Will globalization survive COVID-19?

Yes, but there will be winners and losers

By Massimiliano Castelli, Head of Strategy and Advice, Global Sovereign Markets, Philipp Salman, Director, Strategy and Advice Global Sovereign Markets, UBS Asset Management

Arturo Bris, Professor, Director IMD World Competitiveness Center, Professor of Finance

Globalization, already slowing before the COVID-19 pandemic, will likely take multiple hits in its wake. The pandemic and health emergency measures introduced will lead to a prolonged recession, which will be worse than the one experienced in 2009. But will the impact be strong enough to turn an already ongoing post-Global Financial Crisis (GFC) ‘slowbalization’ into outright deglobalization?

One should always be careful not to extrapolate long-term implications from single big events. We live in a very complex and interconnected world, and some of the long-term implications of massive events such as COVID-19 are very uncertain. What is certain is that—as has been the case with every major crisis in the past—there will be winners and losers. We therefore explore the key drivers of globalization, analyze the impact that COVID-19 might have, and leverage the IMD Country Competitiveness Framework to assess the winners and losers. Long-term investors such as Sovereign Wealth Funds and other sovereign institutions should pay attention to these trends and adjust their portfolios for the post- COVID-19 world.

Slowbalization as a long-term trend

The recent era of hyper-globalization ended with the GFC in 2008-09, and was replaced by the phase we are in now, which The Economist has labelled 'Slowbalization.'¹ Since the GFC, growth in international trade and global capital flows have slowed significantly. In addition, the winds of nationalism started blowing around the world and opposition to migration grew. The China/US relationship deteriorated and the concept of US-China decoupling has gained ground. Protectionism is no longer a taboo and the Washington consensus is no longer dominant around the world.

A decade after the GFC, the global economy is experiencing another severe crisis - the COVID-19 pandemic. Its economic carnage is caused by the restrictive measures taken to slow its spread, which have a negative impact on production and consumption levels. We believe the resulting global recession may possibly be the worst of the post-WWII period. No country – including the majority of EMs which managed relatively better than advanced economies during the GFC – will escape it. China might ultimately still grow in 2020, but after years of buoyant growth, a growth rate of 1% will feel like a recession for this country as well.

The evolving geopolitical situation following the GFC has been an important factor behind the shift from hyper-globalization to ‘Slowbalization’. US-China decoupling, fragmentation in European integration, rising nationalism and protectionism are all associated with the severity of the GFC and its impact on the global economy. Will COVID-19 lead to an acceleration of these trends, pushing the world towards deglobalization?

The recent era of hyper-globalization ended with the Global Financial Crisis (GFC) in 2008-09, replaced by the phase we are in now, which The Economist has labelled 'Slowbalization.'¹ Since the GFC, growth in international trade and global capital flows has slowed significantly. Then the winds of nationalism started blowing around the world and opposition to migration grew. The China/US relationship deteriorated and the concept of US-China decoupling has gained ground. Protectionism is no longer taboo and the Washington consensus is no longer dominant around the world.

A decade after the GFC, the global economy is experiencing another severe crisis -- the COVID-19 pandemic. Its economic carnage is caused by the restrictive measures taken to slow its spread, which all have a negative impact on production and consumption levels. We believe the resulting global recession may possibly be the worst of the post-WWII period. No country – including the majority of EMs which managed relatively better than advanced economies during the GFC – will escape it. China might ultimately still grow in 2020, but after years of buoyant growth, a growth rate of 1% will feel like a recession for this country as well.

The evolving geopolitical situation following the GFC has been an important factor behind the shift from hyperglobalization to slowbalization. US-China decoupling, fragmentation in European integration, rising nationalism and protectionism are all associated with the severity of the GFC and its impact on the global economy. Will COVID-19 lead to an acceleration of these trends, pushing the world towards deglobalization?

The impact of COVID-19 on the key drivers of globalization

COVID-19 is having an impact on the key drivers of globalization. COVID-19 unveiled the risk of complex international value chains — particularly in the health sector — and this is likely to unleash another political response in the years to come.

