Will COVID Kill Globalization?

Everyone is predicting the end of globalization. I disagree.

The economic fallout from COVID19 has led to many dire predictions about the future of globalization. The May 14 cover story in the Economist (see below) is a case in point. Similar doomsday predictions have been made by the World Economic Forum, Foreign Policy, and other prominent publications. These predictions are based on the staggering drop in trade and investment created by the pandemic.

But is globalization really dead, or is this just a short-term blip?

My position is rather boring: I expect globalization to carry on just about as before, after a temporary COVID19-induced drop in cross-border economic activity. It’s foolish of me to make a prediction, because predictions are always wrong. I know that I’ll be wrong, as will most of the other predictions. But sometimes how we develop predictions is just as (or more) important than the predictions themselves, and I believe that an approach based on basic facts—even if boring—may help calm down some of the anxiety about the future of globalization.

Globalization was in vogue not that long ago

Before explaining my boring prediction, it’s useful to provide some context about the history of predictions about globalization.

Many people point to the end of the Soviet Union as the catalyst for the recent era of accelerated globalization. The fall of the Berlin wall in 1989 was followed by a quick succession of events that opened up global markets: the liberalization of India (1991), the European Economic Community (1993), the WTO (1994), the MERCOSUR agreement (early 1990’s), the NAFTA agreement (1994), and China’s admission to the WTO (2001). Each of these events is worthy of a dissertation, but they fit into a story of inexorable progress towards free trade and unbounded foreign investment.

The optimism about globalization during that period was reflected in two bestselling books. Francis Fukuyama’s The End of History and the Last Man (1992) advanced the idea that the world had reached the “end” of history because liberal democracy had won the intellectual and political game, and all countries would converge on pro-market economic policies. Thomas Friedman’s The World is Flat (2005) argued that barriers to cross-border business had all but disappeared, bringing economic prosperity and lowering international conflict.

Who would’ve guessed that less than two decades later we’d be discussing the end of globalization? Pundits today paint globalization as a heavyweight boxer against the ropes, pounded by the 2008 financial crisis, the wave of nationalist-protectionist governments (Putin, Brexit, Trump, Bolsonaro, etc.), and the potential decline of China’s economy—with COVID-19 providing the knockout punch.

A dose of reality

Has the pendulum of globalization really swung so far so soon? I don’t think so. Five facts suggest that both extremely optimistic and extremely pessimistic cases regarding globalization are misplaced.

Fact #1: The level of globalization was never as high as suggested by the hype

As Pankaj Ghemawat has long pointed out, the extent of globalization is far smaller than we expect. For example, immigrants represent only 3% of the world population. Foreign direct investment (FDI) as a percentage of GDP reached only 4% in 1999 (its peak), international tourism is only 10% of total tourism, and international patents are only 15% of total filed patents worldwide. Most of us would guess these numbers to be much higher. Yes, globalization increased meaningfully in the post-Soviet era. But Ghemawat convincingly argues that we never reached extreme globalization; rather, the world is semi-globalized.

Fact #2: Regionalization > Globalization

If there ever was a poster child for globalization, it would be South Korea—a country that went from poor to wealthy within a generation. Korea gave us multinational companies (MNCs) like Samsung, Hyundai, Kia, LG, and Kumho. Now consider this question: what percentage of Korean MNCs subsidiaries are located in each continent (Africa, Asia, Europe, North America, South America, and Oceania)? The chart below, based on my own data, shows the numbers. It should be obvious that Korean firms overwhelmingly operate in Asia. If we did this exercise with US firms, we’d find that they primarily operate in North America. And if we did it with European MNCs, we’d find that they primarily operate in Europe. The point is, regionalization is much more prevalent than globalization. 

