Everyone’s a loser in the age of ‘slowbalisation’

The pandemic, the war in Ukraine, the geopolitical collision between the US and China and the incentives developed economies are creating in their responses to climate change are all accelerating shifts in global trade and investment flows.

And according to the International Monetary Fund, those ructions could eventually cost the world 2 per cent of its economic output.

On Wednesday, the IMF released a report on “geoeconomic fragmentation and foreign direct investment,” which is really about the increasing “friendshoring” and “reshoring” that has been happening as countries respond to the pandemic, heightened geopolitical tensions and efforts to lower carbon emissions.

Containers are piled up in Hamburg harbour. The pandemic exposed the vulnerability of individual economies to the lengthy and complex supply chains that had been built during the period of peak globalisation.Credit: AP

Even before the pandemic, the Trump administration’s trade wars, primarily but not exclusively with China, were impacting global trade and investment.

The Biden administration has left Trump’s tariffs in place, but added layers of sanctions on Chinese companies and exports controls of sensitive technologies, especially semiconductors, while increasingly signing up allies in Europe and Asia to do the same.

The pandemic exposed the vulnerability of individual economies to the lengthy and complex supply chains that had been built during the period of peak globalisation, causing governments to start focusing on reshoring – bringing home production and manufacturing – of not just medical-related supplies, but of vital and/or strategic products and services.

Commitments to net-zero carbon emissions by 2050 have seen initiatives like the carbon border adjustment mechanism in Europe and the Science and Inflation Reduction Act in the US that provide subsidies and incentives for green energy initiatives and protection for those domestic industries most exposed to imports from economies and industries without similar emission reduction targets.

Add in the war in Ukraine and, beyond the geopolitics, there is a significant shift in global capital flows occurring – or as the IMF describes it, a policy-driven reversal of global integration.

That “geoeconomic fragmentation,” the fund says, involves several channels, including trade, capital and migration flows. The one it focused on in its report was foreign direct investment, or cross-border investment.

The IMF says a slowdown in globalisation – which it describes as “slowbalisation” – began with the 2008 financial crisis, and that the decrease in foreign direct investment (FDI) since then has been particularly visible, with global FDI falling from 3.3 per cent of global GDP in the 2000s to just 1.3 per cent between 2018 and 2022.

‘Firms and policymakers are increasingly looking at strategies for moving production processes to trusted countries with aligned political preferences to make supply chains less vulnerable to geopolitical tensions.’

IMF

“While a range of factors have contributed to this protracted phase of slowbalisation, the fragmentation of capital flows along geopolitical fault lines and the potential emergence of regional geopolitical blocs are novel elements that could have largely negative spillovers to the global economy,” the IMF said in its report.

“Firms and policymakers are increasingly looking at strategies for moving production processes to trusted countries with aligned political preferences to make supply chains less vulnerable to geopolitical tensions.”

It found a notable decline in investment between the US and China since 2015 (before the Trump presidency caused the US to treat China, increasingly, as a strategic rival), and noted that money flows and bank lending between the two countries had reduced by about 15 per cent.

Locating capital in friendly countries might improve political security, the IMF said, but it was likely to reduce the diversity of risks and amplify the prospect of economic downturns.

Not surprisingly, the IMF concluded that such friendshoring will hurt developing economies more than developed economies and China more than the US.

French president Emmanuel Macron is in China now, trying to establish a less belligerent European position relative to China than the US.Credit: AP

It’s not just the reduced foreign investment, but the knowledge transfers to firms in less developed economies and the economic growth associated with foreign investment.

The increasing concentration of FDI flows, particularly in strategic sectors like semiconductors, is in countries that are geopolitically aligned. Asia has become less relevant as both a source and host of FDI and China has declined by even more than the Asian average, the IMF said. There had been less of a decline in the US and in some parts of Europe.

The flow of what the IMF described as “strategic FDI” to Asian countries had started to decline in 2019 and has recovered only mildly since. Flows of strategic investments to the US and Europe had been more resilient and, by the fourth quarter last year, were twice those going to Asian countries.

The era of globalisation, where capital flowed freely to wherever products could be sourced most cheaply, isn’t quite over, but clearly capital flows are not nearly as free-flowing as they once were.

There’s a geographical as well as a geopolitical dimension to the reshaping of global supply chains and capital flows the further from the home market the more vulnerable supply chains are, but the study found that the greater the geopolitical distance between source and host countries for FDI, the greater is the vulnerability to friendshoring.

The bottom line to the IMF analysis is that everyone loses from friendshoring and the fragmentation and redirection of investment flows but some – developing countries and China – lose more than others. The US and its geopolitical allies are relative winners.

Friendshoring isn’t complete decoupling. What the US, Europe and, indeed, China want is to de-risk in both economic and hegemonic dimensions rather than decouple.

Even the US is keen to maintain non-strategic trade relationships with China.

French president Emmanuel Macron is in China now and, while trying to get China to play a constructive role in Ukraine, is also trying to establish a less belligerent European position relative to China than the US even as the EU is moving to restrict sales of sensitive technologies to China and protect strategically sensitive sectors of its economies from Chinese investment.

The era of globalisation, where capital flowed freely to wherever products could be sourced most cheaply, isn’t quite over, but clearly capital flows are not nearly as free-flowing as they once were.

The schism in the relationship between the US and China and the pressure on America’s military and economic allies and those countries economically dependent on China to choose sides seems irreversible. There will be less foreign direct investment, less technology transfer and higher costs, with less developed economies impacted the most.

In many respects that’s regrettable – globalisation generated a lot of good, particularly for developing economies and particularly for China – but it does appear inevitable.

The world will be poorer and more fragmented and polarised from the push to reshore and friendshore, but the trends are underpinned in the aftermath of the pandemic and in this era of more intense geopolitics by rational national self-interests and an array of mutual suspicions.

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