Davos and globalization

The researchers at the World Economic Forum (WEF), Davos, presented a white paper on globalization that is worth thinking about. It divides the future of globalization into four scenarios based on a two-by-two matrix of physical and virtual fragmentation or integration. Global connections can be through either through physical trade or some form of virtual or non-physical trade which represent high tech integration. (See "Four Futures for Economic Globalization: Scenarios and their Implications" White Paper May 2022 WEF.) I prefer a physical versus services trade matrix with a third dimension associated with finance, but we can use the WEF for discussion.

The physical trade world is clearly disrupted on two dimensions. Supply chain problems from the pandemic have altered how firms and countries view logistics and where they are sourcing goods. The Ukraine War has created a new view that each country must think about self-sufficient with respect to key physical goods like food and energy. The virtual globe world is changing rapidly as countries attempt to control the flow of data and communication. 

Scenario 1 represents the old world of globalization prior to the pandemic. It may be the desire for many to move back to this world, yet it is less likely given the shock events of pandemic and war. Even the virtual world may see less integration although it many have switched from physical contact to virtual communication. Physical integration may occur albeit less concentrated with fragmentation of e-commerce and communication. The reverse of physical fragmentation and virtual integration is the opposite choice with selection to bring manufacturing home but outsource some intellectual activities for cost benefit. 

Nevertheless, the great fear is a movement to isolation around the world as nations attempt to protection commodity sourcing and onshore more activities. The US has started to discuss the idea of friend shoring where countries pick their trading partners as a way of protecting national interests. This will be the great fear to the liberal order of free trade and will have strong implications for firms trying to navigate cost minimization.

The bottom-line for investors is that country financial markets will become delinked and reduce correlation. International diversification will increase but there will be greater dispersion in returns and more room for active investing. Nonetheless, the focus will change from picking firms to picking countries based on strategic partnerships across governments.