25 February 2019

The Impact of Localization

As protectionist and nationalist sentiment continues to grow in many areas of the world, a trend has emerged that is threatening to reverse the process of globalization that has dominated the world economy for the past four decade.  This trend is localization and it has been gaining momentum in recent years. In fact, there has been a great deal of focus on this trend towards localization as economists realized that the downturn in international trade and investment in the years following the global financial crisis was not an anomaly, but instead, a prolonged period of little or no foreign trade and investment growth.  

Instead of focusing on efforts to achieve economies of scale via mass production in low-cost manufacturing centers, more and more businesses are now focusing on producing goods (and providing services) closer to home.  This is being done for two main reasons.  One, as the global market for goods and services becomes more fragmented thanks to the rising influence of emerging markets and the decline of many developed markets, businesses are forced to increasingly tailor their products towards local or regional tastes that are significantly different than those of their traditional markets.  For example, food and drink companies operating in India must cater to local tastes if they intend to succeed in the world’s fastest-growing large economy.  A second reason is that the threat of rising barriers to trade and investment is forcing businesses to rethink their globalization strategies.  In order to avoid a sudden loss of access to a key export market, or a devastating disruption to their global supply chains, businesses are instead turning to production locations within their key markets. 

Many factors are driving this trend of localization.  First, the aforementioned risk of trade and investment barriers is a growing concern for any business operating outside of their home market.  As support for protectionist and nationalist policies grows in many areas of the world, the potential for even more trade barriers to arise will grow accordingly.  Second, changing technologies are making localization possible.  For example, automation and 3D printing are reducing the cost disadvantages associated with production operations in developed markets. While this won’t bring many manufacturing jobs back to developed economies, it will bring production operations back.  Third, changing consumption patterns, particularly among younger consumers, are making it more desirable to produce goods locally, as opposed to in low-cost emerging economies far from the markets in which the goods are being sold. 

This trend towards localization is evident in the trade and investment data from the past few years.  For example, over the past seven years, global trade levels have barely risen at all, despite a relatively strong performance by many of the world’s leading economies during that period.  In fact, exports from both developed and emerging markets have been relatively stagnant during that period, in contrast to the rapid growth in exports in emerging markets in the preceding decades.  In terms of foreign investment, the changes have been even more significant.  Since 2012, foreign investment levels have fallen by nearly 17%, a dramatic change from the dramatic increases in foreign investment recorded over the previous 30 years. Much of this stems from the significant decline in investment between the world’s leading economies, the United States, China and Europe, which are the result of both rising trade barriers and a focus on producing goods closer to home in each of these markets.

As with any major economic change on this scale, there will be winners and losers.  For example, the process of globalization produced many winners, such as emerging markets that developed export-oriented manufacturing sectors, or consumers that benefitted from lower prices for many products and services. However, there were losers as well, such as many “old industry” manufacturing sectors in developed economies or uncompetitive emerging markets.  Should localization prove to be a long-term trend and not just a short-term reaction to temporary market changes, then there will also be winners and losers.  For example, larger developed markets such as the United States will benefit from a return of production operations, while larger emerging markets such as India will continue to see investment flowing inwards as businesses can ill-afford to miss opportunities in high-growth markets.  In contrast, smaller markets will suffer, particularly those that find themselves either cut off from larger or faster-growing markets, or stuck in low-growth markets.  In addition, many emerging markets that had hoped to follow the example of Japan, South Korea and China and export their way to wealth may find that path much more difficult in an era of localization.  In short, should the trend towards localization persist, the disruptions to the global economy could be as great as those caused by the globalization of the 1980s, 1990s, and early 2000s.