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Globalization Was Already on the Ropes. It’s Solely Going to Get Worse

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Globalization Was Already on the Ropes. It’s Solely Going to Get Worse

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The world economy is caught in a vicious cycle that it cannot seem to break. It all began in 2008 with the shock of the global financial crisis followed two years later by the slow drip of the European debt crisis. In response to these events and the worldwide recession that accompanied them, many countries took steps to protect their economies from international instability and foreign competition. Yet creeping protectionism just acted as a further drag on economic growth. Continued tepid growth helped fuel the growing protectionist backlash in the industrialized world, which is poised to deliver a level of economic closure and conflict not seen in decades.

The headline events of 2016—Brexit, the election of Donald Trump in the United States, a struggling Chinese economy—do not represent the start of a process of “deglobalization.” Rather, they themselves are a product of a slow unraveling of global economic interconnectedness that has been unfolding for nearly a decade now.

Years before Trump was railing about Mexico and China stealing American jobs, protectionism was on the rise. Trade conflicts were becoming more common, and trade growth had slowed to levels not seen in decades. Capital, too, had become increasingly trapped inside national borders, as major banks reduced their international activity and governments steadily embraced the use of measures controlling financial flows in and out of their economies.

Globalization has been in trouble for a while now. Yet, as bad as things have been, 2016 made it clear that they are likely to get worse.

A decade ago, the two most crucial components of worldwide economic integration were U.S.-led multilateralism and the steady integration of China into the international trade and financial systems. Today, both are being seriously called into question. U.S. President Donald Trump’s economic rhetoric on trade and globalization signals a strong break from 70 years of American foreign economic policy orthodoxy. Rather than reaffirm the U.S. commitment to the multilateral liberal economic order it created following World War II, Trump has promoted a zero-sum “America First” approach to globalization. The consequences of this are twofold: First, the American economy will be increasingly walled off from the rest of the world; second, economic conflict between the United States and its major economic partners, especially China, will increase.

Meanwhile, China’s breathtaking economic expansion appears to be over. Economic growth in the world’s second-largest economy has slowed each of the past six years.

Chinese trade has fallen off in recent years as well. The cooling Chinese economy has reverberated around the world, contributing to sluggish global growth. It has also fueled a massive exodus of capital from China as residents worry about the value of their currency, the yuan. This, in turn, has led Beijing to reverse its ambitious liberalization agenda that would have opened the Chinese financial system to foreign investment and fueled another decade of financial globalization.

Without U.S. leadership or continued Chinese growth and integration, it is nearly impossible to imagine a world where globalization moves forward over the next four years. A best-case scenario is that the world economy can tread water and protect the gains that have been achieved over the past several decades. However, this seems optimistic given the headwinds facing globalization today. A more likely outcome is a world with more international economic conflict, where global growth continues to underperform, Western populist political movements become entrenched, and the vicious cycle continues.

Globalization’s Slow and Steady Decline

In 2009, the global economy contracted by nearly 2 percent. The following year, things seemed to quickly rebound. In early 2010, the International Monetary Fund (IMF) noted that the recovery was proceeding “better than expected,” though it was admittedly uneven. Yet, this optimism proved to be short-lived. Every year since, world economic growth has registered below 3 percent. The last time the world strung together four straight years of growth under 3 percent was decades ago—from 1980 through 1983. 2016 may crack the stubborn threshold, but just barely with growth projected to settle at 3.1 percent.

A staggering decline in world trade has accompanied persistent weak economic growth since 2012. For more than 30 years prior to the 2008 crisis, world trade grew twice as fast as global economic growth. Since then, however, trade has struggled to keep pace with even anemic growth. In September, the World Trade Organization (WTO) slashed its trade-growth forecast to below 2 percent, marking the first time in 15 years that trade expansion has lagged behind world economic growth.

Globalization has been in trouble for a while now. Yet, as bad as things have been, 2016 made it clear that they are likely to get worse.

The great trade slowdown reflects, in part, the stagnant global economy. Yet tepid growth is insufficient to explain the current state of international trade. The extent to which trade growth appears to be reaching a plateau is indicative of a clear slowdown in trade liberalization and a rise in protectionism.

