- Market Commentary
- By Jack Ablin
- May 28, 2020
Globalization Isn’t Dead, Just Different
Investors believe COVID-19 is the watershed event that marks the end of globalization. The pandemic laid bare the downside risk of global integration while legitimizing fears of foreigners and trade flows. Businesses worldwide have been suddenly exposed to the risk of relying on complex, “just-in-time” supply chains including places like Wuhan, one of China’s industrial hubs. The COVID-19 lockdown struck both supply and demand. Toyota, the world’s largest automaker, expects an 80 per cent profit plunge in response to moribund global demand. US auto demand fell by one-third year over year through April, according to the US Census Bureau. Governments are closing borders and closing ranks by imposing travel bans, stringent visa requirements and export restrictions in the name of safety. President Trump, fearing he may pay a price in November for his mismanagement of the public health crisis, has created a political foil by demonized China and calling COVID-19 the “Chinese coronavirus.” The Baltic Dry Index (the cost of hiring a freighter) has fallen by more than half over the last 12 months through May 22, reflecting widespread demand destruction. China’s stock market has tended to ebb and flow with trade.
The COVID-19 lockdowns and its concomitant challenges are prompting countries to reevaluate their relationship with China – even those that depend on Chinese demand, like Australia and Brazil. Over the last 40 years, China has mushroomed into the manufacturer to the world: by 2018, it accounted for more than 28 per cent of the world’s manufacturing. The developed world’s tilt toward outsourcing may have made smart economic sense in the short run, but it has now exposed major economic and political vulnerabilities, like suddenly restricted access to vital medical equipment and drugs. COVID-19 stress tore at the fabric of trade. Within the European Union’s so-called “single market,” France and Germany banned the export of medical face masks. Moreover, none of the 26 other EU countries responded to Italy’s urgent appeal for medical assistance, but China did. India, despite its vast pharmaceutical sector, limited exports of life-saving drugs.
Many countries, including the US, are beginning to back away from China. In the years leading up to the pandemic, America’s total trade comprised a diminishing share of our economy, with exports falling faster than imports. Chinese-made products accounted for 18 per cent of US imports in 2019. Since the pandemic began and through the end of March, however, US imports from China plunged by more than one-third.
China itself is becoming inward-looking as well. Hoping to insulate itself from the vagaries of the global business cycle, Beijing has been steering the economy toward domestic consumption, for some seemingly logical reasons: for example, the 1.4 billion domestic Chinese prefer imported food due to its higher quality and consistency. The country is now the least reliant on foreign trade it has ever been at any time in modern history, although that doesn’t erase the fact that the pandemic has destroyed demand for Chinese products worldwide. Exports as a percentage of China’s GDP fell to 17.4 per cent in 2019, down from 36 per cent in 2006.
The US-China trade relationship dates back to 1972, when President Richard Nixon and his national security advisor Henry Kissinger set off for Beijing with an audacious proposal, insisting that our “common interests” transcended our differences. Over the years, the rest of the free world followed our lead by expanding its cooperation with China, hoping that openness would prod it into aligning itself with the liberal democratic order. Instead, China’s Communist ideology didn’t bend while developed world policymakers looked past their new trading partner’s human rights abuses and iron-fisted policies. Despite the ideological chasm between the two nations, President Carter welcomed Deng Xiaoping to the White House in 1979. Profits trumped principles, as US corporations and consumers benefitted from cheap, imported Chinese goods, while ballooning our trade deficit. China advanced its political and pecuniary objectives. Engagement neutralized Washington as an adversary at a time when it was most beneficial to Beijing. Not only did China avoid the threat of war from the world’s most powerful country, it thrived. Now, thanks to a noxious blend of skepticism regarding past trade deals and outright derision related to the COVID-19 outbreak, trade relations have been pushed to the brink, jeopardizing “phase one” of the US-China trade deal. Research from the Peterson Institute shows that China purchased only $19.8 billion in American goods in Q1/20, well short of the $43.2 billion negotiated target. Both Democrats and Republicans increasingly believe that China is a strategic rival that needs to be contained.
From a policy perspective, trade will take a back seat to rethinking how the US sources critical inputs, like technology and medical supplies. Decades of outsourcing have left our nation dependent on China for critical infrastructure, pharmaceuticals and personal protection equipment. US lawmakers have introduced legislation designed to boost US manufacturing by instituting domestic procurement requirements for the nation’s medical stockpile and are considering tax breaks to companies that shift operations back home. They’re also considering a “reshoring fund,” to be funded initially with $25 billion, to encourage US companies to rethink their relationship with China. COVID-19 has supercharged President Trump’s longtime pledge of brining manufacturing capabilities back to the United States.
While most Americans concede to, and even embrace, globalization in some form, they arguably prefer that China play a less dominant role. Rethinking the US economic relationship with China has bipartisan support. Even before the pandemic, companies were beginning to shift production lines out of China to other developing economies, like Vietnam. COVID-19 has accelerated those plans. The Senate recently passed a bill aimed at delisting Chinese companies from US stock exchanges; it requires listed companies to certify that they are not owned or controlled by a foreign government.
