Deglobalization & the Developing World
What happens if the U.S. pulls back?
In this week’s Macro Musings edition:
“How Asia Works” … and can the miracle work elsewhere?
Deglobalization: what happens if the American’s decide to go home?
Possible paths forward for the emerging world
Digitization & Decoupling: the world of atoms vs. the internet
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Will the “East Asian” Model Work for the Rest?
Globalization has been very good for most of the world. While the US middle class is unsurprisingly disenchanted as wages have stagnated for the better part of five decades… elsewhere, the global order crafted by the American’s has been a rising tide for billions.
The East Asian growth story is the most pronounced example - Japan, Korea, Taiwan, and China - all taking the export-oriented, manufacturing-led path to prosperity. Despite academic titans (read Nobel economists like J. Stiglitz) recently making the case this gate is closing fast1, Noah Smith outlines a series of non-East Asian nations - from Bangladesh to Poland, from Turkey to the Philippines - largely using the tried and true “Studwell” model to kickstart per capita GDP growth through industrial policy:
For the unfamiliar, Joe Studwell is a well-known author focusing East Asian development - including his most famous book “How Asia Works”.
As the duo highlight, most developing economy success stories revolve around two themes:
Digging commodities out of the ground and selling them
Export-oriented, manufacturing-led growth - involving tech transfer, learning, and higher value-add inputs over time
The later is more sustainable and has generally been the path of most developing success stories since the end of WWII: most dramatically demonstrated by the Asian Tigers.
In short, Studwell advocates for domestic industrial policy - typically incentives and flavors of local protectionism - to get choice manufacturing sectors off the ground before subjecting local champions to international “export-discipline”. By competing in global markets, previously subsidized businesses must become world class to survive - benefitting from tech and knowledge transfer to move up the value-add manufacturing ladder over time.
In this agriculture → manufacturing → services economic transition, often step two is the most evasive.
Noah’s exploits reveal a common theme - from automotive advances in Turkey to integrated circuits in the Philippines to garment manufacturing in Bangladesh, gaining a foothold in a light manufacturing industry is still THE path to sustained, high GDP per capita increases over time.
At least for now…
However, this model has largely been dependent on global supply chains and a relatively stable American-dominated World Order. With America serving as global hegemon essentially since 1945, the globe has opened up dramatically - ever more complex supply chains for every type of good: from blue jeans to sunglasses to essentials like food and energy - not to mention modern miracles like the iPhone…
Source: Visual Capitalist
From a Benthamite Utilitarian perspective (think Spock), this has been an amazing trade. While the developed west sacrificed blue-collar jobs and industrial capacity, consumers got access to ever cheaper goods, the globe has seen relative peace, and much of the developing world was pulled out of poverty - one pair of black Nikes or microwave components at a time.
However, U.S. and European politicians are not accountable to a global polity. They are responsible to their respective citizens. And their citizens have had enough.
U.S. growth has stagnated (3.7% from 1945 → 1980 vs. just 2.7% from 1980 → 2017)
Incomes in China have increased 10x since 1980 while US median incomes have barely budged (adjusted for inflation)
Productivity and income to labor have decoupled - the difference stripped from the western middle classes and now accruing to the 1% on the coasts and off-shore unskilled labor
In a democratic society, this model is becoming difficult to sustain. The neoliberalism frenzy after the collapse of the Soviet Union bringing American values and unfettered free-trade to global markets is significantly less popular in the U.S. now than the go-go years of the 90s.
The arrangement paid high dividends globally, but has not satisfied the key constituent on which it depended: the median American voter.
Trump’s election was emblematic of the underlying shift in sentiment.
If the median American voter ultimately decides this system - with unfettered free markets putting pressure on unskilled domestic labor, subsidizing military expenditures for Europeans, paying taxes to patrol the world’s oceans, and a shale-revolution at home which makes securing energy needs abroad almost a non-issue - is less appealing, then… the rest of the globe is in for an adjustment period.
Life in the “Post-Order” Order
In his latest book, geopolitical strategist Peter Zeihan makes a compelling case that life - for the vast majority of people - is about to get a lot worse. The tech driven utopia we were promised; the “singularity” in all its glory, will have to wait. The current integrated, global economic system is heavily dependent on an effective “monopoly of violence” by the hegemon and the hegemon appears increasingly disinterested in walking the beat internationally.
This presents a series of challenges.
Most countries are net importers of food, energy, and essential technical components. Most consumers have grown accustomed to prices where any input can be sourced from the cheapest location and combined with other cheap inputs from the optimal location, exported to virtually any end market. It wasn’t always like this. It was never like this.
All supply chains have been optimized for a world of efficiency and minimal risks. The U.S. security blanket enforces free trade, tankers and ports have grown to host large economies of scale, and insurance costs dwindled considerably.
Globalization has (partially by design):
made countries dependent on global supply chains for essential goods and
provided disinflationary pricing pressure for consumers and investments to ever cheaper locations - setting them on an enriched trajectory
In a world without a global hegemon enforcing those rules, uncertainty increases dramatically. Energy importers in East Asia like China, Japan, and Korea start to look nervously at their extended supply chains stretching into the Gulf. Europe is already seeing the ramifications of over-dependence on Russian pipelines. Semiconductor value chains are looking more fragile. Many supply chains requiring strategic inputs between the U.S. and China are at risk of decoupling.