In the past, technological progress, especially in the areas of transport and communication, has been highly supportive of globalization, especially in a world that was still marked by large regional differences when it comes to labor costs, taxes or regulation. However, in the last two decades, technology has changed the structure of the global economy with a shift from tangible to intangible assets. What we consume as technology has seen a dramatic transition, which is sometimes called a move 'from stuff to fluff.' The lockdowns of 2020 have accelerated the shift towards a more online-oriented world, accelerating the rise of the intangible economy.

According to the World Bank, the COVID-19 global recession will lead to the broadest collapse in per capita incomes since 1870.² We believe the rise in poverty in advanced and emerging markets coupled with the loss of jobs as digitization accelerates will fuel populism in the years to come.

Therefore, driven by technological changes, tariffs and populism, two of the three pillars of globalization are already in decline: free movement of people and goods. The third pillar, the free movement of capital, has been under attack for a while and data points to broadly falling global capital flows.

Deglobalization or evolution towards a different type of globalization?

By looking at how COVID-19 impacts the dynamics of globalization, it is clear that the trends already underway before the crisis will continue and in some cases will be strengthened.

One possible outcome could be increased regionalization of the world. It is yet unclear in what form and under which institutional setup new regional blocks, for example in Asia, could organize. Also, the relations of these blocks to the rest of the world as well as 'within' members could manifest in many different ways, with different outcomes for globalization as a whole.

The COVID-19 pandemic also highlighted to large parts of the global population that there are certain global problems that we are facing together on this planet; a feeling that climate change was never really able to fully mobilize. It also unleashed unprecedented levels of international cooperation and feelings of global unity among private individuals.

The COVID-19 pandemic could have also pushed the globalization of data to the next level so that it can finally claim its rightful place as a key factor of globalization next to people, capital and good and continue carrying globalization forward from this point.

The winners and the losers

Who will benefit the most from deglobalization? The 2020 IMD World Competitiveness rankings have shown that the top-5 most competitive economies are all small.³ The ranking is topped by Singapore, Denmark, Switzerland, Netherlands and Hong Kong.

Two of these economies (Singapore and Hong Kong) are authoritarian regimes, where the implementation of long-term economic strategies is easier. Denmark, Switzerland and Netherlands are European democracies.

We believe successful countries in the coming years will be (1) those with strong institutions that are able to build social consensus around policies; (2) small economies that enjoy the protection of nearby, large markets, be them China or Europe; and (3) countries with healthy finances who can support the domestic economy in the most devastating crisis of the last decades.

Implications for long-term investors

One of the key takeaways of this examination is that the slowdown in globalization we experienced since the GFC will continue post-COVID-19, and possibly at a faster rate in certain strategic sectors (i.e. health and technology). We believe globalization will evolve towards a model that is more regionalized, more focused on services, less capital intensive and less energy intensive.

This will present both significant challenges and opportunities for investors. It might be the right time for sovereign investors to take advantage of recent dislocations to take direct exposure to longer-term secular trends that are being accelerated by COVID-19, especially in the technology and healthcare sectors. The growth centers of future regionalization, in particular in Asia, could offer robust long-term opportunities as the region exhibits many potentially attractive megatrends including population growth, urbanization, and aging demographics.

In a more digital, less globalized and more regionalized world, we think the following trends will therefore be crucial to consider for sovereign institutions in their investment process:

Negative real interest rates will remain a key challenge for long-term investors. Institutions will have to adapt their asset allocation framework to achiever their return targets
EM versus DM: a regional/country approach will be needed to increase exposure to winners. A country-by-country approach going beyond the traditional distinction between EM and DM is required
Move away from traditional benchmarks and embrace investment hemes. Diversification across asset classes is no longer sufficient; diversification across themes and regions can provide higher returns over the long term
Expect higher public debt and higher taxation: This is going to impact countries and corporates in different ways depending on the fiscal sustainability of each country
The trend towards sustainability will be strengthened and this is in natural alignment with the objectives of long-term investors and in particular sovereign investors that want to lead by example.

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¹"The Economist asks: Is this the era of slowbalization?" The Economist 24 January 2019.
²World Bank. Global Economic Prospects, June 2020.
³IMD World Competitiveness Center. Data as of December 2019.

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