So far, the potential trade war has not tempered China’s behavior; in fact, it’s emboldened it. China has shifted its aggression toward Hong Kong and Taiwan. Beijing today announced the imposition of new national security legislation over the Hong Kong Special Administrative Region, trampling on the “one country, two systems” arrangement pledged to remain in place until 2047. This has elicited harsh rebuke and risks Hong Kong’s special trading status with the US. Washington responded to Beijing’s aggression by announcing a $180 million sales of torpedoes to Taiwan, further aggravating Beijing, which views Taiwan as part of Greater China. The Trump administration is also attempting to limit China’s access to critical technology by barring US companies from supplying Huawei, China’s telecommunications giant, which is believed to be involved in cyber espionage. Global chipmakers, like Taiwan Semiconductor, are banned from selling Huawei semiconductor chips designed with American equipment and software. China is already pushing development of its own chip industry in its “Made in China 2025” economic plan.
Despite their corrosive relationship, the world’s two largest economies need each other. The US still eyes China as a significant market for our goods, while China relies on the American farm belt to help feed its 1.4 billion population. Last year, the China imported $106 billion of US agricultural products.
Despite escalating tensions and scapegoating, globalization is not dead. While countries may look inward, companies can’t afford to do that. Apple, America’s leading smartphone maker, has optimized globalization to their shareholders’ benefit. The $1.3 trillion company’s complex supply chain is one of its greatest assets, sourcing components throughout the world and assembling them in China. Moreover, the Greater China region (which includes Hong Kong and Taiwan) is Apple’s third-largest market, behind the US and Europe, accounting for 16 per cent of the smartphone giant’s revenue. Saving money isn’t Apple’s prime motivation for sourcing from China. Besides its robust market, the country has a strong technology ecosystem that gives it the right mix of expertise, suppliers and labor. China could potentially use Apple as a bargaining chip if talks with the US break down. Although Apple relies on China’s rare earth metals in smartphone production, it enjoys a modicum of political protection since the company supports more than five million Chinese jobs, more than twice the number it employs in the US. A technological decoupling would force Apple to shift large portions of its supply chain away from China. Due to pandemic-related logistical complexities, the company already has reluctantly shifted a small segment of production away from China.
The pandemic has not been kind to the apparel industry’s $2.5 trillion global supply chain, but significant reshoring is not in the cards. Consulting company McKinsey estimates that up to one-third of global fashion players, such as brands and department stores, will not survive the crisis. US clothing sales skidded 78 per cent in April, according to US Census data. Nonetheless, developed-country consumers have become accustomed to affordable fashion and they’re not willing to pay a higher price for similar goods made in their backyard. China is the largest exporter and sold $93.5 billion in apparel last year; Bangladesh and Vietnam, which have been beneficiaries of the shift in production in recent years, are tied for second at $28 billion, according the Financial Times. The garment industry accounts for most of Bangladesh’s export revenue and has had to lay off over four million workers as a result of the pandemic. Boeing is another multinational corporate player that exports to the world. Investors worry the company can ill afford to wind up as a bargaining chip in the middle of political gamesmanship. The airplane maker, which was already reeling from the grounding of its 737 MAX jet, slashed 16,000 jobs in April, or about 10 per cent of its workforce. China, it should be noted, accounts for nearly 14 per cent of Boeing’s revenue. While Beijing’s policymakers are ideologues, they’re also mercantilists. Turning our back on China doesn’t make business or economic sense.
In the near term, the eroding relationship between the world’s two largest economies could become a headwind for the stock market as China becomes an election issue. Public opinion has swung against China since the COVID-19 pandemic, which emanated from Wuhan, hit our shores. The yuan’s value is a good real-time indicator of the mounting tension: the slide in China’s currency, which does not float freely, represents Beijing’s unhappiness with the actions of the Trump administration.
China would be ill-advised to retaliate against American companies as a political show of force. Such targeting would accelerate the supply chain shift away from China that is already underway. Beijing needs the likes of Apple, Boeing and Nike to contribute to China’s economy recovery. America’s bumptious behavior isn’t helpful either, considering where the US economy is currently situated. Over 36 million Americans have filed for unemployment benefits and economists project a depression-level decline in economic activity this quarter. Election-year winds are blowing in favor of decoupling, but it must be noted that outsourcing decisions are made in corporate boardrooms, not in the Oval Office. Globalization is not dead even though that trend has reversed. This suggests emerging market (EM) equities present an intermediate-term opportunity. EM equities are cheap relative to US equities and are likely to benefit as the world economy recovers from the pandemic. EM’s price-to-book ratio is also cheap relative to its history. Countries like Bangladesh, Vietnam and Indonesia would benefit from shifting sourcing trends in apparel. Thailand, South Korea, Indonesia and India would benefit from manufacturing shifts.