World's apart – protectionist measures in the wake of a global downturn

Cast your mind back two years to 9 August 2007 as the world woke to news that French banking giant BNP Paribas had frozen three of its investment funds and the roof finally fell in on the subprime mortgage house of cards.

There followed two years of introspective corporate management as western companies made sure they got the basics right ­ cost reduction, cash management and risk mitigation have been the watchwords for any finance director looking to keep their head above water ever since.

Since that summer, the world has changed. Rising protectionism, the collapse of global trade, a significant reduction in foreign direct investment (FDI), a slump in cross-border lending and rising inflation in hitherto low-cost locations are now the order of the day. It all points to one daunting realisation: that globalisation, the most significant trend in recent business history, has stalled. It may even be in retreat.

Tim Besley, a professor at the London School of Economics and, until September, a member of the Bank of England’s Monetary Policy Committee, is one expert who believes globalisation is in reverse. “We’re going through a period of quite striking deglobalisation in both goods and capital markets. It’s impossible to know whether this is a temporary blip or the beginning of a more protracted reversal,” he says.

A Lex column article in the Financial Times earlier this year didn’t pull any punches: “Deglobalisation: ugly word, scary concept and now painful reality,” it began. While the article went on to argue that much of the recent fall in global trade can be linked to the financial crisis, rather than ingrained behavioural change, more recent events certainly challenge that hypothesis.

In June, the Organisation for Economic Co-Operation and Development published estimates of FDI into OECD countries during the first quarter of 2009. It didn’t make pleasant reading. Of the 17 members which had reported ­ including the UK, US, Germany, France and Japan ­ FDI inflows declined by 50% and outflows by 40% from Q4 2008. If the rate of decline persists, total FDI inflows for all 30 OECD members in 2009 will fall by more than half to around $500bn, while outflows will drop by 40% to about $1 trillion.

Worrying trend
So, what’s going on? Is it possible to see a long-term trend amid the fallout from the financial crisis? Or is it much ado about nothing?

The latest European Union annual report on US barriers to trade and investment suggests there could be the beginnings of a trend. And on this occasion it has nothing to do with the financial crisis, but is a consequence of the US government’s ongoing fight against terrorism. As part of that battle, the US launched the Container Security Initiative (CSI) to counter potential security threats in the containerisation industry, a move which has created headaches for companies exporting to the US since its inception in 2002.

“According to EU industry, CSI screening and related additional US customs routines are causing significant additional costs and delays to shipments of EU machinery and electrical equipment to the US,” the European Union argues. “This burden is so severe that a number of small European engineering companies have decided not to export to the US any longer.” The thin end of the wedge or a drop in the ocean?

One thing that is for certain is that anti-terrorist legislation is not the only leftfield influencer of the global business and economic agenda. Sustainability is another.

A good example is South Korean auto manufacturer, CT&T United, which makes the eZone electric car ­ one of the new generation of two-seater city cars. While focusing on global markets is clearly central to its strategy, it plans to use local manufacturing centres to build the car, rather than global factories reliant on long supply chains.

The strategy, which CT&T has labelled the Regional Assembly and Sales System, will allow the company to satisfy the needs of local customers more easily as well as reduce the environmental impact of the manufacturing and supply chain process ­ not to mention reduce cost. “Owners of our cars can feel good about supporting a product that has a very low environmental impact and is being made close to home,” says its chief operating officer Joseph White.

Its chairman and company founder goes one further, saying that “regionalisation” could be as big a revolution to the auto industry as the Toyota ‘just-in-time’ manufacturing system was in the 1970s.

Neither is CT&T alone. Dutch electrical and consumer goods giant Philips is another company which has felt a change in the air, with its chief executive, Gerard Kleisterlee, saying that a future where energy is more expensive and less available will lead to far more regional supply chains.

Similarly, The Scotts Miracle-Gro Company is focusing on regionalisation as a key focus of future growth and competitiveness. “We may do it a little bit differently to other companies, but we feel we can gain more market share by understanding the local consumer needs [better] and are reviewing our organisation to go more regional from a sales and marketing perspective,” says global procurement director, Erik Dam.

The other trend we see is companies beginning to manufacture goods closer to home, pulling out of traditional, low-cost destinations because of a combination of price, risk and reputational considerations. Hayter, the British lawnmower manufacturer, is one such company. Earlier this year it announced plans to bring back production to the UK to safeguard jobs at its Hertfordshire plant ­ a process known as insourcing. There are many more recent examples, including PepsiCo’s decision to work with US bottlers again.

Global risk
And there’s good reason for it. Gap and Levi Strauss made headlines recently for outsourcing the production of jeans to a factory in Lesotho, the poverty-stricken enclave surrounded by South Africa which had apparently polluted drinking water and dumped hazardous waste in unsecured tips popular with scavenging children.

