After decades of unprecedented openness, international economic relations have entered a new era, characterized by mistrust and division. Given the potential costs of this shift, it is worth retracing how we got here.
Following the end of the Cold War, globalization brought about a drastic reduction in extreme poverty, not least by enabling East Asian countries, including China, to achieve rapid growth and development. Living standards (as measured by income per capita) also improved globally.
Open trade and market-oriented policies were central to this progress. Trade with low-wage (at the time) countries – such as China, Mexico, South Korea and Vietnam – kept goods prices and wages in advanced economies in check, benefiting both consumers in these countries and workers in the exporting economies.
Economic interconnectedness arguably also contributed significantly to the long period of peace enjoyed by the Western world. In the era of so-called hyper-globalization, war meant disruption of far-flung supply chains, with severe economic consequences. In such a system, everyone has an incentive to behave.
The transition from interconnectedness to fragmentation has occurred in three distinct phases, each with its own causes and implications for the future of globalization. The first phase began in 2016, with the ascendance of inward-looking politics in two former bastions of globalization. With Brexit, the United Kingdom rejected integration with Europe. And by electing Donald Trump as president, the United States embraced an “America first” ethos that opened the way for a trade war with China.
These developments were reactions, first and foremost, to rising inequality. While the average person globally was better off at the end of the 2010s than in 1980, many developed-country workers increasingly felt left behind.
It was not just a feeling. Communities that were more exposed to import competition from low-wage countries – a result of pre-existing spatial industrialization patterns – did worse than communities that were sheltered from imports (compare, for example, Hickory, North Carolina, a traditional factory town, and California’s Silicon Valley). But it was also nothing new. Trade has long been known to improve general welfare, while also generating distributional tensions. The policy response most economists recommended is nothing new, either: rather than embrace protectionism, countries should pursue some form of redistribution.
At any rate, there was little reason to believe that the backlash that began in 2016 would spell doom for globalization. The world was too interconnected to revert to the old regime.
Then came phase two: the Covid-19 pandemic. A pandemic is one of the greatest risks globalization raises. The more interconnected countries are, the easier it is for disease to spread among them. At the same time, it can spur an every-country-for-itself mentality, exemplified by the export restrictions and other inward-looking policies that governments implemented in response to the crisis.
Shortages of essential goods like personal protective equipment and supply bottlenecks provided more fuel for the argument that global supply chains could not be trusted. Many concluded that the “dependencies” created by international trade were sources of vulnerability. Building “resilience” through shorter, more localized supply chains became the order of the day.
Yet the global trading system proved remarkably robust during the past two years. According to the International Monetary Fund, global trade, as measured by the ratio of merchandise imports to world GDP, has increased since 2019. Most shortages proved to be short-lived. Several other supply-chain bottlenecks – such as the recent baby-formula shortage in the US – had domestic, not global, causes. In fact, bottlenecks would probably have been much worse without international trade.
So, despite an unprecedented public health shock, the global economy kept going – wounded and at a much slower pace than before, but still with good prospects eventually to recover. Then Russia invaded Ukraine, and phase three began.
The smooth functioning of global supply chains requires peace, stability and predictability. The war has eroded trust among countries and shifted expectations about geopolitical alliances, spurring calls for “reshoring” or “friend-shoring” in the name of “economic security”. If, for example, China invades Taiwan, what happens to a global economy that depends on chips produced by a single company, TSMC, on the island?
The war in Ukraine has thus achieved what soaring domestic inequality and the Covid-19 pandemic could not. It is one thing to rely on your friends, even if this implies hardship for some workers in your domestic market; it is entirely something else to rely on your enemies. And so, the economic “mutual assured destruction” that was supposed to deter deglobalization has apparently reached its limits.
Now, countries are seeking to build resilience by turning inward, embracing industrial policies for sectors that are viewed as critical for national security, such as semiconductors and energy. But whether this approach will succeed is far from certain. History teaches us that, when industrial policy works, it really works. But it is hard to know what will succeed ex ante.
China is often credited with (or accused of) relying on industrial policy to promote growth. But it was also responsible for one of industrial policy’s biggest failures: the Great Leap Forward, which caused up to 55 million deaths by the time it ended in 1962. As for the policies that did succeed, careful, piecemeal implementation was vital. Reforms were tested at the local and regional levels first, and scaled up only when they had demonstrated their potential. But “crossing the river by feeling the stones”, as Deng Xiaoping put it, takes time, and time is not on Western economies’ side right now.
Complicating matters further, semiconductors are characterized by “massive modularity,” meaning that each unit produced comprises several interconnected functional modules that can be broken down into more specialized modules, each with its own standards, innovation potential, and market structure. Whether such processes can be replicated domestically within a short period of time is questionable. We should remember that centrally planned systems failed because they could not keep up with the increasing complexity of modern economic systems.
It seems we have crossed the Rubicon in international economic relations, leaving globalization behind. The challenge now will be to find our bearings as the consequences play out.
Pinelopi Koujianou Goldberg is a professor of economics at Yale University, the editor-in-chief of the American Economic Review and a former World Bank Group chief economist.
Copyright: Project Syndicate