Why Globalization is in a Tailspin

COVID-19 lands a critical blow to already-faltering global commerce. Can it recover?

By Irving Wladawsky-Berger

“The golden age of globalisation, in 1990–2010, was something to behold,” wrote The Economist in a January, 2019, article. “Commerce soared as the cost of shifting goods in ships and planes fell, phone calls got cheaper, tariffs were cut, and the financial system liberalised.”

Thomas Friedman’s The World is Flat became an international best-seller in 2005 by nicely explaining what this new golden age of globalization was all about, including the key forces that contributed to flattening the world — from the explosive growth of the Internet, open-source software, and related technologies; to the rise of outsourcing, offshoring and global supply chains.

In 2011 I attended a conference where Friedman was one of the speakers. He said that we had transitioned from a connected to an increasingly hyperconnected global economy since he wrote The World is Flat in 2004. Many of the companies and technologies that were part of every day conversations in 2011 — Facebook, Twitter, LinkedIn, smartphones, cloud computing, big data, broadband wireless Internet — weren’t mentioned in his book because they had not yet been born or were still in their infancy.

Decades of Transformation

The very nature of the global firm was transformed during these same decades. In The Globally Integrated Enterprise, a 2006 Foreign Affairs article, then IBM CEO Sam Palmisano argued that the modern industrial corporation was in its third stage of evolution in the way it conducted business around the world.

First came the international corporation around the middle of the 19th century. Based in a home country, its overseas functioning consisted primarily of importing raw materials and exporting and selling finished goods. It was followed by the multinational corporation, which started spreading beyond its home base in the first half of the 20th century by building national subsidiaries around the world. Those local subsidiaries tended to have control over sales, manufacturing and other business functions, while the parent company continued to perform such tasks as R&D, finance and product management.

Then around the late 1980s, technological and market forces started reshaping multinationals into something new, the globally integrated enterprise. These companies operated in an increasingly seamless way across national boundaries, locating their operations wherever it made the most sense in terms of talent, resources and cost. Major improvements in IT and communications as well as the reduction of trade and investment barriers made it much more feasible to share business services, regardless of where they were being performed. Competitive pressures forced every enterprise to examine its operations, asking simple questions like why processes and practices were different from country to country, and why it was necessary to have different departments performing the same set of tasks in each country.

Trade Wars and Tariffs

It seemed at the time that the globally integrated enterprise was destined to become the corporate model of the future. However, as the Economist noted in its 2019 article, “Globalisation has slowed from light speed to a snail’s pace in the past decade for several reasons. The cost of moving goods has stopped falling. Multinational firms have found that global sprawl burns money and that local rivals often eat them alive. Activity is shifting towards services, which are harder to sell across borders: Scissors can be exported in 20-foot-containers, hair stylists cannot.” Then came the trade wars and tariffs of the past three years, with the average tariff rate on American imports rising to 3.4%, the highest in 40 years.

In a more recent issue, The Economist went a step further, now asking whether Covid-19 will be the end of globalization as we’ve known it.

“The open system of trade that had dominated the world economy for decades had been damaged by the financial crash and the Sino-American trade war. Now it is reeling from its third body-blow in a dozen years as lockdowns have sealed borders and disrupted commerce… As economies reopen, activity will recover, but don’t expect a quick return to a carefree world of unfettered movement and free trade.”

Much of the economic damage is due to crashing demand, not new barriers to trade. Nevertheless, “trade will suffer as countries abandon the idea that firms and goods are treated equally regardless of where they come from. Governments and central banks are asking taxpayers to underwrite national firms through their stimulus packages, creating a huge and ongoing incentive to favour them. And the push to bring supply chains back home in the name of resilience is accelerating.”

The pandemic will have an impact not only in the industrial sector— 30% of global GDP— but also in the larger and faster growing service sector— 63% of global GDP. Services are 80% of GDP in the U.S., 69% in Germany, 52% in China, 62% in India, and 73% in Brazil.

Most everyone expects that the pandemic will accelerate the rate and pace of digitization, AI adoption, and automation. Consequently, over the next few years companies may well choose to automate an increasing number of their service jobs rather than continuing to offshore them to lower cost countries. Re-shoring such jobs may not help national economies if they’re destined to be automated out of existence altogether.

But, it’s also quite possible that if companies get used to supervising employees remotely, they will also get used to doing so overseas, driven less by costs than by the availability of precious skills and talent.

Longer term, what’s the likely impact of Covid-19 on globalization? “As defenders of the status quo try to explain that strength lies in openness, and critics crow about globalisation going too far, the reality is that both will probably get their way,” writes The Economist. “The medical and pharmaceutical sectors should expect pressure to localise more of their production in those countries that have enough clout to apply it. Chinese companies hoping to take advantage of the global market in ideas will find it harder to access. Foreign acquisitions will be treated with suspicion. American scrutiny of their suppliers will make international commerce harder. But once companies can start investing again many will continue to set up their supply chains in such a way as to chase the next source of growth — mindful, of course, of governments prone to placing obstacles between them and their favoured suppliers.”

“Don’t be fooled that a trading system with an unstable web of national controls will be more humane or safer,” it further warns. “Poorer countries will find it harder to catch up and, in the rich world, life will be more expensive and less free.

The way to make supply chains more resilient is not to domesticate them, which concentrates risk and forfeits economies of scale, but to diversify them. Moreover, a fractured world will make solving global problems harder, including finding a vaccine and securing an economic recovery.”

This blog first appeared June 20, here.