May 07, 2022
WASHINGTON — On February 24, at the beginning of the Russian invasion of Ukraine, not many observers had any idea that this European conflict would cause famine and high inflation in Africa, sky high energy prices in the US and Europe, and even cooking oil shortages in Indonesia. If this Russian invasion had taken place 50 years ago, probably the impact of what is and remains to this day a regional conflict would have been confined to Russia and Ukraine, the two nations affected, and may be some neighboring countries. But in 2022 the impact of this regional war is global, in large part thanks to the interconnectivities and interdependencies created by globalization in the past three decades.
Consider this. Russia and Ukraine are both major grains exporters. This war has disrupted production and export volumes of this vital commodity. Hence much higher global prices that disproportionately affect poor countries now unable to afford the quantities of food they need to feed their people. Furthermore, Belarus, a close Putin ally now hit by sanctions, produces fertilizers. Higher fertilizers prices will affect the cost of many agricultural products across the globe. Poor nations will be affected the most. For instance, higher cooking oil prices across the world due to food distribution disruptions forced Indonesia, a major palm oil exporter, to cut its own exports in order to guarantee domestic supply of a very basic staple food.
Russia is a major oil and gas exporter. Europe is a major buyer. Economic sanctions, uncertainties about future supplies and the scrambling for alternatives to Russian hydrocarbons, caused a major price hike for both crude oil and natural gas. As a result, consumers in France and in California are dealing with very expensive gasoline and historically high electricity rates.
Put it simply, because of globalization, nowadays significant international crises cause immediate economic disruptions across a more and more interconnected world. Worse yet, multiple crises occurring at the same time have a compounded effect. Indeed, the Ukraine war ripple effects are now added to the negative impact of other unrelated major global upheavals, including ongoing supply chains disruptions caused by the continuing Covid 19 pandemic, and growing trade and investment uncertainties caused by what we can safely call a new Cold War, this time featuring the US and China, with no logical end in sight.
At its dawn, globalization was praised by many if not most observers as a technology-enabled marvelous new era of almost limitless economic opportunity for established and new companies. A new era that would foster win-win partnerships and benign cross fertilization across all frontiers. The internet had transformed everything. New high tech platforms, systems and solutions, all of them reliant on a huge backbone of ultra high capacity fiberoptic cables connecting the entire planet, with the ability to carry unimaginable amounts of data at a negligible cost, had created a new world of instant, virtually zero-cost connectivity. Taken together, these revolutionary technological innovations had established the foundations for a true global economy in which opportunities would multiply, while broad-based prosperity would be expanded.
At the same time, while data transmission had become easy, global logistics had been simplified and optimized through vast investments in sea and land transportation systems standardization. All trading nations now use shipping containers supported by the same types of terminal facilities on shore, plus specially designed container ships, trucks and railways cars. All of this made moving enormous quantities of physical goods at a very low cost possible, in fact the desirable low cost option. Making lawn mowers in China and shipping them to retailers in Nebraska was not just possible but really cost-effective, as it turned out. All in all, outsourcing production to lower cost manufacturers located in cheap labor countries seemed to open up a new era of greater economic efficiencies and, according to most, win-win situations for most if not all participants. Indeed, US brands reduced their production costs via massive outsourcing, Chinese firms got the business, and American consumers benefited from the lower prices of made in China imported goods.
Winners and many losers
But it did not turn out that way. There are many globalization winners, for sure. And they are the (mostly Western) technology leaders who can more easily access new markets, and the low cost producers (mostly Asian and predominantly Chinese) that could easily outcompete the traditional producers. At the beginning, on account of abundant cheap labor, and later on because of their ability to create efficient supply chains centered on their own countries.
The losers are the non-innovative, tech poor, inefficient US and European companies. Think of the “Rust Belt” in the US Mid-West. Once upon a time these manufacturing states (Ohio, Michigan, Illinois, among others), used to be the home of unrivaled technology leaders. Not any more. Large and very large companies, (think General Motors), that had failed to innovate were crushed by the relentless pressure of new, innovative, low cost Asian competitors, (think Honda, Toyota, Nissan, Hyundai, and others). Thousands of high-cost, technologically obsolete Mid-Western factories closed down. Millions of workers lost their jobs. Only few of them managed to gain new skills and move on to comparatively high paying tech jobs. All the others were pushed down the socio-economic ladder. These were and are the millions of globalization losers.
At a different level, now we realize that while technology made globalization possible nobody bothered to write down and clearly agree on the rules that would regulate the new global economy, so that fairness, reciprocity and transparency would be enforced at all levels. So, we started this new era with essentially no clear, binding and enforceable rules.
