The second half of the past century witnessed what seemed to be the unstoppable march of globalization. However, contrary to all expectations, global trade has recently lost steam and even reversed:
Source: WTO
In our view, the reason for this slowdown lies in asymmetric interests at both an international and domestic level. Firstly, on trade issues, there is an increasing misalignment between developed and developing nations (e.g., IP protection, agricultural subsidies). As opposed to peeling an onion, some observers compare the trade liberalization process to peeling an artichoke: once the outer leaves have been peeled off, the hard core – i.e., national interests – remains.
At domestic level, there is a growing perception that globalization is benefiting only a few at the expense of the majority. Politicians have largely failed to find ways to redistribute the benefits of trade. By instead bending to special interests, they have fueled the anti-globalization movement, which has grown from a marginalized position on both extremes of the political spectrum into a transversal movement. Donald Trump is decried as a populist by the elites but his claim that America needs “smart trade” instead of “free trade” is a pointed critique to the special interests enjoyed by US multinationals (profuse party donors) at the expense of ordinary Americans.
Corporations benefit most because modern trade bears little resemblance to countries exchanging goods à la David Ricardo and much of it now takes place within corporations thanks to globalized value chains and transfer pricing techniques. This means that higher returns for shareholders come at the expense of jobs being lost overseas and taxes not collected domestically (think of Apple’s $200+ billion in cash stashed in offshore affiliates). The last aspect is often overlooked as opposition to trade usually focuses on labor spillovers, but in fact is of greater importance. In economics, it is a well accepted idea that trade in goods is a substitute for trade in factors of production. The issue, is that one of the factors being exchanged, is public capital (infrastructure, legal and educational systems, etc.), and when private companies – importers or exporters – do not return capital (by paying taxes), the average citizen is at a loss. This is why tariffs or export taxes, despite being vilified, can make sound economic sense.
What would be the investment implications if globalization goes in reverse? At macro level, if the free movement of capital is curtailed, the return on capital will decrease. Likewise, if the movement of goods is hampered, production costs will increase. The overall outcome will be lower corporate profits and higher inflation. At a micro level, there will be winners and losers. Broadly speaking, large multinationals with business models reliant on globalization are the most at risk (consumer goods; financials). Conversely, domestic companies will benefit from less competition (construction; infrastructure; energy). In the middle, companies producing scarce, complex or strategic goods (defense; machinery; IT) will enjoy few barriers to entering a market, but face increasing pressure to share IP and pay more taxes domestically.
In conclusion, as investors, we should not cheer a retrenchment of globalization. As citizens we may welcome trade regime reform but should be wary of how this is carried out. Closed markets have usually been ripe for crony capitalism, the result being a fall to a lower equilibrium level in terms of social inequality.
Fernando de Frutos, MWM Chief Investment Officer
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