Global supply chains currently play a fundamental part in our economic lives. In this paper, I address three questions about their history and future. I ask: where we used to be, what has changed, and where we are heading.

Where we were

The graph below charts the progress of world trade, world GDP, and global direct investment flows from 1980 up to the time of the financial crash in 2008. It presents a familiar picture of sharp and rapidly accelerating increases in investment, trade and production across the globe.

Growth in World Trade, FDI and GDP – current US$ (1980-2008)

 This sharp increase in global flows and global trade was simultaneous with (and was no doubt in great measure caused by) what Richard Baldwin describes as the second great unbundling. An earlier age had witnessed a transformation from largely localised production and consumption into a much more globalised pattern of trade as a result of technologies that transformed production and reduced transport costs. In much the same way, the second great unbundling of the 1980s, 1990s and 2000s saw  trade policy liberalisation and exponential reductions in the cost of digital communications leading to the fragmentation of production, with low wage economies supplying raw materials and intermediate exports to high tech economies in return for imports of high value-added, high tech goods and services. The effect was the establishment of three great high tech production hubs — in North America, Europe and East Asia — with China playing an increasingly important role over the period, furnishing the East Asian hub and other parts of the world with (mainly) low and mid-tech goods and services. Asia, with China at its centre, became gradually the principal factory of the world.

This was, critically, a period of unusual geo-political stability. In this ‘uni-polar moment’, the US was able to use its unchallenged global hegemony to organise the production of global public goods through international cooperation under the umbrella of its dominant power — guaranteeing the security of sea lanes, flight paths and international digital communications in much the same way as the UK’s Royal Navy had done during the first great unbundling that accompanied the Industrial Revolution of the nineteenth century.

 What has changed

In the years since the global financial crash, these patterns of accelerating globalisation and accelerating economic growth under the protection of unchallenged US hegemony have given way to a new pattern that has aptly been described by the Economist as ‘slowbalisation’. As China’s power and economic weight has increased to the point of challenging American world leadership, the global integration of production has flattened, plateaued, even stagnated. The graph below makes the point very clearly — the sharp increase in global two-way trade between the 1980s and 2008 was temporarily reversed by the 2008 crash, and then (once restored to its 2008 level) remained broadly at that level up to the advent of Covid-19. 

Global two-way trade in goods and services, 1960-2014[1]

This marked change from ‘globalisation’ to ‘slowbalisation’ is reflected in the flattening proportion of global GDP occupied by trade, the declining proportion of intermediate imports into the world’s economies, the flat profitability of multinational companies, and the reduced global flows of foreign direct investment. The only areas in which this pattern-shift has not occurred are digital/data  services, digital communications and (to a lesser extent) e-commerce — all of which have been accelerated by technological advances rather than by policy changes.

Trade policy during the period since 2008 has become increasingly protectionist, both in the West and in China. From 2008 to 2016, this took the form of creeping protectionism. During the Trump presidency, it turned into galloping protectionism (on both sides), with a four-fold increase in protectionist interventions between 2016 and 2020. Although the jury is still out on the degree of protectionist intervention we shall see following the election of President Biden, there is not much sign as yet of any move to re-liberalise.

As the graph below illustrates, an important feature of this ‘new mercantilism’ has been the introduction (again in both China and the West) of increasing measures actively to support domestic production. Rather than simply imposing tariffs and non-tariff barriers to imports (of which there have been plenty), administrations both in China and in the West have aggressively promoted national champions, subsidised entry into new markets, and prohibited export of technologies judged to be too useful to competitors. The fact that China has been using these techniques for many years as part of its effort to reach a higher level of development has been cited by policy makers in the US, the EU and India as a justification for employing similar tactics. And this tendency towards reciprocal mercantilism has become especially visible during the Covid-19 crisis — with restrictions on the export of health equipment allied to distinct signs of vaccine nationalism.

Shares of world trade covered by different trade distortions, 2009-2020

Where we are heading

All of these changes in global trade policy have been taking place against the background of the geopolitical shift from US uni-polarity to a more multi-polar world, in which China’s claims to superpower status cannot be ignored, and in which the clash of political cultures between the West and China has come to be seen by many on both sides of the divide as a significant geopolitical threat. This has, in turn, led the Boards of many global companies to re-evaluate the extent of geopolitical risk arising from cross-global supply chains, and to place far more emphasis than hitherto on the resilience of their supply-chains — a tendency increased by rising concern about the effects of non-policy exogenous shocks following the arrival of Covid-19.

To date, no doubt due to the significant costs and dislocations involved in any major redesign of supply chains, we have seen relatively little shift in the actual patterns of production across the world. Nor can we sensibly anticipate any wholesale ‘decoupling’ of the Chinese economy from the rest of the world or even from the economies of the US, EU, Japan and India: the penalties in terms of efficiency and cost are simply too great for this to be attractive to either side.

Accordingly, we should predict neither the retention of the status quo nor radical decoupling. Rather, the likely mid-term result will be differentiation by sector. Applying the categories used by a recent McKinsey Global Institute report, we can expect the new mercantilist policies on supply chains to focus on the global sectors most subject to technological innovation — such as the automotive sector, consumer electronics, AI, and digital services. It is in these markets where, despite the economic forces that favour China, we are most likely to see sustained mercantilist policy on the part of the West (of which recent measures on semi-conductors were a harbinger), and reciprocal action from the Chinese, leading to partial decoupling.

Simultaneously, in labour-intensive sectors (where movement away from globalisation was happening in any case for economic and social reasons), we should expect to see accelerated moves towards re-shoring or near-shoring, not least because of the exposure of expatriate workers to health and other exogenous risks. We are already seeing shifts of production in such sectors away from China and into lower-cost Asia locations or into home markets. The re-localisation enforced by Covid-19 restrictions has undoubtedly accelerated this trend.

Part of the impact of these changes is likely to be the construction by global companies of dual supply-chains in the sectors most affected by geopolitically motivated trade policy constraints and by exogenous (eg health or climate) risks. In these sectors, we may well find global companies running one supply chain in order to serve the massive Chinese market, and a separate (or, at any rate, differently constituted) supply chain to serve non-Chinese markets.

By contrast, in resource-intensive industries such as agriculture, petroleum products and mining, there may be little if any change in the degree of globalisation. And the same may be true in those sectors that involve large elements of regional processing — such as fabricated metal, rubber and plastic products,  food and drying, glass, cement and ceramics.

In summary, the change we are witnessing is not from universal globalisation to wholesale decoupling, but rather from a world in which the movement was towards greater integration of supply chains and an ever increasing component of trade in global GDP, to a world in which increasing geopolitical fears, combined with increasing worries about resilience in the face of exogenous shocks, are likely to lead (at least in the medium term) to significant elements of decoupling in specific sectors of the world economy.

Dr Razeen Sally is Director of ECIPE, which he co-founded in 2006. He is also Associate Professor at the Lee Kuan Yew School of Public Policy at the National University of Singapore, and Chairman of the Institute of Policy Studies, the main economic think tank in his native Sri Lanka.

[1] Source: “Why Has Trade Stopped Growing? Not Much Liberalization and Lots of Micro-Protection” (Peterson Institute for International Economics)