In a post-Covid world, the focus shifts from “efficiency at all costs” to “resiliency, redundancy and reduction of risks” - in particular, the resurrection of previously dormant geopolitical risks.
The recent CHIPS act in the U.S. (authorizing US$200b in incentives for domestic semiconductor development) is a pretty blatant admission the U.S. is not excited about having significant fabrication capacity off of the coast of its largest geopolitical rival (Taiwan / TSMC and to a lessor extent Korea / Samsung). The geopolitical risks outweigh the efficiency.
Things are going to change. I do not agree with many of Zeihan’s more extreme claims - like the inevitable near-term collapse of the CCP in China based on mounting pressures from a loss of access to cheap capital, challenging demographics, dependency on global supply chains for essential inputs like food and energy, and a decoupling from U.S. technological expertise. However, East Asia has arguably been the biggest beneficiary of the U.S. led order and when those underlying constants suddenly become variables, the footing will get more treacherous.
What does this mean for the emerging world?
Developing amidst Deglobalization
Unfortunately, it likely means challenges ahead. The traditional path of manufacturing-led exports to higher living standards is likely to take a substantial hit. Where possible, supply chains will begin to relocate closer to end-market shores or within “ally” countries. The search for ever-cheaper labor will be reduced by investments in automation and redundancy. One global, integrated market may fray towards more regional density meaning less China-esk growth stories lower in the rung.
The traditional path: industrial policy focused on building capabilities in “light manufacturing” and working up the value-chain will begin to narrow as the costs to secure inputs from distant shores increase and manufacturing becomes less labor intensive overall.
More machines to build the machines which build the machines… ad infinitum.
Don’t believe me? Please take a look inside a Tesla factory…
There will be clear near-to-medium term tailwinds to countries like Vietnam or Indonesia which can play substitute for certain multinationals looking to diversify supply chains away from China. Arguably, underperformers like Mexico which got dominated by Chinese labor competition after the entry of China into the World Trade Organization in 2001 should see a material boost.
However, on the whole, a reduction in globalization will spell trouble for much of the emerging world and the traditional path to prosperity will come under fire.
The biggest question is… what comes next?
Is there a path which skips the world of atoms and manufacturing altogether and dives straight into services? India is giving it a go, but the results are very much.. tbd.
Digitization & Decoupling
If the world of atoms goes into retreat, many historically viable job opportunities for a young kid in Anhui, China or Da Nang, Vietnam are likely to follow suit. My own hypothesis is many youths in the emerging world will go digital. The “dreary” premature digitization or deindustrialization thesis writ large; a Ready Player One dystopia becoming more likely by the day.
Instead of building components for integrated circuits, maybe the 21-year-old in the outskirts of Manila will make videos on KUMU or join the “Play-2-Earn” revolution which blossomed in the Philippines during 20212.
I’m skeptical these digital services will have what it takes to create mass prosperity in the same vein as the “Studwell” model. After all, the internet is subject to power laws and gladiatorially cut-throat competition as well. The subsequent value-capture, growth in wages, learning, tech transfer, tax revenues, investments in healthcare and human capital, and agglomeration effects are unlikely to be near as transformational. However, there might not be much of a choice.
Web3 is far from a panacea, but will likely provide opportunities for the more technically savvy. As traditional opportunities dry up, Indians, Filipinos, and Turks will turn to the new frontier: the internet.
And the internet is getting even more interesting.
Instead of simple information exchange, users can now exchange and store value, natively, in encrypted peer-to-peer networks online. The vision is to build digitally-native economies based not on (in many jurisdictions) the arbitrary rule of law or American security guarantees, but on math and code. “Smart contracts” are essentially commercial agreements in the cloud enforced not men with guns, but by code. Globalization (in a notably reduced form) rekindled.
Maybe the post-Cold War American ideology will win out after all, just not in the way Reagan or Clinton envisioned. In many ways, the next version of the internet provides many of America’s core values exported through the medium of 1s and 0s: liberalism, free-markets, free speech, and property rights adopted from the bottom up (democratic) - in cyber space.
Global markets are cutthroat. They are ruthlessly meritocratic. The spoils will not be enjoyed equally. We should be realistic. Just as there is no international body which taxes U.S. citizens for infrastructure spending in India, we should not expect welfare transfers in the next generation of cyberspace. Like the global economy, the rewards will not be distributed equally.
However, the recent increases in living standards for younger generations in the emerging world over the past four decades may become more suspect. New paths must be explored.
In a world where the U.S. retreats, globalization begins to unwind, geopolitical tensions rise, prices increase, supply chains re-shore, and the traditional manufacturing-led path to prosperity begins to dim, my bet is many will go digital.
Free exchange, open to anyone with a signal, competing by the same rules, with plenty of whitespace. The new frontier.
I don’t think it will be enough, but its one of the few bright spots if a material reversal in globalization begins to materialize. The last 77 years have been miraculous by historical standards. I sincerely hope we look back on it as the new standard and not the exception.
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Primary argument is based on the automation of manufacturing requiring a lower number of workers and labor inputs; secondarily reshoring amidst COVID and greater geopolitical uncertainty
Hit game “Axie Infinity” essentially provided a platform for wage-labor arbitrage, mining digital goods with substantially inflated prices. The game has since come back down to earth, but the model holds potential as an area of new “digital labor” of which is bound to recur in many forms.