PERSPECTIVE3-5 min to read

Regime shift: Globalisation dividend coming to an end



Azad Zangana
Senior European Economist and Strategist

Even beyond the current economic cycle, structural inflation pressures are emerging, which are likely to change the battle for central banks. For the past two decades, central banks have struggled to push inflation rates up to their respective targets, with deflation fears dominating the balance of risk during the “lowflation” period since the global financial crisis. Looking ahead, central banks are now more likely to struggle to avoid inflation from overshooting those targets.

Before the pandemic, the productivity gains from globalisation were being called into question. Since the 1970s, advanced economies have enjoyed falling production costs and lower inflation thanks to profound changes to supply chains. Improved trade and technology, but also improved accessibility and infrastructure in emerging markets meant that manufacturers could shift more of their complex production to parts of the world where cheaper labour was available. While global trade between countries that have a competitive advantage is nothing new, outsourcing and offshoring in particular was a major change.

Production shifting to lower-cost countries helped boost the share of global exports for many of the emerging markets. China’s entry to the World Trade Organization in 2001 helped it catch up with other emerging markets in capturing a growing segment of world exports and really embedded the globalised model of extended supply chains, or global value chains.

For advanced economies, although many jobs were lost in the globalisation process, the benefit of cheaper products helped boost disposable incomes. Both the US and UK experienced a significant decline in core goods inflation through the 1980s (which was a high inflation period), and eventually core goods prices disinflation from the early 1990s. The two decades which followed were distinct for a lack of inflation. This was helped, of course, by falling prices of imported goods, but also by the impact of globalisation on wages whereby the global supply of labour increased significantly. Governments responded with labour market reforms that introduced additional flexibility.

Active labour market policy, including adult training and linking benefit payments to work, helped increase the incentives for the unemployed to return to work. The trade unions, which were instrumental during the high-inflation regime, slowly lost their power, leading to a dramatic fall in the share of wage settlements covered by collective bargaining.

For central banks, the improved trade-off between inflation and growth had snuck up on them. Initially, policymakers celebrated, declaring victory over the high-inflation regime that had dogged economies over the previous decade. But they soon became concerned as inflation started to persistently undershoot their targets. They initially responded by cutting interest rates to lower and lower levels, causing bonds yields to fall on a secular basis.

It was only with the benefit of hindsight that policymakers about a decade later recognised that a structural break had occurred. The benefits of globalisation had wider consequences beyond the profits of firms and the location of jobs. It had created an unprecedented dynamic.

Speaking in 2004, former governor of the Bank of England Mervyn King described the previous 10 years as ‘…a non-inflationary consistently expansionary – or “nice” – decade; a period in which growth was above trend, unemployment fell steadily, and inflation remained stable. The ups and downs of the economy were much smaller in the nice decade than in any previous historical period.’ (Eden Project speech - 12 October 2004).

The internet revolution aided the nice decade, which we argue continued well after King’s speech. The introduction of e-commerce, along with the gains in efficiencies and productivity resulted in better management of economic resources. By exuding disinflationary dynamics, these changes ensured inflation pressures remained well contained as activity grew and economies expanded. The combination of international and domestic disinflationary pressures meant that there was room for more domestic inflation and growth in most economies, which allowed policymakers to lower interest rates even further as time went on.

In closing his speech and answering the question as to whether the nice decade would last, King concluded that ‘…the combination of low and stable inflation and continuously falling unemployment must come to an end at some point…’. This reflected his concern that with little spare capacity, the trade-off between growth and inflation was becoming more difficult. ‘The nice decade we might expect to be followed by the “not-so-bad” [not othe same order but also desirable] decade.’ Yes, central bankers had more time on their hands back then.

The new world order will result in disruption and higher costs

The gains from globalisation appeared to have peaked by around the start of the new millennium, but in recent years, new forces have emerged to stall the progress of world trade, and in some cases even reverse it. The ensuing new world order is challenging globalisation. It is encouraging multi-national companies to re-shore, or near-shore overseas production as well as redirect investment into other “friendly” lower risk countries, so-called “friend-shoring”.

Geopolitical tensions have been rising for some time. These politically-driven restrictions have forced many companies to re-think and even change their operation plans. The Covid pandemic also highlighted the fragility of supply chains, and the danger of having too much production concentrated in a particular country or region. Companies are more likely to consider “acts of God” in their risk planning, and seek to diversify their supply chains. On a risk-adjusted basis, this makes economic sense. However, shifting manufacturing locations, setting up new factories, and potentially even contributing to the creation of infrastructure all adds to costs, and inflation.

Europe and the Russia-Ukraine conflict have been a prime example of political risk re-shaping the economic and trade landscape. A significant proportion of European energy needs were met by Russian oil and gas. Many EU member states began to voluntarily cease Russian energy imports shortly after the invasion of Ukraine in early 2022. This occurred before a more explicit stop to exports from Russia began at the end of the summer. While some Russian energy is still clearly making its way to Europe via third countries, Europe is planning ahead, and signing long-term energy trade agreements with alternative partners.

Russia has found other customers for the majority of its energy, circumventing the sanctions placed on it. India and China appear to be the main beneficiaries.

Ultimately, though politically more acceptable, the new sources of energy, especially being imported in the form of liquified natural gas (LNG), is far more expensive. This will maintain much higher energy costs for firms and households for years to come.

Decarbonisation and greenflation

In response to the energy crisis, European politicians are accelerating the transition to renewable energy. Even before the Russia-Ukraine conflict, global governments had recognised the need to make more progress towards net-zero emissions, and had made significant strides in agreeing on various climate change initiatives. These include both initiatives to support the growth of companies specialising in providing clean energy, but also measures that raise the costs of carbon-based energy, so to incentivise a switch. These trends are only likely to accelerate. Meanwhile, companies are also making great efforts, investing considerable resources to change behaviours and clean up supply chains.

Decarbonisation is yet another structural shift which is set to accelerate in the coming years. Although the cost of producing renewable energy is falling sharply, the cost of replacing carbon-based energy will raise energy inflation for many years to come. In turn, the cost of manufacturing goods, transportation, home energy and in many more areas is set to rise, adding to yet further inflation pressures. Not only will there be associated investment costs, but also regulatory costs designed to shift incentives.

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Azad Zangana
Senior European Economist and Strategist


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