From Seeking Alpha –
- COVID-19 is accelerating the demise of globalization. That is a good thing.
- We will revert to post-World War II free and fair trade without its obvious abuses.
- COVID-19 is accelerating the deglobalization and the digital revolution.
We will get through this crisis. COVID-19 is bad, but it is not the bubonic plague. Alas, more people will die, but we are likely close to the worst of this scourge.
The coronavirus pandemic, in addition to inflicting vast human suffering, is also drastically changing the world as we know it. Notably, it is accelerating the demise of globalization.
What will that mean? A return to twentieth century-style Depression with hard borders, tariffs and wars? I don’t think so. The post-coronavirus world will more likely be about regionalization and reciprocity. Supranational organizations, from the World Health Organization to the World Trade Organization and even the European Union, have been manifestly useless in this time of crisis. They may not survive.
Globalization Never Was What We Thought it Would Be
Globalization is dying, and that is a good thing. Over the course of recent decades, too many decision-makers sold us a fairy tale made of free markets and happy cultural exchange. In its most naive form, often preached in academia, globalization leads to a wonderful world where countries exchange their best products. South Korea exports electronic consumer goods to France. France, in return, exports prized luxury bags to Korea. Americans buy Italian fashion goods and German cars, while exporting Hollywood movies, social media and rap music. Everybody benefits. The world is a better place for it.
So far so good. But globalization was also supposed to bring emerging economies up to speed with the industrialized world by the mere fact of adopting free markets, which would inevitably lead to democracy.
It all sounded great. Unfortunately, uglier sides of globalization are now being revealed. In many ways, globalization has turned out to be more about exploitation than about democracy and free markets.
Globalization as a process has led to abuses typically associated with unfettered capitalism. To be sustainable, capitalism has always needed a minimum set of rules, with the emphasis on “minimum.” America, arguably the most capitalist country in the world, has antitrust laws, antidumping laws, laws protecting labor, even minimum wages. Within the US, everybody is expected to play by those rules.
However, problems arise in an open global system, when different countries with different rules and different goals try to operate together. Less scrupulous capitalists and governments have indeed been able to get around pesky regulations, even using them to their advantage. The World Trade Organization, the supposed referee, has unfortunately utterly failed to keep harmony.
Take outsourcing, for example. Western companies moved production to China en masse to take advantage of very flexible and cheap labor. Three hundred of the world’s top five hundred companies have facilities in Wuhan alone*. By producing in China, the virtuous Europeans, for example, avoided their own burdensome social laws. In contrast to their home markets, overseas production bases have no high wages, no social taxes and no restrictions on lay-offs. This workaround is reminiscent of the old system of indulgences where one could sin, but pay a priest money and still go to heaven. In its modern version, one can exploit workers (in China) and still be virtuous.
It is not just European companies, of course. All nationalities’ manufacturers occasionally look the other way when convenient. Too often, Western companies do not want to know what the suppliers of the suppliers are doing.
Consumers in the West loved globalization too. Cheap goods imported from low-cost countries kept feeding our addiction to consumption. It is astonishing how we let this play out to such an extreme. Our dependency on imports, especially from China, is now so deep-rooted that it is becoming a threat to our survival as a free society.
In the current health crisis, the urgent need for pharmaceutical products, masks and ventilators has revealed our vulnerability in the starkest terms. Chinese officials’ threats that they might prohibit exports of needed pharmaceutical products in such a moment of need should give us all chills. Communist China is not a friend. We can, and should, trade with China, but always keep in mind our long-term interests and safety.
All that is now well-known and well-documented. But globalization has led to many different forms of exploitation. American consumers, for example, unknowingly subsidize the world’s pharmaceutical research and innovation.
In Europe, healthcare systems are nationalized and market forces do not apply. Governments dictate prices of drugs, which is a convenient way to save money. Pharmaceutical companies must look elsewhere to generate enough profits to finance research & development, so they overcharge where they can. That is why identical drugs often cost ten times more in the US than in Europe.
We know from what happened in the Soviet Union that a closed system lacking market forces produces zero innovation and very poor healthcare. But Europe today, despite sidestepping market forces, has access to advanced drugs at unreal prices, thanks to the wonders of globalization.
This is one example of blatant exploitation of one country’s private sector by another country’s state-owned industry. China has pushed such practices to an art form with nefarious intentions.
The Belt And Road Initiative Is The End Of Global Commerce As We Know It
We once dreamed that globalization would bring free trade and democracy to every corner of the world. Instead, the world is now waking up to the reality of Chairman’s Xi’s ambition to use globalization to destroy free markets. Xi Jinping does not care about fair competition or free markets. He wants the Chinese Communist Party to dominate the world. His Belt and Road Initiative is about control, not cooperation. So is the militarization of the South China Sea.
