Analysts, policymakers, and journalists have strong incentives to specialise. Consequently, we may overlook important links between shifting public policies, cross-border corporate strategies, and trade and investment flows, and miss potential turning points in globalisation. From time to time, however, a jolt induces reflection on larger developments affecting the world economy. The speech by Jeff Immelt, CEO of General Electric, to the Stern School of Business on 20 May 2016 is one of those jolts.
When Immelt joined GE in 1982, 80% of its revenue was earned in the US; in 2015, 70% of group revenues were earned abroad. GE now operates 420 production facilities worldwide and has customers located in 180 countries. He argued, “[b]eing global has helped us become more efficient, more competitive”.
Circumstances have now changed, Immelt observed. “Globalsation is being attacked as never before”, he said, noting the rise of populism and protectionism in every region of the world economy. With $80 billion in overseas sales at stake, Immelt argued that GE – and indeed, every company – cannot ignore the growing headwinds. Specifically he argued:
“In the face of a protectionist global environment, companies must navigate the world on their own. We must level the playing field, without government engagement. This requires dramatic transformation. Going forward: We will localise. In the future, sustainable growth will require a local capability inside a global footprint.”
GE has already begun adjusting. Rather than produce locomotives at a single location in the US, Immelt noted, “now we have multiple global sites that give us market access”. GE is pursuing similar strategies with its other manufacturing, services and software businesses. “A localisation strategy can’t be shut down by protectionist politics”. As foreign investment shifts to serve local demands, “[w]e will produce for the US in the US, but our exports may decline. At the same time, we will localize production in big end-use markets like Saudi Arabia.”
GE isn’t the first or only US company to implement a localisation strategy. What distinguishes Immelt’s remarks is that he explicitly ties that strategy to protectionist policy shifts.
The proliferation of localisation requirements
Generals often devote too much energy to refighting the wars of yesteryear. Data collection on commercially relevant trade policies suffers from the same defect. When the Global Crisis hit, the trade spotlight focused only of tariffs, and since they were not raised, leaders in the WTO and the G20 prematurely relaxed. Meanwhile, many policymakers – keen to favour domestic production and visibly create jobs for their constituents – found ways to sharpen less well-monitored protectionist tools.
Local content requirements (LCRs), which many analysts wrongly imagined had been banned under the Uruguay Round, made a comeback. In addition to classic local content requirements that mandate certain percentages of goods and services be produced locally, governments at the national and sub-national level added new twists (Hufbauer et al. 2013, Stone et al. 2015):
- Condition tax, tariff, and price concessions on local procurement;
- Condition bailouts, government contracts, and export financing on local sourcing;
- Tailor import licensing procedures to encourage domestic purchases;
- Reserve certain lines of business can for domestic firms;
- Require that data must be stored and analysed locally;
- Require that products be tested locally.
As a result of these policy innovations, many analysts now refer to the broader category of “localisation measures” (LMs). Several attempts have been made to document how often governments have resorted LMs since the onset of the global financial crisis. Hufbauer et al (2013) documented 117 LMs; Stone et al (2015) found 146 LMs. The European Centre for International Political Economy (ECIPE) documented numerous data-related LMs in Brazil, China, the EU, India, Indonesia, Korea, and Vietnam (Bauer et al. 2014). Worldwide, ECIPE has now identified 82 LMs aimed at data localisation.
Meanwhile, the Global Trade Alert team has identified 343 LMs implemented since November 2008. In addition, another 371 state purchasing regulations or decisions were found to require some form of local sourcing. The range of economic activities affected is not trivial as shown by Maps 1 and 2, which report the percentage of 2-digit sectors where LMs have been imposed since the crisis began.
Map 1 Since the Global Crisis began localisation measures have been implemented in every continent
Source: Global Trade Alert, June 2016.
Map 2 Localisation rules in government procurement rules have spread too
Source: Global Trade Alert, June 2016.
