Rise of Economic Nationalism – Post Pandemic

1. The current crisis has shown that the world’s dependence on global supply chains is a weak link
2. Going forward, companies may accelerate their supply-chain transition from China to other parts of Asia.
3. Europe and the US. will continue to protect strategically-important companies from overseas takeovers.
4. Even if a foreign policy “traditionalist” such as former Vice President Joseph Biden wins the November presidential election, resistance from Congress and the public will prevent the full-scale return of an expansive U.S. role in the world.
5. No other country, not China or anyone else, has both the desire and the ability to fill the void the United States has created.

Unfortunately policy decisions around handling the pandemic have led to allegations of various government’s hoarding medical equipment, pharmaceuticals, dollar liquidity, local markets, opportunities for exports, even aid to poorer countries. No I am not just talking about the US, but also Brazil, Hungary, India, the Philippines, Poland, and the UK.

While fear-based hoarding on a national basis is human and understandable, history suggests that it is counter-productive and costly as we learned in the early part of the twentieth century in the run up to World War II.

Both public health and macroeconomics demonstrated long ago that if every national government, let alone every household, tries to self-insure in a panic, the outcome makes everyone worse off. On the economic side, demand collapses, as do asset prices; liquidity and credit disappear; and shortages of critical components, skilled labour, and supplies of, yes, food and medicine emerge. Over time, those countries which try to be self-sufficient across the board and decoupled from the global economy just will end up suffering more from lack of diversified sourcing and unavoidable local shocks, though this harsh reality gets obscured in the current crisis.

But looking beyond the pandemic.  The current crisis has shown that the world’s dependence on global supply chains is a weak link, especially for commodities with a concentration around what now seem to be vulnerable nodes. China, for example, accounts for about 50 to 70 percent of global demand for copper, iron ore, metallurgical coal, and nickel.

We could see a massive restructuring of supply chains: production and sourcing may move closer to end users, and companies could localize or regionalize their supply chains. This change is likely to become especially prominent in Asia, where a growing middle class creates its own demand for production. Intraregional trade, which has already driven Asian trade for the past decade, accounts for almost as much of the total in Asia as in Europe.

Going forward, companies may accelerate their supply-chain transition from China to other parts of Asia. According to a 2019 American Chamber of Commerce (AmCham) survey, about 17 percent of companies have considered or actively relocated their supply chains away from China. In some sectors such as textiles, this has already been happening, and the supply-side impact of the coronavirus could accelerate this change.

• Japan’s automakers and South Korea’s electronics players have indicated that they may accelerate the diversification of the manufacturing footprint beyond China.
• France’s Finance Minister Bruno Le Maire called on retailers to be “economically patriotic” and favour products from French farmers.
• Supermarket chain Carrefour said it would stop selling fruit and vegetables of foreign origin when there is a French alternative.
• In Italy, Minister of Foreign Affairs Luigi Di Maio appealed to the population of the worst-hit country to “Buy Italian.”
• In Portugal, where the economy minister asked the population to buy domestic products, as reported by the Lisbon newspaper Público.
• Belgian Finance Minister Alexander De Croo has warned of intra-European moves towards economic nationalism.

There is potential for the coronavirus to trigger a downturn in flows likely made more acute by increasing efforts to control FDI in two of its main destinations, Europe and the US.  This is to protect strategically-important companies from overseas takeovers.

Beijing’s position as a major provider and recipient of FDI is expected to be affected significantly by the pandemic, which may increase developed world nervousness over predatory Chinese investment and China’s value as a major manufacturing hub.

A worldwide FDI recovery will clearly depend on the efficacy of governmental crisis-mitigation measures, in tackling the spread of the virus and supporting business. But when that recovery comes, the foreign investment landscape may have changed markedly.

In late March the UN trade, development and investment agency, UNCTAD, forecast that the pandemic could cause global FDI to fall by up to 40% this year through to next.  The announcement came a day after Europe expressed heightened concern about the vulnerability of companies to acquisition by foreign investors, as share prices tumble, with EU member states called upon to step up screening of inward investment.

