Commentary

It’s the End of Globalization as We Know It (and That’s Probably Fine), Part 2

Let’s talk about trade rules.

April 6, 2022 • Commentary

This article appeared in The Dispatch on April 6, 2022.

Dear Capitolisters,

This week we’ll jump right into Part 2 of my musings on the big “deglobalization” narrative that’s sweeping the (ahem) planet. You can read Part 1 here, to which I’ll just add these useful notes and chart from a fellow skeptic, Schwab’s Jeffrey Kleintop:

All of these were going to end globalization:
2016 Brexit
2017 Trump trade war
2018 Nationalism
2020 Pandemic
2022 Ukraine War

Yet, global trade is at record highs and so it is the international share of corporate profits.
— Jeffrey Kleintop (@JeffreyKleintop) March 30, 2022

Now on to Part 2…

Then There Are the Trade Rules

The second big misunderstanding regarding all of this deglobalization talk relates to the rules governing global trade, particularly at the World Trade Organization. Yes, the WTO agreements do generally prohibit a member country from discriminating among other members (the “most favored nation” principle) or in favor of their own entities (“national treatment”), and they generally encourage members to “channel” trade restrictions into tariffs and “bind” these tariffs at relatively low levels. However, these rules also contain myriad exceptions from both nondiscrimination and trade liberalization principles—for things like subsidies, trade remedies (anti-dumping, etc.), procurement restrictions, quotas, environmental or health regulation, and even high tariffs on “politically sensitive” items. Most of these measures are subject to certain conditions (which sovereign nations, including the United States, can and do sometimes ignore), but the rules generally do permit WTO members to deviate from pro-trade principles and reflect, as my former Cato colleague Simon Lester just explained, the political balance between free trade and protectionism that has undergirded the multilateral trading system since its inception in the 1940s. This has never been “unfettered free trade” and probably never will be.

Most notable for today’s purposes is the fact that the WTO agreements expressly exempt measures taken on national security grounds. Article XXI of the General Agreement on Tariffs and Trade, for example, reads in relevant part:

Nothing in this Agreement shall be construed… to prevent any contracting party from taking any action which it considers necessary for the protection of its essential security interests (i) relating to fissionable materials or the materials from which they are derived; (ii) relating to the traffic in arms, ammunition and implements of war and to such traffic in other goods and materials as is carried on directly or indirectly for the purpose of supplying a military establishment; [or] (iii) taken in time of war or other emergency in international relations…

A similar exception applies to services trade. Given the breadth of this exception (see bolded parts above), WTO members have used it sparingly—at least until President Trump came along. (Hey, maybe flippantly throwing around “national security” as a get-out-of-trade-free card isn’t very smart after all?!) Regardless, few would argue that the Ukraine crisis and related government sanctions don’t fit squarely with global trade rules as intended.

Indeed, as I discussed a few weeks ago, the immediate multilateral response to the Russian invasion is arguably evidence that the WTO-backed trading system is working, not failing. As Danil Bochkov subsequently documented in The Diplomat, China’s lukewarm treatment of Russia would seem to corroborate that conclusion:

Beijing will further carry on with its stance of offering muted sympathy to Moscow while also promoting its own agenda of doing business with the United States and the EU. In a telephone call on February 17, Macron and Xi pledged to promote ratification of the stalled China-EU investment deal—a prospect that looks unlikely if China is seen as actively backing Russia. China is also seeking to secure its admission to the CPTPP and patch frayed trade ties with the United States, a point raised during recent Yang-Sullivan discussions.

Trade relations with the U.S. are of paramount importance for China, as both remain each other’s largest trading partners. Amid the current conflict, China was seeking waivers from the United States for most of the Trump-sanctioned Chinese goods, but in the end China got just two-thirds of the tariff waivers it had requested. China also purchased 200,000 tonnes of soybeans and booked orders for 300,000 tonnes more, along with 10 shipments of corn from the United States to compensate for pricing fluctuations in agriculture markets following ruptured supply chains from Ukraine and Russia.

It’s too soon to definitively rule out a return to the GATT-less world of pre-WWI regional trading blocs, but it sure doesn’t look that way so far.

On the trade liberalization side, the crisis has certainly discouraged additional negotiations at the WTO, but that’s just-as-certainly nothing new: There hasn’t been a major multilateral round of trade liberalization completed since the mid-1990s, and, following the death of the WTO’s “Doha Round” a decade ago, members have instead resorted to nibbling around the WTO’s edges on small-ball things like trade facilitation and fisheries subsidies.

“Globalization” nevertheless marched on (see Part 1).

Members have also utilized other WTO agreement rules that allow them to liberalize trade among themselves outside and beyond those agreements, via bilateral or regional “free trade” deals. And here, again, there’s been little sign of “deglobalization.” Indeed, in just the last few years we’ve seen the completion of the large Comprehensive and Progressive Transpacific Partnership (formerly the Trans-Pacific Partnership) and the even-larger (but less ambitious) Regional Comprehensive Economic Partnership, as well as numerous non-party nations expressing an interest in joining on:

In Africa, meanwhile, the 54-nation African Continental Free Trade Area took effect this January, and, while it’s pretty limited so far, the more serious East African Community just welcomed its seventh member (the Democratic Republic of Congo), thus “bringing the regional trading bloc’s market size to a quarter of the continent’s population and providing it with access to the Atlantic Ocean.”

