The countries set to benefit from the globalisation reset

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[00:00:07.930] - David Brett

Welcome to the Investor Download the podcast about the themes driving markets and the economy now and in the future. I'm your host David Brett. At the turn of the millennium, the global economy was soaring, growing at 8% a year. It was good times for businesses and consumers. The catalyst was China opening up its economy and joining the World Trade Organisation, which marked a significant shift in the way multinational organisations worked and global trade operated.

[00:00:47.490] - David Rees

So we saw a long period, particularly after China joined the WTO, which really turbocharged this shift in manufacturing production located in Asia.

[00:00:58.230] - David Brett

That's David Rees, Senior Emerging Markets Economist at Schroders.

[00:01:02.600] - David Rees

We've seen a shift from manufacturing in the west to China predominantly, but other emerging markets as well, where companies have been looking for cheap labour as a way to bring down the cost of production to widen their margins.

[00:01:21.450] - David Brett

However, the good times for now appear to be over.

[00:01:26.570] - News clips

International finances on the precipice. IMF chief Kristalina Georgieva says the global economy is on pace for the weakest growth since 1990. After three decades of mostly steady paced growth, global economic growth is now hitting a speed limit. On Wednesday, the World Bank released a new report that warns of global GDP growth shrinking to 2.2% annually between now and 2030.

[00:01:51.520] - David Brett

And for the first time in decades, the global economy is going through a significant reset.

[00:01:57.790] - Andrew Rymer

And in a nutshell we're thinking about this is a rewiring of global manufacturing supply chain.

[00:02:04.590] - David Brett

That's Andrew Rymer, Senior Strategist at Schroders.

[00:02:08.340] - Andrew Rymer

You might have heard the terms near shoring, onshoring, reshoring, reglobalization, slobilization. There are a range of terms out there. Ultimately what these are all referring to is some form of supply chain diversification or reorientation, one might say.

[00:02:26.560] - David Brett

So in this show, along with David and Andrew, we'll be discussing the globalisation reset and in particular what it means in terms of which economies and which markets are set to benefit. But before that, we'll discuss what's driving the reset and the evidence for it.

[00:02:44.710] - Announcer

On Apple podcasts, Spotify, or wherever you get your podcasts. You're listening to the Investor Download.

[00:02:52.150] - David Brett

Back in 1980, China looked markedly different to what it does today. The country was still recovering from the economic and social upheaval of the Cultural Revolution. Its economy was relatively insular, focused on agriculture and heavy industry, including mining and steel production. China's gross domestic product at the time was around $305 billion, compared with $2.8 trillion for the US, according to the World Bank. But things were about to change.

[00:03:26.850] - News clips

The death of Mao Zedong in 1976 brought with it radical changes for the Chinese Communist Party and the nation. When Deng Xiaoping became a key player in China's leadership in 1978, he embarked on a reform initiative aimed at opening up the economically and politically isolated People's Republic of China.

[00:03:48.830] - David Brett

Under leadership of Deng Xiaoping, a series of economic reforms aimed at modernising China's economy and integrating it into the global economy were introduced. Their effects would transform the fortunes of China's economy and supercharge global economic growth.

[00:04:08.340] - Andrew Rymer

So if you think back to this period of globalisation companies at the time, the sort of driver of the globalisation was multinational companies looking to lower costs and become more efficient and that led them to shift production across border so into other geographies. So this was really that they were attracted to large pools of lower cost labour.

[00:04:39.520] - David Brett

The cost of manufacturing wages in China at the time was around forty cents per hour. Compare that with the average across the G seven of $17 per hour and you could see why multinational companies were keen to move production to China.

[00:04:54.600] - David Rees

So there were huge savings there that allowed pretty much led to global goods deflation actually for quite a long period. So if you think about that run through the early 2000s into the global financial crisis, economy activity was booming, but actually inflation was quite low and you had this massive goods deflation which allowed people, even if there wasn't particularly strong wage growth, they could buy more stuff with the money that they had.

[00:05:20.680] - David Brett

When China joined the World Trade Organisation in 2001, the impact on globalisation was even more significant.