The UN forecast for FDI falls, more than double an estimate in early March, assessed that the pandemic, coupled with government lockdown measures, would put severe pressure on FDI worldwide, with the worst-hit sectors including energy-related industries, airlines and car-manufacturing.

According to the UN, the closure of businesses, manufacturing plants and construction sites is causing immediate delays in the implementation of investment projects; while completions of merger and acquisitions are running into delays that could result in cancellations. It reported a large slump in the number of such deals in recent months, from an average of 1,200 a month last year to 385 in March.

Rising labour costs in China and the punitive tariffs imposed in the trade war with the US have already prompted many global manufacturers to switch some or all of their production facilities to other parts of Asia. Beijing is concerned that the coronavirus could expedite this trend. Yet the pandemic may even force multi-nationals to look beyond South-East Asian countries for manufacturing capacity since they are themselves reliant on China for inputs. That could open the way for the expansion of production hubs in jurisdictions such as Eastern Europe, Turkey and Mexico, as the benefits of being geographically close to China recede.

But it is not just China’s prospects as an FDI recipient that have been hit by the coronavirus. The country’s inevitable economic recession is likely to further squeeze its overseas-bound FDI, which at its peak in 2016 amounted to over $200 billion, nearly 2% of the country’s GDP. Chinese investment flows were subsequently hit by Beijing’s efforts to curb capital flight along with the emerging protectionism of some advanced economies. From 2018 China saw outward FDI drop around 50% over two years.

Protectionism

Even before the current health crisis, Chinese investment flows into Europe had experienced substantial reductions and a further decline seems likely – although some of the finance shortfall will be offset by business assistance packages. The European Bank for Reconstruction and Development has set up a one billion euro ‘Solidarity Package’ to help companies impacted by the pandemic across the region, and says it stands ready to do more when needed.

In March 2020 the head of the European Commission, Ursula von der Leyen, urged member states to screen potential outside investors carefully to counter takeovers of companies with reduced market capitalisation, particular those in sectors such as security, public health, medical research and strategic infrastructure. Her appeal coincided with the launch of new guidelines on the screening of inbound FDI, including the types of measures that can be taken to restrict capital movements when justified.

Von der Leyen’s warning comes as a new EU-wide screening regime, aimed at safeguarding the bloc’s strategic assets, is expected to be fully applied across the Union later this year.

The policy includes a new mechanism that enables member states and the Commission to exchange information and raise concerns related to specific foreign investments, especially those that are deemed to pose a threat to more than one EU country, or undermine a project or programme of interest to the bloc as a whole.

This comes as a number of European countries, seeking extra protections against foreign takeovers that potentially undermine their national interests, introduce their own inbound FDI regulations. Countries toughening their foreign investment scrutiny policies include Italy, France and Germany. German Finance Minister Olaf Scholz recently expressed concern that Beijing might exploit the pandemic to acquire more cheap European assets.

In America, where economic nationalism under President Trump has made it less accommodating than the EU to Chinese investment, efforts to vet incoming FDI deemed to threaten national interests were already increasing before the current pandemic. In 2018 Congress enacted the Foreign Investment Risk Review Modernisation Act – the most comprehensive revision of the scrutiny process for over a decade. The law widened the scope of the Committee on Foreign Investment in the United States (CFIUS), which assists the US president with reviews of transactions for potential national security risks. The reform came amid an acceleration of CFIUS’s investigative activities – with much of its attention focused on acquisition bids by Chinese investors.

A worldwide FDI recovery will clearly depend on the efficacy of governmental crisis-mitigation measures, in tackling the spread of the virus and supporting business. But when that recovery comes, the foreign investment landscape may have changed markedly.

