The New Cold War
America, China, and the Echoes of History
By many standard measures, globalization is in retreat. The 2008 financial crisis and the ensuing recession brought an end to three decades of rapid growth in the trade of goods and services. Cross-border financial flows have fallen by two-thirds. In many countries that have traditionally championed globalization, including the United States and the United Kingdom, the political conversation about trade has shifted from a focus on economic benefits to concerns about job loss, dislocation, deindustrialization, and inequality. A once solid consensus that trade is a win-win proposition has given way to zero-sum thinking and calls for higher barriers. Since November 2008, according to the research group Global Trade Alert, the G-20 countries have implemented more than 6,600 protectionist measures.
But that’s only part of the story. Even as its detractors erect new impediments and walk away from free-trade agreements, globalization is in fact continuing its forward march—but along new paths. In its previous incarnation, it was trade-based and Western-led. Today, globalization is being driven by digital technology and is increasingly led by China and other emerging economies. While trade predicated on global supply chains that take advantage of cheap labor is slowing, new digital technologies mean that more actors can participate in cross-border transactions than ever before, from small businesses to multinational corporations. And economic leadership is shifting east and south, as the United States turns inward and the EU and the United Kingdom negotiate a divorce.
In other words, globalization has not given way to deglobalization; it has simply entered a different phase. This new era will bring economic and societal benefits, boosting innovation and productivity, offering people unprecedented (and often free) access to information, and linking consumers and suppliers across the world. But it will also be disruptive. After certain sectors fade away, certain jobs will disappear, and new winners will emerge. The benefits will be tangible and significant, but the challenges will be considerable. Companies and governments must prepare for the coming disruption.
THE NEW ERA
The threads that used to weave the global economy together are fraying. Beginning in the 1980s, the falling costs of transportation and communication, along with a raft of new multilateral free-trade agreements, caused international commerce to swell. Between 1986 and 2008, global trade in goods and services grew at more than twice the pace of global GDP. For the last five years, however, growth in trade has barely outpaced global GDP growth. A weak and uneven recovery from the Great Recession explains part of the trade slowdown, but structural factors are also to blame. Global value chains, which gave rise to a growing trade in manufactured parts, have reached maturity; most of the efficiency gains have already been realized. Although the location of production will continue to shift among countries in response to differences in wages and the prices of other factors of production—from China to Vietnam and Bangladesh, for example—these shifts will merely change the patterns of trade. They will not increase its overall volume.
Cross-border financial flows—which include purchases of foreign bonds and equities, international lending, and foreign direct investment—grew from four percent of global GDP in 1990 to 23 percent on the eve of the financial crisis, but they have since fallen to just six percent. Trade in services, meanwhile, has increased, but it is growing slowly and is unlikely to assume the role that trade in goods has played in driving globalization. That’s because most services simply cannot be bought and sold across national borders: they are local (dining and construction), highly regulated (law and accounting), or both (health care).
This is where digital flows come in, from e-mailing and video streaming to file sharing and the Internet of Things. The movement of data is already surpassing traditional physical trade as the connective tissue in the global economy: according to Cisco Systems, the amount of cross-border bandwidth used grew 90-fold from 2005 to 2016, and it will grow an additional 13-fold by 2023. The number of minutes of all Skype calls made now equals approximately 40 percent of all traditional international phone call minutes. Although digital flows today mostly link developed countries, emerging economies are catching up quickly.
This surge in the movement of data not only constitutes a huge flow in and of itself; it is also turbocharging other types of flows. Half of all trade in global services now depends on digital technology one way or another. Companies can cut losses on goods in transit by installing tracking sensors on shipments—by 30 percent or more, in McKinsey’s experience. They can also reach consumers around the world without going through retail shops. AliResearch (the research arm of the Chinese online shopping company Alibaba) and the consulting firm Accenture project that by 2020, cross-border e-commerce will reach one billion consumers and total $1 trillion in annual sales.
The countries that led the world during the last era of globalization may not necessarily be the same ones that thrive in the new one. Consider Estonia, which has a population of just 1.3 million but has emerged as a giant in the digital era. Its pioneering e-government initiative allows Estonians to go online to vote, pay taxes, and appear in court, all with a digital identity card. Once an economy based heavily on logging, Estonia is now home to the founders of Skype and other technology start-ups, and it has historically been one of the fastest-growing economies in the EU.
