Is It the End of the Line for Globalization?

Since the late 20^th century, globalization—the interweaving of world economies through cross-border flows of ideas, goods, services and capital—has been the prevailing trend. Rapid improvements in technology, transportation and communication would suggest that this trend would always move in one direction—that is, more interconnected.

And yet, a combination of secular trends and geopolitical shifts are conspiring to slow globalization—or even reverse it—and trade tensions are only part of the story.

“Tariffs might be the most visible barrier, but other trade barriers such as new foreign investment review in the U.S. are now weakening the business incentive to globalize corporate footprints and supply chains,” says Michael Zezas, Morgan Stanley's Head of U.S. Public Policy Research.

Meanwhile, a growing reliance on leaner manufacturing approaches, changes in consumer preferences, and increased purchasing power in emerging markets are emphasizing regional trade over global trade. This all adds up to what some economists are calling “slow-balization,” a term coined by Dutch trend watcher Adjiedj Bakas.

For investors, there are pluses and minuses. Global trade barriers could disrupt autos, capital goods, semiconductors and telecoms, among others. “These are industries where companies use technologies sensitive to the economic or national security interests of their home country and use supply chains that are globally diffuse,” says Zezas.

At the same time, more localization could be a boon for companies that are less reliant on foreign markets, but whose products or technology are critical economic or national security interest. These “emerging regional champions” include Chinese Internet companies, small and midcap U.S. Internet companies, and payment processors.

Geopolitical conditions, and trade uncertainties in particular, are impeding globalization. Still, even before trade tensions re-emerged, there were secular winds of change blowing.

Around the turn of the century, declining transportation and communication costs made long-haul trade across oceans increasingly prevalent. The share of goods traded between countries in the same region declined from 51% in 2000 to 45% in 2012, according to McKinsey Global Institute research. Recently, however, that trend has been reversing, with regional trade again gaining traction.

For one thing, service trade is growing faster than goods trade. Moreover, globalization may be the victim of its own success, as emerging market countries have grown rich enough that they're consuming more of the goods that they sell. “This appears to be a natural evolution of the change brought about by globalization,” says Zezas. Consequently, the share of output moving across the world's borders has fallen from 28.1% in 2007 to 22.5% in 2017, according to McKinsey.

World Service Exports Are Growing as a Percentage of GDP

The shift toward “just-in-time” logistics—a lean manufacturing approach that emphasizes low inventory levels—is also changing trade patterns. During the 1990s and early 2000s, many companies based their supply-chain decisions on access to low-cost labor, even if it meant shipping supplies, parts and finished goods halfway around the world. Today, just 18% of goods trade is based on labor-cost arbitrage, McKinsey reports, and that share could further shrink as companies look to streamline their supply chains and bring more automation into the fold.

Finally, technology is transforming how countries think about their economic interests and national security. “The U.S. is increasingly defining sensitivity in a broader manner, so it's not just products and infrastructure that are material to national security, but also technologies that are viewed as fundamental to future economic growth or data security,” says Zezas. In the case of automobiles, for instance, the technology that is the backbone of autonomous driving likely has direct military applications. “It's no longer just about moving hunks of metal,” he adds.

Without question, the shifting tides of trade create a complex dynamic. That said, investors can start to think about the broad implications through a relatively simple framework based on key questions: How sensitive is a company's product or process to a country's economic or national security? How much does its production rely on a global supply chain, and does that reliance continue to make sense?

The companies most vulnerable to “slowbalization” are those that deal in sensitive technologies and depend on supply chains that are globally diffuse. For these reasons, autos, European capital goods, IT hardware, semiconductors and telecoms are particularly vulnerable.

For Internet companies, the prognosis is mixed. One the one hand, the largest consumer Internet companies face a higher cost of doing business now when platform health and data security play a bigger role. “Each government has its own nuanced approach to these issues and this universe may have to adapt to an environment in which protectionist behaviors drive decision making,” Zezas says.

On the other hand, small and midsize Internet companies could be the beneficiaries—for the same reasons their larger peers are vulnerable. In fact, the rise of more protectionist policies and manufacturing closer to home could actually be good for companies that deal in potentially sensitive areas but aren't closely linked to the rest of the world.

Chinese Internet companies also fit squarely into the category of so-called emerging national champions. “They are vital for China's future economic security and outlook in the long run, especially when major names have been moving into industrial applications,” says Grace Chen, Morgan Stanley's Head of China Internet research. “But their business is focused almost exclusively on China.”

Payments companies could also be net beneficiaries. “They are already tuned into issues of banking functions, tax collection and national security, and the continued shift toward digital payments across all markets will happen irrespective of global trade,” says James Faucette, Morgan Stanley's Head of Payments and Processing Research. Although many countries will keep doors open for global operators with scale advantages, domestically developed payment schemes could get an edge. “Politics, not technological advancements, will be key to how this unfolds,” Faucette says. “There is potential for some unevenness as countries look to protect their own.”

For Morgan Stanley Research on global trade, ask your Morgan Stanley representative or Financial Advisor for the full report, “The Slowbalization Playbook” (May 29, 2019). Plus, more Ideas from Morgan Stanley's thought leaders.