In the past, Britain’s naval force protected the flow of goods from its colonies to the motherland. So did those of the French, Dutch or Portuguese. That all changed after World War II. American naval dominance filled the vacuum created by European weakness and kept the sea lanes open for everybody.
Today, China is challenging this world order. It is rejecting freedom of navigation by claiming sovereignty over the South China Sea. It is furthermore creating a Chinese strategic network by taking control over ports around the globe, from Sri Lanka to Italy.
It is China’s clear ambition to turn back the clock to a time of imperialistic zones of influence, where each major power controls trade within its own international empire and excludes competition. The Belt and Road Initiative, formerly known as the New Silk Road, is a fancy name for a world of competing empires.
The Invisible Eye
One irony is that we were so in love with the idea of globalization that we let the Chinese Communists use it to impose an Orwellian world on China and its allies. The CCP does not care much for its people. Under Xi, China is replacing the Invisible Hand with the Invisible Eye. He aims to create a world where Western companies are unlikely to thrive in the long run. Whatever our illusions, the coronavirus pandemic is greatly accelerating the awakening of the West.
A Brave New World: The End of Globalization and Life After a Pandemic
Crises tend to change people’s attitudes, sometimes for the better, sometimes not. No one can say for sure what life will look like post COVID-19, but there is little doubt the world will be a very different place.
We argued that the pandemic will be the final nail in the coffin of globalization. But what other impacts might it have? In response to COVID-19 and quarantine, people’s lives have rapidly undergone a number of changes. Of these, some will prove fleeting, but others will endure long after COVID-19 is a memory. And then, perhaps most important of all, we are seeing the acceleration of existing secular trends.
Short-Term Changes in Consumer Behavior
We are all, somehow or other, adjusting to life in confinement. We spend more time online, watching movies or playing video games. We communicate by video conference. With business wear only required for video conference calls, and then only from the waist up, comfort wear is booming.
We are washing our hands more often, which contributes to the increase in demand for hand lotions and other skin care products. Marketing people are observing strong sales of little luxuries like designer hand sanitizers and antibacterial oils, as well as home manicure and pedicure products. In Wuhan, the end of confinement triggered an explosion in demand for skin care, beauty and health products.
Long-Term Changes And Acceleration of Existing Trends
In what may be a long-lived shift, attitudes toward the pharmaceutical industry have changed markedly in recent months. “One lesson from this pandemic is how dependent we are for our survival on an innovative and robust pharmaceutical industry. Maybe we should do more as a country to cultivate it than tear it down”** writes Bret Stephens in The New York Times. There are no atheists in foxholes.
Another palpable change is the emerging desire to return to a more regional economy. Companies, and for that matter countries, must reduce their dependence on China. In some ways, de-globalization is mostly about “de-Chinafication”. Too much of our supply chain is in one country that does not believe in free and fair markets.
We can safely assume most Western companies with production in China are rethinking their supply chain. When the Italian coffee machine maker De’Longhi had to shut down its production in Wuhan, it promptly expanded its other facilities in Romania.
Like De’Longhi, many European companies are thinking of relocating their factories – at least partially – to Central Europe. Likewise, US and Japanese manufacturers are looking to bring production closer to home. Labor cost in Mexico, for example, is already lower than in most parts of China. Wages in Mexico are, on average, below $3.95 per hour vs. $4.50 in China.*** Japan is offering subsidies to their companies to bring back production home.
Businesses from all over the world were drawn to China by the economic boom unleashed following Deng Xiaoping’s late ’80s reforms. From German and Japanese engineering companies to French and Italian fashion icons or American technology behemoths, companies could not resist the lure of the huge and growing Chinese market. But for many, the reality turned out to be different from the dream.
Tariffs and non-tariff barriers have made it difficult to translate sales into profits. Communist China forces foreign companies to set up 50/50 joint ventures with a local partner, which usually proceeds to steal as much expertise as possible. Intellectual property is not protected, and the repatriation of profits is subject to an expensive and tedious bureaucratic process, to name a few hurdles.
After decades of naïve hope that China would eventually morph into a “normal” trading partner, the US has started to push back against these predatory practices. COVID-19 and the Chinese government’s lack of transparency – to put it mildly – is rapidly changing attitudes in other countries as well. America’s trade war with China is likely to intensify and to include many other countries.
China’s exports – the pillar of its economic miracle – are going to be hurt. As a consequence, domestic buying power will suffer and consumption will likely decline. China’s seemingly unstoppable economic miracle has come to an end.
Global brands, from Louis Vuitton (LVMHF) to Volkswagen (VWAGY), will no longer be able to count on the Chinese market for their expansion. Likewise, demand for commodities, driven by China’s explosive economic growth, will slowdown, if not crash. Australia, for example, which accounts for 70% of Chinese imports of iron ore, for example, is facing difficult times ahead.
