Pieces in the puzzle

Just as the fall of the Berlin Wall in 1989 kick started the wave of globalisation, so the Russian invasion of Ukraine threatens to throw the process into reverse. Whereas its rise was initially a slow process which only seeped into the wider consciousness around the turn of the century, the reversal of globalisation is likely to take the form of a screeching U-turn as the west reassesses its security and economic needs. Whether or not the fighting in Ukraine quickly comes to an end, it is clear that Russia under its current government will remain an untrustworthy geopolitical partner which will require governments to reassess their political alliances. This in turn will have consequences for the shape of the global economy.

Assessing China’s position

The role of China will be particularly fascinating. Prior to 2008 it was hoped that China would align more closely with the west as rising prosperity convinced the government that opening up the economy would be in its best interests. That has proved a forlorn hope. An ever stronger China has continued to plough its own political and economic furrow with ambitions of usurping the US to become the dominant Asian power. It is ultimately likely to achieve that goal one way or another. At issue is the timing and the extent to which this transition occurs peacefully or otherwise.

It was therefore particularly interesting to hear suggestions that Russia has asked China for financial and logistical support for its invasion of Ukraine which further complicate the geopolitical mix. Whether China will agree to do this remains unclear. Last month, Russia and China extended the 2001 Sino-Russian Treaty of Friendship for another five years which commits China to support Russia “in its policies on the issue of defending the national unity and territorial integrity of the Russian Federation.” It also states that “when a situation arises in which one of the contracting parties deems that peace is being threatened and undermined or its security interests are involved or when it is confronted with the threat of aggression, the contracting parties shall immediately hold contacts and consultations in order to eliminate such threats.” Clearly, the ties between the two are very strong although it is questionable whether China expected Russia to launch its invasion which runs counter to its interests.

A particularly interesting article by Hu Wei, vice-chairman of the Public Policy Research Centre of the Counsellor’s Office of the State Council, suggests that China’s alignment with Russia could cause more problems than it solves. The thrust of the text is that if the conflict were to spiral, with NATO becoming involved, Russia cannot win by military means which would raise US influence on the global stage and leave China more isolated. He suggests that “China cannot be tied to Putin and needs to be cut off as soon as possible … Being in the same boat with Putin will impact China should he lose power. Unless Putin can secure victory with China’s backing, a prospect which looks bleak at the moment, China does not have the clout to back Russia.” It is important to stress that this does not reflect government policy and the fact that it was submitted to the Chinese-language edition of the US-China Perception Monitor and translated into English suggests it was designed for a western audience.

The official Chinese position views the world in zero-sum terms: What is good for the US must be bad for China (although the Trump administration was guilty of the same mindset). It does not have to be this way and rather than issuing threats about how the US would react – wielding the big stick would likely prove counterproductive, especially since China is aware of the consequences – a better approach may be to highlight the benefits of the cooperation which China claims to value. Whilst we should not expect China to publicly oppose Russia’s actions, at the UN or elsewhere, it has more potential than any other external force to act as a restraining influence.  

China is also aware that it runs significant reputational risk if it aligns itself with Russia and has more to lose than to gain if the west does decide to loosen economic ties. Moreover, Russia’s actions will cause problems for one of China’s signature economic policies – the Belt and Road Initiative. The BRI is designed to create a land route across central Asia, linking China to consumer markets in western Europe and raw material producers across Europe and Asia. War in eastern Europe will disrupt the supply of commodities to China and elsewhere, particularly in the event of a protracted conflict. It is thus in China’s economic interests that the war in Ukraine is swiftly resolved.

Big questions for Europe

From a European perspective, the western alliance has come together far more quickly and in a more unified fashion than we have seen for many years. The EU’s actions are a reminder that it has its roots in a project designed to ensure that the continent would not revisit the ravages of the first half of the twentieth century – a point that was lost on large parts of the UK electorate during the Brexit referendum. With the spectre of conflict once again at the EU’s border, the nature of the union is likely to change. The commitment to raising defence spending will mean more expansionary fiscal policies across Europe. During the Cold War, European economies routinely spent around 3% of GDP on defence. Recent figures suggest that this has slipped to around 1.5%. In order to boost outlays will mean either higher taxes or an increase in debt issuance (and this is before we discuss the costs of dealing with the refugee crisis).

In addition the rush to diversify away from Russian energy sources will impact on living standards for many years to come as the relative cost of energy remains elevated. This may also have implications for the EU’s green agenda. Whilst there are increased incentives to diversify away from hydrocarbon fuels, it will be difficult to make the sudden switch to renewables. Consequently, many EU countries may be forced to extend the lifetime of coal-fired power stations, rather than using gas as a transition fuel until such times as renewable sources come online.