When the concept of ‘Chimerica’ was first created (I saw a YouTube talk delivered by Niall Ferguson where he explained it)  in 2007, it was intended to encapsulate a new world economic order that combined Chinese export‐led economic growth with U.S. over‐consumption.  Chimerica was an unlikely financial marriage between the world’s sole superpower and its most likely future rival. Behind this two‐sided economic phenomenon was the integration of a massive Asian labor force and savings surplus into the world economy, which increased global returns on capital, by reducing labor costs, while depressing the cost of capital.

Thanks in large measure to its symbiotic relationship with the United States, China is now (on a current dollar basis) the second‐largest economy in this world.  For the United States, Chimerica meant cheaper consumer goods and lower interest rates.  The global financial crisis of 2008–2009 was the beginning of the end of Chimerica.  Today’s Chimerica is significantly different from its 2007 antecedent. For one thing, China itself has changed. It might be said that China has increasingly come to resemble the United States, with rising levels of household consumption, higher wages, and an increasingly complex financial system characterized by shadow banking, off‐balance‐sheet entities, and a very large aggregate debt burden. The biggest change, however, is in the United States, leadership has taken an anti‐Chinese turn.  The new National Security Strategy, published in December 2017, explicitly identified China—along with Russia—as a ‘strategic competitor’ of the United States.

It appears that the US will achieve its objective.

The pandemic is exacerbating friction between the two countries. In Washington, many hold the Chinese government responsible, thanks to its weeks of cover-up and inaction, including failing to promptly lock down Wuhan, the city where the outbreak started, and allowing thousands of infected people to leave and spread the virus farther. China’s attempt now to portray itself as offering a successful model for coping with the pandemic and to use this moment as an opportunity to expand its influence around the world will only add to American hostility.  Meanwhile, nothing about the current crisis will change China’s view that the U.S. presence in Asia is a historical anomaly or reduce its resentment of U.S. policy on a range of issues, including trade, human rights, and Taiwan.

The idea of “decoupling” the two economies had gained considerable traction before the pandemic, driven by fears in the United States that it was becoming too dependent on a potential adversary for many essential goods and overly susceptible to Chinese espionage and intellectual property theft. The impetus to decouple will grow as a result of the pandemic, and only in part because of concerns about China. There will be renewed focus on the potential for interruption of supply chains along with a desire to stimulate domestic manufacturing. Global trade will partly recover, but more of it will be managed by governments rather than markets.

The resistance across much of the developed world to accepting large numbers of immigrants and refugees, a trend that had been visible for at least the past half-decade, will also be intensified by the pandemic. This will be in part out of concern over the risk of importing infectious disease, in part because high unemployment will make societies wary of accepting outsiders. This opposition will grow even as the number of displaced persons and refugees—already at historic levels—will continue to increase significantly.

The result will be both widespread human suffering and greater burdens on states that can ill afford them. State weakness has been a significant global problem for decades, but the economic toll of the pandemic will create even more weak or failing states. This will almost certainly be exacerbated by a mounting debt problem: public and private debt in much of the world was already at unprecedented levels, and the need for government spending to cover health-care costs and support the unemployed will cause debt to skyrocket. The developing world in particular will face enormous requirements it cannot meet, and it remains to be seen whether developed countries will be willing to provide help given demands at home. There is a real potential for aftershocks—in India, in Brazil and Mexico, and throughout Africa—that could interfere with global recovery.

The spread of COVID-19 to and through Europe has also highlighted the loss of momentum of the European project. Countries have mostly responded individually to the pandemic and its economic effects. But the process of European integration had run out of steam long before this crisis—as Brexit demonstrated especially clearly. The principal question in the post-pandemic world is how much the pendulum will continue to swing from Brussels to national capitals, as countries question whether control over their own borders could have slowed the virus’s spread.

This United States is not currently disposed to take on a leading international role, the result of fatigue brought on by two long wars in Afghanistan and Iraq and rising needs at home. Even if a foreign policy “traditionalist” such as former Vice President Joseph Biden wins the November presidential election, resistance from Congress and the public will prevent the full-scale return of an expansive U.S. role in the world. And no other country, not China or anyone else, has both the desire and the ability to fill the void the United States has created.