Since the Great Recession, reductions in tariff rates and the spread of new free trade agreements have each decelerated. More significantly, every year since the global financial crisis, new discriminatory trade measures have outpaced liberalizing measures by a ratio of nearly 3-to-1. Many of these new measures are concentrated among the world’s largest economies. Together, the slowing pace of liberalization and the rising tide of protectionism are taking a bite out of trade.

Financial globalization has also taken a serious hit. In the years leading up to the financial crisis, gross international capital flows totaled around 10 to 15 percent of world GDP. Over the past four years, this has fallen to an average of just 5 percent. This means that international capital flows today have receded to mid-1990s levels.

A retrenchment in international bank lending has fueled much of this decline. This cutback has been most pronounced among European banks, which continue to reel from the repercussions of the European debt crisis, new financial regulations and negative interest rates.

However, like trade, the slowdown in global financial integration also reflects a rise in protectionism, as the use of capital controls—limits on the movement of financial assets in and out of national economies—has also been on the rise. One new metric of capital-account openness indicates a persistent global shift away from liberalization since 2008. This has pushed the international financial system toward a level of closure not seen in over 15 years.

In short, globalization has experienced a slow and steady decline over the past eight years. Given the radical shift in U.S. foreign economic policy and the China slowdown, 2016 signals this trend is likely to continue if not intensify.

America First, Globalization Second

For the past 70 years, the United States has led a multilateral effort to promote international economic cooperation and integration. Its efforts began before the end of World War II with the creation of the IMF and the World Bank. This was quickly followed by the launch of the General Agreement on Tariffs and Trade (GATT), which, in 1995, was transformed into the WTO—the foundation of the global free trade regime.

Trump’s economic rhetoric on trade and globalization signals a strong break from 70 years of American foreign economic policy orthodoxy.

Outside of these global forums, the United States aggressively promoted globalization by signing additional free trade deals such as the North American Free Trade Agreement (NAFTA). It did so through bilateral investment treaties designed to promote foreign direct investment (FDI) abroad and by stabilizing the global economy through providing billions of dollars in emergency loans to foreign governments during times of crisis.

Because of America’s efforts, protectionism declined, and national markets for goods, services and capital became progressively integrated into a budding global marketplace. Even as globalization slowed after 2008, U.S. leadership did not waver, as evidenced by the Obama administration’s work on two far-reaching trade and investment deals: the Trans Pacific Partnership (TPP) and Transatlantic Trade and Investment Partnership (TTIP).

Trump represents a sharp break from tradition. During his presidential campaign, he repeatedly questioned the American foreign economic policy orthodoxy with his “America First” slogan. At campaign stops, he railed against America’s primary trading partners, pledged to kill TPP, threatened to pull out of the WTO, and hammered away at corporations that have expanded production outside of the United States.

His surprising victory has greatly increased the risks to globalization. While there is no way to know exactly how the next four years will unfold, it seems implausible that a Trump administration will turn an about-face and embrace a traditional U.S. foreign economic policy. Instead, the world must prepare for two important changes. First, Trump appears poised to end American economic leadership as we know it and instead work to build walls around the U.S. economy. Second, Trump has committed his administration to a much more aggressive foreign economic policy—an approach that will lead to economic conflict, especially with China.

In one of his first public policy statements after winning the election, Trump pledged to pull the United States out of the TPP—a deal Washington once championed—in his first 100 days in office. He made good on that promise with 96 days to spare, pulling out of the deal by executive order on Monday. While he has made no definitive statement on the TTIP, the European Union has accepted that talks are now effectively frozen. On NAFTA, Trump’s repeated campaign pledge to renegotiate that deal puts some pressure on him to do something, even if he stops short of actually withdrawing the U.S. from it. Together, this means that the world’s access to the U.S. market will not grow and will perhaps even shrink over the next four years.

Trump’s rhetoric on trade, the high-profile Carrier deal and his threats on Twitter that American companies thinking of expanding production abroad will face “consequences” already appear to be having their intended effects. Some corporate leaders are rethinking their plans to invest abroad. Thus, a Trump presidency could reduce U.S. outward FDI—a development that will hurt developing and emerging economies that benefit from such investment.

