WKLY - Is Globalization As We Know It Gone?
2023-05-24 12:06:00 ET
Summary
- Globalization has changed and created a new investment regime.
- Why governments are focusing more on manufacturing security rather than global supply chains.
- How reshoring is impacting profits and the global economy.
The COVID-19 pandemic and rising political tensions have caused governments and companies to re-think global supply chains. This is raising questions about the future of trade. William Priest, Co-CIO at Epoch Investment Partners, looks at the impact of onshoring on the global landscape.
Transcript
Kim Parlee: Let's talk a bit about globalization. You're here, I know, to talk to a number of folks about the idea that globalization is gone. What does that even mean?
William Priest: Well, globalization began in earnest, I think, around 1989 with the fall of the wall. When the Berlin Wall fell, that's how it all started. But there were a number of things that began even earlier than that basically going back to the early '80s, which championed by Reagan, Thatcher, Mulroney. And then the Chinese, when Deng Xiaoping came into power, China opened up.
But the real catalyst was the dissolution of the Soviet Union. And China joined the WTO in 2001. And essentially, what globalization did was to allow for the law of comparative advantage to be written large. And that basically says, you should trade as much as possible with other nations with the attempt to create absolute growth for you and them as well. And it's one of the immutable laws. And in economics, it actually works.
Kim Parlee: Yeah, and I know we've talked before about comparative advantage where just for people who may not be up on their economics, just the idea that even though you're not the absolute best in everything, it often does make sense to trade with others.
William Priest: It does. The most simple idea was if there were two countries making food and clothing, each country wanted the same amounts. But one country was twice as good as food and three times better in clothing. It still pays for the second country to trade with the first because the key is the relative differential. As long as there's a relative differential, trade.
Kim Parlee: Yeah. You talked about all the things that were driving globalization. And you mentioned the last one being China and the WTO. And we've got a chart that showed that. But when we look at the things that are, I guess, moving us towards this new era, if you will, and that we're deglobalization. Is that happening? And what's causing that?
William Priest: Deglobalization is happening, and it's almost unchangeable. Back in 1989, in that era, there was a book written by Francis Fukuyama called-- [CLEARS THROAT] called The New World Order or The End of History, I think, was the actual title of the book. And basically, it was I called it the death of the isms. There wasn't going to be a communism, a socialism. There's going to be one ism.
There was going to be a mix of some socialism and capitalism, and it lasted for about 20 years. It started to fall apart in 2008 with the global financial crisis. And now, we have this geopolitical issue with the rise of China and the threats to democracy from autocracy. All of this has destabilized the world. So what was a pursuit of efficiency is now being transitioned to the pursuit of security.
Kim Parlee: What is the impact of that? I mean, I think that's what it really comes down to, right?
William Priest: Well, the impact economically is going to be everything is going to cost more because you're trading efficiency for security of supply chains. It's more important be able to know that it's made in America or made in Canada than to have it being made in China. So you're essentially reshoring. You're basically taking a lot of capital that had been spent and repositioning it to the extent you can onshore. And you can see that particularly in two places.
Technology and chips, chips is the new oil. If you don't understand chips, no one's going to have it. You will not be able to participate in economy going forward. There's an excellent book out by Chris Miller called The Chip War. I would highly recommend that. It will give you a vision of what the future can be. And the US is clearly trying to make it very difficult for China to possess some of the technology necessary to make the bigger, more powerful chips.
Kim Parlee: I mean, it's something that it's such a change. It's such a change from where we were coming from before. And I think people really need to understand that. I want to bring up a chart that you brought in. And this is looking at manufacturing, construction, computer electronics, US dollars, and the spike we're seeing on the right-hand side, which shows what's happening in 2023. Just take us through this and why this matters.
William Priest: Well, and when you look at the chart, basically, the lower-- the earlier years where it's relatively flat, that was all about the law of comparative advantage writ large. This has changed. It's changed because of national policy. You want energy security. You want tech security. And you want to make your supply chain made here wherever here may be.
And so the US is spending tens of billions of dollars to build fab plants. Fab plants cost a fortune. And it takes a long time to build them. But the effect of this is going to be when you look at the value added chain, let's just take the difference between profits and labor, capital and labor. Well, when you look at the return on capital over a long period of time in the last 20 or 30 years, a lot of that growth has gone to profits.
