Has Globalization Passed Its Peak?

Rawi Abdelal and Adam Segal

From Foreign Affairs, January/February 2007

Summary:  Not long ago, the expansion of free trade worldwide seemed inevitable. Over the last few years, however, economic barriers have started to rise once more. The forecast for the future looks mixed: some integration will probably continue even as a new economic nationalism takes hold. Managing this new, muddled world will take deft handling, in Washington, Brussels, and Beijing.

Rawi Abdelal is an Associate Professor at Harvard Business School and the author of the forthcoming Capital Rules: The Construction of Global finance. Adam Segal is Maurice R. Greenberg Senior Fellow for China Studies at the Council on Foreign Relations and the author of Digital Dragon: High Technology Enterprises in China.

One of the most worrisome aspects of the general decline of globalization today is the growth of public skepticism and the increasing popular dissatisfaction with the uneven distribution of globalization's benefits both across and within countries. These sentiments, now evident virtually everywhere, are perhaps most striking in two countries: the United States and China. In both places, they are already starting to force policymakers to erect economic barriers.

The irony of this trend is that both the United States and China have benefited handsomely from globalization. Yet politics in these two states now constrain their governments from further embracing cross-border flows of capital, goods, and labor. As Ben Bernanke, chair of the Federal Reserve Board, suggested in August 2006, the problem "arises because changes in the patterns of production are likely to threaten the livelihoods of some workers and the profits of some firms, even when these changes lead to greater productivity and output overall. The natural reaction of those so affected is to resist change, for example, by seeking the passage of protectionist measures."

Consider what has recently happened in the United States. The country is now confronted with the largest current account deficit ever -- a deficit that necessarily must be matched by capital inflows, that is, borrowing from abroad. And yet, just when the United States needs foreign investors the most, popular sentiment has turned against them. In recent years, intense public pressure has essentially forced Washington to reject two high-profile transactions: an attempt by CNOOC, a giant Chinese oil firm, to acquire the U.S. firm Unocal and Dubai Ports World's move to take over a British company that administered several U.S. ports. Now, ongoing legislative efforts to reform the Committee on Foreign Investments in the United States threaten to politicize the approval process further. Even as the United States' need for foreign investors to finance the current account deficit grows, members of the U.S. Congress are acting as though the country were still in a position of strength and able to dictate the terms of such deals.

Washington's commitment to the free flow of goods -- especially Chinese goods -- has also started to falter. The Bush administration has refused to endorse accusations by the media and legislators that Beijing deliberately keeps its currency weak in order to boost Chinese exports. But Congress has been far less reticent: Senators Charles Schumer (D-N.Y.) and Lindsey Graham (R-S.C.) have proposed a highly punitive 27.5 percent tariff on Chinese goods, and Senators Max Baucus (D-Mont.) and Chuck Grassley (R-Iowa) have sponsored a more moderate (and more WTO-compliant) version. Another worrisome factor is that fast-track trade-negotiating authority, given to the president in 2002, expires in 2007. Before the November congressional election, Democrats announced that they would not renew this authority if they won control of the House and the Senate -- which would make any new trade measures that much harder to win approval for.

A similar retrenchment has occurred in China. Access to commercial banking, communications, and real estate remains severely limited for foreign investors, and Chinese officials have started giving more scrutiny to potential foreign investment in other sectors as well. A bid by the private equity firm the Carlyle Group to take over China's Xugong Group Construction Machinery Company has been held up for months, and Carlyle recently reduced its proposed ownership share to 50 percent in an effort to limit political opposition to the deal. Beijing also introduced measures in August 2006 to require government review of mergers and acquisitions that could affect China's "economic security" or that involve "key industries" or popular domestic trademarks. And a new antimonopoly law primarily targets multinationals that the Chinese government believes have too much market power.

Underlying these moves, the very nature of the Chinese development model has, with little fanfare, changed in recent years. In 2005, Beijing concluded that its previous model, which had been in place since around 1978, had been too dependent on greenfield foreign direct investment (that is, foreign money that goes to the construction of new facilities and new technologies). Foreign investors in China had received better tax and regulatory treatment than domestic entrepreneurs. Beijing decided to reverse this orientation, and in November 2005, China's National Development and Reform Commission, a sort of overarching reform ministry, accordingly issued the innocuous sounding Measure 39. Under this regulation, domestic venture capitalists now receive much better tax and regulatory treatment than do their foreign counterparts. China will still, to be sure, find a place for foreign investment, but Beijing will no longer give it the protected status it once enjoyed.

Beijing, like other governments, is also coming under increasing pressure to address the inequalities brought on by rapid economic development and globalization. According to Chinese sources, the richest 10 percent of households in China now account for more than 40 percent of the country's wealth, whereas the poorest 10 percent of households account for only about 2 percent. The regional income gap is also increasing, with coastal provinces now enjoying a per capita gross domestic product more than ten times that of the poorest interior provinces. President Hu Jintao has publicly recognized the need to address these disparities by making the attainment of a "harmonious socialist society" one of his government's central goals, and he is slowly taking measures, such as simplifying and reducing the tax burden on farmers, to effect it.

OIL OF ONE'S OWN

One of the best ways to measure the health of globalization worldwide is to look at energy markets, and those for oil in particular. Oil has become the ultimate global commodity, unparalleled in importance. As go oil markets, therefore, so goes the global economy. And here, too, the signs are worrisome.