The hyper-globalization that has dominated the global economy over the past 30 years is giving way to an era of regionalization.
How regionalization plays outThe decoupling of the American, European and Japanese economies from China is resulting in bifurcation of trade relations into two tracks: the goods economy and the services economy, with technology at the center of it all. The trade track: On the first track—the goods track—trade, capital and technology flows are being heavily influenced by security concerns among G-7 nations as they embrace the return of industrial policy . Consider the recent restrictions on transfers of technology, including sophisticated microchips, placed by the United States on China. A primary goal of these restrictions is to nurture nationally important industries and to protect a manufacturing labor base. Some businesses will come out as winners in this new landscape. But for consumers, these policies will result in generally higher prices as firms shift from low-cost manufacturing centers in China. This, in plain English, is what Treasury Secretary Janet Yellen means when she says American firms and their major trading partners should consider “friendshoring,” or relocating production to countries that fall within the U.S. economic sphere of influence. Such a shift will almost certainly result in more North American investment by foreign firms that want access to wealthy U.S. consumers. It will also result in more investment in places like India and Vietnam for American firms that want access to the dynamic Asian economic region. Apple’s recent announcement that it would begin sourcing sophisticated chips from North America is the signal that many global firms have been waiting for to begin reducing their exposure to China. The services track: On the second track—services— policymakers are taking a different approach. For the most part, the service sector will continue with fewer trade restrictions, just as it has over the past three decades. If anything, that approach will accelerate. Scott Lincicome at the Cato Institute finds that even as the global trade of goods peaked before the financial crisis, the digitization of services has enabled increased global trade of services. Digital globalization offers tremendous potential for rural communities, health care, small businesses, manufacturing and especially entertainment, all of which benefit from greater access to international markets as broadband proliferates. It is natural for economies to help push this along as they move from providing basic goods to meeting the increased demand for services that results when incomes rise and consumer choice expands. In short, it is natural that firms and households will want to move up the value chain as the global digital transformation of commerce advances. This trend is happening in advanced economies all over the world, wherever internet access is commonplace. Expect it to become the norm in developing economies as well. In the meantime, we are nowhere near the end of identifying all the implications of digital trade or managing its governance. The competition for geopolitical security for the most part will not alter the digital transformation of the service sector. The ideas behind that evolution are fungible, easily transferable and not amenable to trade restrictions. It is far easier to put constraints on the transfer of existing or older technology, as well as physical goods, than it is to stop the movement of ideas. Recall how quickly the American nuclear monopoly melted after 1945. But there will be constraints outside of those economies that remain on good terms with Washington, Brussels, London and Tokyo. For this reason, the flow of capital is also going to be constrained.
Stagnating growthWhen an economy experiences a series of shocks, it often ends up with less capacity to produce as firms exit existing patterns of production and investment shifts to more profitable and/or less risky areas of the economy. The post-pandemic era will be no different, and we expect stagnant growth over the next 24 to 36 months. Growth in the U.S. economy is a function of productivity and labor force expansion. During the past decade, annual economic growth overall was generally 2%, driven by growth of roughly 1.5% in productivity and 0.5% in the size of the labor force. The American labor force grew by an average of 1% annually during the postwar period. That increase was as reliable as the sun rising in the morning and setting in the evening. Today that is not the case, and labor force growth has settled in below the recent 0.5% trend. Now, when rising costs driven by the shift of production away from China are added to this slowing productivity and labor force growth, the result will be a slower overall pace of growth.
Today, the growth of the labor supply is not sufficient to meet demand.