The Globalization Chameleon

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William Alan Reinsch

Although last week was eventful—China talks, Brexit debates, among other things—I’m going to take a week off from commenting on current events and instead look at the long term and the changing face of globalization. This is prompted by a McKinsey Global Institute study, Globalization in Transition: The Future of Trade and Value Chains.

In brief, what McKinsey found was that while trade continues to increase in absolute terms, although at a slower rate, the share of goods output that is traded, as opposed to consumed domestically, is declining pretty much across the board—from 28.1 percent in 2007 to 22.5 percent in 2017. At the same time, cross-border flows of services have grown over 60 percent faster than goods trade and intangible assets transferred across borders (software, branding, design, etc.) as well as data transfers contribute substantial economic value not adequately represented in national statistics.

As the report explains:

Although output and trade continue to increase in absolute terms, trade intensity (that is, the share of output that is traded) is declining within almost every goods-producing value chain. Flows of services and data now play a much bigger role in tying the global economy together. Not only is trade in services growing faster than trade in goods, but services are creating value far beyond what national accounts measure. Using alternative measures, we find that services already constitute more value in global trade than goods. In addition, all global value chains are becoming more knowledge-intensive. Low-skill labor is becoming less important as factor of production. Contrary to popular perception, only about 18 percent of global goods trade is now driven by labor-cost arbitrage.

It appears there are three reasons for this. First, consumer demand is growing in China and other developing countries, which implies a gradual shift away from export-led growth to consumption-led growth. In the sectors McKinsey studied, China exported 17 percent of what it produced in 2007 but only 9 percent in 2017. This is increasingly true in other developing countries as well, particularly in Southeast Asia. This is exactly what U.S. economists have been telling the Chinese for years they need to do, but it has more consequences than we thought because it also means the development of domestic rather than global supply chains, an evolution encouraged in the Chinese case by a government increasingly worried about the reliability of overseas suppliers, particularly the Americans in the wake of President Trump’s trade policies. The first development—increased domestic consumption—means fewer exports, while the second—domestic supply chains—means fewer imports. Together that will mean less overall trade or at least slower growth of trade.

The third reason is the impact of new technologies. Some of them, like digital platforms and improvements in logistics technologies via the Internet of Things, artificial intelligence, and blockchain, significantly reduce goods manufacturing costs while they themselves represent services exports. Others, like additive manufacturing (3-D printing), will eventually reduce overall trade by allowing more things to be manufactured locally. Other changes, like the shift to electric vehicles, will mean reduced trade in parts and components since fewer are needed. Not all of this is predictable, and, as with the logistics changes, some of it is trade-enhancing rather than reducing. But there is clearly a shift underway towards services and data transfers and away from goods, and in the goods sector, toward domestic consumption and domestic (and regional) supply chains and away from global chains.

Much of this will be driven by large economies like China, India, and Indonesia—proof once again that size matters. In addition, it appears that proximity matters as well. Manufacturers are focusing on shorter supply chains that are closer to the large markets they covet.

So, what does all this mean? First, it’s too soon to say. These appear to be trends but have not been trending long enough to be sure. Second, it suggests an economic shift in the direction of U.S. strengths—services and advanced technologies. Of course, the United States is not the only service provider or high-tech producer in the world. If these changes do become trends, you can be sure there will be lots of other countries chasing after the new pot of gold, which means it will be more important than ever for us to pursue policies that keep us running faster than everybody else, rather than focusing our energy on holding the other guys back. Third, U.S. businesses will increasingly develop domestic or regional supply chains rather than extended international ones. That makes the United States-Mexico-Canada Agreement more important and large multilateral agreements less urgent. That in turn means more fragmentation into regional blocs and less multilateral cooperation which means more trade friction.

The shift to domestic and regional supply chains (but not the shift to services and data) will be music to the Trump administration’s ears because it tracks with his America First approach and his view that we can bully our way into trade successes. For us multilateralists, this is a sad trend both because it is contrary to the way we think the world should be evolving and because we can’t blame it entirely on Trump—it appears to be happening regardless of him.