Issues to be addressed in this paper
Have we seen the end of the globalisation wave, or is the current slowdown in international trade just a blip on the curve? When we decided to add this theme to our list of megatrends (see Appendix A), we considered naming it differently – From Globalisation to Localisation and Globalisation in Reverse being the original frontrunners. For reasons that will become obvious if you carry on reading, we chose instead to name it Globalisation 2.0.
We have definitely had to modify our understanding of globalisation since the Global Financial Crisis (GFC). The crisis caused a great deal of upheaval, which resulted in a more fragmented and disunited world, with many nations no longer prepared to engage with other nations as much as they did prior to the GFC. The two best examples of that are probably Donald Trump moving into the White House and the outcome of the EU membership referendum (Brexit) in the UK.
In this paper, I will look at why behaviour has changed. I will also look at the implications for financial markets. As you can see in Exhibit 1 below, international trade no longer counts for a rising share of global GDP. As international trade is a key driver of GDP growth, it shouldn’t really surprise any of us that the global economy is not firing on all cylinders these days, and that obviously affects financial markets too.
One more point before I begin. You can define globalisation in a number of different ways. In the following, when I use the term globalisation, I refer to the rise in international trade of goods and services, to international outsourcing of manufacturing (typically from DM to EM countries), and to companies expanding worldwide.
The history of globalisation in one minute
For many, many years – probably starting in earnest in the years after World War II – international trade grew relentlessly. Why? Probably because the cost of distance collapsed, and the primary reason the cost of distance crumpled was better and cheaper technology, first and foremost more advanced transportation options.
Suddenly, with the advent of the GFC in 2008, attitudes changed, and one example of that is the attitude towards foreigners. Again, one has to ask why? Probably because globalisation created more losers than winners in the developed world. The winners were often big corporates and their shareholders – hence why the rich are richer than ever – whereas the losers were mostly the Joe Publics of the world. However, Joe Public also has a right to vote, and politicians like Donald Trump and Boris Johnson (but they are far from the only ones) developed shrewd plans that appealed as much to Joe Public as they did to the financial elite.
A great example as to how easy it was (and still is) to take advantage of Joe Public’s frustration with things was the Brexit referendum in the UK in June 2016. Boris Johnson manipulated Joe Public into believing the EU was at fault and persuaded him to vote for something he didn’t really understand. (Neither did Boris, I should probably add.)
The Brexit camp bombarded the British public with all sorts of lies, which stood untested because the sitting Prime Minister at the time, David Cameron, was arrogant enough to assume that the Brexiteers stood no chance of winning. I bring up this story to illustrate the tragic side of globalisation. The UK has now denied itself access to the largest free market in the world (the EU) because the political elite allowed the financial elite to skim all the cream from globalisation.
Adding to that, I note that, from the height of the GFC in November 2008 to October 2016 some eight years later, protectionist measures adopted by members of the G20 reached a new all-time high of 5,560. This created a huge increase in the number of trade frictions worldwide (Exhibit 2). Consequently, international trade started to slow. WTO estimate that the volume of global trade in goods and services grew by only 1.7% in 2016, significantly below the growth rate of the global economy, which has remained the case for five consecutive years.
The last time globalisation went into reverse in a major way was during the Great Depression in the 1930s. The most important lesson learned from that episode was that self-isolation harms everybody. Nobody wins.
Globalisation as a topic has always had the ability to make many people rather uncomfortable. Think back to 1944 when it was first proposed to create an international trade organisation. Nothing happened for another 50 years! It was only in 1995 that the WTO was finally established. By then, the GATT rounds of talks had lowered international trade tariffs to the point where only agriculture remained unresolved.
When international trade slowed in the aftermath of the GFC (see Exhibit 1 again), it was predominantly social discontent which caused the problem. Millions of workers were afraid of losing their job to China, India, Bangladesh, etc., and many actually did. These days, supply chain problems, climate change concerns and war can probably be assigned a higher weight than social discontent when looking for reasons to blame for the current slowdown in international trade. However, given the recent, and very dramatic rise in inflation, real discontent is back on the agenda.
So what’s next? It is tempting, but not necessarily correct, to conclude that international trade is in serious trouble. One could even argue that the current pause is desirable, as globalisation since the 1980s has been poorly balanced – high on finance and information technology and low on regulation, allowing Big Tech to effectively run the world, which is undesirable – for EM as well as for DM countries. If the pause can be used to improve what is missing today, then the pause is not a bad thing at all.
