In the first of our conversations, Erik Knutzen spoke with economist Nancy Lazar about the future of globalization.
"The key to a low inflation backdrop is investment and productivity growth, not importing cheap goods from the emerging world."
|Erik Knutzen:||In 1970, global trade accounted for 25% of global GDP. By 2007, it had grown to 61%. This rapid globalization powered significant global economic growth and helped reduce global inequality. It arguably led to higher inequality within some countries, however, and the subsequent rise of populism and other challenges. Since 2007, that growth in global trade has essentially stalled. So, how should we think about these developments?|
|Nancy Lazar:||I think we get a clearer picture of what’s happening when we look at investment cycles. These classically last about 30 years. Instead of starting in 1970, we should go back to the end of World War II, which was the start of very strong capital investment cycles in the U.S. and Western Europe. That spending was what drove most of the world’s GDP growth between 1945 and the 1970s. It was succeeded by another investment cycle elsewhere in the world. This doesn’t start with China’s entry into the World Trade Organization in 2000, but really with Japan in the 1980s. That investment boom spread through Asia in the 1990s and then to China and the rest of the emerging world in the 2000s. So, it’s easy to forget that this emerging markets investment cycle is now quite “long in the tooth,” almost 40 years old. Moreover, China’s extraordinary boom, driven by capital spending at 50% of GDP, probably pulled globalization forward by a decade.|
|Erik Knutzen:||Does the end of that investment cycle signal the end of globalization?|
|Nancy Lazar:||Globalization is not dead, it has simply matured. Over the past decade, we have seen capital investment rising again in the developed economies. That’s because the cost of doing business in China and the emerging world has gone up significantly, the cost and risks of transportation has risen substantially, as have geopolitical and trade tensions, while technological innovation has made it more cost-effective to make things in the U.S. and Europe. In fact, this re-started in Japan a decade ago, with Abenomics. Cutting corporate taxation, bringing more women into the workforce, encouraging businesses to reinvest domestically—these were game changers in Japan. I see a similar approach from President Macron of France and potentially with Mario Draghi in Italy. Germany’s manufacturers have always recognized the importance of domestic investment, but even there, we’ve just seen Porsche decide against shifting some production to China. To come back to your point about populism, that redistribution of investment is healthy for everyone. Between 2000 and 2010 the U.S. lost seven million blue-collar jobs, and real median family income growth was non-existent. Since around 2014 family income has started to grow again, and now, even after the pandemic, it’s at an all-time high. The labor force participation rate is up, number of people on disability benefits is down. That might seem to threaten an arrest of the reduction in global inequality, but in fact, now that the emerging world sells to the developed world, it is dependent on robust U.S. and European consumption for its own growth. It might also imply slightly lower overall global growth, but again, that’s not necessarily worse than the booms and busts we tend to get around higher levels of growth—as China’s policymakers have recognized over the past decade.|
|Erik Knutzen:||Your view on populism is contrarian. We seem to be in an epic of rising populism. And this didn’t start with Brexit and the Trump administration’s “America First” agenda: there has arguably been a decade’s worth of incrementally protectionist policies worldwide.|
|Nancy Lazar:||It is contrarian, you’re right. But oftentimes, economists focus on the past rather than where we’re heading. Think about the 1980s. People just would not let go of the idea that inflation was a problem, even after Paul Volcker killed it, because they’d lived with the threat for years. Today, we are obsessed by the populism that has been born out the globalization trend of the past 40 years, that giant sucking sound of high-paying manufacturing jobs leaving our economies. But I would argue the data indicate that we’ve already turned the corner on that. People miss this turn, perhaps because they under-appreciate the importance of private sector capital spending to a healthy economy. But Abe didn’t miss that, Macron doesn’t miss it, U.S. industry has recognized it for the past decade.|
|Erik Knutzen:||I like one of your favorite comments, which is that middle America is the most promising emerging market. But is new capital expenditure really going to create new high-paying jobs, as opposed to new low-paying jobs next to robots? And if it does create high-paying jobs, won’t it be costly to retrain the workforce to do them?|
|Nancy Lazar:||Yes, we'll need to train. The good news is that's not new. We've been doing that constantly in this country and we can see it in recent data. The unemployment rate for those without a high school diploma over the past year—during the pandemic—has gone from 21% to 9%. That tells me companies want to retrain people, and people want to accept that training for good jobs.|
|Erik Knutzen:||Is the mature phase of globalization just a euphemism for secular stagnation? Or worse, secular stagflation, as we lose some of the disinflationary force of rising global trade?|
|Nancy Lazar:||Concerns about secular stagnation are, again, in the rear-view mirror. It has already ended. It was here because we destroyed the breadth in our jobs growth in the developed world, which robbed our workforces of their pricing power. After 2014, we start to see the effect of the return of capital spending: wage inflation went back up to 3% in the U.S. Do I think wage growth is going to be back up at those 3-4% levels? Yes. That’s normal for a healthy economy. Do I think that means problematically higher inflation? No, because I think the last phase of globalization was not as disinflationary as people tend to believe. For sure, we got cheaper t-shirts, but we also destroyed our productivity growth through lack of investment. After China’s boom years, global growth stabilized at around 4%. That’s a good average number, but it hid the fact that China was growing at 6% while the U.S. was growing at 2%. Potential GDP growth, which tells us about the capacity of the supply side of the economy to add productivity and demand for labor, fell even lower than 2%. That was a recipe for stagnation, because it made any increase in GDP growth inflationary. By contrast, the return of capital investment over recent years has raised productivity and labor supply, which are both disinflationary forces because they raise potential GDP. That is why inflation has been so low since 2015, while corporate profits and stock market performance have been so strong. In short, the key to a low inflation backdrop is investment and productivity growth, not importing cheap goods from the emerging world.|
|Erik Knutzen:||The COVID-19 crisis seems to have pushed this theme of localization or regionalization of supply chains up the agenda. There has been a lot written about semiconductor shortages, for example, and we see the response to that with Taiwan Semiconductor and Samsung making large investments in U.S. fabrication plants, South Korea making big domestic investments, China prioritizing chipmaking in its latest Five Year Plan and the European Union making it part of their COVID-recovery plan.|
|Nancy Lazar:||It’s a decade-old story but, yes, COVID probably pulled the re-shoring trend forward by many years, but also the related productivity-enhancement trend. What is perhaps important is that these trends are being pushed within the private sector—and that tends to make them more engrained than when governments try to mandate these things.|
|Erik Knutzen:||What are your thoughts about the potential winners and losers in the mature phase of globalization?|
|Nancy Lazar:||The losers are likely to be those countries and companies who remain geared to a high growth trajectory in the emerging world, and particularly those geared to China’s investment cycle. Many of those countries have failed to make progress on structural reform, and many of those companies have failed to invest in improving their productivity. Brazil comes to mind, but it is not alone among emerging countries with this exposure. By contrast, countries and companies that are more balanced in supplying both the emerging and the developed world are likely to benefit. That is interesting, because it’s quite a big change from the way we have become used to analyzing things over the past 20 years. It also highlights how, in a moderate-growth environment, investments to improve productivity are likely to be an increasingly important aspect of the outlook for corporate profits.|
|Erik Knutzen:||Nancy, thank you for joining us, and for providing some fascinating and often challenging and contrarian viewpoints.|
This article is based on a webinar hosted by Neuberger Berman on June 8, 2021. A recording is available. Should you wish to see it, please contact your NB representative for details.