Globalization Resets

• Author: Sebastian Mallaby

Globalization Resets Finance & Development, December 2016, Vol. 53, No. 4

Sebastian Mallaby

Globalization's winners and losers

The retrenchment in cross-border capital flows and trade may be less dire than it seems

The two decades following the Cold War were celebrated and decried as the era of globalization. Cross-border movement of capital, goods, and people expanded inexorably. Between the fall of the Berlin Wall in 1989 and the early onset of the global financial crisis in 2007, international capital flows grew from 5 percent of global GDP to 21 percent; trade leaped from 39 percent to 59 percent; and the number of people living outside their country of birth jumped by more than a quarter.

But today the picture is more complex. International flows of capital have collapsed. Trade has stagnated. Only the cross-border movement of people marches on.

Do these developments portend the start of a new era—perhaps one of deglobalization? Such a reversal is possible: the rapid globalization of the late 19th century gave way to the deglobalization of the early 20th. And yet, in the absence of a shock comparable to World War I or the Great Depression of the 1930s, history seems unlikely to repeat itself. A look beyond the headlines suggests that globalization is changing rather than stagnating or reversing.

Capital flows Consider first the trends in global capital movement—the most compelling area of the deglobalization story. The McKinsey Global Institute (Lund and others, 2013) reports that, in 2008, cross-border flows of capital crashed to 4 percent of global output, a fifth of their peak the previous year (see Chart 1). That collapse, and the even lower level of cross-border financing in 2009, reflected the extraordinary freeze-up of financial markets following the September 2008 bankruptcy of the U.S. investment firm Lehman Brothers. But what is more remarkable is that financial globalization has yet to recover. McKinsey, in an update of the data used in its 2013 study, reports cross-border flows fell to 2.6 percent of global GDP in 2015 and over the period 2011–15 averaged just 5.4 percent of global GDP—a quarter of the 2007 level.

What might explain this? The first clue can be found by separating cross-border finance into four categories (see Chart 2). One of these—portfolio equity investment, that is, investors’ purchases of shares in foreign stock markets—is up slightly in dollar terms since 2007. Two types of flows—bond purchases and foreign direct investment—have fallen, but not dramatically. It is the fourth—bank lending—that has collapsed. In 2015, net cross-border lending was actually negative, as banks called in more international loans than they extended. Taking these figures together, McKinsey calculates that the evaporation of cross-border bank lending explains three-quarters of the overall fall in cross-border finance since 2007.

To some extent—indeed, probably to quite a large extent—the retreat from cross-border lending represents a healthy correction. In the years before 2007, two parallel manias boosted international lending unsustainably: European banks were loading up on U.S. subprime mortgages, and banks in northern Europe were lending prodigiously to the Mediterranean periphery. It is therefore not surprising that the collapse of cross-border lending has been concentrated among banks in Europe. According to the Bank for International Settlements, euro area banks reduced their overseas claims by almost $1 trillion annually in the eight years following the Lehman Brothers bankruptcy, a far more dramatic contraction than occurred in other regions.

Getting it rightSeen in this light, the years leading up to the financial crisis are not a useful guide to how much financial globalization is normal or desirable. Cross-border capital flows peaking at 21 percent of global output reflected a toxic mix of ambition and credulity, notably among European banks. But if 2005–07 was an aberration, what is the appropriate benchmark for global...