The movement of data is already surpassing physical trade as the connective tissue in the global economy.
Digital flows are also upending the corporate world. Giant multinational firms have long dominated the trade in goods and services, but digital platforms have made it easier for smaller firms to muscle their way in. So-called micro-multinationals can use online marketplaces to reach far more customers than ever before; Amazon hosts two million third-party sellers, and Alibaba hosts more than ten million. Some 50 million small and medium-sized enterprises use Facebook for marketing, and nearly 40 percent of their fans are foreign. Digital platforms and marketplaces such as these are creating vast new opportunities for small businesses, which form the bedrock of employment in most countries.
THE RISE OF THE REST
As globalization has gone digital, its center of gravity has shifted. As recently as 2000, just five percent of the companies on the Fortune Global 500 list, the world’s largest international companies, were headquartered in the developing world. By 2025, by the McKinsey Global Institute’s estimate, that figure will reach 45 percent, and China will boast more companies with $1 billion or more in annual revenues than either the United States or Europe. The United States continues to produce the majority of digital content consumed in most parts of the world, but that, too, will likely soon change, as Chinese Internet giants such as Alibaba, Baidu, and Tencent rival Amazon, Facebook, and Google. China now accounts for 42 percent of global e-commerce transactions by value. The country’s investments in artificial intelligence, while still lagging behind those of the United States, are more than double Europe’s. In 2017, China announced an ambitious investment plan designed to turn the country into the world’s leading center for artificial intelligence research by 2030.
The geography of globalization is even changing within the developing world. The McKinsey Global Institute predicts that roughly half of global GDP growth over the next ten years will come from some 440 rapidly expanding cities and regions in the developing world, some of which Western executives may not be able to find on a map, such as the city of Hsinchu in Taiwan or the state of Santa Catarina in Brazil. Moreover, as many as one billion people in these places will see their incomes rise above $10 a day, high enough to make them significant consumers of goods and services—at the same time that tens of millions of Americans, Europeans, and Japanese will enter retirement and reduce their spending.
The world economy is already adapting to this new reality. Today, more than half of all international trade in goods involves at least one developing country, and trade in goods between developing countries—so-called South–South trade—grew from seven percent of the global total in 2000 to 18 percent in 2016. So open is Asia that the region more than doubled its share of world trade (from 15 percent to 35 percent) between 1990 and 2016. Remarkably, more than half of that trade stays within the region, a similar proportion to that found in Europe, a much richer region with its own free-trade zone.
As Washington pulls back from global trade agreements, the rest of the world is moving forward without it. After the United States withdrew from the Trans-Pacific Partnership, the remaining 11 countries negotiated their own pact, the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, which was signed in March. This version left out 20 provisions that were important to the United States, including ones concerning copyright, intellectual property, and the environment. Separately, a number of Asian countries are negotiating the Regional Comprehensive Economic Partnership, a trade deal that includes all the members of the Association of Southeast Asian Nations plus Australia, China, India, Japan, New Zealand, and South Korea—but not the United States. If ratified, this agreement would cover about 40 percent of global trade and nearly half of the world’s population. Meanwhile, the EU has struck new bilateral trade arrangements with countries including Canada and Japan, and it is negotiating one with China. So busy is the EU making such deals, in fact, that its agricultural, environmental, and labor standards may soon become the new benchmarks in global trade.
One notable aspect of this realignment is that China has gained a greater voice as a champion of globalization. To provide a counterweight to Washington-based economic institutions, Beijing has launched numerous initiatives of its own, including the Asian Infrastructure Investment Bank, which has attracted 57 member nations, many of them U.S. allies that joined over the objection of the United States. Together with Brazil, India, and Russia, China was a driving force behind the creation of the New Development Bank, an alternative to the World Bank. The China-Africa Investment Forum, an annual meeting begun in 2016, is gaining momentum as a platform for deals in Africa. Then there is the Belt and Road Initiative, China’s $1 trillion plan to add maritime and land links in Eurasia. Although still at an early stage, it could prompt a major shift in the pattern of global investment, spurring faster economic growth across Asia and connecting many countries that the last era of globalization left behind.
THE COMING DISRUPTION
Although it will lead to countless new opportunities, the new era of globalization will also present considerable challenges to individuals, companies, and countries. For one thing, because openness will be so rewarded, developing countries now at the periphery of global connections risk falling further behind, especially if they lack the infrastructure and skills to benefit from digital trade. With global trade tensions mounting, it is essential to recognize that countries will reap economic gains not from export surpluses but from both inflows and outflows. In fact, as in the past, it is precisely the countries that open themselves up to foreign competition, foreign investment, and foreign talent that stand to benefit the most in the new era.
