Is the World Deglobalizing?

On this episode of The Long View, Neil Shearing, the group chief economist at London-based research firm Capital Economics, tells us where he’s found pockets of trouble (and strength) in emerging markets, how the upcoming election could affect bond markets, and why there’s a fracture between the US and global markets.

Here are a few excerpts from Shearing’s conversation with Morningstar’s Christine Benz and Dan Lefkovitz.

Pockets of Trouble and Strength in Emerging Markets

Christine Benz: We’re hoping you can discuss emerging markets other than China. You were an emerging-markets economist. When you survey emerging markets today, besides China, where do you see pockets of trouble as well as pockets of strength?

Neil Shearing: Pockets of trouble is an interesting idea in emerging markets because if you said to an EM investor 25 years ago, “OK, the Fed has just raised interest rates by 500 basis points, what’s happened to EM debt markets, EM currencies?” There would have been an absolute apocalypse, you would have forecast. But instead, we’ve not seen that. And indeed, in many respects, central banks in the emerging world have played the inflation shock and spike a lot better than the central banks in the developed world.

Part of the reason for that is because they saw high inflation in the ‘80s and ‘90s. And they didn’t wait to see whether inflation in the 2020s was transitory or not. They just got on with tightening policy. And so, as a result, they managed to shore up their currencies, and they managed to get on top of inflation a bit better than the central banks in the developed world. But the fundamental thing that has changed is they were able to do that because there’s been the shift from fixed to floating exchange rates and in the debt markets from foreign-currency to local-currency debt. So, there’s been a structural improvement in the balance sheets of emerging economies. And this has been the first real cycle where that has played to their benefit, in a very general sense. There are pockets of weakness. Argentina is the obvious one. Turkey is going through its own particular adjustment at the moment. And there are, of course, more wrenching adjustments and crises playing out in sub-Saharan Africa. But for the major EMs, the economic outlook, I think, is relatively benign.

The question we get all the time is, “In a world where there’s greater geopolitical competition between the US and China, which EM can emerge from China’s shadow and become the next China, the next motor of global growth?” I’m not sure that’s the right way of framing it or thinking about the issue. But I do think that India, of all the major economies that we track here at Capital Economics, is the one that we’re most bullish about, both in the near term but also in the long term. The demographics are good. It’s well placed to capitalize on the fallout from the US-China fracturing. The Modi government has pushed through some economic reforms. They’ve not been particularly aggressive on that front, but they’re moving in the right direction. Put all that together, and I think the medium-term outlook for India is among the brightest of any major economy.

Will the Bond Market Allow Tax Cuts?

Dan Lefkovitz: I saw a Capital Economics piece about the election called “Read my lips: no new tax cuts.” Why don’t you envision any more tax cuts even if Trump is reelected?

Shearing: Well, it’s possible that he’ll try. I think we can be pretty sure that he will try, and he might even get his own way and get some tax cuts if there’s Republican control of Congress, too. But I think it will require Republican control of Congress. The question in our minds is whether or not the bond market allows this. And part of our thinking here goes back to what happened in the case of the UK government in 2022. If you remember then, we had this disastrous so-called mini-budget under Prime Minister Liz Truss. She lasted all of 44 days because of the disastrous budget. But back that episode was notable as much for what the government didn’t do as what it did do. In the runup to the budget, the market was already pricing in some pretty significant tax cuts. And actually, what was announced on the day was a bit larger, but not dramatically larger than the market had expected. The key thing that upset the market was the way these tax cuts were enacted and the fiscal forecasts were put together. So, the independent Office for Budget Responsibility was sidelined. The permanent secretary, the senior civil servant of the UK Treasury was sacked. The bond market wobbled on the Friday after the budget on the Thursday. And then the chancellor took to the airways over the weekend and said, “If you thought that was impressive, you’ve not seen anything yet. We’ve got much bigger tax cuts to come.” And then, of course, the sterling fell out of bed on Monday morning, and the gilt market collapsed. And so, it was about the fact that the government was perceived to have lost all sense of fiscal responsibility.

I think that is the danger when it comes to the US situation. It’s not so much the fact that the deficit is large. It is large. It’s not so much that the debt burden is large. It is large. The risk is that if the bond market gets a sense that the government is not taking fiscal responsibility seriously and does not have a plan to get on top of the deficit and bring it down in a credible way, then things can get ugly quite quickly. We start to see the term premium going. It’s already gone from being negative to broadly neutral. We start to get very strongly positive because of high risk in bond markets. I think that’s the key brake on the Trump administration and the ability to push through new tax cuts. It’s will the bond market allow it? And there’s much less fiscal space for tax cuts now than was the case in 2016, partly because interest rates are so much higher, but also, of course, the deficit is bigger and the debt burden is larger as well.

Is the World Deglobalizing?

Lefkovitz: You’ve referenced global fracturing several times. I know that’s another area where your team has done a lot of work. We hear about friend-shoring and near-shoring. Do you see globalization in decline or is it just changing?

Shearing: I think it’s a bit of both if I’m being honest. I’m giving you the classic economist answer. I think this is a classic way in which economists get things wrong. If you ask someone for their views on globalization, it will typically fall into one of two camps. Either there will be those who view globalization as impossible to unravel and essentially, it’s here to stay. Or there will be those who view the world as deglobalizing: supply chains unraveling, production being moved back to the US or to Europe and out of emerging economies. I think neither of those things is true. You only have to look at examples from history to know that globalization can be unwound pretty rapidly. Look at what happened in the early 20th century. We had a small burst of globalization after the Second World War that then stalled in the 1970s. There are lots of examples from recent history where we’ve had integration that’s now either unwound or stalled. I don’t buy the idea that the world is deglobalizing, either. The poster child for reshoring was going to be Foxconn’s plant in Wisconsin. And look how that’s played out.

So, I think rather what’s happening is, as you suggest, that there’s this fracturing in the relationship between the US and China. And why is that happening? It’s because what drove the integration of China into the global economy was the idea that it would become economically liberal, perhaps even politically more liberal, more like the US and other European economies, democratic economies. Instead, of course, this emerged as this strategic rival to the US. And so, we’re in this era of geopolitical competition. What that means is that the US and China are breaking apart because of this geopolitical position, and other countries are having to choose which camp to side with. Even countries that would prefer to keep their heads down are being forced to pick a side. And then decisions within those blocks are being increasingly made on the grounds of geopolitics and national security.

And that’s the key part. Because if you’re thinking about supply chains globally, there’s no good geopolitical reason not to buy toys or furniture or flat-screen TVs from China. But there are lots of really good reasons if you’re in the US not to have your mobile phone manufactured in China or not to have lots of dependence on Chinese batteries for electric vehicles or chips or data or biotech. There are lots of areas of manufacturing where you can imagine that there will be good reasons on national security grounds to break apart from China. And that’s where the deglobalization will take place. And it won’t go back to the US. Production in those areas won’t go back to the US. It will go to a more friendly nation—this idea of friend-shoring. Indeed, that’s what we’re seeing starting to play to play out.

So, my view is the world is not deglobalizing, but by the same token, the era of hyper-globalization is behind us, and we’re in this world of fragmentation, fracturing. And that will have really wrenching effects in some sectors and consequences in some sectors. But in others—like, say, toy manufacturing, low-end manufacturing goods—the impact might be minimal. If it’s about manufacturing, if Trump is in office and he is starting to put 60% tariffs on Chinese goods and maybe turn away from Europe as well and inward to the US, then the situation becomes far more malign and potentially economically damaging.