[00:05:27.950] - News clips

In accordance with the decision making procedures under Article Nine and Twelve of the World Trade Organisation agreement agreed in November 95, WT/L/93 to adopt the draft decision on the accession of the People's Republic of China. The Minister's Ministerial Conference so agrees.

[00:06:00.860] - News clips

By adding China to the WTO, we strengthen the organisation by further integrating China's 1.2 billion people and $1 trillion economy into the world market network.

[00:06:12.930] - David Brett

As well as increased trade and rerouting of global supply chains, it increased competition and significantly shifted economic power from developed countries to emerging markets. The opening up of China also turboboosted the global working age population. Back in the early 1980s, the global working age population was about 700 million people. By 2010, nine years after China joined the WTO, the global working age population was more than 2 billion.

[00:06:46.210] - David Rees

So that was obviously good for sales volumes of multinational companies as well, and that they were also able to then tap into growth markets like China for the future. Because not only could you set up shop in China to reduce your cost of production, but you also then got access to a huge growth market for the long term. So it was kind of a win win, I suppose for multinationals at the time.

[00:07:08.760] - David Brett

By 2008, China's GDP had grown to be the third largest in the world. However, the financial crisis would prove to be a spanner in the works for global trade, with many countries implementing protectionist measures to shield their economies from the effects of the crisis. Eight years later, President Donald Trump implemented a number of policies, including tariffs and technology restrictions.

[00:07:35.250] - News clips

President Trump is escalating his trade showdown with China. Yeah. President Donald Trump just announced that he's imposing 10% tariffs on $200 billion worth of Chinese goods. The US China trade tensions further heating up as another tit for tat tariff looms between the two economic giants. China expresses strong opposition against US president Donald Trump's latest announcement Washington will impose more tariffs on Chinese imports.

[00:08:02.750] - David Brett

The die had been cast, but an even bigger crisis would hit globalisation.

[00:08:07.830] - News clips

We have a new name for the coronavirus. The World Health Organisation has officially called it COVID-19. Chinese businesses are warning of the severe impact of Shanghai's prolonged lockdown. What we're seeing now is that there's a lot of goods that are just stuck in China they can't get out. Shanghai and Yantian are two of the most largest important ports. Yantian has 25% of UX exports, Shenzhen 50%. And then when you're looking at Shanghai, they are 25%.

[00:08:41.060] - Andrew Rymer

There are two factors driving multinationals to reassess their global supply chains. The first really is just diversification. The COVID pandemic highlighted the risks of concentration and you saw huge disruption, dislocation and bottlenecks in supply chains for several years through the pandemic. And this was a reminder, served as a reminder to multinationals of having sort of all their eggs in one basket, or at least being insufficiently diversified. And we talked about in the 90s, this driver of globalisation being focused or led by a focus on efficiency and cost, whereas today the focus is increasingly on resilience and reliability supply chains. And there's a second factor which sort of emphasises some of the points we've already discussed, which is just [00:09:41.210] geopolitics. Geopolitical tensions between the US and China predate the pandemic by several years, but have continued to escalate.

[00:09:52.980] - David Brett

Yet despite these challenges and policies and talk of a globalisation reset, China's economy has continued to grow. It was worth nearly $15 trillion by 2020. And macro numbers show that 2020 was an all time record year for world trade, an all time record year for Chinese exports and an all time record year for US China trade.

[00:10:15.180] - David Rees

It's a bit funny, right, because obviously nominal numbers rise over time and we've been through a burst of inflation with goods prices going up. So that's distorted. If you look at it as a share of China's GDP, China's exports to the US, they kind of peaked out around ten years ago. If you look at it from the US side, it's a similar kind of period. So in nominal terms, it's rising. The numbers will keep rising over time, but as a share of GDP, things have at least stabilised after a rapid period of growth.

[00:10:45.350] - David Brett

So what evidence is there of this globalisation reset?

