Russia war ends era of globalization that kept inflation low

Mar 29, 2022, 7:00 PM | Updated: Mar 30, 2022, 9:23 am
A damaged building and car after recent shelling, in the center of Kharkiv, Ukraine, Sunday, March ...

A damaged building and car after recent shelling, in the center of Kharkiv, Ukraine, Sunday, March 27, 2022. (AP Photo/Efrem Lukatsky)

(AP Photo/Efrem Lukatsky)

For decades, the free flow of trade across much of the world allowed the richest nations to enjoy easy access to low-priced goods and supplies. It meant solid economies and stable markets.

And for households and businesses, especially in the United States and Europe, it meant an entire generation of ultra-low inflation.

Now, Russia’s invasion of Ukraine has delivered a devastating blow to that system. Prices, which had already been rising, have shot up further. Supply chains, already disrupted by the swift recovery from the pandemic recession, face renewed pressure.

The widening rupture between the world’s democracies and its autocracies has further darkened the global picture.

The new New World Order leaves multinational corporations in a tricky spot: They’re straining to keep costs low and profits high while halting ties with Russia and facing pressure from consumers troubled by Russian aggression and Chinese human rights abuses.

Larry Fink, CEO of the investment management giant BlackRock, wrote last week in an annual letter to shareholders that Russia’s invasion “upended the world order that had been in place since the end of the Cold War” and “put an end to the globalization we have experienced over the last three decades.”

“A large-scale reorientation of supply chains,” Fink warned, “will inherently be inflationary.”

Adam Posen, president of the Peterson Institute for International Economics, wrote in Foreign Affairs that “it now seems likely that the world economy really will split into blocs — one oriented around China and one around the United States.”

Though the rift has been years in the making, Russia’s war against Ukraine may have completed it. It likely concludes an era in which countries with clashing political systems — democracies and authoritarian states alike — could trade and mutually benefit. With Russian missiles killing Ukrainian civilians, it seems almost quaint to recall that unfriendly nations could take their disputes to the World Trade Organization and expect a peaceful resolution.

“It is hard to imagine Americans or Europeans in the same room as Russian delegates, pretending that one WTO member didn’t just invade another,” Rufus Yerxa and Wendy Cutler, both former U.S. trade negotiators, wrote in The National Interest.

Three decades ago, as the Cold War ended, globalization looked promising. The Soviet Union had collapsed. Communist China emerged from isolation and traded with the world. China gained entry to the World Trade Organization in 2001. Russia followed in 2012.

The scholar Francis Fukuyama famously declared “the end of history,” saying the future would inevitably belong to free-market democracies like the United States and its European allies.

Trade flows accelerated. Multinational companies moved production to China to access low-wage labor. They further cut costs by using a “just-in-time” strategy to acquire materials only as needed to fill orders. Profits swelled.

A flood of Chinese imports gave American consumers access to inexpensive toys, clothes and electronics. U.S. policymakers dared to hope that freer trade would nudge Beijing and other authoritarian regimes toward political openness, too.

But strains emerged. Europe became reliant on energy from Vladimir Putin’s Russia. In 2011, an earthquake and tsunami damaged auto parts plants in Japan. A resulting parts shortages idled factories in the United States, a reminder that supply chains that spanned the Pacific risked disruptions.

Then COVID-19 outbreaks closed Chinese factories and ports, snarling supply chains, causing shipping delays and higher prices and forcing U.S. companies to consider bringing production close to home.

The geopolitics got nastier.

American manufacturers accused China of foul play. They asserted — and many global analysts agreed — that Beijing manipulated its currency to make its exports less expensive and U.S. imports costlier, illicitly subsidized its own industries and restricted Western companies’ access to China’s market. The United States posted gaping trade deficits with China. Many U.S. factories succumbed to the competition.

Riding a backlash against globalization to the presidency, President Donald Trump launched a trade war with Beijing. Direct investment between the two sides tumbled, a consequence of Beijing’s drive to keep money from leaving China, tighter U.S. scrutiny of Chinese investments in the United States and corporate efforts to move some supply chains out of China.

Now, Russia’s war is accelerating the economic breakup between democracies and autocracies. Putin’s aggression spurred Western sanctions against the Russian economy and financial system. China, alone among major nations as a Russia ally, has sought to strike a balance. It has criticized the Western response to the war but done nothing that would clearly violate the Western sanctions.

Some companies have responded to Moscow’s status as an economic pariah by leaving Russia. BP and Shell abandoned investments. McDonald’s and Starbucks stopped serving customers. Ukrainian President Volodymyr Zelenskyy has criticized Nestle, Unilever, Johnson & Johnson, Samsung and LG, among others, for continuing to operate in Russia.

“If you’re a (Western) business and you’re looking toward the future in terms of building new plants, sourcing new products, expanding business lines, you’re going to be more prone to look toward countries and companies with similar values and norms,” Cutler, now vice president at the Asia Society Policy Institute, said in an interview.

The emerging economic divide suggests a throwback to the Cold War, when the West and the Soviet bloc largely operated in separate economic spheres. But back then, China was an economic backwater. This time, it’s the world’s top exporter and second-biggest economy.

Indeed, despite rising tensions between Beijing and Washington, Americans maintain a ravenous appetite for low-cost Chinese products. China last year exported nearly $507 billion of goods to the United States, the second-highest figure on record and far more than any other country.

The West’s retaliation against Russian aggression, though justified, will “have negative economic consequences that will go far beyond Russia’s financial collapse, that will persist, and that are not pretty,” Posen warned in Foreign Affairs.

Innovation will likely falter as U.S. and European scientists collaborate less with Chinese and Russian counterparts. Denied access to low-cost labor and materials, Western companies may turn out pricier products. Consumers may no longer be able to count on readily available, low-cost goods — an alarming prospect with U.S. inflation at a 40-year high.

A shift away from China eventually could move more production back to the United States and help restore some manufacturing jobs. Still, Christopher Rupkey, chief economist at the research firm FWDBONDS, foresees at least “one gigantic stumbling block” to that idea: A labor shortage has left U.S. companies already struggling to fill a near-record levels of job openings.

“There is no one to work the factories to produce the goods here on American soil,” Rupkey wrote in a research report.

Relying on low-cost suppliers was so profitable that “it was easy to overlook or minimize potential pitfalls,” Howard Marks, co-chairman of Oaktree Capital, told investors in a letter.

The COVID disruptions, along with trade and geopolitical conflicts, mean that “companies are seeking to shorten their supply lines and make them more dependable, primarily by bringing production back on shore,” Marks wrote. “Rather than cheapest, easiest and greenest sources, there’ll probably be more of a premium put on the safest and surest.”

Bindiya Vakil, CEO of Resilinc, a supply chain consultancy, thinks any such economic decoupling may take years. Still, she said, “A lot of companies that would have taken maybe 20 years to exit China will now exit within three.”

At least for now, the breakdown of three decades of globalization will make supply chains less efficient and perhaps jeopardize a fragile global economy. It will also likely prolong the high inflation that has bedeviled households and businesses.

“I would say this is a shift for the next 30 years,” Vakil said.

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Russia war ends era of globalization that kept inflation low