Across the continent, governments are likely to be far more engaged in economic management than has been the case for many years, which they will justify on national security grounds. As this post from the Breugel think tank pointed out, the private sector may have responsibility for the generation and distribution of energy but has no responsibility for ensuring security of supply nor for ensuring that consumers have access to energy. The private sector may also be unwilling to carry the costs of replenishing supplies at current prices, for fear of huge losses in the event that oil and gas prices fall. All of this suggests that significant fiscal intervention may be required to guarantee energy supply.

Europe has perhaps been too complacent about the risks emerging from the geopolitical sphere in recent years, partly because it has had to cope with the aftershocks of the Greek debt crisis and Brexit. However, it has acted remarkably swiftly in the last three weeks as latest events highlight that the time for complacency is over. In the wake of the 2008 crash, hopes were expressed that we could return to the old world order. The pandemic and the war in Ukraine suggest that we are likely to return to a geopolitical order more reminiscent of 1985 than 2005.

Globalisation: The good and the bad

Around fifteen years ago I was asked by the late Ulric Spencer to review a book for the Society of Business Economists  journal. The book in question was entitled “Localization:A Global Manifesto” by Colin Hines, a former head of economics at Greenpeace. I am rather afraid to say that when I first read the book in 2001, I did not particularly enjoy it and summed it up thus: “ultimately, it is difficult to escape the feeling that the book is a diatribe against the evils of capitalism.” But in the spirit of intellectual flexibility based on empirical observation, I may have been too hasty in my dismissal of some of Hines’ observations.

The basic premise of the book is that the global economic order “must reduce inequality, improve the basic provision of needs and adequately protect the environment.” There is nothing wrong with that, of course, but Hines’ proposed solution is a process of localisation in which policy actively discriminates in favour of the local. It is essentially the polar opposite of globalisation and can (in his view) be brought about by imposing restrictions on global capital flows and using the tax system to discriminate in favour of local interests.

I still think that his economic analysis is naïve and that it is essentially a late-twentieth century first world view of global problems. Nor am I sure that many people in less developed countries would thank Hines: After all, World Bank data suggest that poverty rates (defined as those living on less than $1.90 per day) have fallen from 42% of the world population in 1981 to below 11% by 2013. It is notable, too, that the book was written before China became the global powerhouse which it is today. Arguably, China has used elements of this localisation strategy to benefit the local economy. For example, many of the mighty western multinationals which Hines criticises have been forced to transfer their technology to local Chinese partners in order to be able to conduct business in the Middle Kingdom. Indeed, China has perhaps conducted the biggest poverty reduction policy of all time precisely thanks to globalisation, which has boosted incomes based on exports.

But where Hines’s views may carry more weight is in the process he described which might lead to a pushback against globalisation. In his words, “global deflation is being driven by relocation to cheaper labour countries, automation and public spending cuts.” This in turn results in significant under-utilisation of labour resources in western economies. He could well have foreshadowed the process which has led to the upsurge in anti-establishment political movements in recent years. There is more than an echo of Donald Trump in his assessment that the rolling back of the state has led to a vacuum which has been filled by multinational corporations, which have usurped government’s role in many areas of policymaking.

Part of the Brexit campaign’s appeal was to idealise a version of Britain as a powerhouse of world output, which was wiped out by government’s willingness to sell out the UK’s interests to the EU. I have a different take on it: The anger manifest during the Brexit campaign was partly the result of the failure by successive governments to promote local interests, at a time when the threat posed by globalisation did indeed mean that a lot of British jobs were exported to lower cost locations (a view echoed in the US election campaign). This was given full expression in the immigration debate. But as Beatrice Weder di Mauro points out (here), German immigration numbers are roughly similar to those of the UK. Yet the degree of anger in Germany towards the EU is a lot lower than in the UK. You might conclude from this that the real problem in the UK is not so much the EU, or immigration, but general dissatisfaction with the economic status quo - a view which is increasingly the consensus.

But although Hines appears to have correctly identified the process triggering the backlash, this does not mean that his solutions are necessarily the right ones. Localisation essentially places limits on trade but all economists would agree that trade does lead to higher living standards, although as BoE Governor Carney noted recently, “the benefits from trade are unequally spread across individuals and time.” Hines may be wrong to simply dismiss “the flawed theory of comparative advantage” but he is right in that much greater emphasis must be placed on the negative consequences. The events of 2016 should act as a wakeup call for western governments to look more closely at their policy prescriptions. This does not mean that protectionism is the answer, but it does mean a rethink of a policy which allows markets to provide unfettered solutions may be in order.