The conflict in Ukraine has crystallized into a phenomenon that has been slowly evolving since the 2008 global financial crisis (GFC). Until the GFC, measures of globalization were increasing, even accelerating, in terms of trade, capital flows and networks. Since then, those indicators have begun to paint a mixed picture. During the same period, a prolonged trend of deflation that began in the 1980s also began to plateau, as the US Federal Reserve reduced its balance sheet from about $1 trillion to about $4.5 trillion in the 10-year period following the GFC. quadrupled. Recently, in response to the COVID pandemic, the Fed swelled its balance sheet to nearly $9 trillion in a very short period of time, raising fears of continued inflation. Central banks in other Western countries have generally followed the same approach, though not to the same extent.
There is a great deal of evidence that globalization has greatly benefited the world, with nearly a billion people freed from poverty. Most of the gains went to China and some to India and other developing countries. China benefited disproportionately as it exploited the global commerce system by following a targeted industrial policy, managing its exchange rate, and not being rigid with the enforcement of intellectual property rights. The data also shows that parts of the population in the West were left behind as high-paying jobs moved overseas. This differential effect has resulted in strong political sentiment in favor of economic nationalism, protectionism, and what some observers have called “hyper-globalisation”. The rise of Trumpism in the US and the UK vote for Brexit was partly due to dissent. Globalization.
The pandemic and its aftermath and the war in Ukraine have only exacerbated that trend. Many experts are now calling it the era of de-globalisation. Others are calling it a “slowdown” in anticipation of a secular halt in global growth.
There is no significant evidence of de-globalization yet. Global trade and capital flows sharply increased, making up for disrupted trade in 2020. Overall global trade has now caught up with its pre-pandemic trend, although aggregate data hide substantial problems in specific supply chains such as semiconductors and automobiles. While there is a lot of noise and cross-talk, the trade in goods and services generally remains strong.
Russia’s invasion of Ukraine has added a new dimension to it by disrupting food and fertilizer supplies to global markets, the effects of which are yet to be fully eroded. In particular, insurance costs that have shot through the roof are unlikely to settle soon, as the Baltic Sea is on a critical path of movement of many ships.
The era of ‘friction free’ globalization is behind us. Instead, we now have what I describe as ‘disrupted globalization’. Some goods and services may increase and even accelerate in the context of global trade, while others will plateau or decrease as economic participants and countries adopt risk mitigation strategies. Still others may grow within regions or blocs, such as the Regional Comprehensive Economic Partnership and the United States-Mexico-Canada Agreement, but see a decline in global trade. Strategic commodities such as rare earths and piped gas in Europe may actually face sanctions and the world would find it very difficult to argue against agricultural tariffs or sanctions established in the name of domestic security.
Global networks that are based on trust, such as university ecosystems, can also find themselves disrupted. For example, Chinese students may no longer have unrestricted access to US universities. Although it is difficult to measure, the bottleneck of the learning network will probably have the biggest long-term impact. Genomic collaborations and large-scale science projects such as particle colliders, space telescopes and stations could be split into ‘trust blocks’ of the West and China.
Whether this world of disrupted globalization will inevitably be accompanied by inflation is a more difficult question to answer. Prima facie, and initially, re-adjustment of supply chains and ‘near-shoring’ of production will lead to cost escalation. As the world shifts from ‘just in time’ to ‘just in case’, this change is likely to add to the cost. However, there is no reason to believe that after the settlement period, costs will continue to increase chronologically. Global inflation will continue to be primarily a monetary phenomenon. If the Fed and other major central banks are able to deliver on their own in a constructive manner, we can regain a managed inflationary environment. Even disrupted globalization allows supply chains to catch up with demand trends over time.
The era of ‘geopolitical friend-shoring’ for some goods and services and old-fashioned global sourcing for some others will likely be the evolving norm. This world of constrained globalization will on average slow growth slightly and push inflation up slightly, but the transition will also present many opportunities. Countries that are competitive on talent and labor costs are likely to benefit from this transition: India, Vietnam and Mexico perhaps. India must actively navigate this transition, especially as it pertains to business in the global information technology services, SaaS industry and entertainment sector.
PS: “The wide world is all about you; you can turn yourself in, but you can’t shut it down forever,” said JRR Tolkien, author of The Lord of the Rings.
Narayana Ramachandran is the chairman of Include Labs. Read Narayan’s mint column at www.livemint.com/avisiblehand