The Bear’s Lair: How poor countries can beat de-globalization

The outstanding winners from the 1991-2016 policies of globalization were dwellers in poor countries. With international sourcing much cheaper and easier and foreign investment flows soaring, well-run poor countries could attract capital, jobs and export-producing industries in profusion, producing revenues that could educate their workforce and hugely raise their living standards. For poor countries, the world has now become harder. Yet even without globalization, well-run poor countries can still become middle-income and then rich.

The thesis behind globalization was that, as tariff and other barriers lowered worldwide and global sourcing became easier, living standards would tend to equalize between rich and poor countries. Poor countries would miss out on global prosperity only if they were so corrupt or socialist that their people were unable to participate in the global market. Even poorly-educated, rural poor people now had contact with the global market through cellphones (their own or their neighbors’) and so could gain information on crop prices and demand, for example, making decisions that related to the global economic system. Over time, incomes in poor countries would be raised and those in rich countries suppressed, though even in the long run better institutions and education and closeness to high-income consumers would leave rich-country workers with some income advantage.

For its first 15 years until about 2005, globalization appeared to work well. Numerous poor nations, notably China, but also Vietnam, much of Eastern Europe and even parts of Africa, enjoyed economic growth rates far beyond those they had achieved previously. Meanwhile, although rich country living standards slowed their rise, they continued to drift upwards generally, and so there was little political backlash to the globalization program.

Then two factors derailed the process. The 2008 financial crisis, caused by low interest rates and excess debt, knocked back the world economy, reducing the availability of credit to many poor countries that had overborrowed and causing a wave of bankruptcies worldwide. It also sharply reduced living standards and employment in most Western countries, causing their proletariats to realize for the first time just how badly globalist policies had treated them.

Then the cure chosen by the world’s central banks, zero interest rates and massive injections of liquidity, made matters worse. It reduced still further the credit premium paid by borrowers in poor countries, making their cheap labor even more competitive to outsourcing multinationals, whose top management had by now lost contact with their national origins and were overwhelmed by sheer stock-option greed. It increased debt worldwide, making the financial system less stable and leading to much unproductive investment. Many poor countries were still uncreditworthy, but at this point China intervened, tying them up through its gigantic “Belt and Road” initiative in capital investments that mostly provided useless infrastructure rather than productive industries (which might compete with China). Inhabitants of poor countries, now aware how much richer the West was, started moving towards the West in vast illegal immigrant caravans, fueled by criminal elements.

At this point the West’s proletariat and middle classes rebelled. Their living standards were being seriously eroded by the forces of globalization, artificially accelerated by funny money, domestic cheap-labor lobbies of big business isolated from their countrymen, and international crime. The result was a change in policies, notably from Donald Trump and the leaders of the Brexit referendum, but also in Brazil and much of Eastern Europe.

There is not yet a consensus on what the new global politics will be, but a few things can be said. It will be far more protectionist, looking with deep suspicion at schemes that move jobs and especially intellectual property to cheap-labor markets. It will be more suspicious of global treaties and institutions, regarding them as schemes to add bureaucracy, cost and burdensome regulations. For poor countries, the “playing field” will no longer be tilted so consistently in their favor. Nevertheless, there are ways for poor countries to adapt to the new order and continue making their citizens richer.

First, a poor country must recognize the advantages it has. Its labor cost advantages are not going away, nor are the better communications links its people have with the world as a whole – even the most rabid protectionist cannot abolish cellphones and the Internet. (Yes, countries like Iran and North Korea may try; they will condemn themselves to permanent poverty and isolation if they do so. Stupidity is fatal, as in all economic scenarios.)

There are two ways for poor countries to leverage their advantages. First, they can build consumer-oriented businesses in their domestic markets, which in most cases will be underdeveloped. The true economies of scale from operating globally are significant in only a few sectors (automobiles and aircraft, for example). In other sectors, a country with a population of say 50 million, emerged from dire poverty, already has a substantial potential domestic market, which modern communications technology and software makes it easier to address.

Producers of most goods in poor countries can tailor their offerings to the requirements of domestic consumers, in most cases offsetting the cost advantages of the multinationals. Provided the management and some of the technical staff in such domestic companies are sufficiently aware of the latest practices in their industry (again, easier now through the Internet) they will not merely be replicating the dozy “import substitution” of past statist regimes, but will be creating genuinely competitive offerings. Over time, they may be able to expand those offerings to neighboring or culturally similar countries with similar consumption preferences.

The other way for poor countries to expand their wealth and employment, will be to form new links with richer countries and multinationals. Even protectionist countries may offer export opportunities to countries that are not the primary target of their tariffs. While there may be fewer sweetheart tariff deals for poor countries than in the globalization decades, the cost advantage of low-wage manufacturing will often overcome modest tariff barriers. To maximize access, poor countries must cultivate their political links with rich countries and encourage rich-country multinationals to set up manufacturing facilities in their country. Conversely, debt-for-infrastructure deals such as China’s “Belt and Road” initiative should be avoided; the infrastructure is rarely as profitable as promised, in which case the debt will become an intolerable economic and political burden.

Since the poor country’s competitive position in its key areas of strength depends on it having a cost advantage, it must keep its costs as low as possible. Corruption must be stamped out, expensive welfare schemes should be cut back, and government spending should be kept to a lower percentage of GDP than its competitors. Brazil, for example, has under the Bolsonaro government cut back the excessive pension plans promised under its 1988 Constitution and is working to bring its public spending to GDP ratio down from above 40% to the Latin American average of around 30%.

In a de-globalizing world, poor countries cannot simply award themselves Western welfare states or Pharaonic corruption and expect the world to continue supporting them. They should especially resist multinational entities such as the African Union and the 2015 Paris Agreement, that attempt to impose rich country regulations and costs on them from the outside.

There are two demographic essentials to a poor country achieving prosperity. First, it must restrain its own rate of population growth, by whatever means its people find acceptable. China’s emergence from dire poverty, for example, was greatly assisted by its “one child policy” adopted at the beginning of reforms in 1979, which is estimated to have prevented 500 million births in 1979-2015, and allegedly had 76% support in a survey carried out in China in 2008. Rapid population growth makes enrichment impossible; the infrastructure costs alone of extra housing and school facilities are impossible for a poor country to bear, and youth unemployment remains high, with incalculably bad social and economic consequences. As countries grow richer, their population growth declines naturally, in a virtuous circle, but countries must find the means to set this benign process in motion.

Finally, countries must ensure that the rich West does not denude them of their best talent, through H1B visa schemes and the like. Partly this can be done by making domestic conditions tolerable for the talented, for example not imposing a steeply graduated income tax. However diplomatic pressure will also be needed, to prevent the expansion of skilled labor emigration. Essentially, by encouraging contract labor that does not give full immigration rights, the rich country is looting the poor country’s education system, without giving anything in return. This is damaging to the rights of skilled workers in the rich country, but more so to the growth potential of the poor country; it should be resisted at all costs. Allowing multinationals to game the global immigration systems in this way is a lose-lose for both sides.

De-globalization is damaging to the inhabitants of poor countries only if their governments allow it to be so. With good management, it can be beneficial to both rich- and poor- country populations, only limiting the wealth of the very rich corporate managers and private equity providers who previously rigged the globalization system in their favor.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)