That's going to change. There will be profits. The labour will be taking share of the value add. The onshoring effect will be sufficient to basically cause wages to be rising much faster than they have in the past.
Kim Parlee: And all that is inflationary. That's something that we're dealing with now. But it sounds like it's going to be getting worse?
William Priest: Now, inflation-- inflation isn't going away very quickly. And I would also argue that the Fed has this policy of a 2% target. I would venture to say you might find 4% to be the new 2%. It's going to be very difficult to get inflation, interest rates, and inflation back to where 2% was a tolerable number. The underlying pressure on wages is just too high.
The other way to think about that, when you think about-- when you think about GDP, for example, most of us were taught that it's consumption plus investment plus government spending plus net exports. But there's another way to think about it. And that's the value-added chain. And on the value-added chain called net national product, something like 70% or 75% of that is labor. That number is going up. Well, that means profits as a percent of value added are going down. It'll be profitable but much less than it used to be.
Kim Parlee: What does that mean?
William Priest: Well, what it's likely to mean-- and this is speculation on my part-- is the P/E ratio range we've been used to for the last 10 years, it's going to be lower going forward. Price-earnings ratios are really tied to interest rates. If interest rates are high, P/Es are low. If interest rates are low, P/Es are high. Well, if, in fact, rates are going to be trending upward or just even flat to where they are today, P/Es going forward will be less than they were the last 10 years. Think of it as capitalization rates.
Capitalization rates applied to earnings will be going up. But the earnings growth rate is also likely to be a little slower than people think. The only offset to that really is technology. And if you can use technology, if you're running a business, if I can substitute technology for labor and hold my revenues constant, my profit margins go up. If I can substitute technology for physical plant and hold my revenues constant, my return on capital in the business goes up.
So as long as you can have a strategy-- and I call it the business strategy for the digital age, my favorite question in talking to CFOs, what's your business strategy for the digital age? If you have one, you might have a chance. If you don't have one, you're going to die. So the way I think about it, technology may be able to offset some of these macro trends. But you better look very carefully at it because if you can't do it, you're going to suffer in terms of profitability.
Kim Parlee: It's a fascinating discussion, Bill, because I just think you're encapsulating so much. We talk about all the cross-currents that are happening right now in the markets. And you've really identified the near-shoring very inflationary, technology, very deflationary. Where does it all net out for people? Where would you say-- what does this mean for capital markets overall as the markets try and price in what's going to be happening?
William Priest: There's going to be more volatility. And what was viewed once phrase was used by-- I forget which economist-- called the Great Moderation. That's probably over. We're going to have more volatile markets. We're going to probably have a narrow-- a smaller P/E range that we'll be dealing with. The absolute numbers will be large.
But we're not going to have a consistency of-- it won't be a narrow band around multiples. I think they'll be much higher. And you also have to find, well, what segments are going to prosper in this period? Growth is going to be sluggish. When you think about growth, growth of GDP is simply the sum of two things-- it's growth in the workforce and growth in productivity.
Worldwide, there's virtually no population growth outside of Africa. When you look out 30, 40 years, you'll see the growth in the workforce is probably 50 basis points. It's not much at all. So on top of that, you say, well, what might be productivity? It will vary by industry. You need -- the bigger the number, the better, in terms of profitability. But you'll be lucky to get 2% real growth in my view, maybe 2.5. You'll be very lucky to get that going forward. That'll be different than what we've had for the last decade.
Kim Parlee: It's really-- what you're talking about is really a dawn of an entirely new investing regime.
William Priest: There will be a new investment regime. And I think when you look at what-- you invest for a purpose. And probably, the biggest challenge we have today, when you look at the developed world, is the aging of our societies. Essentially, you have an income replacement problem. To the extent people normally retire around 65, if you pick that number, life expectancy if you've made it to 65 is in your 80s.
So very often, how are you going to finance those years post-65? It's a challenge for every society right now. And there's no easy answer for this. You saw the pressure in France when they simply wanted to raise the retirement age from 62 to 64.
Kim Parlee: Fires in the street.
William Priest: Oh, if they can't fix this, the country goes broke. I mean, you have to have-- somebody has to fund this liability that you need to pay the retirees. So we'll see how that plays out. But the opportunity set for an investment firm is going to be dealing with income replacement.
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Is Globalization As We Know It Gone?