The EM perspective
The support for globalisation is clearly higher in EM than it is in DM countries (Exhibit 3), and there is a simple reason for that. Whereas outsourcing to the poorer parts of the world has had a very measurable impact on living standards in those countries, the impact in developed countries is harder to quantify. That said, it is a fact that workers in developed countries have enjoyed higher real earnings, i.e. higher living standards, as a result of the disinflation globalisation has delivered over the last 40 years. (I have chosen to ignore the current bout of inflation.)
Adding to that, the economic growth model in many EM countries is based on exports. A country like China would struggle, if it was barred from trading internationally. According to a Danish intelligence source, the US have told China in no uncertain terms that, if it delivers as much as a single rifle to the Russian army, the sanctions programme that applies to Russia at the moment will also apply to China. That probably explains why President Xi Jinping looks so uncomfortable when talking about his friend Putin.
Longer term, China (and many other EM countries) could quite possibly come to pay a high price for the Russian invasion of Ukraine. Although most of those countries are innocent bystanders to the current crisis, Western powers are keen to lower the reliance on totalitarian regimes for critical goods and services, but it is still premature to draw any firm conclusions. We shall see when the dust eventually settles in Ukraine, but my assessment at present is that the Russian invasion of Ukraine could be quite damaging for trade between different parts of the world.
In that context, I note that the world’s biggest free trade agreement so far, RCEP (the Regional Comprehensive Economic Partnership), came into force on the 1st of January. Over a decade in the making, RCEP consists of ten South-East Asian countries (Brunei, Myanmar, Cambodia, Indonesia, Laos, Malaysia, the Philippines, Singapore, Thailand and Vietnam) with five additional partner countries (Australia, China, Japan, Korea, and New Zealand).
RCEP represents a market of more than 2.2 billion people, nearly one-third of the world’s population, and it covers about 30% of global GDP. It is also noteworthy that it is the first free trade agreement ever between China, Japan, and South Korea, three of the four largest economies in Asia (source: diplomatist.com). Maybe globalisation is going regional?
The impact on financial markets
As I see things, two groups of companies stand to lose out in the conversion to Globalisation 2.0. The first shouldn’t surprise you that much. Any company that manufactures products that count as a liability on the CO2 balance sheet will find it increasingly difficult to export, and you need to think much broader than oil and gas.
In 2020, the EU introduced a carbon trading system, which more than 11,000 EU-domiciled power stations and industrial companies are subjected to today. The model is relatively simple. Those 11,000+ EU corporates are allocated a certain number of carbon credits every year. Those credits allow them to emit a certain amount of CO2 into the atmosphere. Should actual emissions exceed the allocated amount, more carbon credits must be acquired in the secondary market. If actual emissions fall short of the allocated amount, the un-utilised credits can be sold in the secondary market. Today, there is a relatively liquid market for these credits which is increasingly used by financial investors. As you can see below (Exhibit 4), at least so far, being long carbon credits hasn’t been a bad investment, but that is not my point.
The important point to make note of is that the EU will most likely expand the carbon credit scheme to include most, if not all, manufacturing companies. This will most likely have a significant impact on corporate behaviour and on the public’s opinions of many of those companies. Opinions travel quite easily these days and will therefore also affect international trade over time.
The other potential loser is Big Tech. You may or may not be aware of this, but the EU Commission is already on the war path against all those large tech companies that have grown big enough, and arrogant enough, to think that the rules no longer apply to them (see for example here). Some argue that Big Tech has already lost the legislative battle. Whether that is correct or not, the EU’s intent is pretty obvious.
The reason the war on Big Tech is likely to affect international trade is that technology is the prime engine in the facilitation of international transactions. Exactly how it could damage it is too early to say, but Big Tech is definitely on the losing side.
On a far more positive note, anything remotely green, or anything that can assist in accelerating the green transition will almost certainly be a big winner, as far as international trade is concerned. Lithium, copper and other green metals are already being shipped around the world in massive quantities, and the numbers keep growing. In that context, I note that Chile is rich in green metals. Could Chile become the Saudi Arabia of Globalisation 2.0?
