The new US president is prepared to carry the torch for a shrinking band of globalists, but the growing trend of economic nationalism will prove hard to reverse.
Economic nationalism is not a new phenomenon; it has been rising steadily as sub-par economic performance across much of the developed world following the financial crisis led nation after nation, most notably the US under former President Donald Trump, to turn inwards.
International trade’s share of world economic output has stagnated since 2008
For so long a lynchpin of global growth, international trade’s share of world economic output has stagnated since 2008 as a growing number of companies re-shored supply chains and (more recently) as the US, China and other nations slapped tariffs on each other’s products.
The coronavirus pandemic has reinforced these trends. International cooperation all but evaporated in the spring of 2020 as countries scrambled to secure supplies of vital medical equipment and life-saving drugs.
More was to follow a year later. Hopes the pandemic would be brought under control were boosted towards the end of 2020 with the arrival of several safe and effective vaccines. However, it wasn’t long before countries were quarrelling over access to them and threatening to block exports, to ensure sufficient supply for their own domestic needs.
The current episode of vaccine nationalism is primarily about the speed of access
Ian Pizer, Aviva Investors’ senior strategist, multi-asset & macro, believes the current episode of vaccine nationalism is primarily about the speed of access as countries ramp up vaccine manufacturing capacity. As such, it is likely to be a temporary phenomenon. After all, not only is production of current vaccines increasing, but there will be further approvals of additional candidates.
Nonetheless, by throwing a spotlight on the perils posed by porous borders, the pandemic is likely to have other, longer-lasting effects. In doing so, it will probably reinforce various trends that pre-date COVID-19.
Governments will want to tilt various supply chains towards domestic manufacturers
Most obviously, governments will want to tilt various supply chains towards domestic manufacturers. Beyond vaccines, they could look to build up domestic production capacity for ‘critical products’ to minimise the risk of a repeat of the global supply shortages experienced early on in the pandemic.
Politicians may be tempted to go further. On February 24, US President Joe Biden signed an executive order in which he stated he wanted to make supply chains “resilient, diverse, and secure” for a host of products, ranging from microchips and electric vehicle batteries to critical minerals and rare-earth elements.1
Significantly, while people may return to relative normality quite quickly (assuming the pandemic is brought under control), government policies towards containing outbreaks could be affected for years to come thanks to the financial scarring inflicted.
“Every government is going to have a contingency plan. With that, the rules of how to respond to a new pathogen of this sort are going to be re-written. As and when we see something like MERS or SARS happen again, borders, unlike then, are likely to be closed hastily,” says Pizer.
The economic hit from becoming isolationist for a short period is not as severe as might have been expected
The experience of New Zealand and Australia makes it even more likely countries will adopt a safety-first attitude. Even though both nations have taken reasonably draconian measures to quell any outbreaks, their economies have held up better than most. This experience suggests the economic hit from becoming isolationist for a short period is not as severe as might have been expected.
“The cost of reacting too slowly and letting an outbreak get out of control is far higher. It probably exceeds that of even ten false alarms, where you lock your economy down for a month unnecessarily,” Pizer argues.
Greater frequency of border lockdowns is another reason to believe supply chains will become more localised and cross-border trade may suffer.
“Few, if any, companies had even considered a pandemic prior to COVID-19, but now planning for one will be front and centre. Although companies are unlikely to stop buying from overseas just because of the threat of sudden border controls, previously marginal decisions are now likely to fall in favour of going domestic,” says Stewart Robertson, senior economist for the UK and Europe at Aviva Investors.
The huge amounts of fiscal and monetary support will need to be withdrawn eventually
There are other reasons to believe economic nationalism could intensify. While the global economy is widely expected to grow sharply this year and next, the longer-term outlook is uncertain. Eventually, the huge amounts of fiscal and monetary support that have been offered to economies will need to be withdrawn.