Even the “deglobalizers” are getting in on the act. Notoriously difficult India, for example, is about to conclude an FTA with Australia. The United States, of course, foolishly bailed on the TPP/CPTPP in 2017 but then signed on with TPP parties Canada and Mexico to the USMCA, which contains a few protectionist things but generally keeps NAFTA’s trade liberalization in place and even gets more liberalized on digital trade. (It also cuts-and-pastes a lot of TPP provisions too.) The Trump administration then continued its Humpty Dumpty act by signing a more modest tariff liberalization deal with TPP signatory Japan and started other negotiations with the U.K. and Kenya. Speaking of the U.K., it finished Brexit but also signed numerous FTAs after the departure became official (including with the EU, by the way). And now the Brits are scrambling to sign even more.

Overall, cumulative data from the WTO show that Regional Trade Agreements (RTAs) continue to proliferate:

Meanwhile, WTO rules continue to serve as a baseline for the vast majority of global trade (basically everything except non-members Iran and North Korea, now Russia, and the still-tariffed U.S.-China stuff). Surely, the organization needs reform and a big shot in the arm—some of which President Biden could do unilaterally, by the way—but it’s needed those things for years now, and nothing in the last few months indicates (so far) that the system is collapsing entirely. Odds are that it’ll continue to limp along, as real-world “globalization” forges ahead.

Speaking of …

“Reglobalization,” Not Deglobalization

The final mistake in the deglobalization narrative is that “globalization” is some sort of immutable, straight-line series of trade flows and transactions instead of a constantly changing web of individual, mostly private actors doing business daily across national borders. As we discussed in January, the latter is reality: Multinational corporations and investors are always balancing numerous factors—from costs and quality to transportation and storage to domestic and global political risk, and so on— and adapting when those factors change (which they do a lot). And since foreign “supply shocks” are as old as internationalized production itself (and more common than you’d think), seasoned pros aren’t just throwing up their hands at the latest shocks and abandoning global trade. They’re adapting once again.

According to a new Goldman Sachs report (no link, sorry), for example, corporations in the United States have expressed heightened concerns (e.g., on shareholder conference calls) about recent geopolitical and supply chain risks, including in Ukraine. But they’re generally not responding by reshoring—building new factories here and bringing their supply chains back home:

Goldman adds that, “[t]he clearest evidence that there has not been meaningful reshoring—or at least that any reshoring has been outweighed by increases in offshoring—is that imports of foreign intermediate and final manufactured goods have continued to grow faster than domestic manufacturing output”:

Meanwhile, imports of manufactured goods have shifted a bit out of China, but Chinese imports remain above 2019 levels and have been replaced not by U.S.-made goods but by—and forgive me if you’ve heard this before—other imports.

And this is all part of a supply chain diversification—not repatriation—effort as companies look to broaden their supplier base in response to the pandemic-related disruptions:

Finally, Goldman finds that the most common global supply chain strategy right now has little do with “globalization” at all: “Inventory overstocking is the strategy for improving supply chain resilience that is most clearly underway. Last quarter’s Russell 1000 earnings call transcripts show that the share of companies that report plans to target a permanently high level of inventory has doubled relative to before the pandemic, especially in durable goods sectors”—a trend their sector analysts confirm:

Evidence of this “reglobalization” is everywhere—if you’re willing to look. The Wall Street Journal reports, for example, that restrictions on Russian commodities have pushed buyers to turn not inward but to Canada:

Canada, which shares similar climate and geographical features, produces many of the same commodities as Russia. Both countries are among the world’s largest producers of crude oil, uranium, nickel and potash. Along with Ukraine, they are among the world’s largest wheat exporters. Buyers are turning to Canada to replace the energy, food and minerals that are being blocked because of the war and international sanctions on Russia.

Even some countries that have sufficient domestic crops are calling on Canada for additional imports to build reserves as insurance against further geopolitical or climate disruptions.

They add that Canada isn’t the only exporter seeing new international demand: “[b]uyers seeking replacements for commodities that are restricted in Russia are also looking to Brazil for oil, to South Africa for platinum and Argentina for wheat.” India’s helping on wheat too:

“Booming Wheat Exports From India to Ease Global Shortage” https://t.co/CTRPrui6Vi pic.twitter.com/HHWf7bfU3Y
— Scott Lincicome (@scottlincicome) April 2, 2022

Things are also booming south of the U.S. border. As Bloomberg reported yesterday (and also in December), the combination of U.S.-China acrimony, the pandemic, and the Russia-Ukraine situation has set off an investment and export boom in Mexico (particularly in border states), as multinational manufacturers work to serve U.S. consumers or otherwise rejigger their global supply chains:

Due to strong U.S. demand and a revival of the auto sector, investors are moving in and banks are getting ready to finance new projects. Exports of non-petroleum goods grew almost 27% in February compared with the year earlier. If you’re interested in cars, toys, or medical supplies, there’s probably a company ready to ship through the world’s busiest border.