One consequence of openness has been immigration. In the past 40 years, the number of migrants worldwide has tripled. Today, almost 250 million people live and work outside their country of birth, and 90 percent of them do so voluntarily to improve their economic prospects, with the remaining ten percent being refugees and asylum seekers. Economic migrants have become a major source of growth. According to the McKinsey Global Institute, they contribute approximately $6.7 trillion to the world economy every year, or nine percent of global GDP—some $3 trillion more than they would have produced had they stayed in their home countries.
But for some workers, the rapid expansion of trade has led to stagnant wages or lost jobs. As the economists David Autor, David Dorn, and Gordon Hanson have found, of the roughly five million U.S. manufacturing jobs lost between 1990 and 2007, a quarter disappeared because of trade with China. And as the economist Elhanan Helpman has concluded, although globalization explains just a small part of the rise in inequality over the last few decades, it has still contributed to it, by making the skills of experts and professionals more valuable while lowering the wages of workers with less education and more generic skills. Globalization has its winners and losers, and in theory, the gains should be big enough to compensate the losers. But in practice, the benefits have rarely been redistributed, and the communities and workers harmed by globalization have turned to populism and protectionism.
The new era of globalization will also prove disruptive, in that it will intensify competition; indeed, it already has. New ideas now flow around the world at an astonishing speed, allowing companies to react to demand faster than ever before. Fashion retailers such as H&M and Zara can take a trendy idea and turn it into clothing on the rack in just weeks, rather than the months it used to take. The flip side is that the period during which a company can profit from an innovation before competitors copy it has shrunk dramatically. As a result, product life cycles have become shorter—by 30 percent over the past 20 years in some industries. Meanwhile, the variety of products is exploding, and many industries are adopting “mass customization,” using technology to produce built-to-order goods without sacrificing economies of scale.
The growing economic clout of developing countries is also changing the rules of competition. Companies from emerging economies are taking a growing share of global revenue, and their governance structures differ from those of companies in the United States and other developed countries. In emerging markets, firms are more often state- or family-owned and less often publicly traded. They therefore face less pressure to hit quarterly profit targets and can make longer-term investments that take time to pay off. Developing-world companies also tend to enjoy lower costs of capital, lower taxes, and lower dividend payouts, enabling them to sell goods and services at smaller profit margins compared with U.S. and European companies. The balance sheets reveal the difference: for companies in advanced economies, improvements in overall profits stem largely from growing margins, whereas for companies in emerging markets, they come from growing revenues.
Because the rise of digital flows is increasing competition in knowledge-intensive sectors, the importance of intellectual property is growing, generating new forms of competition around patents. One example is the development of “patent thickets,” clusters of overlapping patents that companies acquire to cover a wide area of economic activity and impede competitors. Another is the practice of “patent fencing,” whereby firms apply for multiple patents in related areas with the intention of cordoning off future research in them. The smartphone industry and the pharmaceutical industry have been particularly hard hit by these tactics.
In the new era, digital capabilities will serve as rocket fuel for a country's economy.
As digital flows grow, some governments have turned to digital protectionism. Invoking concerns about cybersecurity, China enacted a new law in 2016 that requires companies to store all their data within Chinese borders, pass security reviews, and standardize the collection of personal information, effectively giving the government access to vast amounts of private data. A similar law went into effect in Russia in 2015. Rules requiring companies to build data servers in each country where they operate threaten their economies of scale and increase their costs. Not surprisingly, these and other forms of digital protectionism inhibit economic growth—reducing growth rates by as much as 1.7 percentage points, according to the Information Technology and Innovation Foundation.
Digital technologies are also affecting companies’ decisions about where to locate their factories. For most manufactured products, digitally driven automation is making labor costs less relevant, reducing the appeal of global supply chains premised on low-cost foreign workers. Today, when multinational companies choose where to build plants, they more heavily weigh factors other than labor costs, such as the quality of the infrastructure, the distance to consumers, the costs of energy and transportation, the skill level of the labor force, and the regulatory and legal environment. As a result, some types of production are shifting from emerging markets back to advanced economies, where labor costs are considerably higher. (In 2015, for instance, Ford moved its production of pick-up trucks from Mexico to Ohio.) Three-dimensional printing could have a similar effect. Already, companies are using 3-D printers to produce parts for tankers and gas turbines in the locations where they are needed. These trends are good news for the United States and other developed countries, but they are bad news for low-wage countries. It’s now far less clear that other developing countries in Africa and Asia will be able to follow the path that China and South Korea did to move tens of millions of workers out of low-productivity agriculture and into higher-productivity manufacturing.
