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Localization Trend Stands to Rewrite the Rules of Global Trade in 2020

In 2020, globalization will give way to localization.

Global economies heading into a new decade will shift their focus to localization opportunities and wars will rage over tech, rather than trade. Three decades of economic growth fueled by globalization–cross-border free flow of goods and capital, cheap labor and low consumer prices–are poised to give way to new forms of thinking.

Brexit and the U.S.-China trade war are salient signs this shift is already underway. Although dubbed a trade war, the actual dispute between the U.S. and China has to do with intellectual property protection, and each side has employed trade tactics as the tool to exert pressure designed to help them realize their own demands.

“Many of the driving factors–central bank policy, globalization, oil–have peaked, and new economic paradigms are emerging in response to a different set of challenges facing the world’s social, environment, political and economic systems,” Candace Browning, head of global research at Bank of America Merrill Lynch, said.

And that set of challenges also calls for new rules of engagement.

“The megatrends that have impacted the world have reached a boiling point,” said Haim Israel, head of thematic investing strategy, who spoke at the Bank of America Merrill Lynch’s Annual Year Ahead Outlook presentation at company headquarters in Manhattan last Tuesday. “The paradigms in the last 20 years have to change–it’s a shift in the way [the world is] thinking.”

As for globalization, the “last decade was the peak of the free movement of services,” Israel said. Now there’s a shift from free cross-border transactions to a focus on local economies. Given the $18 trillion sitting on global balance sheets, new monetary theories are at work–all with local economies in mind.

As more countries focus on themselves and their own economic goals, that also means there’s little or no incentive to keep the focus on the globalized, collaborative efforts connected to free trade and services seen in the past.

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The move is already happening in parts of Europe, now the battleground for taxes on digital services. That fight is resulting in “physical separations among a lot of platforms now,” Israel said, referring to the move as “splinternet.” Splinternet–another shift toward localization–is part of the new monetary thinking at work as countries consider what they can tax to raise revenues.

Technology is another key battleground that will grab much of the attention in the next decade as countries–particularly the U.S. and China–compete on the race for innovation to claim supremacy. This drive to be No. 1, and even control how technology is used, further fuels the localization trend.

“Tech wars are won through innovation,” said Israel, who expects governments to take on a greater, and more direct, role in influencing the course of innovation in the years to come. “They see it as a security matter. Governments see a need to have more influence, and more sovereigns will get into internet spending on innovation in [areas such as] AI,” he explained.

The U.S.-China dispute

Ethan Harris, who heads up global economics at Bank of America Merrill Lynch, is already predicting a symbolic “skinny” agreement in the trade dispute between the U.S. and China, with the battle on hold for 2020 before re-escalating in 2021 after the U.S. presidential election.

And while the dispute has been dubbed a trade war, the disagreement itself is really a “local” battle over the protection of American intellectual property assets. Tariffs have merely been the tool used to exert pressure as the U.S. pushes to keep its position at the top of the totem pole in technological innovation, now that China’s advancement has moved the country closer to the top spot.

For now, a so-called “skinny” deal is expected to be concluded as part of a phase one agreement ahead of Dec. 15, when the final group of Tranche 4 tariffs on Chinese imports are slated to take effect. The tariffs, at 15 percent, would be levied on roughly $200 billion of remaining Chinese goods, including the remaining apparel and footwear items not impacted by the first group of 15 percent tariffs imposed on Sept. 1.

Apparel items include bathrobes and socks, as well as winter clothing and accessories, like gloves. For footwear, the new round of tariffs includes waterproof shoes and boots, sports footwear and slip-ons, plus inputs, such as removable insoles. Consumer technology goods, like cellphones and laptops, are also targeted in the list, as are toys, another key category at about $12 billion in imports.

But even if a symbolic deal comes to fruition, the tech battle will be far from over. And a “ceasefire” on trade issues won’t be conducive to business planning at this stage, given the overhang of uncertainty going into 2021 and beyond, according to Harris. What’s more, extending the trade war past the 2020 elections would prove negative for the U.S. economy, according to the National Retail Federation.

