalization can be achieved by finding a balance between national interest and the reach of the global market.

Just as Adam Smith’s Invisible Hand will drive the efficient use of resources when individuals seek their self-interest, focusing on national interest will also drive a healthy level of globalization. Without an aggressive focus on the values and principles of the nations, the strong economic interdependency could force nations to either give up their democracy or sovereignty.

Finding this balance is not easy because businesses are so profit-driven. If left unchecked, businesses will always go as far as they can to access the bigger market. One way to achieve this balance is to have a strong regulatory body establishes a set of “hygiene factors” for conducting businesses abroad. Some examples of these hygiene factors may be sustainability, labor protection, national security, self-sufficiency, economic resilience, and stability, etc. Since there must be an incentive for companies to conduct business “properly,” taxation may be a mechanism to deter companies from crossing those lines.

This is starting to take shape! Nations around the world are beginning to reclaim control over the production and reshape their supply chains. Japan and the US have started funding the relocation of their production line for the sake of economic stability and national security. Germany has also imposed restrictions on foreign investments in essential technologies. It will be interesting to see where different countries find their balance.

... --- === --- ...

This article is part of a series, if you miss the previous installments, they are linked below.

1. Making Sense of the Reality
2. The Immediate Urgency
3. Socioeconomic Side Effect
4. The Dark Side
5. The Bright Side
6. Immediate Opportunities