CFA conference: The beginning of deglobalization or just a blip?

Populist and nationalist policies on trade and migration, two of the main indicators of a globalized world, are clearly on the rise.

But economists at the CFA Society’s annual investment forum in October came to different conclusions about whether the tariffs announced by U.S. President Donald Trump against China and more protectionist measures in general would bring an end to the era of globalization.

Carl Riccadonna

Bloomberg economist Carl J. Riccadonna said the current “trade war” was more a “trade skirmish” and that globalization was just slowing. Michael Pettis, professor of finance at Peking University’s Guanghua School of Management, in contrast, believes that we have entered a phase of deglobalization.

Riccadonna noted that while globalization is beneficial for an economy as a whole, it has produced both winners and losers. The failure to account for the negative externalities of a globalized economy had led to a public revolt. Most economists, he argued, tended to overestimate the ability of workers to adapt to competitive pressures caused by a globalized economy.

This has resulted in a shift in the labor market. Although unemployment in the U.S. is at a record low, at levels last seen in the days of the draft during the Vietnam War in 1969, the lack of pressure to increase wages suggests a high level of underemployment. This means that the unemployment rate has become an unreliable indicator of slack in the labor market, the Bloomberg economist said.

Nevertheless, Riccadonna does not think the world is entering a period of deglobalization. The so-called trade war only had a fairly benign impact so far, he said, mainly because the volume of affected goods is quite small compared to the size of the economy and China had effectively absorbed the effect of U.S. tariffs by devaluing its currency.

Michael Pettis

Pettis on the other hand quoted Harvard economist Dani Rodrik’s conclusion that most countries face one of two options: either greater global integration or greater control of their domestic economy. Rodrik used to argue that globalization was inevitable but recently changed his mind, stating Trump and events like Brexit had proved households will not accept giving up control of their economy and that globalization needs to be reversed. “I think he is absolutely right,” Pettis said.

Pettis believes that the trade imbalances, decried by President Trump, are less about trade flows than the result of capital flows caused by distortions in other markets.

Pettis argued that most people, and many economists, misinterpret trade imbalances because they stick to an outdated trade model based on assumptions that are no longer valid.

In the past, trade imbalances mainly used to reflect the relative production costs of goods in different countries. If one country was able to produce certain goods cheaper, it would eventually export them to another country, creating a trade imbalance, which was financed with funds going in the opposite direction, generating an equivalent capital imbalance.

Because trade finance once made up 90 percent of capital flows, the model was intuitive and largely correct. But capital flows had grown to such an extent that nowadays investment flows far outweigh trade flows and the dynamics of global trade and investment have made the old trade model obsolete.

A country’s current account, of which the trade account is by far the largest item, is the difference between a country’s total investment and its savings. Those savings are comprised of household and business savings and the fiscal surplus or deficit.

Trade surpluses are therefore closely tied to high savings rates exceeding investment rates. While savings rates are often explained with thrifty consumer behavior, that is not the case, said Pettis. Instead, persistent trade surpluses, like those in China and Germany, were caused by distortions in income distribution that statistically force up savings rates in those economies.

For instance, Germany has on average a higher household savings rate than the U.S. but it has declined slightly over the years, even though Germany’s trade surplus has been growing.

Pettis ascribes the country’s trade surplus to German labor market reforms that began in 2003 and both pushed down wages and increased business profits, while in the process transferring wealth from workers to business owners.

China, Germany and Japan together have among the highest savings rates in the world and account for most of the world’s savings excess not because their households are thrifty but as a result of domestic distortions in income distribution which leaves households with a much lower share of GDP.

According to Pettis, it is the deficient domestic demand in these countries that produces excess savings which must be absorbed by the rest of the world.

The United States is by far the largest recipient of the world’s excess savings. This is not just a result of interest rates, as often assumed, but mainly forced on the U.S. because it has capital markets that are both deep and completely open to foreigners, Pettis said.

For the Beijing-based finance professor, the U.S. capital account surplus is therefore not a reflection of trade flows but caused independently by investors moving capital to the United States. And the low U.S. savings rate is a direct consequence of balance of payments pressures that originate outside of the U.S.

“I think we are at the end of globalization because the existing trade and capital regime that came out of Bretton Woods requires that the U.S. plays a role it can only continue to play at a huge cost,” he said.

The problem can only be resolved by the surplus countries through wealth transfers that increase the household share of GDP and bring down their savings rates compared to investments. This is, however, politically difficult to achieve because in a globalized economy it is likely to hurt the competitiveness of these countries.

In China, where the growth model relied on a suppression of the household share of GDP, it would mean transferring wealth from the elites to ordinary households. And in Germany it requires higher wages and more domestic consumption and investment.

“If you believe that income inequality is the world’s greatest problem because it forces down consumption and forces up excess savings, then the solution is to raise wages and to reduce income inequality,” Pettis said. “But in a globalized economy you cannot do that because you lose competitiveness and you lose out on global trade.”

Instead, the game that everyone has to play in a globalized economy is either lowering wages directly, like Germany did very successfully, or indirectly, by putting up tariffs or depreciating the currency, he noted. “And, of course, we cannot all do it,” he said, because ultimately it leads to a reduction in contribution to global trade in exchange for a bigger share of what is left.

“The system has to change, and I think it will change. Over the next 20 years we will see a reversal.”

Significant income inequality happened before, and it always reverses, he said, either through war, through hyperinflation or through political redistribution, by raising taxes or massive infrastructure investments boom that increase wages.