“Sluggish economic growth and rising inequality drove the rise in nationalist sentiment in the years that followed the financial crisis. Though the outlook may have brightened remarkably from the depths of the COVID-19 crisis, beyond the initial recovery period those forces could still be with us,” argues Robertson.
Little thaw in US-China relations
Despite Biden being undoubtedly less bellicose than his predecessor, there seems little prospect of much, if any, thaw in relations between the two main protagonists in the trade hostilities of recent years.
While the US might be open to trade negotiations, it isn’t ready to lift tariffs on Chinese imports soon
On the campaign trail, Biden said Trump’s tariffs were not only hurting US farmers who sold to China, but also consumers and domestic manufacturers who relied on cheap Chinese imports. Yet, on March 4, Commerce Secretary Gina Raimondo described Trump’s 25 per cent levy on foreign steel and ten per cent tariff on aluminium imports as “effective”.2 Later that month, US Trade Representative Katherine Tai said while the US might be open to trade negotiations, it isn’t ready to lift tariffs on Chinese imports soon.3
Much as Biden appears keen to mend fences with the US’s traditional European allies, there appears plenty of scope for tensions to boil over. For example, Europe’s efforts to clamp down on big US technology companies run the risk of retaliatory action, as evidenced by the US warning it could put tariffs of up to 25 per cent on a host of UK exports in retaliation for a UK tax on tech firms.4
Washington recently proposed a new model for taxing multinational corporations, calling for the world’s biggest businesses to pay levies to national governments based on their sales in each country as part of a deal on a global minimum tax. It is unclear how other countries and trade blocs will respond.5
The same economic doctrine that lay behind trade liberalisation simultaneously drove reduced state involvement in many economies across the West over the last forty years – at least until the financial crisis. As with that period, governments have taken a very active role in their economies throughout COVID-19 to prevent a wave of bankruptcies. They have provided loans to, and bought shares in, some firms, and bailed out others.
The current crisis has seen support extended to a far wider array of businesses
While 2008 was primarily about shoring up banks and other financial institutions, the current crisis has seen support extended to a far wider array of businesses, including transport, hospitality and retail.
In one of the most striking examples, the French government recently said it will contribute up to €4 billion to strengthen Air France-KLM’s balance sheet. This would potentially double its shareholding as it tries to steer the airline through the pandemic.6
Though few would deny governments had little option but to step in to support businesses, the question is to what extent this heralds the beginning of a period of greater state involvement in economies. In March 2020, Trump was keen to stress the US state’s intervention did not mark a government takeover, arguing its purpose was not to “weaken” the free market but to “preserve it”.7
However, while some will reassure themselves this period of government activism will prove temporary, history suggests the state cannot be relied upon to relinquish control. Crises such as this tend to lead to a permanently bigger state with many more powers and responsibilities – as well as the taxes required to pay for them. The welfare state, income tax and nationalisation all grew out of conflict and crisis.
It is only natural to expect governments will take measures to protect their interests
Where governments have stepped in to support companies, it is only natural to expect they will take measures to protect their interests. For example, following protracted negotiations between the French government and the EU to get the state aid approved, Air France had to give up 18 of its more than 300 landing and take-off slots at Paris-Orly airport. French finance minister Bruno Le Maire insisted there would be restrictions on certain low-cost airlines picking up the slots to make sure companies operating at the airport abided by French labour rules.8
At the same time, fiscal policy is expected to be far more expansionary than in the period that followed the financial crisis. That means governments will almost inevitably hand out sizeable contracts to private sector companies, in turn providing investment opportunities.
Giles Parkinson, global equities portfolio manager at Aviva Investors, says two holdings in his fund have already benefited from the shift in US policy. Biden, as part of his $1.9 trillion relief plan agreed earlier in the year, has earmarked up to $129 billion for additional education spending to help reopen US schools. That has lifted the shares of Allegion, an American-Irish provider of security services, and Trane Technology, a heating and ventilation business.