Non-government-procurement-related localisation measures are particularly concentrated in Chapters 85 and 87 of the UN Harmonised System. These chapters refer to trade in electrical machinery and equipment including telecommunications equipment, and vehicles (other than trains). Of the 11 four-digit product lines hit by ten or more LMs since the crisis began, ten are in these two chapters. In 2014, total trade in these 11 four-digit product lines exceeded $2.1 trillion or 11.5% of world trade.
With respect to LMs associated with government procurement, Stone et al. (2015) calculated the value of government purchases associated with 22 measures that discourage foreign sourcing, as implemented by 11 countries. Taking account of the fact that some measures are expected to last several years, they calculate that $423 billion of state purchases are likely to be affected.
In addition to documenting the scale of localisation measures, research has generated estimates of their adverse effects. Hufbauer et al. (2013) conservatively estimate that the 117 LMs they documented reduced trade by $93 billion. Stone et al. (2015) estimate that 11 LMs that sought to ‘displace’ imports did so by $10 billion, with the percentage of imports affected varying widely across the cases studied.
A large number of LMs have been implemented as part of government initiatives to promote ‘green’ growth. OECD (2015) contains an econometric analysis of domestic and cross-border investment flows in wind and solar-PV power generation in 64 nations over the years 2000-2011. The impact of various policy interventions, including feed-In-tariffs (FITs), by 20 jurisdictions was then estimated. The OECD (2015) analysts concluded:
“… LCR policies in destination countries do not show a significant effect on volumes nor likelihood of investment; nevertheless, when the LCR are combined with FiTs in destination countries, we see a significant and negative effect of LCRs for cross-border investment, and this result holds in the worldwide sample” (page 71).
With respect to data-related localisation measures, Bauer et al. (2014) use GTAP (a computable general equilibrium model) to assess the effect of legislation proposed or enacted in seven jurisdictions. In the EU, for example, data-related LMs that have already been enacted were estimated to lower GDP by 0.4%. A ‘full data localisation’ scenario would reduce EU welfare by 1.1%, which may not seem a lot until it is appreciated just how slowly the EU economy has been growing in recent years. Capital expenditure in the EU would fall by 3.9% as a result of enacting existing legislation and that figure would rise to 5.1% with full data localisation. The welfare of the EU28 would fall by $80 billion under the former scenario and by $193 billion under the latter.
Overall, the evidence is mounting as to the adverse trade-, investment- and welfare-related costs of the spread of localisation measures during the crisis era. Given the prevalence and likely effects of localisation measures, it is not so surprising that firms have begun to react to the growing fragmentation of world markets.
Implications for the world trading system
During the past 20 years, international trade scholars have made great strides in incorporating firms into their empirical analyses of trade and investment flows. Curiously, despite the Doha Round failure and crisis-era protectionism, the backdrop for most of these studies is often taken to be a world economy moving towards ever greater liberalisation. Immelt’s speech – signalling a profound shift in corporate strategy – should prompt a rethink of the assumptions that analysts make concerning the global business environment.
Governments have made numerous innovations to their policy tool boxes – of which localisation measures are a prominent example. The revival of interest in industrial policy is another case in point (Aggarwal and Evenett 2014). As Immelt made clear, so long as protectionism is not reined in through international accords and domestic restraint, then private firms will react by localising production, even when economically sub-optimal. Widespread localisation will weaken the link between trade and economic growth, limiting the potential for trade expansion to raise living standards.
Enhanced productivity is the fundamental driver of higher living standards. The productivity driver has sputtered in the past decade. A contributing factor is that the new agenda of LMs has displaced the old agenda of trade liberalisation.
If anti-globalisation sentiment flourishes in the years ahead – not only defeating new trade agreements such as the Trans Pacific Partnership, but also expanding the reach of LMs – many more firms will adjust their production strategies to the prevailing winds. Firms will not only survive, they will thrive; but workers and consumers will lose as the long-term benefits of specialisation and comparative advantage are sacrificed on the altar of short-term political gratification.
–Karan Bhatia, Simon J Evenett, Gary Clyde Hufbauer