Fact #3: Globalization returned to pre-crisis levels in 2008

The chart below shows how the 2008 financial crisis affected world trade (imports and exports). The 2008 crisis caused a serious drop in trade as a % of GDP, from just over 60% down to about 52%. But by 2011, trade returned to pre-crisis levels and has remained more or less the same. We still don’t know how far trade will drop due to COVID-19, and surely the drop will be bigger than in 2008. But there are reasons to expect a rebound. In my opinion, the 2008 crisis was based on deeper economic fundamentals, while this is a temporary recession driven by a public health issue. I expect the world to return to its steady state when the pandemic is under control. I don’t know if that will take 1, 2, or 3 years—but the drop is probably not permanent.

Fact #4: COVID19 has the potential to seriously weaken nationalist/populist governments

The nationalist/populist governments that swept to power in many countries starting in 2016 are a bigger threat to globalization than COVID-19. So far there’s little evidence that they have seriously or permanently hampered world trade and investment. Many pundits see COVID-19 as interacting with these governments to supercharge the demise of international business activity.

But the data suggest that we have good reason to believe the opposite. The chart below shows that countries led by nationalist/protectionist governments (e.g. U.S., Brazil, Russia, India) have handled the pandemic the worst and are in for a protracted recovery. This has been a serious black eye for many of the leaders of those countries, and has done more to delegitimize them than any internal political opposition. This could end up hurting the economically protectionist government in upcoming elections, which would bring in other leaders more favorable towards global trade. In the U.S. for example, Joe Biden is supportive of the post-war liberal order that brought about the increase in globalization touted in the late 1990’s. Should he win, we can expect a reversal of at least some of Trump’s protectionist measures.

Fact #5: The strategic imperatives of multinational firms suggest that supply chains will not fully de-globalize

Since the pandemic began, several people have argued that firms have learned that global supply chains are too risky. Therefore, we should expect to see many firms re-shoring production. I agree that dependence on a single source country for the supply of critical inputs can be too risky in some cases.

But the economic fundamentals that lead firms to go abroad haven’t changed. Most large firms can’t rely on only their home countries as markets or sources of production (even firms from large countries like the U.S. or India). And most of the protectionist measures taken by politicians (e.g. tariffs) assume that firms produce abroad primarily to reduce costs. While this is clearly a very important motive, firms operate abroad for many non-cost reasons. Accessing consumer markets is an obvious one. Perhaps less obvious—but increasingly common—is that MNCs increasingly depend on talent from multiple countries, and that they learn and develop new technologies in foreign locations. These non-cost reasons aren’t as sensitive to protectionist measures.

Further, firms have many strategic levers to respond to political and economic shocks around the world. Those levers are what I teach my students as global strategy. For instance, firms reallocate production to other countries in response to tariffs or changes in cost structure instead of “reshoring.” Or they can move from centralized supply chains (e.g. make in China, ship to the world) to regional production hubs to serve regional markets. Or they can switch the ownership structures of their various operations by adopting a mix of fully-owned, partially-owned, and partnered activities to de-risk local exposure. These examples only scratch the surface of the various ways firms can strategize and organize globally. The point is, all of these options are much more viable than fully reshoring production or serving only domestic markets.

As long as the economic fundamentals pushing firms abroad remain (they do), and as long as firms can engage in complex global strategies (they can), I don’t expect we’ll see a full-scale (or even large-scale) retrenchment in multinational production and sales.

The boring prediction

Given all these considerations, here’s my boring prediction:

1. The level of globalization after the COVID pandemic will more or less return to pre-pandemic levels.

2. The global economy will continue to be driven by regionalization.

3. The globalization of firms will increasingly be driven less by cost considerations and more by accessing talent, technology, and consumers. These non-cost reasons are not as sensitive to protectionism in the long run.

4. While the level of globalization will remain more or less the same, we’ll see changes in the countries, firms, and industries that dominate international markets. This type of churn is normal. In the 1980’s, everyone predicted that Japanese firms would take over the world. Lately the same has been said of Chinese firms. It’s never a good idea to predict who will be the winners and losers, but we can be sure that there will be both as globalization continues to matter.