After decades in which economic ties pulled the world closer together, the relentless pursuit of efficiency has been frayed by conflict, widening ideological differences and COVID-19. International ties aren’t ending, but they are being reevaluated and recast.
For decades, industry grew by making the world smaller. The math underpinning globalization was as simple as it was alluring: Technological improvements in communications and logistics allowed manufacturers to locate factories around the world, thus leveraging vast differentials in labor costs. Low-interest loans painlessly financed the expansion. As international supply chains became more specialized, new manufacturing hubs became more efficient — a virtuous cycle supported by a prolonged period of generous central bank policy.
“The more you exchange goods and services with your international neighbors, the more globalized you are,” explains Capital Group political economist Talha Khan. “Globalization is a system of interdependence that integrates people, economies and governments.”
Today, big changes on many fronts, from supply chain breakdowns to venomous trade disputes, are prompting businesses to reassess their global footprints. It isn’t that globalization is about to unwind or reverse — it’s not. International commerce is far too advanced and entwined for that.
Rather, the emerging “reglobalization” trend is more about approach. Businesses are less transfixed by what could go right and far more alert to what could go wrong. Instead of reflexively uprooting to the lowest-cost venues, they’re reappraising the risks and stressing contingency planning. That can mean switching production to friendlier countries, developing backup facilities, rerouting supply chains, stockpiling parts or doubling up on suppliers.
“I don’t think we can fully deglobalize,” says Capital Group analyst Ben Lin, who covers Asian machinery, construction, engineering and electrical equipment. “The internet is not going to deglobalize. We are connected, and we will continue to be connected. I just think we can’t take the global integration we’ve seen in the last 30 years, particularly in terms of supply chains, for granted anymore.”
“Globalization really benefited the world. We became very efficient,” adds Kohei Higashi, a Capital Group equity analyst whose coverage includes electrical equipment, industrial conglomerates, machinery and consumer electronics. “But now the pendulum is shifting. How we globalize will change, and that’s already happening.”
This shift presents formidable challenges — but also meaningful opportunities for companies, industries and investors. Forward-thinking businesses with fortified operations may have a leg up in the next stage of global competition. The same holds true for industries, especially those whose services may be in particular demand. For example, factory automation providers may benefit as corporate customers seek to galvanize existing operations or create parallel ones, as we investigate in our story on page 12.
From an investment standpoint, reglobalization will affect individual sectors and the businesses within them very differently. For some, creating backup facilities or diversifying global networks could add significant costs that tug at profitability. Others, however, may be able to use the shifting environment to their advantage by distinguishing themselves from competitors. It will be essential to differentiate potential winners from the losers. Capital Group analysts and portfolio managers are working to pinpoint industries and companies that are well positioned for the changes ahead.
The logic behind globalization was always simple: By steering operations to low-cost venues, companies could achieve economies of scale and tap into vast new markets. For decades, the stars seemed to align behind the ideal of free trade as China kept opening to the world and the internet spread its tendrils.
However, globalization has long been a flashpoint. Supporters argued that the benefits went well beyond improved profits; rising tides lifted all boats, they said, pointing to lower prices for consumers and powerful engines of growth for emerging markets. Detractors highlighted security and intellectual property risks, and noted that developed nations lost high-quality middle-class jobs when manufacturing decamped overseas.
Even before the current upheavals, there were questions around the sustainability of the existing model. As China came into its own and focused on domestic development, it became clear that the population size, low costs and regulatory advantages that made the country so attractive to manufacturers also made it a fearsome competitor. Meanwhile, loose monetary policy was likely going to end eventually; central banks had long fretted that they needed to raise rates so they would have room to maneuver in an economic crisis.
“The pace of globalization started to slow after the global financial crisis in 2008,” Khan says. “As credit and liquidity dried up, it had a knock-on impact on the flow of trade and services. That trend of ever-deepening flows slowed down, never really reversing to precrisis levels.”
In the past few years, multiple forces have caused businesses to reconsider their global strategies. COVID-19 shutdowns paralyzed supply chains, leading to spiraling prices, shipping delays and product shortages that have yet to be overcome. Shifting government priorities, rancorous trade relations and armed conflict have compounded the disruptions.
Looking forward, additional rips are forming in the fabric of international relations. The war in Ukraine threatens to drag on, and the divisions between Russia and the West are starker than they’ve been since the fall of the Soviet Union. The relationship between the U.S. and China continues to shift from symbiotic manufacturing partners to heated economic rivals. And soaring inflation has prompted central banks to increase interest rates from decadelong lows.
Taken together, the advantages of dispersing operations to low-cost venues are being weighed against the deepening logistical and political risks. That’s particularly true in a world where national policies appear to be turning inward to become more isolationist and protectionist. Freewheeling globalization simply doesn’t have the cachet it once did.