Trump has also signaled that he wants to slow FDI into the United States, meaning foreign mergers and acquisitions of American companies could decline under his watch.

Trump’s election also means the world must prepare for a more aggressive U.S. foreign economic policy—one where America does not shy away from conflict. This combative approach should manifest itself early in Trump’s presidential tenure, as his election has served to aggravate some of the very problems he promised to fix. Predictions that Trump and Congress will push through a large, fiscal stimulus in the form of an infrastructure bill have raised inflation expectations. This is fueling projections that the Federal Reserve will raise interest rates at a faster clip than previously thought. Such projections are, in turn, driving up the value of the dollar.

U.S. President Donald Trump signs an executive order to withdraw from the 12-nation Trans-Pacific Partnership trade pact, Washington D.C., Jan. 23, 2017 (AP photo by Evan Vucci).

As the dollar strengthens, U.S. exports become less competitive. The U.S. trade deficit is already on the rise because of the strong dollar. If this trend continues it will intensify pressure on Trump from his base to “do something fast” about trade.

More than anything, Trump should be expected to aggravate an already rocky trade relationship with China.

The president has indicated he is unwilling to grant China “market economy” status at the WTO, a position in keeping with the Obama administration. Opposing this will make it easier for the United States and other member countries to continue employing anti-dumping measures against Chinese products to protect domestic industries from what is deemed unfair competition. Unsurprisingly, this position does not sit well with China.

As one 2016 study notes, since the Great Recession, a staggering 90 percent of WTO disputes among major powers have been related to China. The institution, the report continues, has been “struggling to adjust to a rising China” as Beijing’s economic model builds in advantages for Chinese industry that are difficult for the WTO to rule against. If Trump feels that the WTO is an ineffective tool to achieve his stated trade goals, he could push for unilateral protections, even if such measures violate WTO rules.

In years past, China may have been more likely to back down. However, a November report from the Federal Reserve notes that China is increasingly self-sufficient and, therefore, Washington’s leverage vis-a-vis Beijing is waning. This may push Trump toward a more radical approach like using the “one China” policy as a bargaining chip—something that would almost certainly poison U.S.-China economic relations.

There are already signs that China is pushing back. In what some view as a clear geopolitical move, Beijing just launched an antitrust investigation of General Motors, a major American corporation with substantial sales in China. An already ailing global economy must brace for intensified economic conflict between the world’s two biggest economies over the coming years.

The China Slowdown

Alongside U.S. multilateral economic leadership, the steady integration of the fast-growing Chinese economy into the global marketplace was also a key driver of globalization in the decades leading up to the Great Recession. Since 2000, China’s share of world trade in goods has risen from 7.5 percent to more than 25 percent in 2016; its share of global FDI inflows has grown from around 4 percent to nearly 20 percent; its share of global GDP has grown from around 4 percent to nearly 15 percent, according to data from the World Bank, U.N. Comtrade and the U.N. Conference on Trade and Development. China’s economic explosion throughout the 2000s fueled growth in scores of developing countries—especially those that exported raw materials. Its emergence as the world’s top trading state kept prices down in industrialized countries, which kept inflation under control, allowing for more accommodative, pro-growth monetary policy.

The China boom is now over. Chinese economic growth has fallen every year since 2012. The IMF projects that in 2016, the Chinese economy expanded by just 6.6 percent; this will drop to 6.2 percent in 2017. While still high by many standards, these numbers are a far cry from the sustained 8 to 14 percent growth rates of the previous decade.

Trump’s election means the world must prepare for a more aggressive U.S. foreign economic policy—one where America does not shy away from conflict.

It is not just growth that is faltering in China, either. Chinese exports and imports have both fallen over the past two years. While the spillovers from the China slowdown will be concentrated in Asia, its effects will be felt in every corner of the world.

This development is not entirely unexpected. For years, observers have been predicting that China would eventually have to shift away from an export-led growth model to one based more on domestic consumption. Yet as these changes take effect, Beijing will face a greater temptation to protect its own economy from foreign competition.

China has recently faced criticism for its increased use of trade-protecting measures as well as what some view as an increasingly inhospitable environment for FDI. For example, a new cybersecurity law requires tech firms to turn over their source code to the Chinese government. This has raised fears about intellectual property theft and could dampen investment enthusiasm.