A few final remarks
This is the first time we add a new megatrend. Therefore, it will be work in progress for some considerable time. That said, megatrends are, by definition, not short-term in nature. This megatrend, like the other six we have identified, will be with us for years to come.
Furthermore, I should add that, in addition to the megatrends we have identified, we have also identified a number of associated investment themes – see Appendices A and B. One investment theme which has been on the list for years, has just been removed, as I feel (quite strongly) that it has come to the end of the road. The investment theme I have removed is Currency Wars – also known as QE.
This investment theme, more than any other theme on the list, has been responsible for the outstanding returns we have enjoyed on risk assets in recent years, but the winds are changing direction. High inflation will force central banks to turn QE into QT, and you can already see the impact on global equity markets.
Before I finish, allow me to make one more point. Increased economic interaction between sovereign nations has not come to a halt, but Mother Earth has definitely come up to the surface for a bit of air, and that was probably long overdue. When she goes down again, in search of Globalisation 2.0, it will be with a strong desire to address the mishaps of the last dive. Big Tech won’t be allowed to run the world next time. Neither will crypto-currencies, as they are just another speculative asset class. That doesn’t necessarily make them a bad investment, but they are not money. How speculative they have become is obvious if you take a quick look at Exhibit 5 below. The correlation between bitcoin and Nasdaq 100 is now close to 0.8!
Niels C. Jensen
25 May 2022
Globalization in Reverse and Its Transformation
- China Institute of International Studies, 2020
What the world thinks about globalisation
- The Economist, 2016
- Pascal Lamy, President, Paris Peace Forum, former Director General, WTO, 2019
- Rohinton Medhara, 2017
The importance of international trade
- Teivan Pettinger, 2021
World Trade Report 2021
- World Trade Organization (WTO), 2021
The Seven Megatrends and Associated Investment Themes
The Complex Nature of the Megatrend Jigsaw
Megatrend #7 and associated investment themes
Changing global trade conditions will not necessarily hurt international trade, hence economic growth, but the configuration of it, and how various sovereign nations choose to align themselves, may dramatically change and thus result in a different mix of winners and losers.
Being less willing to open your borders to foreign trade is a trend that started in earnest in the aftermath of the Global Financial Crisis, and the war in Ukraine has put further momentum behind it. It has become a very legitimate question amongst developed countries to ask if imports from various rogue nations (rogue as defined by the developed world) can be justified.
Even if Russia pulls back from Ukraine quite soon, in the heads of policy makers in the developed world, this question will linger for many years. Having said that, in some respects, this is not necessarily bad. Take for example the transition to green energy forms which will almost certainly accelerate as a consequence of the sanction programme against Russia. Although there is a short-term price to pay for that – higher inflation – longer term, it will have a significant, and positive, impact on all the issues to do with climate change.
The Digital Revolution
At a very high level, one could fear that the introduction of industrial robots could put globalisation into reverse. Take for example the European company with a sizeable presence in China that I happen to know one or two things about. The company has decided to move most of its production back to Germany. As management told me: “We can produce our products more cheaply in Germany, provided we use robots and, at the same time, we can significantly reduce the probability of industrial espionage.”
On aggregate, the introduction of industrial robots (which continue to grow robustly – see Exhibit C2) has not had a negative effect on international trade, though. Introducing robots on the manufacturing floor has required significant investments but, in general, manufacturing costs have been much reduced as a result. This has made early adopters of industrial robots very competitive, and that has boosted international trade. Worldwide, the density of industrial robots is highest in Singapore, Korea and Japan (in that order), whereas Germany is the leader in Europe (source: European Commission).
The Productivity Conundrum
All else equal, increased international trade should lead to higher productivity as most companies and consumers will place their orders where prices are the sharpest, and those prices will, to a significant degree, be dictated by the underlying productivity of the company in question. Right? Wrong! Precisely the opposite has happened. As international trade continues to grow (even if it is taking a pause at present), productivity growth continues to fade. Why is that?
It is indeed a paradox that productivity growth has slowed throughout the digital age, i.e. over the last 20-25 years. Could it be that advanced robotics have actually had a negative effect on productivity? No. There is plenty of evidence to suggest that companies that have deployed industrial robots are, on average, doing much better than non-adopters (Exhibit C3). That would hardly be the case, if robots had a negative impact on productivity.
