Schroders - Regime shift: Globalisation dividend coming to an end
In a significant shift that is likely to impact central banks worldwide, structural inflation pressures are emerging, signaling the end of the globalisation dividend, even beyond the current economic cycle.
Over the past two decades, central banks have struggled to push inflation rates up to their respective targets, with deflation fears dominating the balance of risk since the global financial crisis. However, the outlook is changing, as central banks are now more likely to face challenges in preventing inflation from overshooting their targets, says Schroders.
Even before the pandemic, doubts were cast on the productivity gains derived from globalisation. The transformation of supply chains since the 1970s has led to falling production costs and lower inflation in advanced economies. Factors such as improved trade, technology, accessibility, and infrastructure in emerging markets facilitated the relocation of complex production processes to regions with cheaper labor. While global trade between countries with competitive advantages is not new, the significant shift in outsourcing and offshoring had a profound impact.
This production shift to lower-cost countries boosted the share of global exports for many emerging markets. China's entry into the World Trade Organization in 2001 propelled it to catch up with other emerging economies, leading to a surge in its portion of world exports and solidifying the model of extended supply chains or global value chains.
For advanced economies, while the process of globalisation resulted in job losses, the benefits of cheaper products contributed to higher disposable incomes. Both the United States and the United Kingdom experienced a notable decline in core goods inflation throughout the 1980s and eventually witnessed disinflation in core goods prices from the early 1990s. These two decades were characterized by a lack of inflation, supported by falling prices of imported goods and the impact of globalisation on wages due to a substantial increase in the global labor supply. Governments responded by implementing labor market reforms that introduced additional flexibility.
Labor market policies, including adult training and linking benefit payments to work, incentivized unemployed individuals to return to work. Trade unions, which played a crucial role during the high-inflation period, gradually lost their influence, resulting in a significant decline in the share of wage settlements covered by collective bargaining.
For central banks, the improved trade-off between inflation and growth caught them by surprise. Initially, policymakers celebrated the victory over the high-inflation era that plagued economies in the previous decade. However, they soon became concerned when inflation persistently fell short of their targets. To combat this, central banks continuously lowered interest rates, leading to a secular decline in bond yields.
It was only with hindsight, around a decade later, that policymakers recognized the occurrence of a structural break. The benefits of globalisation extended beyond the profits of firms and job relocation, creating an unprecedented dynamic. In a 2004 speech, former Bank of England governor Mervyn King described the preceding decade as a "non-inflationary consistently expansionary" period, marked by above-trend growth, declining unemployment, and stable inflation. This favorable decade, often referred to as the "nice decade," continued well after King's speech, aided by the internet revolution, e-commerce, and increased efficiencies and productivity. These disinflationary dynamics contained inflation pressures as economic activity grew and expanded.
However, the gains from globalisation seem to have peaked around the turn of the millennium. In recent years, new forces have emerged to hinder and, in some cases, reverse the progress of world trade, challenging the concept of globalisation. Geopolitical tensions, driven by political motivations, have led to restrictions and forced companies to reconsider their operational plans. The COVID-19 pandemic further highlighted the vulnerabilities of concentrated supply chains, prompting companies to diversify and reevaluate risk planning.
For more on the market and economic implications of regime shift, visit: www.schroders.com/regimeshift.