The end of globalisation? Growth, efficiency and China

Synopsis: Three major trends which have together driven the world economy for several decades are ending simultaneously. The era of cheap money, political and economic stability and cheap Chinese labour is over. Business leaders will need to consider carefully what comes next.

Since the 1990s, the corporate world has been able to rely on three long-term trends which together have provided a powerful tailwind and together form the foundations of globalisation.

• Chinese spare capacity: In manufacturing, driven by migration and demographics.
• Cheap money: A secular trend of falling real and nominal interest rates, driven by falling inflation (and China!).
• Falling geopolitical tension: With the end of the Cold War, global geopolitical tension fell off a cliff, and stayed low for twenty years, driven by rapidly falling trade barriers after the formation of the WTO in 1995, US hegemonic power, and resulting in globalised supply chains.

By this process we created the modern corporation, based around China-centric manufacturing, a supply chain that spans the globe, and a remorseless focus on growth and economies of scale, fuelled by cheap capital. With China operating as the low-cost producer with effectively infinite space capacity, and with trade barriers low and falling, it made sense to centralise production in China and export everywhere else. Global trade predictably boomed. Fittingly, the world’s most valuable company, Apple, is closest to the Platonic ideal of this strategic triad – a strategy executed very successfully.

The entry of China into the WTO in 2001 and the subsequent explosive growth of its manufacturing sector represented in many ways the synthesis of the three trends. Chinese capacity provided a very strong deflationary impulse to manufactured goods, and it was made possible by a combination of the country’s ‘coming in from the cold’ and joining the world economy, with a demographic golden moment – the dividends of the one-child policy alleviated the burden of childcare and meant that China’s dependency ratio plummeted, from 80% in 1976 to 37% in 2010. Hundreds of millions of Chinese could follow the higher wages and move from subsistence agriculture to urban factories.

What is next?

As to what comes next – our crystal ball is cloudy, but given demographic changes globally and a normalisation of interest rates, it seems clear that part of the answer will be a de-prioritisation of growth and volume expansion, and a return to traditional metrics of corporate finance by investors. Profits and return on capital will be the watchwords of corporate earnings reports for the foreseeable future. It is unlikely that ‘blitzscaling’ will remain a feasible strategy in Silicon Valley. The rapid ‘right-sizing’ moves underway in Silicon Valley only serve to underline this fact, coming after aggressive hiring campaigns in the past few years.

A move from economies of scale to economies of scope, and from global economies of density to regional or local economies of density seem plausible consequences. The move towards ‘friend-shoring’ and ‘near-shoring’ seems unlikely to reverse for a long time to come. Second order consequences could include the return of conglomerates and or even the re-emergence of ‘national champions’ in the US and Europe.

We should be careful not to allow our outlook to be pessimistic or fatalist on the world economy. The world remains large, and, as current advances in AI, renewable energy and electric vehicles are demonstrating, extremely dynamic. It is also undoubtedly true that China will remain a major manufacturing power for years to come. There is no rule that says China and the US have to come to blows, over Taiwan or elsewhere, and despite all the excitable speculation, the Thucydides Trap is nothing more than a conjecture. It is also critical to remember that these trends will make themselves felt over years and decades, and there will remain large opportunities for those with the foresight, risk appetite and dynamism to seize.

Even so, the ending of the three trends we discussed above is so consequential, that executives would do well to start thinking through the potential scenarios well ahead of time. We have not discussed the likely effect of climate change and its interactions with the trends mentioned. The growth in extreme weather events and linked phenomena such as desertification and drought could potentially have large and hard to anticipate effects in circumstances where global economies have become dislocated or fragile.

As the organising principle of the world economy, globalisation has driven the greatest increase in living standards in human history. Soon, the world will have to decide whether we are willing to undergo the upheaval of transforming ourselves again, in order to continue that happy record.