While the lack of rules made it very difficult to plan and execute long term strategies aimed at dealing with global competition, what we are facing now now is much worse. Globalization created or at least vastly enhanced interdependence. This would be good assuming that all the key players in the globalized economy were peaceful countries, genuinely willing to play by established and easily enforceable rules, recognized by all as essential and binding. But we have none of the above. As it turned out, while chasing cost cuts far too many companies based in democracies outsourced almost their entire production to companies in autocratic countries that, as we later found out, bend all the rules to their advantage. As a result, new trade relationships supposedly driven by a search for cost-effectiveness and efficiency were easily transformed into dangerous dependence traps.
We now realize that China did not join the global economy more than thirty years ago with the intent to compete in a fair and equitable manner. China sees itself as the next world hegemon. Beijing is not interested in integrating its economy with the rest of the world. It is interested in dominating other countries via unequal economic relations based on dependence. In emerging countries, in order to achieve this goal the Chinese use the enormous advantage of large State Owned Corporations, SOEs, capable of securing huge contracts in Africa or Asia, simply because the SOEs are under no government pressure to produce immediate economic results via investments that amount to enormous levels of debt for the recipient countries. And it is well known that China does not respect intellectual property rights while it uses newly minted competition laws against foreign competitors.
Energy from Russia
If we look at critical energy supplies, European countries import large amounts of oil (about 25%) and natural gas (about 40%) from Russia. Assuming peaceful and friendly relations between Russia and the European Union members, there would be nothing wrong with Europe purchasing hydrocarbons from a neighboring country with vast excess capacity and a proven ability to guarantee uninterrupted supplies for many decades.
But Russia turned out to be a hostile neighbor. It is the rogue power that just invaded Ukraine without any provocation, while making dark threats to Europe. All of a sudden, the one way energy commerce that seemed to be natural and cost-effective has become a national security trap for all the European countries importing large amounts of oil and gas from Russia. And yet, despite their strong (in most cases) disapproval of Russia’s invasion of Ukraine, the Europeans at least for some time will be forced to buy the energy they do need from a rogue nation. And, sad irony, with the revenue generated by this energy trade Russia can continue to finance the war of aggression against Ukraine the same Europeans strongly oppose. As a result of this sudden need to quickly identify and secure vital energy supplies from other sources, the European Union countries are now in a crisis mode, scrambling to find viable alternatives to Russian energy imports.
How can we get out of this?
Now that we know all this, the arduous task ahead it to disentangle the economies of the western democracies from the dangerous dependence on economic and trade partners clearly unwilling to play by the rules of peaceful behavior and transparent competition. Unfortunately, this is more easily said than done.
About 31% of the world GDP is generated by autocracies –China first and foremost– that do not operate according to western values supposedly upheld and monitored by the World Trade Organization, WTO. Over many decades, the West outsourced production to them under the mistaken assumption that business relations would operate on a separate, safe track, unaffected by geopolitics. In fact many believed that increased trade and investments from the West would somehow cause a benign influence on the autocracies so that they would be magically transformed into something like liberal democracies. Now we know it is not so, and the West is reacting –in an emergency mode.
For large importers of Chinese manufactured goods, such as the US, the task is to identify and then establish productive business relations with alternative suppliers in different countries –suppliers who share our values and play by the same rules we uphold– while also looking at sectors where it would make sense to bring production back to America.
Realistically, this will be a multi-year monumental effort, considering the sheer number of sectors affected and the astronomically large volumes of made in China goods that the US imports every day. Likewise, if Europe wants to lessen it dependence on Russian oil and gas, brand new energy policies must be agreed upon and implemented by the European Union Members in a very short time. A very daunting task.
More broadly, the lesson we have hopefully learned by now is that business relations do not occur in a self-contained, conflict-free space. They are part of overall international relations. For this simple reason, outsourcing production of strategic goods to countries that hold values incompatible with ours is likely to lead to unpleasant, in fact dangerous situations, as we have just found out.
Do business with your friends
Having understood all this, it would make sense for the developed democracies of the West and many other countries that have genuinely embraced western values (think India, Mexico, Indonesia, South Africa, Thailand, among others) to look at ways in which they could strengthen and deepen investments, business and trade relations with one another, while upholding the highest standards in doing business with emerging markets that have experienced Chinese predatory practices, (think many countries in Asia and Africa).
It is not that we have no resources. Taken together, the economies of the European Union, a most powerful trading block, and the US represent about 40% of the world GDP. If you add Japan, (the world’s third largest economy), the UK, Canada, India, Mexico, South Korea, Australia, New Zealand and other countries willing to play by recognized international rules, we are talking much more than half of the world economy.
It is almost guaranteed that there are plenty of unexplored opportunities for deeper, mutually advantageous business relations among western nations and many important emerging markets willing to play by the rules. These opportunities should be swiftly and enthusiastically pursued.
The simple truth is that it is better and safer to do business with your friends and other like-minded partners rather than engaging in superficially lucrative relations with potentially or openly hostile countries that create dependence and strategic vulnerabilities.