“We want and need to see a deal as soon as possible. The tariffs continue to hurt U.S. businesses, workers and consumers and are a substantial drag on the U.S. economy,” David French, NRF’s senior vice president for government relations, said.

“Waiting another year to resolve the cost and uncertainty of the trade war is a bad deal not just for retailers and their customers but every segment of the economy from farmers who export their crops to small manufacturers who rely on imported parts and materials,” French added.

Even if American consumers and business have to bear the brunt of higher costs, President Trump and his administration are actually after bigger game. The U.S. has often used–or threatened to use–tariffs as a tool to align with the president’s 2016 campaign slogan, “Make America Great Again.” And that, too, is an example of the trend in more localized thinking.

In 2019, global trade was under attack.

This year, the U.S. threatened tariffs on Mexican imports as a national security issue to get the Mexican government to take action at the southern border to prevent illegals from entering the U.S.

Trump has also tweeted about Vietnam as a possible next target, and has terminated India‘s designation as a beneficiary developing nation under the U.S. trade preference program Generalized System of Preferences in June, moves geared toward trade imbalances and reducing the U.S. trade deficit.

“U.S. and Indian governments have been in talks on GSP and I expect some positive outcome from that,” Aqeel Ahmed, chairman of the Council for Leather Exports (CLE), said. India has seen growth in manufacturing exports of leather goods. The CLE was in Manhattan for a trade show last week, with 50 exhibiting companies showing leather options for footwear, handbags, small leather goods and apparel.

But given the macro trends and how tariffs are being used as weapons to fight battles ranging from tech to national security, trade tensions won’t likely dissipate anytime soon. New battlefronts are already playing out.

Rise of taxes on digital services

In another form of localization, the battle surrounding digital services taxes will likely escalate in the coming months as more countries look to their own economies as they look at how to raise local revenues. If other countries levy a tax on American firms, as France did this summer, look for the U.S. to retaliate, while in turn generating some revenues of its own.

France had been pushing for a Euro-wide digital tax plan for the past year, but French lawmakers approved their own plan in June, which charges foreign entities, like Google, Apple, Facebook and Amazon, 3 percent on revenues they earn from providing digital services in the country. The tax is aimed at digital firms that generate revenue above 750 million euros ($830.9 million), with at least 25 million euros ($27.7 million) generated in France.

U.S. Trade Representative Robert Lighthizer, called the tax “unusually burdensome,” and now the U.S. is proposing additional tariffs of up to 100 percent on $2.4 billion worth of French goods, including handbags, champagne and fresh cheese. Next up will be investigating similar digital services taxes in Austria, Italy and Turkey.

Panjiva, the supply chain research unit at S&P Global Market Intelligence, said U.S. imports of the 63 French products targeted for tariffs were worth $2.38 billion in the 12 months through Sept. 30, with beauty goods the largest product category targeted. Imports in the category were worth $842 million in the past 12 months, followed by champagne at $806 million and handbags at $434 million.

According to S&P, the section 301 review process now moves to a consultation period, meaning tariffs likely couldn’t be applied before late January.

U.K. Prime Minister Boris Johnson is also backing a plan that would place a 2 percent tax on sales of digital services in the U.K. The tax is scheduled to take effect in April 2020 and could raise close to 500 million pounds ($655.0 million) in revenue for the U.K.

Some countries, the U.S. included, are trying to figure out a multilateral solution, hoping to work with other countries through efforts of the Organization for Economic Cooperation and Development (OECD) to reach a multilateral agreement to address challenges to the international tax system.

In a letter to the OECD Tuesday, U.S. Treasury Secretary Steven Mnuchin urged countries to suspend plans for taxes on digital services and let the OECD lead the way for a global-led agreement. His letter also expressed concern that the new unilateral tax strategies are putting an emphasis on revenues instead of profits.