Fragmented Globalization

By Mohamed A. El-Erian

CAMBRIDGE – For three decades, businesses and governments around the world operated under the assumption that economic and financial globalization will continue apace. As the international order has come under strain in recent years, however, the concept of deglobalization – the delinking of trade and investment – has increasingly gained traction with households, companies, and governments. But the available data suggest that globalization is not ending so much as it is changing.

Not too long ago, it seemed that there were no limits to global economic and financial integration. For decades, globalization’s benefits appeared to be obvious and unassailable. The interconnectedness of production, consumption, and investment flows provided consumers with a wider range of choices at attractive prices, enabled companies to expand their markets, and improved the efficiency of their supply chains. Global capital markets expanded access to credit and lowered its cost for private and public borrowers alike. The world’s governments engaged in what seemed to be a series of win-win partnerships. And technology – including, most recently, the accelerating shift toward remote work – made national borders seem largely irrelevant.

But while globalization made markets work better, policymakers lost sight of its adverse distributional consequences. Many communities and countries were left behind, contributing to a widespread sense of marginalization and alienation.

The result was a backlash against globalization, whose most visible political manifestations were the United Kingdom’s vote to leave the European Union and Donald Trump’s election to the US presidency in 2016. Soon, the United States had entered a tariff war with China, deepening the divide between the two economic powers. Western consumers, meanwhile, have increasingly pushed back against human-rights violators and countries that harm the environment. And the invasion of Ukraine has led to unprecedented sanctions on Russia (a G20 country) and the weaponization of the international payments system.

It follows, then, that many would conclude that globalization has ended. But, rather than a sharp reversal of the past 30 years, it seems far more likely that we are entering an era of fragmented globalization characterized by substitution, not negation.

The sanctions regime imposed on Russia is a case in point. Over the past year, the EU-US-led restrictions have not materially reduced Russia’s oil exports but redirected them elsewhere, primarily to China and India. Similarly, rather than bringing Russia’s economy to its knees as many had predicted, the comprehensive sanctions shrunk its GDP by just 2%, as Russian technocrats found ways to reorient and rewire both domestic and external activities. Even more worryingly, Russia and some of its allies have also made progress in creating somewhat of a parallel cross-border payments and settlement system, albeit a rudimentary and inefficient one.

This trend will likely continue over the next few years, as companies increasingly diversify their supply chains away from China and as Western governments resort to near-shoring and friend-shoring to maintain the production of critical inputs and sensitive exports.

In short, the combination of geopolitical shocks, corporate strategies, and changing societal values will affect trade and investment patterns along four main axes. As companies opt for resilience over efficiency, they will increasingly shift their approach to supply chains from “just in time” to “just in case.” This will come at a time when security concerns gain greater weight in commercial considerations, and companies will move away from risk-sharing and general partnerships to more narrowly-designed arrangements. Meanwhile, consumers will increasingly look for an emphasis on purpose in their commercial interactions.

While this process will produce winners and losers, their identity will depend to a significant extent on how policymakers adapt to the global economy’s new operating model. Mexico, for example, stands to gain from US friend-shoring, as well as the corporate sector’s shift to more diversified supply chains. Yet, as the Mexican government itself has recognized, notional demand will not be translated into effective demand unless policymakers accelerate progress on infrastructure, clean energy, deregulation, and the like.

In a world in which households actively avoid certain commercial interactions, governments and businesses will need to work harder to devise alternatives. Companies must work with governments, both at home and abroad, to facilitate the inherently tricky process of rewiring supply chains and to accelerate the green transition. National and global policymakers need to revise how they think and operate. And long-term investors should incorporate more sophisticated geopolitical, sociopolitical, and environmental analyses into their allocation strategies.

While some may consider the phrase “fragmented globalization” an oxymoron, I believe it is the most probable scenario for the global economy. As the world increasingly divides into blocs, a few more fluid than most others, globalization stands to become more inflationary, reducing potential growth. Avoiding this outcome depends on how national governments and multilateral institutions navigate the new economic reality. The world may not fully deglobalize, but that does not mean we should assume smooth sailing ahead.

Mohamed A. El-Erian, President of Queens’ College at the University of Cambridge, is a professor at the Wharton School of the University of Pennsylvania and the author of The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse (Random House, 2016).