In the new era, digital capabilities will serve as rocket fuel for a country’s economy. Near the top of the policy agenda, then, should be the construction of robust high-speed broadband networks. But governments should also create incentives for companies to invest in new digital technologies and in the human capital they require, especially given how low productivity growth has stayed. Since digital literacy will be even more essential than it already is, schools will have to rethink their curricula to emphasize digital skills—for example, introducing computer coding in elementary school and requiring basic engineering and statistics in secondary school.
When negotiating trade agreements, policymakers will need to make sure that issues such as data privacy and cybersecurity figure prominently. Currently, rules vary widely from place to place—the EU’s new data regulations that are scheduled to come into effect this year, for example, are far more restrictive than those in the United States—and so governments should seek to harmonize them when possible. The trick will be to strike the right balance between protecting individual rights and remaining open to digital flows. Negotiators should also seek to remove tariffs and other barriers that have hampered trade in computer hardware, software, and other knowledge-intensive products. Laws requiring data to be stored locally are particularly burdensome in the era of cloud storage. And to make it easier for smaller companies to ship smaller quantities of goods globally, customs regulations will need to be revamped to do away with much of the red tape that exists. The World Trade Organization’s Trade Facilitation Agreement, which came into effect in 2017, has helped simplify the import-export process, but there is room to broaden it.
In order to maintain political and societal support for digital globalization, governments will have to make sure that its benefits are distributed widely and that those who have been harmed are compensated. (Indeed, it was partly the failure to do this during the last era of globalization that led to the populist backlash rocking the United States and other countries today.) To help those displaced by globalization both old and new, governments should offer temporary income assistance and other social services to workers as they train for new jobs. Benefits should be made portable, ending the practice of tying health-care, retirement, and child-care benefits to a single employer and making it easier to change jobs. Finally, governments should expand and improve their worker-training programs to teach the skills needed to succeed in the digital era, a move that would reverse the decline in spending on worker training that has taken place over the past decade in nearly all advanced countries.
Work-force training alone will not solve the problems faced by smaller communities built on declining industries; what’s also needed are initiatives to revitalize local economies and nurture new industries. At the same time, governments should recognize that the geography of employment is changing. In the United States, for example, the jobs are moving from smaller Midwestern cities to faster-growing urban areas in the South and the Southwest. So the goal should be to make it easier for people to move to where the jobs are—for example, by offering one-time relocation payments to help defray the costs of moving.
The era of digital trade will also pose considerable challenges for the private sector. Setting aside the serious problem of cyberattacks, companies will need to invest more in digital technologies, including automation, artificial intelligence, and advanced analytics, in order to remain competitive. That will mean developing their own digital capabilities and partnering with, or acquiring, digital players. Successful global companies, whether large or small, will also need to compete strenuously in the global battle for talent, especially for top managers who have both an understanding of technology and an international perspective. Firms can gain an edge in this battle by spreading their research and development and other core functions across the world, a shift that would tap talent from different places, thus ensuring diversity of thinking.
Corporate strategy will also need to be reset: no longer will companies be able to rely on highly centralized approaches to producing and selling their goods now that consumers around the world expect customized products to meet their tastes. Increasingly, companies will need a strong local presence and a differentiated strategy in the markets where they compete. That will require strong relationships with governments and a commitment to corporate social responsibility.
Globalization is not in retreat. A revamped version of it, with digital underpinnings and shifting geopolitics, is already taking shape. In its last incarnation, globalization became a battleground for opposing forces: on one side stood the political and business elites who benefited the most, and on the other stood the workers and communities that suffered the most. But while debates raged between these two groups about the effects of globalization, globalization itself proceeded apace. Today, the same debates about globalization’s effects on employment and inequality continue, even as its new, digital form is gaining momentum. Rather than relitigating old debates, it is time to accept the reality of the new era of globalization and work to maximize its benefits, minimize its costs, and distribute the gains inclusively. Only then can its true promise be realized.