Divided we suffer

In recent years, deep divisions have emerged within and across countries. Political polarization has become pronounced in the United States, the United Kingdom and across Europe. Fledgling democracies in Eastern Europe, Latin America, Africa and Asia are under assault from autocrats. International affairs are characterized by acrimony and withdrawal into isolationism. Institutions of global cooperation and support—ranging from the International Monetary Fund (IMF) and World Bank to the World Health Organization and World Trade Organization—have seen their support and influence eroded by populism and nationalism.

Those shifts are plain for all to see. Less visible are growing cracks in the foundations of international trade, commerce and finance, which have contributed to a slowing, even reversal, of postwar globalization. Yet like the gulfs that divide us politically, the growing fissures in international economics and finance will become sources of falling living standards and lost welfare if left unaddressed.

Growing economy, reduced globalization

Today, the world economy is nearly a third larger than it was before the global financial crisis (GFC) in 2008. Specifically, the World Bank estimates that in 2020, despite the COVID-19 pandemic, global gross domestic product reached US$84.7 trillion, up from US$63.7 in 2008.[1] Yet, cross-border capital flows today are smaller than they were before the GFC. According to an IMF study, international capital flows peaked in 2007 at nearly US$13 trillion, plunged during the GFC and had not quite reached 50% of their prior peak by 2018.[2] There have been no changes to that picture in the past three years.

Much of the reported decline in international financial activity since 2008 was due to diminished cross-border lending. The collapse of housing markets in the United States, the United Kingdom, and parts of western Europe during the GFC precipitated large withdrawals of cross-border real estate lending by banks and securitized entities. The eurozone crisis forced heavy borrowers—such as Greece, Spain, Portugal, or Ireland—to impose draconian austerity. Among other things, this led to a collapse in their external deficits and hence foreign borrowing activity.

Indeed, a welcome decline in trade imbalances since the GFC is the counterpart to falling cross-border lending. But not all the slowing or reversal of globalized finance is due to the achievement of better macroeconomic balance. Global foreign direct investment, for example, also peaked in 2007 at US$3.2 trillion. By 2017 it had shrunk to half that level, or US$1.6 trillion.[3]

In addition, a recent IMF study points out that the growth of cross-border stock and bond investing has also slowed in the past decade.[4] Momentum in international investment is waning.

Globalization has been disrupted since the GFC

A variety of factors have contributed to slowing financial globalization over the past dozen years. The end of global imbalances and the heavy losses suffered by the financial sector during the financial crisis have been significant. Slowing growth in emerging economies and lower returns on their equity, bond and real estate assets have also contributed to less global investment in those markets. An array of both globally coordinated and national regulatory responses to the GFC reshaped the terms, pricing and availability of financial instruments. And, in recent years, waves of populism, nationalism and unorthodox economic policies in various countries have increased perceptions of international risk, slowing cross-border lending and investment. Finally, the disruptions to global supply chains unleashed by the pandemic may further slow or reduce the pace of international financial transactions.

Investors need to watch the risks

For investors, intrusive governments create new risks. For instance, recent regulatory shifts in China curbing foreign listings by Chinese companies have resulted in sharp stock price losses and have eroded investor confidence in transparent policymaking. The recent elections in Germany create uncertainty about European Union enlargement and integration.  The United States continues down a path of greater involvement of government in monetary and fiscal terms, accelerating trends underway since the GFC. 

In short, investors are more exposed today to political or policy steps and missteps.

History shows that global growth, trade and finance are strongly intertwined. The health of global finance is important for growth and development, above all in emerging economies. Indeed, the most successful emerging economies have been those that embraced global trade and capital flows. Trade brings foreign know-how, enabling less developed economies to acquire valuable business and technological skills. But trade requires finance. The two are inexorably linked.

Slowing global trade and finance affects every country

Slowing global trade and finance, or even its reversal, would lower living standards everywhere. And perhaps most pernicious is that ebbing financial globalization goes mostly unnoticed. It is not as dramatic as barbed exchanges, aggressive rhetoric or hasty military withdrawals. A world divided, whether by politics, economics or finance, is a less prosperous one.  And that lowers returns for investors—above all where access to finance, know-how and markets is most needed, namely in emerging markets.

Solutions begin with recognition. Understanding how global economic and financial fissures are emerging, and how they lead to inexorable erosion of individual and common welfare is critical because it can lead to discussions about better choices. Yet in a world characterized by combustible political divisions, jump-starting financial and economic globalization won’t be easy nor will it happen quickly. By acknowledging that the status quo will not quickly be restored, today’s investors must find new ways to navigate the complexities of the present with an understanding that the past may no longer be a reliable guide for the future.

For additional commentary on the shifting tides in Germany and China read Franklin Templeton Fixed Income piece entitled Greener Post-Election Germany Likely, but Limited Fixed Income Impact and Templeton Emerging Markets Equity piece, China’s Regulatory Tightening: Our View on Goals and Scope.

US: Greener Post-Election Germany Likely, but Limited Fixed Income Impact and China’s Regulatory Tightening: Our View on Goals and Scope

Global: Greener Post-Election Germany Likely, but Limited Fixed Income Impact and China’s Regulatory Tightening: Our View on Goals and Scope

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[1] Source: World Bank IBRD databank.  

[2] Source: Lund, S. and Harle, P., International Monetary Fund, Finance and Development 2017 Vol 54 No 4.

[3] Source: McKinsey Global Institute, A decade after the global financial crisis: What has (and hasn’t) changed?, 29 August 2018.

[4] Source: Lund, S. and Harle, P., International Monetary Fund, Finance and Development 2017 Vol 54 No 4.