Having said that, despite the rapid advance of robots, there are plenty of negative productivity agents in society these days. Productivity is hampered by an ageing workforce, by excessive amounts of debt, by outdated infrastructure, etc., etc. I believe those countries that suffer the least from these other negative factors will benefit the most from the deployment of industrial robots.
Electrification of Everything
The Russian invasion of Ukraine is a human tragedy but, perversely so, has turned into a major opportunity to finally get our political leadership to see the writing on the wall – that we must rid ourselves of our dependence on fossil fuels.
The conversion to electric power, whether in the car industry or elsewhere, is constrained by the limitations of the two ‘greenest’ energy forms, wind and solar. I have written extensively about this issue already and shall not repeat myself. Suffice to say that neither wind energy nor solar is reliable enough to form the basis of primary energy in a modern economy.
This has raised the probability of nuclear enjoying a renaissance in Europe, North America and Japan, where it has been out of favour since the Fukushima disaster in 2011. Earlier this year, the European Commission labelled nuclear “green”, which was clearly a first step to encourage all member countries to invest in nuclear.
Allow me to make one further point on nuclear, and that has to do with the next generation of the fission technology, which is about to be rolled out, called SMR (Small Modular Reactors). According to the World Nuclear Association, the Chinese are furthest along in developing the SMR technology with Chinergy having already started the construction of the first SMR power plant in China, but the British, the Canadians and the Americans are all quite advanced in developing their own SMR programmes.
Apart from many added safety features and much lower construction costs, a great advantage of the SMR technology when compared to conventional nuclear is that it can easily slot into a brownfield site in place of a decommissioned coal-fired power plant. A proposed 920 MWe Nuscale SMR plant (and that is much larger than an average SMR plant) shall require about 35 acres of land. A conventional nuclear power plant delivering the same output requires nearly 500 acres.
It is estimated that the average US coal-fired power plant being retired these days has an electricity output of 145 MWe. An SMR power plant is typically designed to deliver 2-300 MWe, but that number can be adjusted upwards or downwards depending on how many modules you add together.
The Death of Fossil Fuels
The Death of Fossil Fuels is essentially the antithesis of Electricity of Everything. To get our climate problems under control, fossil fuels must be retired as soon as possible, and all the green energy forms available today must be used when producing electricity for tomorrow’s society. In the 2020 edition of the annual Energy Outlook from BP, the company conceded (for the very first time) that global oil demand will never regain the levels seen in pre-COVID times. In the 2020 report, 2019 is now considered to be the year of Peak Oil – something which wasn’t expected to happen for another 15 years or so.
Of the three most common fossil fuels, coal will probably be the first to be retired, and the same will happen to natural gas over time. Until recently, I was of the opinion that oil will not disappear anytime soon, as it is needed in the manufacturing of plastic products. Having said that, a new technology called Power-to-X allows you to convert electricity to liquid hydrogen, which can then be used instead of oil when manufacturing plastic products.
Of all the major countries around the world, only China and India have not (yet) committed to phasing out fossil fuels relatively quickly, but western powers will probably put enormous pressure on those two countries to speed up the green transition. Such pressure will probably lead to BP’s latest estimate on oil demand (which suggests it will still be about one-quarter of peak demand by the middle of the century) being too low, i.e. BP may underestimate the pace of conversion.
The Race to +2°C
The Race to +2°C is effectively a race to arrest the relentless rise in CO2 emissions and the resulting rise in the average temperature. The climate implications from the rise in CO2 emissions are truly catastrophic – rising seawater levels, flooding, droughts, wildfires, etc., etc. Most of those natural disasters will affect less wealthy parts of the world more than they will affect developed countries, and maybe that explains why the political leadership in the OECD have been so poor at putting some action behind all their understanding words.
Now, there is one natural disaster likely to do significantly more damage in the developed world than any of the others, and that is rising seawater levels. If you read our recent research paper on lithium-ion batteries vs. hydrogen fuel cells (which you can find here), you may recall that I mentioned the recent break-up of the Thwaites Glacier in Antarctica. As a consequence of that, global sea-water levels could rise no less than 65cm over the next handful of years. I suggest you take a look at Exhibit C4 below to see how many people in the world would suddenly live below seawater level, should that happen. As you can also see, many OECD countries will be severely affected by a rise of that magnitude.
This will have all sorts of implications which is why astute investors follow events in Antarctica very closely.