[00:10:49.250] - David Rees

I mean, this is the rub right because it's so early, the story seems to hang true. So if you look at earning transcripts from certainly US or multinational companies, there's been a huge pickup companies talking about reshoring, et cetera. We've seen anecdotal evidence of, particularly in, say, the semi sector, where companies are facing sanctions, announcements of investments in the US, announcements of investments in Europe, et cetera. Moving away to some degree from Asia, of course, partly because of geopolitics, partly because of massive tax incentives, et cetera they're receiving. If we talk to our credit, analysts say Latin America real estate, commercial real estate in Mexico along the border, is booked out. You've got capacity pressures, so it does seem like something's happening, but it's going to be slow moving. And so to see it in the data is going to be a while, because you're going to be looking for things like FDI flows, increase in construction of real estate, commercial real estate, increase in manufacturing, [00:11:49.800] output, export, but it's going to be slow moving. So certainly the early indications are there and now we're looking for the follow through.

[00:11:56.380] - David Brett

So if you believe in the globalisation reset and the world economy is beginning to shift, if you're an investor or a multinational company looking to take advantage of it, it'll be good to know which economies might benefit from the reset that's coming up in part two.

[00:12:12.940] - Announcer

Get in touch with us by email at schroderspodcasts@schroders.com or visit our website, schroders.com/theinvestordownload.

[00:12:23.700] - David Brett

So recently, Andrew and David ran the numbers.

[00:12:27.230] - Andrew Rymer

To think about this we put together a scorecard ranking to try and assess which might be the most attractive economies for multinationals thinking about this theme.

[00:12:37.770] - David Brett

Countries were given a ranking based on four factors businesses, freedom or how open the economy was for business. Growth of total factor productivity, which is the growth in output that's not explained by the growth in inputs such as labour and capital. And that was between 2015 and 2019. They looked at growth per capita as a share of US GDP, which was used as a proxy for wages and the estimated working age population by 2028. Now, there are caveats, so I would urge you to seek out the full article at schroders.com/insights or search globalisation reset: which economies and markets stand to benefit? We'll also put a link in the show notes. Anyway, the economy set to benefit the most is.

[00:13:25.970] - Andrew Rymer

Now the top ranking economy was India, followed by Vietnam. Now, which factors were supportive of their ranking? Working age population by 2028 for both. But for India it will have the is forecast to have the largest working age population in the world and ranks top on that factor.

[00:13:49.410] - David Brett

India has been mentioned as a burgeoning economy for the best part of the last 20 years. But what makes it so different this time that it can take advantage of the global reset?

[00:14:00.590] - David Rees

Well, this is the big question, isn't it? Because India has had these basic ingredients for a long time, a long, long time. And probably what's got in the way of India seizing grasping the nettle and becoming a manufacturing hub? I guess one is that China was being so successful. And why was China being successful? Is the degrees of the policy making. So there's work to do, I think, with the Modi government, the promising thing is that the government, even though Modi has been in power a long time, he's maintained at least some momentum of reform, which is unusual. Usually when someone's been in power a long time, reforms dry up and you concentrate more on staying in power. So there has been some momentum, but I guess what the key difference this time is that there's also a stick for companies to look for new locations because of the decoupling and geopolitical tensions, et cetera. India, on balance, being more of an ally of the West, I guess, these days, than China, so there is more of an incentive for companies to look for a new location.

[00:14:59.430] - David Brett

Emerging economies such as Vietnam, Thailand and Bangladesh, perhaps unsurprisingly, given their cheap labour and willingness to do business with the West, dominated the top 20. But there were a few surprises.

[00:15:11.710] - David Rees

I guess the biggest surprise came from developed markets, that even though a lot of the focus was on wage costs, productivity and working age populations, there are actually quite a few developed markets still scored quite highly.

[00:15:26.080] - David Brett

Germany, for instance, ranked 9th and the US came in 11th.

[00:15:30.510] - David Rees

So that's already a slight surprise. And I guess that to some degree supports the notion that at least some of this diversification will come through reshoring. Probably, it won't be labour intensive, it will be fairly automated use of robotics that will help with productivity, sort of puzzles in some of these economies. So I guess that was one surprise. I guess the other surprise, not necessarily a surprise, but obviously we have to sort of acknowledge that China still ranks very highly in all of this.