Beijing is also busy developing the “Made In China 2025” plan, which is designed to make China more competitive in the area of high-tech, “smart” manufacturing. The basic premise is to develop domestic Chinese champions that can outcompete and eventually replace foreign competitors.

As part of this plan, foreign firms that already have dominant positions in strategic sectors of the Chinese economy—such as telecommunications, renewable energy and pharmaceuticals—could be required to license their technology to upstart Chinese companies, or face antitrust sanctions. The proposed rule would effectively force foreign companies to transfer intellectual property to their competition. The European Union Chamber of Commerce has already warned that China’s 2025 strategy could result in a protectionist backlash from Europe.

Another consequence of the China slowdown has been a dramatic reversal of Beijing’s plans to open its domestic financial markets to foreign investors. While China liberalized its trade and FDI policies decades ago, its capital account has remained tightly closed. International investors have long coveted access to China’s large equity and bond markets. They represent the final frontier of financial globalization.

Chinese President Xi Jinping after his speech at the World Economic Forum, Davos, Switzerland, Jan. 17, 2017 (AP photo by Michel Euler).

Until last year, Beijing was taking small steps toward liberalization, going as far as declaring that all financial restrictions would be eliminated by 2020. However, these plans are now on hold indefinitely as Beijing is fighting to slow a massive outflow of capital.

In short, as the Chinese economy has cooled, Chinese residents have sought out investments abroad—like real estate in Vancouver—in anticipation of a weaker yuan. By buying assets in foreign markets, they can preserve their wealth against losses driven by unfavorable exchange rates. Citizens have been moving money out in creative ways to get around controls on capital outflows, which in 2015 topped $1 trillion.

More than anything, Trump should be expected to aggravate an already rocky trade relationship with China.

This pace of outflows has continued into 2016, forcing Beijing to impose round after round of new capital controls, including new restrictions that limit Chinese firms’ foreign merger and acquisition activities. Beijing has little choice but to impose such measures, since lifting the restrictions could lead to massive withdrawals from shaky Chinese banks, which would invite a financial crisis.

For the foreseeable future, then, China’s financial system will remain closed. Meanwhile, outflows are likely to continue, despite the new controls, which will further weaken the yuan. This will only intensify the protectionist backlash in the United States and Europe as Chinese goods gain a competitive edge from the exchange-rate shift.

Globalization on Hold

The world economy has yet to wake up from the nightmare of 2008. The economic recovery has been far too weak. Sustained low growth rates around the world have pushed governments to enact protectionist measures affecting trade, FDI and capital flows.

Yet these measures are only intensifying the “growth funk” the world economy finds itself in. After eight years of slow and steady deglobalization, 2016 signals there is even more trouble ahead. Trump’s presidency marks a shift away from U.S. multilateral economic leadership to an America First strategy that will lead to more protectionism and a conflictual foreign economic policy.

China’s economic growth will continue to slow, adding pressure on Beijing to find a new growth model. So far, things are pointing to a less-welcome environment for foreign firms operating in China, which will discourage future investment. Meanwhile, capital outflows will force Beijing to delay, likely for years, its ambitious financial liberalization plans.

For now, globalization as we have known it is on hold. Perhaps, given the current political climate, this is not entirely a bad thing. There are compelling arguments to be made that global economic integration went too far too fast, and hitting the pause button is appropriate, especially in advanced democracies.

Hitting pause is one thing—but rolling back the progress that has been made over the past 70 years is another. Protectionist policies are easy to enact, but difficult to remove.

The greatest risk moving forward is not that world trade will continue growing at a slow pace relative to previous decades. Rather, the greatest risk is that opposition to globalization will turn into outright economic conflict. A major trade war, or broader economic conflict, between the United States and China seems more likely than ever before. Such a development would be a disaster, not only for the two belligerents, but also for the global economy.

Globalization’s past progress depended on the United States and China. Globalization’s future will as well. For now, though, the future looks dim.

Daniel McDowell is an assistant professor of political science in the Maxwell School at Syracuse University, specializing in international political economy. He is a regular contributor to World Politics Review.

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