Michael Waugh Monetary Advisor

“The end of globalization” is trending.

In mid-March, the president of the Peterson Institute for International Economics declared as much in the pages of Foreign Affairs, describing a new era of “corroding globalization” in which nations are “trying to retreat into separate corners, looking to protect themselves by withdrawing from the global economy.” The head of the world’s largest money manager followed suit a few days later, with economist and New York Times columnist Paul Krugman not far behind.

It's a compelling argument at this moment of geopolitical upheaval. So we brought it to Minneapolis Fed Monetary Advisor Michael Waugh, whose research focuses on international trade and the effects of trade on local economies. Waugh is also a research associate at the National Bureau of Economic Research and runs the website TradeWarTracker.com, capturing real-time data to visualize trade flows and trade disputes, especially with China.

Let’s just start with this concept of “the end of globalization.” Is that hyperbole? Would you go that far?

I just read an article about Larry Fink, who's the head of BlackRock (the investment management firm) who said, “Globalization is over.” And I thought, I don't know what that means. So, let me turn it around: What do you think that means?

I hear that as a retrenching from patterns of increasing international trade. That is not a new concept—we can go back at least five years, with the rise of populism and protectionism generally. And now the Russia-Ukraine war has people renewing the claim that globalization is reversing.

That’s a good answer, and that's what I think people mean. But I find it hard to believe—and let me give you one example of this. People were saying this in 2018 and 2019. And then COVID hit and people were like, "This is the end! We're not going to see the patterns of trade or expansion in trade that we had seen leading up to this."

And then look how trade responded, after the first couple of months (of the pandemic) when everything shut down. We have never traded more in the history of the globe. U.S. exports are at an all-time high. U.S. imports are at an all-time high. U.S. exports to China, all-time high. U.S. imports from China, all-time high.

And this is all in the presence of all those tariffs that (the Trump administration) put on Chinese goods. When you look outside of China, you see expansions in trade with other Southeast Asian countries like Vietnam in particular.

So, is trade going to look the way it looked in 2010 or 2014? No, but the world is not going to disappear, and everyone's still going to be thinking, “How can I exploit other countries’ comparative advantages?” That's here to stay. Also, think about trade in services, not just trade in goods. For the United States, this is huge—this is our comparative advantage. It's finance, it's universities, it's various forms of technology: Google or Facebook/Meta—these are platforms that are global in scale and that's not going away.

It sounds cool to say globalization is over, but it's not. It’s not.

The complex effects of global uncertainty

You had a recent paper in the Journal of International Economics looking at when uncertainty could actually be good for trade. And you began with a graph showing that even as U.S. policy turned very hostile to trade, rhetorically, after 2016, U.S. exports continued to grow by leaps and bounds (see figure). How do you think about that research in relation to this present global moment?

We thought it was an obvious answer that with more uncertainty there'd be less trade. But then we started finding non-obvious answers, situations when uncertainty goes up and you actually get more trade. That paper is very theoretically oriented and features a model with just two countries, but I think it has a message that relates in the following sense: When there's more uncertainty, you want to try different things. You want to diversify, especially when times are bad.

Let’s map this back into the real world. People are saying, OK, supply chains are all messed up; we're all uncertain about what's going to happen in the world. One gut instinct is, let's pull everything back home. But there's also another force, which is to diversify: Maybe I keep the China operation, but then I start exploring Vietnam, or I start exploring Thailand. Maybe I go into Africa.

The supply chains that we're working with today and we've been working with the past couple years are like having all of your eggs in one basket. Everything has to work perfectly. The stuff shows up just in time; we don't hold on to any inventories.

But now the uncertainty comes up. So, what am I going to do? Maybe I don't want to have all my eggs in one basket, be sourcing completely from China. I diversify. And diversifying could mean across countries or it could be across time (building up inventories). Whether I'm diversifying across countries or I'm buying and holding more stuff from abroad, it's going to show up as more trade. I think that story is kind of underdeveloped in the research literature. But I'm sure that's what business executives are doing today, thinking about how they hedge their bets, especially against future conflict with China.