Another change that is likely to be long-lasting comes from world monetary authorities’ response to crises. QE has led to more QE. Every economic slowdown, let alone a crisis, seems to require a response from central banks. Economic cycles are no longer acceptable in a world of ever-shorter political cycles. Asset inflation has become the panacea for any downturn. Central banks prop up asset prices by buying government bonds, corporate bonds, REITs and even stocks.
A recent Wall Street Journal article wrote about “the central bank that ate Japan”*****. Other major central banks are not far behind. We are panicking into the destruction of free markets, and the long-term consequences will certainly be far-reaching. Are we going to see real inflation? How else could countries pay back governments’ huge debt?
The Mighty Dollar
The profound damage we are doing to our economy with the lockdown and trillions of dollars of stimulus notwithstanding, it is ironic that global dominance of the US currency has been reinforced by the pandemic. No longer is the euro or the renminbi in a position to challenge the mighty dollar.
The European central bank has shown itself incapable of leading in a global crisis. It is becoming clear that until the countries of the EU agree to issue bonds that are jointly guaranteed by its members, the euro will remain subject to a patchwork of competing interests. As for the renminbi, the decoupling of Chinese and American economies has ended its potential as a viable alternative to the dollar. At best, the renminbi could become another Soviet-style rouble used by China and its satellites exclusively.
The Digital Revolution on Steroids
Quarantining has kicked the move toward a digital economy into high gear. Demand for both streaming and video games has exploded. Telemedicine and internet learning have finally gotten off the ground. The desire to avoid physical contact when making purchases has nudged us toward using Apple Pay (AAPL), Google Pay (GOOG, GOOGL) or any NFC (Near Field Communication) payment systems. Other countries like Sweden have been earlier adopters, but fear of contagion is now spurring Americans to catch up.
Working from home already seems more natural to us, even though this may be one of the most profound and difficult societal transformations. Not every culture will make this adjustment easily. Hierarchical and bureaucratic societies will have a hard time. Think of Japan, where employees are not supposed to leave their office before their boss and where the use of e-signatures clashes with the age-old use of physical stamps of personal or company seals on every official document.
Different formulas for buying groceries are being tested worldwide. In Continental Europe, supermarket chains sell groceries online to be picked up in the store. In London, Ocado has spearheaded the home delivery of fresh products within a one-hour window. Recently, a Korean company named Kurly got a $150 million injection from private equity after the success of “dawn delivery” services: order today and get your groceries tomorrow morning at dawn.
The coronavirus has also accelerated point-of-care testing. Several companies have developed sophisticated machines that analyze samples and test for diseases at the doctor’s office. Many of them are getting involved in testing for COVID-19. Now, instead of sending tests to a national laboratory and waiting weeks for the results, doctors will increasingly be able to test their patients in-house and get results within a few hours.
Every severe crisis results in the consolidation of industries. Weak companies get wiped out during hard times. They disappear or get taken over by stronger players.
The End of Globalization and the Aftermath of the Pandemic Will Bring Incredible Changes
Because of COVID-19, we are entering another period of very serious debate about healthcare delivery and how best to invest in research & development. How the different European models have fared during the pandemic will endlessly be compared to ours in the US. Hopefully, we can have a productive debate.
Change in hygiene practices and social behavior will lead to new investment opportunities. Hopefully we’ll still hug each other, but handshakes may become a thing of the past. America’s love affair with cars may be reignited by a new reluctance to use public transportation. Concerns about sharing public space will similarly challenge taxis and businesses like Uber (UBER) and Lyft (LYFT) going forward.
Can the EU survive? If so, what reforms are needed? The European Union was hijacked in recent years by bureaucrats in Brussels. Maybe it needs to go back to Margaret Thatcher and Jacques Delors’ limited ambition of free market union and nothing more?
We have entered a new era of fierce technological competition between superpowers. A race to explore space may be the focus, but this time the US is competing with China, not Russia. As happened with the 1960’s race to the moon, the coming competition may lead to incredible innovations whose potential applications can barely be imagined today.
Many more ramifications will become obvious with time. Carefully monitoring transformations in the world economy and relentlessly seeking out innovative companies that can leverage those changes will bring great investment opportunities.
If there is one lesson we have learned from the experts in this pandemic, it is that computer models are not the way to project the future. Quantitative models or ETFs are not the best way to participate in the new digital revolution as it gathers speed. The best way to capture future opportunities is to build a portfolio of innovative companies one stock at a time.
*Javorcik, B. (April, 2, 2020). Coronavirus Will Change the Way the World Does Business for Good. Financial Times.
** Opinion | The Story of Remdesivir
*** Mexico vs. China Manufacturing Comparison Breakdown | NAPS
**** Public expenditure on medical research 2013-2019 statistics | Statista
***** Opinion | The Central Bank That Ate Japan