(Mexico also has 13 FTAs with 50 different countries, helping it to become an export platform for many key markets, not just the United States. Lessons abound.)

Elsewhere, the Journal finds the same reglobalization trends that Goldman did—with Southeast Asia again being a big beneficiary:

For many companies, the pandemic-fueled pause in globalization is turning into a broad effort to figure out how to make supply chains more robust by adding more factories, suppliers and sources of materials. It isn’t deglobalization by any stretch, but it is an expensive and time-consuming reshuffling of where things are made.

All those materials and goods still have to come from somewhere. In logistics, this shift from supply chains to webs is known as “multiple sourcing,” says Nathan Resnick, president and co-founder of Sourcify, which helps businesses find and manage factories in Asia. It has long been standard practice to have more than one supplier for goods and parts in a supply chain, but beginning with the most recent trade wars, more companies, even small and medium-size ones, have been forced to do the hard work of setting up more factories and synchronizing the quality of goods across them, he adds.…

Southeast Asia in particular has become a hotbed of regional “nearsourcing” of tech manufacturing. (Nearsourcing is when manufacturing is set up in countries close to where an item is consumed or where final assembly takes place—a classic example is when U.S. companies move manufacturing to Mexico from China.) In Southeast Asia, whole Chinese factories are copied and dropped into countries like Vietnam and Thailand, which remain close to parts and materials that are still manufactured in China, but where labor costs are lower. Samsung Electronics, for example, makes the majority of its smartphones in Vietnam, as well as its smart appliances.…

(I’d be remiss not to note that the exodus of some manufacturing capacity out of China started years ago now, but recent events do seem to have accelerated the trend.)

Bloomberg’s Brooke Sutherland, meanwhile, gets into the weeds of American multinationals’ sourcing and inventory operations and finds far more minor tweaks to existing “lean manufacturing” business practices than a wholesale abandonment of their globalized business models:

Many industrial companies practice lean manufacturing, a philosophical umbrella that encompasses the efficiency goals of just-in-time but also seeks continuous improvement in all processes. It’s a holistic ideology that centers on an ultimate goal of delivering better safety performance, higher-quality products, more consistent on-time delivery and lower costs — in that order. The pandemic may inspire some tinkering around the edges on best practices, but it’s unlikely to force a sweeping reevaluation of the basic principles. Efforts such as drilling deeper into the geographical diversity of the supply chain, localizing more of the production process or coordinating more closely with parts and raw materials vendors have been framed by critics of “just-in-time” manufacturing as a sign that industry is thinking more in terms of “just-in-case.” But industrial leaders don’t see it that way. To them, these concepts fit hand in hand with the lean operating ideologies they’ve been preaching for years and their focus on creating value for the customer. They’re not about to drop the steady pursuit of greater productivity in favor of a higher tolerance for slack; quite the opposite in fact.…

Even for elite just-in-time practitioners, the concept of strategic buffers is far less anathema than one might think. The operating philosophy doesn’t actually work without a cushion somewhere in the system. It’s usually just deep down in the supply chain so it doesn’t weigh on profitability at the top in an obvious way. Parts arrive in a perfectly coordinated fashion at the final assembly plant, but feeder facilities have to keep inventory on hand to enable this choreography. “It’s very flexible for the original equipment manufacturer, but it’s pretty difficult to manage on the supply-base side,” Pilz of Honeywell said. The nature of these buffers is what’s being reassessed in the wake of the pandemic disruptions. There’s an impetus toward being more thoughtful and deliberate about where those guardrails exist. That’s quite different from having them for the sake of having them — a reversion to “just-in-case” supply-chains — or debating whether they should exist at all.

Sutherland adds that U.S. companies like Honeywell, GE, and Trane are also doing simpler things like redesigning products to work around chip shortages (something engineers are doing everywhere) or investing in new tools to improve transparency and communication in their existing supply chains. Some aren’t even reconsidering sole-source suppliers, which was supposedly a big problem during the pandemic: “If it’s a sole source supplier that can manufacture that component in three different plants around the world, I like that supplier.… We have a lot of those types of suppliers.”

In short, multinational manufacturing is still complicated and still very much global. It’s just different from what it was a few years ago. And it’ll be different again in a few more.

Summing It All Up

So the deglobalization narrative whiffs on what globalization actually is, on what global trade agreement rules say, and on what governments (via trade agreements) and multinational companies are actually doing (so far) in response to recent shocks. Overall, uncertainty reigns and changes are afoot, but there’s little sign that Ukraine will cause the widescale abandonment of either the WTO or “globalization” properly understood. As Sutherland put it last week, “[s]ome of the popular recent prescriptions for fixing the pitfalls of just-in-time manufacturing run the risk of being carried to an overly simplified extreme. There’s no one right answer for all, and there are plenty of nuances.”

That sums it up nicely, I think.

Capitolism will be off next week, so you’ll need to get your chart fix elsewhere.

Chart of the Week

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