That makes me think about Europe suddenly looking to diversify away from Russia, finding other sources of liquified natural gas somehow coming from the United States or elsewhere.

Exactly. Germany basically was doing the all-eggs-in-one-basket plan in terms of energy. They shut down the nuclear power plants, and even before the Nord Stream 2 pipeline, most of their energy was coming from Russia. And now things become uncertain.

Germany does not have an absolute or comparative advantage in producing energy. So, they have to figure something out. How are they going to spread their eggs in different baskets? Some of it might come from Qatar, some of it might come from the United States. For sure this is going to speed up (changes in how) Germany wants to generate energy in the future. Does that mean moving to green sources? Does that mean setting up a grid so they can get France’s nuclear power?

I don't know, but the thing is, there are a lot of substitution possibilities here. You're actually going to see more trade: More stuff from different countries now coming into Germany.

It's just not going to look like the simple Ricardian, comparative advantage model of trade.

That's exactly right. Four months ago, this looked like Ricardo: Russia has a comparative advantage in energy; Germany has a comparative advantage in high-end manufacturing. So they trade. Now we are back to a much more complicated world because of political consequences.

Could we wind up with globalization, global trade, but among a subset of the world without Russia and maybe without China, depending on how things play out? That's hard to conceive given our current trading relationship with China, but it's one scenario here, right?

This goes back to your original question about globalization. Maybe trade becomes more regional and more integrated within regions. The U.S., for example, might lean even more into North American or Latin American trade. For Europe, they're already pretty integrated with the European common market there, but maybe they start looking elsewhere.

Do we think we’ll ever go back to 15 years ago, where we believe everyone is trying to play the same game or trying to play according to the same rules—we are buying stuff from Russia, buying stuff from China, and everything's A-OK?

Maybe that's not going to be the future. But that doesn't mean that we're not going to be engaging in relations with other countries. No country has ever grown without engaging in trade with other countries. Why was Ricardo talking about trade? Because it's so important.

A pivotal moment with China

It might be feasible to make a moral decision to diversify away from Russia, which has an economy that's not much larger than the state of Florida. China is another story, and that’s a trading relationship I know you track very closely.

Our relations with China are in a very complicated spot right now. Businesses in the United States, no matter what you're doing, whether you're in technology or just making bicycles, you’ve got to be thinking carefully about that relationship with China.

As oil is to Russia and Germany, goods production is to China and the United States. COVID generated this massive demand for goods, and durable goods in particular. Sure, some of that stuff came from different countries, but a lot of it came from China, and it just keeps feeding the beast—the U.S. consumer.

Even while we're nominally in the midst of some sort of trade war.

Yes, and I think that's the most important lesson from this: There are large swaths of what we are importing from China that are facing tariffs, and we just kind of went right through it. Consumers absorbed this, manufacturers absorbed this. We went through this massive shock, and we still demanded all these goods and services from China.

I think definitely this has to change the calculus for businesses about (whether and how much) to be in China. Do I want to be sourcing from China? Do I want to put my business at risk if I can't get goods from China? That’s the core issue in the United States right now. Russia-Ukraine is a humanitarian issue. But for the United States economically, (it’s about) what does this portend for China? And that's, I think, the scary scenario about the whole thing.

You pointed out that we blew right through whatever trade restrictions were in place. Does that recent history suggest the need to trade with China is so strong that whatever reservations people might be having right now, they aren't going to change their behavior?

That's the conundrum. The Office of the U.S. Trade Representative issued a report recently about the status of the U.S.-China relationship. It’s really the first time we've heard from the Biden administration exactly about the U.S.-China trading relationship. And if you read that report and what it says about China, it brings up exactly this problem. Set aside Taiwan or (concerns about) the Uyghur population—the economic relationship is broken: market access, (forced) technology transfer …

Allegations about China manipulating the value of its currency.

Yes. These are problems that the United States has with China in the trading relationship, problems that have been continually discussed for the past 20 years. And there's been no resolution at all with respect to these.