The US and other governments will want their spending to boost job creation
“Increased stimulus spending wasn’t the rationale behind either of these positions. But this nonetheless shows investors need to be aware of this trend. At the margin, it could support an investment case,” he says.
Where possible, the US and other governments will want their spending to boost job creation. That may mean domestic companies are preferred over foreign rivals when it comes to handing out government contracts. As part of his campaign pledge, Biden promised: “When we spend taxpayer money, we should buy American products”, adding he would require companies receiving procurement contracts “to support good American jobs”.9
Industrial strategies to make a comeback?
Whether nations go even further and resurrect the kind of industrial strategies popular in the post-war years only to fall out of favour in the 1980s and 1990s is unknown. However, there are signs the US and others may at least be tempted to shield industries deemed of national importance in response to China’s state-led development, secure a supply of critical materials and products, and develop technologies to tackle climate change.
There are signs the US and others may at least be tempted to shield industries deemed of national importance
Biden has promised a “comprehensive manufacturing and innovation strategy that will marshal the resources of the federal government in ways not seen since World War II”. For its part, the EU is finalising a new industrial strategy. It is reported to be contemplating whether to try to reshore key sectors or allow greater use of state subsidies, with Germany, France and other members understood to be pushing for the bloc to become more protectionist.
As for the UK, having abandoned a formal industrial strategy first developed in 2017, its plans are vague. Nonetheless, it has signalled it wishes to improve transport infrastructure and innovation in the digital economy. Like other countries, it is looking to drive innovation in new technologies to support the transition to a low-carbon economy.
Whether countries adopt formal industrial strategies, more companies are likely to be favoured by their own governments via subsidies and tax incentives. If governments look to build up ‘national champions’, that could provide attractive investment opportunities.
Take UK industrial group Rolls Royce. In February, it said it had almost completed the feasibility stage in the development of its small modular (nuclear) reactor (SMR) and in May will focus on securing investment. The technology will be ready for assessment by UK regulators in 2024 and the company says it aims to have it ready for grid use by the end of the decade.10 Indeed, late last year the UK government said it will plough £215 million into helping Rolls Royce develop the technology.11
The desire to support the domestic economy and jobs is largely behind the UK government’s offer
According to Aviva Investors’ managing director of Infrastructure, Darryl Murphy, the desire to support the domestic economy and jobs is largely behind the UK government’s offer.
“Part of the reason for this is we don’t build conventional nuclear reactors and are beholden to international companies. Rolls Royce is waving the Union Jack flag. The fact that much of the UK’s nuclear expertise is in the north of England where the government wants to create jobs, and this is a technology we could potentially export, makes this something of a Nirvana,” says Murphy.
Climate change: A new front in the trade war?
With the economic impact of climate change forecast by some to reach $69 trillion this century, governments around the world are stepping up efforts to address the issue. According to Bank of America Securities, tackling climate change will require annual investment of between two and four trillion US dollars.12
Steve Waygood, Aviva Investors’ chief responsible investment officer, believes a race to be at the forefront of the key technologies needed to combat climate change could mark the next front in the battle between the world’s leading powers.
Climate wars could be set to replace the trade and tech wars of recent years
“Climate wars could be set to replace the trade and tech wars of recent years. Whether through regulation, limits on exports, tariffs, or significant investments, we believe the US, China and EU will be keen to take the lead on climate action,” he says.
Waygood cites China’s rare earth monopoly, the EU’s battery regulation, and President Biden’s plans to buy American-made electric vehicles for government fleets – all announced since December 2020 – as evidence.
It would be somewhat ironic if the global drive to tackle climate change were to lead to a further ratcheting up of tensions, given the urgent need for international co-operation. Then again, the same could have been said about the coronavirus pandemic and yet cooperation has been in short supply. Globalists are pinning their hopes on Biden countering this, but he faces a tall order in reversing the tide of economic nationalism.