It highlighted the risk of outsourcing production to low-cost countries. The potential scale of the threat, however, was put into stark relief by Panjiva, a database that tracks low-cost country suppliers to assess risk and which soon discovered another 10 customers of the factory. In global business, risk spreads quickly.

As ever, cost is the benchmark. But even here the trappings of globalisation are less attractive than they once were as rising inflation in low-cost countries and currency fluctuations wreak havoc with even the best-laid plans.

Take business process outsourcing (BPO), one of the stories of the past 20 years as an increasing number of companies look to farm out aspects of their back-office operations which are non-core and purely transactional. But the initial reasons for doing so are no longer obvious.

According to Everest Research Institute, India, the most popular offshore destination for such outsourcing, experienced wage inflation of between 8% and 12% in 2008. In 2007, however, it reached between 15% and 20%. China is no different. According to the China Statistical Yearbook 2008, average earnings increased by more than 18% in 2007 over 2006. The 2006 average had, in turn, increased by more than 14% on 2005. Combine such hidden cost increases with even less tangible costs, such as high rates of attrition and the immediate benefits of BPO and offshoring look much less attractive.

If anyone’s still in any doubt about the decline in globalisation, it’s worth returning, as ever, to the numbers: according to the World Trade Organisation, global trade will fall by 9% in 2009, the biggest decline since the Second World War and a frightening indication of the depths of the current crisis.

Investment slump
As mentioned, FDI has plummeted as corporations look closer to home for those rare investment opportunities. Up until July 2009, data provider Dealogic claims that European outbound merger and acquisition activity fell by 82% on the same period the year before.

The same can be said for bank lending. According to the Bank for International Settlements. After adjustments for exchange rate movements, cross-border bank lending fell by $720bn, or 2.3%, in Q1 2009. This followed an even more dramatic fall of $1.9 trillion in Q4 2008. The UK has been particularly hard hit, with overall inwards bank lending falling by 5.7%, or $53.6bn, during Q1. The cumulative decline over the past three quarters is a massive $190bn.

Add to this the comments made by some of the most influential figures in finance today. Speaking at the annual banking conference, Financial Services Authority chairman Lord (Adair) Turner talked about proposals to introduce more stringent country-based legislation to govern the banking industry. “I know that proposal creates concerns that such ring-fencing would drive deglobalisation, reducing the ease with which global capital flows to its most productive uses,” he said.

Similarly, Pascal Lamy, head of the World Trade Organisation, is well aware of the risk of deglobalisation ­ but he believes its roots lie in the bank bailouts of last year. “There is a danger that the finance industry will be on the side of the forces of deglobalisation,” he told the Financial Times.

His reasoning is, in many ways, supported by the figures above ­ that the bailouts had constrained risk taking outside the territories familiar to national banks. “I am convinced the worst is yet to come,” he said. “The real stress test is for the future when the shrinking of economies translates into unemployment and social hardship and that translates into a political reaction that could influence trade policy. The toolbox for protection is a wide one.”

For finance directors, the challenges are clear. For all but the most cash-rich companies, a more hesitant, introspective and risk-averse financing sector will have a substantial impact on future expansion strategies. It’s probably best to shelve those cross-border acquisition plans for a few years yet (the largest such deal in the UK so far this year has been GlaxoSmithKline’s $3.6bn bid for Stiefel Laboratories ­ the two largest deals in 2008, involving brewing giant Anheuser-Busch and Roche, reached $107.5bn).

The phrase deglobalisation ­ perhaps correctly ­ receives a liberal dose of cynicism from the majority of observers. The very idea of something as ingrained in modern business as cross-border trade and investment going into reverse seems so spectacularly unlikely that this isn’t surprising.

But consider the facts. The combination of global recession, increasing environmental concerns ­ and, more to the point, approaching legislation, rising protectionism, heightened risk and more insular corporate management is an extremely heady mix. Finance directors should prepare themselves for a subtle shift in how they help to manage multinational corporations in an era when business leaders, governments and consumers are thinking local.

And, to answer Besley’s question, it appears more than a “temporary blip”.

Protectionism: fact from fiction
A rise of protectionist measures has been one reaction to the economic crisis ­ or, at least that’s what the headlines have often screamed. However, thanks to Global Trade Alert, a new database of protectionist government legislation co-ordinated by the Centre for Economic Policy Research, we can now see exactly what measures are being introduced.

GTA claims that the UK is currently affected by 43 pieces of protectionist legislation. Here’s a sample:
• Russia: The introduction of temporary import tariffs on laundry equipment
• Australia: New South Wales launches a “local jobs first” programme as part of its stimulus package
• Brazil: The introduction of import tariffs on certain steel products
• US: Employ American workers Act, affects hiring companies that are recipients of bailout funds
Of the 43 measures implemented, GTA considers 25 of them to be discriminatory ­ and a third of all measures have been introduced within the last month.