But then, with all that said, you read in the report that China is an important part of the U.S. economy—it’s critical. And this is where the report gets really vague, (implying that) we need to figure out a path forward so that this important part of the U.S. economy is maintained but we can also somehow address these problems. And then it kind of leaves it at that, without a clear path forward.

This is a really hard problem. We put tariffs on China and nothing happened. China retaliated. But it didn't change the behavior of the U.S. consumer.

So we have this geopolitical moment with Russia, and China caught in the middle. We can't look at a crystal ball and predict how it's going to play out, but could it potentially help provide that fundamental reckoning with China that you're suggesting we really need to have?

It could, depending on how China aligns itself. You could see it going two different ways. One way is that China says they don't like what's going on in Russia and Ukraine. And we find common ground with China on that issue, which allows us to find common ground on these other (trade) issues. That’s the optimistic scenario.

The pessimistic scenario is we don't find common ground with China on the Russia-Ukraine situation. And then we take strong action in response, like put in the final tranche of Trump tariffs—the “4B” list (of currently suspended tariffs)—and then perhaps escalate in different ways from there.

It would definitely catch their attention, because China's in a relatively weak position right now with their economy. There's the zero-COVID policy—that’s a hard thing to deal with, especially when you need all those people working to produce this stuff to export and create output. The second issue is turmoil in the real estate market right now in China. And then China already set this GDP target of 5.5 percent growth in 2022. Even if you believe their numbers, I think most people think that's a stretch.

Maybe now U.S. action might get more attention because of where the Chinese economy is. Whereas when you have China, with 1.5 billion people, growing at 10 percent a year, it is just like a boulder rolling forward. This might be a moment when we could get the attention of the Chinese government and find some common ground.

Developing nations slammed by shifting trade flows

You have an interest in the economic growth of developing countries. What risks do you see in current events and potential changes to trade flows for low-income or developing nations?

Ukraine and Russia make up a huge portion of wheat exports, and most of those end up in developing countries. You’re going to see prices go up pretty dramatically in the developing world. We’re already seeing this in the Middle East. Just from a humanitarian perspective, it's bad for these countries that they're going to have a hard time feeding themselves. And it's not clear we (in the West) have the capacity to step in.

Some of these countries don't have much to export. Unlike the U.S., they don't have this technological capability that everyone demands. They also have to import a bunch of products they can’t make themselves, and one of them is food. And when the terms-of-trade, the prices, move against them—it’s a big deal.

And then you can see roll-on effects because sometimes what these governments do is subsidize this stuff (as prices go up). So then the government has to start paying for that, taking on sovereign debt, and these countries can't pay their debts.

Does that series of events ironically drive them closer to China, potentially? China has tried to develop a lot of outreach to the developing world—the Belt and Road Initiative—and to be there for those countries. If they are seeing their trading relationships with Ukraine and Russia severely disrupted, they’ve got to go somewhere.

I think that's exactly right. When you think about Africa, I think the American public doesn't understand how oriented Africa is toward China, and China's ability to kind of “cushion” is definitely there. There’s a story here: I went to Tanzania with my co-author David Lagakos—just imagine the most rural part of the world, thatched huts, and you are so far off the grid. We are walking in the village and these kids run out and they're all chasing us, and this man who is with us asks, “Can you hear what those kids are saying about you guys?” We have no idea. He goes, “They're asking if you guys are Chinese.”

That's how oriented these countries are to China. There are large swaths of the world where China has made an investment in goodwill and engaged in developing relationships that the United States has kind of ignored. Another good example is Argentina, which has developed pretty strong relations with China and has what I would call antagonistic relations with the United States.

So this goes back to the concept that when existing trade flows are disrupted, people are going to diversify. Europe will diversify in certain ways, Africa and Argentina will diversify in other ways, quite possibly toward China, unless the U.S. has some sort of an answer for that.

The Economist had a graphic recently that showed a map of who imports the most from either China or the U.S. Basically you had Canada and Mexico (importing from the U.S.), then the rest of the world was red—they buy the most stuff from China.

But that said, remember that's about the goods trade. Remember the U.S. education system, our universities, our financing, our technological capability is unmatched. And we have institutions to go along with it. And those are the golden eggs that China can't replicate.