[00:15:59.510] - David Brett

Despite the talk of companies moving their supply chains away from China, the country remains a huge draw for multinationals, given its manufacturing prowess, which poses a conundrum for businesses.

[00:16:12.450] - David Rees

So this, again, this is a pretty big question. It's quite a big unknown because in theory, you could imagine a world where companies just upsticks from China and move to India, or move to Century, or move to Mexico, build a new plant and carry on as they were. Probably things are going to be a little bit more difficult than that, because if you decide that you're going to leave China, there's a risk in the near term that the Chinese government make life quite difficult for you. You could go onto an export ban list, but you're also probably, more importantly, or just as importantly, going to lose access to the Chinese market in the future, potentially. And for all of the negative talk about China, it is still a huge economy, it is still one that's growing relatively quickly. That growth is going to come down in time, but it's going to be an important market in the future that companies won't want to lose access to. So when we did the work, certainly when I did some work a while back on this, it kind of stood out to me that probably you're going to end up with companies either running [00:17:12.860] regionalized supply chains or a China plus One strategy to maintain access to the China market.

[00:17:19.500] - David Rees

Actually, to maintain access to the fact that China's manufacturing sector is supremely better than anywhere else at the moment. So you keep one foot in there, but then also diversify into another area.

[00:17:30.450] - David Brett

So we know which economies might benefit from this globalisation reset. But does that mean their stock markets will do too? That's coming up in the final part of the show.

[00:17:46.630] - David Brett

So the natural assumption might be that just because a country's economy is doing well, then the stock market will do well too. But that's not always the case.

[00:17:56.800] - Andrew Rymer

Yeah, I think there's this common belief that strong GDP growth flows through to strong equity market returns. That's not always guaranteed, and there are a few reasons for that. GDP as a measurement can suffer from issues in terms of data quality and measurement. Corporate profits as a share of GDP can fluctuate through time. Equity issuance can dilute earnings per share growth. Then valuations today may already reflect the opportunity that this theme has potential to deliver.

[00:18:39.970] - David Rees

But India, for example. We've found India to be the most likely beneficiary of all of this. But of course, the stock market is always quite expensive. There's a premium in there for future growth.

[00:18:50.700] - Andrew Rymer

And then the sector makeup of the economy and the equity market can differ. So the opportunity to invest in related sectors may not always be present in all of these economies.

[00:19:07.030] - David Brett

Take the UK, for example, particularly the FTSE 100. Despite the economy having its travails over the last few years, the UK's blue chip index remains near record highs. In part, that's to do with the fact that nearly two thirds of earnings of companies listed on the FTSE 100 come from overseas. So if the success of a country's economy as a result of the reset doesn't guarantee the success of its stock market, how do investors capture these opportunities?

[00:19:36.450] - Andrew Rymer

I mean, the first thing to say is that this is a long term multi year theme and there's significant nuance. The majority of economies and markets that we flag in our research are as beneficiaries are in emerging markets. So you would think that for an active emerging market manager, there ought to be the opportunity to capture this theme, at least in theory, because they can deploy their approach to analyse and to filter out the sectors and stocks where this theme may be most prevalent. But it's not just in emerging markets. There are some developed markets that rank highly and I think it might be, I would sort of make a difference, a contrast between... We talked earlier about this period of the 90s when companies were attracted to some of these emerging markets because of their higher pools of [00:20:36.570] labour which was also lower cost. Whereas today you may find that while that stay still may be applicable for some of the opportunities in emerging markets in developed it might be that these are more smart manufacturing focused.

[00:20:56.130] - David Brett

Well that was a show, we very much hope you enjoyed it. If you want to find out more please head to Schroders.com/insights and we're endeavouring to record as many of these shows in the studio on video. And if you want to watch them in their full unabridged version then go to Schroder's YouTube channel. If you want to get in touch with us it's schroderspodcasts@schroders.com and remember you can listen, subscribe and review the Investor Download wherever you get your podcast. New shows drop every Thursday at 05:00 p.m. UK time. But above all keep safe and go well. Cheers.

[00:21:31.840] - Announcer

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