“I see the world going from single sourcing to dual sourcing or multilateral sourcing,” Lin says. “The world has become so dependent on China, but I think there are multiple pressure points. There’s the geopolitical tension. The ups and downs and the supply chain disruptions in China have forced manufacturers and multinationals to have a rethink.”
Supply chains exemplify the emerging reglobalization dynamic. They define how companies source and produce goods — how and where raw materials are harvested, sold, transported and combined to create products that are then delivered to retailers and, ultimately, to consumers.
Overseas manufacturing facilities allowed Western businesses to cut back on local warehouses, excess stock and anything else branded as wasteful slack. Businesses tightly calibrated deliveries to ensure materials arrived exactly when needed. It was a carefully managed waltz designed to maximize efficiency and minimize costs.
The tradeoff, however, was a reduced margin for error, and that weakness was laid bare when the pandemic hit. Once-unimaginable supply shortages caught businesses flat-footed. That partly explains the surge in car prices in 2021: Many automakers slashed orders of microchips in the depths of the 2020 shutdowns, leaving them with an insufficient supply when the world reopened and demand ballooned.
Similarly, highly concentrated supply chains are deeply exposed to geopolitical flare-ups. China’s aggressive anti-pandemic measures continue to exacerbate supply shortages. There have been echoes of this in the invasion of Ukraine. Russia produces so much copper, oil and fertilizer that those markets, and the goods that rely on them, are grappling with significant price increases.
In response, many businesses are seeking to balance efficiency and resilience. “Just-in-time” delivery models that were once celebrated as marvels of efficiency are being supplanted by more prosaic but reliable “just-in-case” supply chains. By keeping stocks of critical supplies on hand and using multiple suppliers, companies hope to minimize the odds of an emergency leading to a crippling production shutdown.
Some companies are building in “redundancies” — essentially, duplicative production lines or similar systems — in the belief that an abrupt shutdown in one country can be offset by parallel operations in another. For example, Taiwan Semiconductor Manufacturing, one of the world’s most significant microprocessor manufacturers, is building a plant in Arizona to complement its Taiwanese foundries.
In the long term, this shift will likely lead to higher capital expenditures, Lin says. That could feed through to industries that benefit from facility expansion and renovation, such as factory automation.
Industries with less complex manufacturing requirements, such as apparel, have long been trickling out of China, partly because wages there have risen over time. Although these companies were generally chasing lower labor costs in countries like Bangladesh and Vietnam, their moves provided a template for others to follow.
“Low-end manufacturing, particularly in industries that can be automated, is more likely to move,” Lin explains. “Good examples would be food and beverages, and apparel. Robotics have improved significantly over the years, so the bar is a little lower, even in electronics. For example, Samsung moved its entire smartphone production to Vietnam from China only a few years ago.”
Vietnam has proven especially attractive as a second home for factories because of its receptive government and low labor costs, Lin says. But that country also demonstrates some of the obstacles to relocation. Vietnam lacks much of the major infrastructure that makes transporting goods in and out of China so easy, and its pool of white-collar workers is far smaller than China’s. Furthermore, Vietnam lacks the kind of literal nuts-and-bolts support industries that provide the basic necessities of manufacturing, meaning that spare parts and tools would have to be imported or developed locally. While those are surmountable difficulties, they’ll likely demand long-term solutions.
“China spent 30 years building infrastructure, developing its workforce and making life easy for manufacturers,” Lin says. “Why don’t some of these companies move out of Guangdong, for example? It’s because the entire supply chain is within a two-hour radius.”
Relocating is even more fraught for highly sophisticated industries. For example, while semiconductor manufacturing is dominated by a few high-end businesses, there’s a panoply of highly specialized companies that largely control the markets for niche tools or components.
“A lot of the components come from suppliers that have 80% to 90% market share,” Lin says. “These are critical components, and only one company can make it. That especially shows you how integrated we are.”
ASML, for instance, is a Dutch company that creates the photolithography systems used to etch the silicon wafers that are critical to semiconductors. Without ASML’s machines, microprocessors couldn’t be made, yet the company is essentially unchallenged in its space. By some estimates, re-creating its technology could take decades of research and development. That means that any company or country interested in creating cutting-edge microprocessors must use ASML machinery — exactly the kind of interdependence that globalism is based on.
“I just don’t think that China could leave the international market and make a fully independent semiconductor supply chain, precisely because of these kinds of critical components,” Lin says.
Of course, the forces pushing this reglobalization are still playing out. Previous ebbs and flows in globalization have all brought challenges, Khan says, and they haven’t always been predictable.
“I think it’s important to recognize that we’re now in a period that comes after great events,” he says. “What comes after is flux, which is what we’re living through now.”