Peak Globalization or Peak “Chinaization”?

Anuradha Gaggar, CFA®, FRM®

Anuradha Gaggar, CFA®, FRM®

11.04.20 in Market & Economic Perspectives

Market and Economic Perspective

In “The Pandemic Is a Portal,” author Arundhati Roy writes, “Historically, pandemics have forced humans to break with the past and imagine their world anew. This one is no different. It is a portal, a gateway between one world and the next.”

As we begin to position portfolios for a post-COVID world, we need to read the tea leaves about how different the world will look when we emerge from this crisis. Among the many changes we’ll see, one that might substantially change our lives—and hence our investing landscape—is the interconnectedness of countries and regions.

A Polarized World

The pandemic has accelerated many preexisting cultural trends. Polarization is one of them. Many commentators believe that the pandemic has highlighted the importance of countries, governments, and organizations working together on problems that affect the entire human race. At the same time, many others believe that if people did not travel so freely, the virus would not have made its way out of Wuhan and into the rest of the world. If manufacturing remained local, supply chains would not have been disrupted. When lockdowns occurred, we would not have seen the mad rush for toilet paper, other consumer staples, and everything else we needed but suddenly couldn’t find.

Cracks in the Global Era

For the past four decades, globalization—the growing interdependence of the world’s economies and cultures—has been one of the world’s most powerful economic drivers. World trade increased from less than 40 percent of the world’s GDP in 1980 to more than 60 percent today. After the global financial crisis of 2008, however, the cracks in this era began to emerge. They spotlighted the problems that global trade created in many Western countries, including low growth of real wages (wages adjusted for inflation), the outsourcing of many low-paid jobs, and increased income inequality. In response to the financial crisis, changes in governmental monetary policy propped up the existing systems but did not address these underlying issues.

The Brexit crisis in the U.K. and the 2016 election in the U.S. were both manifestations of rising populism and the politics of resentment. But waves of discontent and nationalism have also been growing across the globe. And then came the worldwide spread of COVID and the ensuing lockdowns. As a consequence, pandemic-inspired obituaries for globalization abound. A very real question has arisen: Will the COVID crisis be the last nail in the globalization coffin?

A Commonsense Hypothesis

To evaluate the future of globalization, we need to understand that global trade was not inspired by the whims of politicians and administrators. Instead, common sense—both economic and business—is the driver. Countries benefit by focusing production where they have a competitive advantage and can leverage specialization to generate economies of scale. Their trading partners also benefit, and total global output increases. Economics will remain a strong motivator for trade to continue between countries in a post-pandemic world.

So, will we return to the status quo when the COVID crisis is over and the pandemic-inspired banter about deglobalization fades away? Probably not. Evolution is the natural order of things, and it’s likely that certain elements of worldwide trade will evolve.

“Chinaization” of Global Trade

The previous wave of globalization saw China gain economic clout. China became a critical element in most global supply chains, resulting in the Chinaization of global trade. As China rose in power, the Western world began to understand that China wasn’t going to play by the rules of a liberal world order, or an American world order. Rising strains became evident in China’s relations with most of the developed world, as well as several emerging countries. Trade wars were symptomatic of the world’s rising discontent with China’s ways of doing business.

Retreat from China?

The COVID crisis could be the last straw and expedite the peak Chinaization of global supply chains. Supply chains will likely diversify away from China. This trend was simmering before the COVID crisis and will probably accelerate after the pandemic is over. Companies have come to realize that dependency on a single source for a component critical to their manufacturing process can be disruptive, especially in times of crisis. Nonetheless, as companies and countries retreat from a reliance on China’s supply chains, they may not retreat from those of the rest of the world. Quite simply, that move would not make economic sense.

Supply Chains Reimagined

In the future, it’s likely we’ll see the following supply chain trends:

  • Core strategic or automatable activities may be on-shored, building up domestic supply chains for critical products (e.g., food and pharmaceuticals).

  • Companies may adopt the Toyota model of regionalization or move production closer to the point of sale.

  • The complexity of supply chains could be reduced with vertical integration so intermediate goods cross borders less frequently.

  • Companies may rethink their product mix. BMW, for example, builds several of its X Series models in South Carolina, but about 70 percent of these cars are exported.

  • Companies may shift away from models that focus on low costs and lean inventory to ones that emphasize greater stability and resilience. To that end, companies will evaluate developing multiple sources or additional safety stocks. For example, Novo Nordisk, which manufactures half of the world’s supply of insulin at its Denmark facility, maintains a five-year reserve.

  • Smaller countries may entice multinationals to move operations to their shores. For example, Vietnam is rapidly realizing its potential as the “next China” and moving up the manufacturing ladder. Other countries such as India, if they can get their acts together, may offer an attractive alternative to basing operations in China.

Increased Globalization?

Our post-COVID world could well become more global—not less. The rate of globalization may slow down, the rules for trade may change, and supply chains may become diversified. Some operations could be handled on national shores, but labor-intensive production could be established in other countries. Ultimately, agility and diversity will be the key supply chain themes coming out of this crisis. Extreme deglobalization is not a likely outcome.

As organizations wrestle through the effects of the pandemic, they should plan for a world where both globalization and anti-Chinaization pressures remain an enduring feature of the business environment. China will continue building its own geopolitical turf, promoting national champions, and blocking the growth of international companies within its borders. As a result, the profitability of many multinationals that count on Chinese consumers for future growth will be challenged.

From an investment perspective, the post-pandemic world will present opportunities and challenges for investors. We’ll need to follow the winds of trade and trace the paths that supply chains take. That’s where the next set of opportunities will emerge—whether in a region, country, sector, industry, or company.

Editor’s Note: The original version of this article appeared on the Independent Market Observer.

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