The Real Economy

Weary of disruption and change, globalization-lite hits the spot

Mar 01, 2020
The Real Economy

The rules-based framework for global commerce that emerged from the ashes of World War II is evolving under the stress of technological disruption, mass migration, economic populism and rising nationalism. Globalization–the harmonization of international trade, tax and environmental rules–is clearly headed toward a temporary timeout as policymakers attempt to find novel ways to mitigate the pace and scope of economic and social change for populations that, in the wake of the Great Recession, increasingly appear unprepared for it.

While much is being said about the demise of globalization, in our estimation its death notice is premature; such thinking significantly underestimates the durability of the international institutions constructed post-WWII and how the digital economy will effectively blunt this latest round of temporary global protectionism.

For now, we expect a temporary severing of the global economy into distinct blocs organized around regional trade arrangements and agreements–what might be referred to as globalization-lite–until new social arrangements can be made in the major economies to support the greater international integration of financial and economic life. Even so, in the long run, the pace, scope and depth of the evolution of the digital economy will operate according to its own logic, separate from that of the old traditional global economy, and ultimately, overwhelm this last gasp of old-school protectionism.

Echoes of the 1930s

After 75 years of operating within a rules-based system, the architects of the postwar order, the United States and the U.K., are ironically moving to modify that system in ways that are harming their own economies. In an eerie echo of the 1930s, masses of displaced individuals from Africa, Latin America and the Middle East have spawned rising nationalism and economic protectionism in the industrial economies, overriding the logic of trade and finance that underscore global prosperity.

In 2016 in the U.K., displaced industrial workers voted to leave the European common market, and in the United States, policy has turned to outright protectionist measures to stem the pace of globalization. These measures have increased business uncertainty and trade and economic tensions in such a way that the protectionist policies put in place over the past few years look increasingly untenable, and will likely cause a reassessment of these developments. Tomas Philipson, economist and chairman of the Council of Economic Advisers at the White House, acknowledged the uncertainty related to trade policy in a briefing to reporters on the annual Economic Report of the President released Feb. 2. He said, “uncertainty generated by trade negotiations dampened investment.” Capital expenditures have long been a soft spot in the proprietary RSM US Middle Market Business Index survey.

U.S. and U.K. trade policies adopted in the aftermath of World War II articulated the need to implement a rulesbased framework for integrating the world economies and preventing another global catastrophe. First and foremost, this framework would replace conflict among nations through the promotion of international trade—better to trade goods than artillery rounds—and would facilitate economic growth among the world’s economies, ushering in an era of international financing and assistance, and a rules-based framework for trade.

The attempt by economic populists to displace this framework has resulted in rising policy uncertainty and decreasing business investment, and if these policies are sustained, they will create a feedback loop that will, ironically, accelerate the loss of economic and social status of those individuals without the capacity or skill sets to compete in the new economy. The loss of investment—and in the absence of the next big thing to boost productivity—will have an enduring effect on potential growth of developed economies that follow that policy path, and again ironically, the individuals who have expressed such discontent around the most recent wave of globalization.

Regionalization for now, reglobalization later

The evidence for such an optimistic outcome can be seen in the recent United States-Mexico-Canada Agreement. About 70% of the text is taken straight from the Trans Pacific Partnership trade agreement. This is not exactly globalization in retreat. Rather, it demonstrates the institutional depth that evolved out of the Bretton-Woods Agreement of 1944, when Allied nations agreed to terms around currency exchange rates.

MIDDLE MARKET INSIGHT Tensions and tariffs are unlikely to fade in the near-term. Longer term, the cost of doing business for firms that depend on disrupted supply chains as the global economy fragments will increase, which will stimulate a strong powerful counterreaction and subsequent move toward more efficient and lower-cost outcomes.

Yes, the United States did insert language that curbed intra-North American trade in autos and imposed a wage floor affecting 30% of auto production immediately and a target of 40% by 2023 if an auto is produced with 70% of steel and aluminum produced in North America. Yet once one examines the depth and modernization of auto production in Mexico, the rise of digital systems and ability of North American entrepreneurs to respond to other production incentives, the short-term protectionist benefits will themselves dissolve over the medium-term.

More importantly, the trade agreement was preserved and extended to previously considered novel areas of the regional economy such as digital, intellectual property, cross-border trade in services, protection of intellectual property, and reducion of the role of state-owned enterprises and provisions for small- and medium-sized enterprises to more robustly participate in trade. In our estimation, the chapters covering these substantial trade areas, taken almost verbatim from the TPP, have created a positive framework and the precedents for future modernization and subsequent trade accords.

Ironically, five years into the global populist economic experiment, the first wave of pushback is starting around the impact of such policies. The U.S.-Chinese trade conflict caused noticeable economic losses in both economies to the point where each side has, at least for now, chosen to cease deleterious tariff increases, take a step back and reduce rhetorical hostilities, and avoid what was clearly shaping up as a potential shock to both economies. This is not exactly the stuff of successful policy upon which the rollback of trade and financial agreements or the end of the World Trade Organization should be based.

Of course, the move of both the United States and U.K. to seek a free trade treaty based on the free flow of financial services and almost surely the digital integration of the two modern economies in coming months will put to the test those who wish to close off economies to trade, finance and the movement of ideas and individuals. 

Digital is global

A misconception within the current wave of economic populism is that one can redirect incentives away from global economic activity. During the two-year U.S.- China trade conflict, many individual purchasers simply circumvented the trade barriers. Despite the large uncertainty tax imposed on the two economies due to the trade war, peer-to-peer and business-to-business commerce via the internet didn’t suffer the damage that traditional manufacturing companies absorbed.

The ability of regulators to contain fungible technologies in the areas of electric vehicles, biotechnology and artificial intelligence has passed. These technologies are mutable, transferable and subject to the law of digital economies. Ideas and digital innovation are not the same as technologies to produce autos. Artificial intelligencebased trade platforms such as Amazon, Alibaba, Baidu or eBay will simply outpace the capacity of regulators to keep up. Once something is digitized and its underlying information technology is available, law of pricing tends toward that which implies the cost of access, replication and distribution tends to fall toward zero.

The evolution of artificial intelligence and its impact on trade and finance will almost surely become an impediment to trade protectionism. Productivity improvements, an acceleration toward trade in services and the rapid tapping of intellectual capacity and new ideas to drive global trade and finance are sure to envelop early 20th century policy choices in the near-term.

In fact, one might make the case that the entire global movement toward trade protectionism and limiting the flow of people, ideas and capital rests on an unsteady foundation that is not prepared to face the quickly evolving logic of digital economics. The idea of a durable decoupling of the internet often causes one to think of a different time when countries created such things as a “Maginot Line.” Digital Maginot Lines are not tenable and are based on an erroneous analysis of the direction of the global economy. Over time, that logic will overwhelm the recidivism around which trade protectionism is based. Beware those fighting the lost ancient wars; they will be overwhelmed by a digital logic that can foresee alternative arrangements that facilitate new avenues of growth, finance and opportunity.

RSM contributors

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