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    • Business in the New Era of Globalization


    As recently as a decade ago, most business leaders believed that the world was becoming “flat” and that global companies, unconstrained by national borders, would soon dominate the world economy.

    Today, those exaggerated claims have been proven wrong.

    In fact, we hear cries for a massive pullback from globalization in the face of new protectionist pressures. And we believe those proclamations will prove as wrong as those of 1990s globalists.

    Admittedly, some of the euphoria about globalization has shifted to gloom, especially in the United States. But globalization has yet to experience a serious reversal. And even if it did, it would be a mistake to talk about the end of globalization.

    A full-scale retreat from globalization or an overreliance on localization would hamper companies’ ability to create value across borders and distance using the rich array of globalization strategies that are still effective?and which will continue to work well into the future. Today’s turmoil calls for multinationals to subtly rework strategies, organizational structures, and approaches to societal engagement.

    To see how globalization is actually evolving, consider the DHL Global Connectedness Index, which tracks international flows of trade, capital, information, and people. The two index components of greatest business interest are merchandise trade and foreign direct investment; these were hit hard during the financial crisis, but neither has suffered a similar decline since then. Trade experienced a large drop-off in 2015, but that was almost entirely a price effect, driven by plunging commodity prices and the rising value of the U.S. dollar. Updated data suggests that in 2016 foreign direct investment dipped, in part because of the U.S. crackdown on tax inversions. Complete data for 2016 is not yet available, but factoring in people and information flows will probably reinforce the conclusion that globalization has stayed flat or even increased.

    What has nose-dived, however, is the public sentiment in the United States and other advanced economies. An analysis of media mentions for the term “globalization” across several major newspapers?including the Wall Street Journal, the New York Times, and the Washington Post in the U.S. and the Times of London, the Guardian, and the Financial Times in the UK?reveals a marked souring of sentiment, with scores plummeting in 2016.

    The contrast be-tween the mixed-to-positive data on actual international flows and the sharply negative swing in the sentiment about globalization may be rooted, ironically, in the tendency of even experienced executives to greatly overestimate the intensity of international business flows relative to domestic activity. In other words, people tend to believe the world is a lot more globalized than it actually is. Globalization expert and NYU professor, Pankaj Ghemawat, refers to this mismatch as “globaloney.”1

    Ghemawat sums up the realities of globalization in two so-called “laws:

    - The first is the “law of semiglobalization,” which says, “International business activity, while significant, is much less intense than domestic activity.”

    - The second law is called “the law of distance” and it says, “International interactions are dampened by distance along cultural, administrative, geographic, and, often, economic dimensions.”

    These laws are still operative and will remain so in the years ahead. And they imply that any protectionist wave is likely to be much less disruptive than it first appears.

    The law of semiglobalization affords an important insight, as well: Addressing much of our current malaise?including but not confined to antiglobalization sentiment?requires domestic policy changes rather than the closing of borders. For example, one of the principal complaints about globalization today is the sense that it has contributed to rising income inequality and that a large swath of the population in advanced economies has been “left behind.” In the U.S., income inequality has recently risen to levels last seen in the 1920s, and other countries, especially developed ones, have registered similar, if less dramatic, increases. Meanwhile, corporate profits are running close to their highest historical levels.

    The widespread perception that globalization is primarily responsible for this situation is empirically implausible. Most research suggests that technological progress has been a far bigger contributor to inequality than globalization. Corroboration is supplied by real-world examples: The Netherlands has preserved a flatter income distribution despite having a trade-to-GDP ratio six times that of the United States. Therefore, it seems odd to blame globalization for the rising level of inequality in the U.S. economy. And even if one is inclined to point fingers at globalization, it is clear that protectionism is a much more expensive solution than government safety nets and job-training programs. Furthermore, closing borders does nothing to prepare a country to deal with the automation-related threats to jobs that dominate the debate about the future of work.

    Some threats, such as the risks associated with international imbalances in trade and investment, are indeed real and significant. Most others, however, turn out to be overblown in relation to actual levels of international integration.

    In the new era, which is likely to be less friendly to globalization than the past four decades, some multinational firms may choose to pull back from globalization and refocus on their home markets. On the other hand, if a company chooses to continue doing business in a variety of markets, it needs to figure out whether to change its globalization strategy.

    What are the choices?

    - ADAPTATION boosts revenues and market share by tailoring products and services to suit local tastes and needs.

    - AGGREGATION delivers economies of scale by expanding operations into regional or global markets.

    - ARBITRAGE exploits differences in labor costs, tax regimes, and other factors between national and regional markets.

    According to Ghemawat, companies use adaptation when they want to adjust to cross-country differences in order to be locally responsive. They use aggregation to achieve economies of scale and scope that extend across national borders. And arbitrage strategies are used to exploit differences, such as low labor costs in one country or better tax incentives in another.

    What’s the bottom line? The laws of economics have not changed. Free and fair trade makes everyone better off. But powerful trends like the Death of Distance, the North American Energy Revolution, super-abundant capital, the rise of the global middle class, and the graying planet are rapidly changing how each industry, country, and firm makes the most of that proposition. The result will be new trade agreements, new capital investments, and new business strategies. Those who fail to adapt, will suffer the consequences.

    Given this trend, we offer the following forecasts for your consideration:

    First, global trade will not dry up in the 2020s and for the most part, the trading partners with which most countries do business will not significantly change.

    We can learn two lessons from the 1930s trade war. The first lesson is that although trade dropped precipitously in the 1930s, it did not dry up entirely. The second lesson is that distance of various sorts continued to dampen international business activity. For example, from 1928 to 1935, the relationship between trade flows and geographic distance barely budged. The beneficial effects of a common language and colonial ties remained powerful. The net result was that the trading partners with whom countries (or groups of countries) did most of their business before the crash remained largely unchanged afterward. If global trade didn’t screech to a halt in the 1930s, it’s reasonably safe to say that it won’t in the 2020s, either. In fact, Moody’s Analytics estimates that if the United States were to impose proposed tariffs on China and Mexico and those two countries retaliated in kind, that and other factors would shrink U.S. exports by $85 billion in 2019. That’s only about 4 percent of total U.S. exports in 2015. Of course, a wider trade war would have a more significant effect, but it is very unlikely that the consequences would be as dire as in the 1930s.

    Second, major trade “battles” will hurt virtually every national economy involved, but smaller, more advanced economies are likely to be hurt the most.

    For example, Singapore, a small but highly developed economy, exports goods and services equivalent to 176 percent of its GDP. It’s apt to be much harder hit than the United States, whose exports account for only 13 percent of its GDP.

    References
    1. Harvard Business Review, July/August 2017, “Globalization in the Age of Trump,” by Pankaj Ghemawat. ⓒ 2017 Harvard Business Publishing. All rights reserved. https://hbr.org/2017/07/globalization-in-the-age-of-trump. All rights reserved.