Marc Chandler, Global Head of Currency Strategy, Brown Brothers Harriman
The cross-border movement of goods, services, and capital increased markedly for the thirty years up to the Great Financial Crisis. Although the recovery has given way to a new economic expansion in the major economies, global trade and capital flows remain well below pre-crisis levels. It had given rise to a sense globalization is ending.
Starting a new era
The election of Donald Trump as the 45th US President has underscored these fears. His first few weeks in office clearly mark a new era not just for America, but given its central role in late-20th-century globalization, for the world as well. Trump is a bit of a Rorschach test. He did not win a plurality, let alone a majority of the popular vote, but that does not stop pundits from claiming that Trump won because of this or that issue.
There are some campaign promises which Trump has backed away such as citing China as a currency manipulator on his first day as President or pursuing legal charges against Hillary Clinton. His priorities have been repealing the national health insurance, formally withdrawing from the Trans-Pacific Partnership, and signaled an intention to re-open the North American Free Trade Agreement.
Grand Strategic Shift
Trump and his closest advisers seem intent to unwind not just his predecessor’s initiative, but the general thrust of America’s grand strategy since the end of WWII. His rhetoric of America First harkens back to Warren Harding, who succeeded Woodrow Wilson after the US Senate rejected the League of Nations. Some historians refer to that period as ‘isolationism, ’ but in practice it was unilateralist.
The US grand strategy was first articulated around the start of the 20th century. China was being carved up by the European imperialist powers and Japan. The US was the new revisionist power. It objected to traditional spheres of influence approach to international relations and defended China’s territorial integrity.
Spheres of influence is not a particularly stable approach. It is a zero-sum exercise. To expand one’s sphere meant encroaching on another. This was frequent the source of wars. As an alternative to fixed spheres of influence, the US proposed variable shares. The variability was determined by one’s economic prowess. Rather than try to secure its own concessions in China as numerous European countries and Japan did, the US wanted to have access to all of China for its goods and capital.
Direct Investment vs Export Approach
It was not until after WWII that a political consensus was forged for Open Door. The World Bank, the International Monetary Fund and the General Agreement on Tariffs and Trade institutionalized the variable shares strategy. It also required that Britain and France give up their colonial practices. By early in the 21st century, nearly all countries had joined the World Trade Organization, the successor of GATT and were members of the IMF and World Bank.
The reduction of tariff barriers to trade and the conflict resolution mechanism made possible the economic development of emerging market economies in Latin America and Asia, including China. The rule of law has helped avoid the escalation of trade conflicts.
Within the free-trade system, there are two basic approaches to meeting foreign demand. The first is the traditional export approach. Germany is the worlds’ largest exporter. It typically exports around 40% of GDP. Finland, Sweden, and Switzerland are also examples of advanced economies that rely on exports.
Change of game rules
For more than half a century, the US developed an alternative approach. It is based on foreign direct investment: build locally, sell locally. Since the early 1960s, the sales by the foreign affiliates of US multinationals exceeds US exports. It is not even close. Local sales exceed exports by a nearly five to one. Ministry of Finance data suggests Japanese companies made a similar transition in the late 1990s.
The direct investment strategy is also consistent with extensive global supply chains. The production process itself is dissembled, and the pieces are distributed around the world. It is driven by numerous considerations, and not all reduced to short-term bottom line savings, like labor costs. For example, most of the US foreign direct investment is not in the lowest labor cost centers, but the opposite. US businesses often want to be close to their customers.
The direct investment strategy also can lead to development in the countries, which means increased standards of living in absolute terms, in a way that export strategy simply does not. A German company exports a machine tool to China. The company that buys it may succeed in its domestic competition, but the export does not generate new aggregate demand.
Foreign direct investment in China creates new jobs and may transfer technology to China. It helps boost aggregate demand. It does not stop there. Some of the new demand will be for goods from foreign countries. The latest research suggests that an American firm that hires low-skilled workers abroad does indeed compete with low-skilled domestic workers. However, the employment of skilled workers outside of the US bolsters the employment of skilled domestic workers.
The direct investment strategy also has advantages over the export-oriented strategy in a period of floating, which is to say volatile foreign exchange prices. An exporter is often at the mercy of its currency relative to its largest customers and competitors. With the foreign direct investment, one can construct diversified exposure, with natural hedges or internal offsets.
On the eve of World War I, as Lenin was writing Imperialism: The Highest Stage of Capitalism, late-19th-century globalism was about to collapse. It was not rebuilt until after WWII under what some call Pax Americana. It is that which is often meant by globalization now.
It is under threat now but not because of terrorism or intra-capitalist rivalries. Competing ideologies and visions are not undermining globalization. The threat is emanating from the country that is often accused of benefiting the most with its exorbitant privilege and its vast economic and military power. BM
Reproduce on permission by Brown Brothers Harriman, subtitles added by the editor of BENCHMARK Today. The opinion expressed does not necessarily represent that of the staff and the management of BENCHMARK Today and WealthAsia Media