Populism and protectionism are putting a strain on global flows of trade and investment capital. As a key conduit to these flows, are international financial centres under threat from declining globalisation?
The headlines have been stark: ‘Globalisation in retreat’, ‘Will globalisation go into reverse?’ and ‘Globalisation: the rise and fall of an idea that swept the world’.
Since 2016, with Brexit heralding what some see as the break-up of the European Union (EU) and US President Donald Trump fighting a protectionist battle on several fronts in support of ‘America First’, the idea of an interconnected and steadily integrating world economy has appeared to be in question as never before.
And that poses significant questions for international financial centres (IFCs) such as Jersey and Guernsey. Globalisation is not just about trade – it’s also about the global movement of capital flowing in and out of countries to oil the wheels of commerce.
IFCs play a key role in that process, providing much of the finance that enables individuals and companies in one jurisdiction to invest in assets in another. The demise of globalisation, then, would potentially be a serious blow for the Channel Islands. Or would it?
Broad definition
First of all, it’s worth acknowledging that the term ‘globalisation’ is bandied around using a broad range of definitions. For some, it’s about the transfer of economic power from sovereign governments to trans-national players, including global corporations; for others, it means the free movement of goods, capital and ideas around the world; and for others still, it’s about integration – a worldwide movement towards a common economic, financial, trade and communications system.
The same can be said about the origins of globalisation. Some credit Scottish political economist Adam Smith with first espousing the theory in his The Wealth of Nations; others point to Harvard Business School professor Theodore Levitt, who coined the term in the 1980s.
Either way, globalisation has become the ubiquitous buzzword of the millennial era, held responsible for many of society’s goods or ills, depending on who you talk to.
Geoff Cook, a former CEO of Jersey Finance and Head of Wealth Management for HSBC, and now a Consultant for Mourant and Quilter Cheviot, points out that while many of the headlines about globalisation refer to trade, for IFCs it relates entirely to investment capital.
“IFCs enable the deployment of capital in a more efficient manner that allows the pooling of investment more easily, with less cost and less friction,” he explains. “We are a kind of warehouse for capital and we take footloose capital that isn’t currently working hard, we package it in the right kind of container, and then we carry it to a market and put it to work.”
As Joe Moynihan, Cook’s successor as CEO at Jersey Finance, recently put it: “We are making it easier for investors around the world to pool their assets and put them to work; bringing about tangible change through infrastructure development in developing countries; facilitating investment in renewable energies; allowing companies large and small to trade and grow internationally; creating jobs around the world; and helping people in all corners of the globe to realise their ambitions.”
Pooled, tax-neutral investment products provide the perfect vehicle to aggregate finance from different parts of the world and put it to use where it can be most profitable – generating jobs and prosperity in the target market at the same time.
Investment overseas by governments, companies and individuals can be driven by a number of factors – the need to diversify, the ability to generate foreign currency earnings and to relieve inflationary pressures at home, to name but three.
In retreat?
So what’s the evidence that globalisation is in retreat? In the broader trade context, the US’s protectionism, imposing tariffs on China and pulling out of important trade agreements, shows which way the wind is blowing for the world’s biggest economy.
In a more specific financial context, the main evidence is the decline in foreign direct investment (FDI) in recent years. Figures from the Organisation for Economic Cooperation and Development, for example, show that FDI dropped 27% to just over $1trn in 2018 – the third consecutive year of decline – bringing FDI down to its lowest proportion of global GDP since 1999.
Cross-border bank loans have also declined enormously since they peaked just before the global financial crisis in 2008, and any growth has been anaemic in the past three years. “Cross-border capital flows are back to their level of the late 1990s,” says the International Monetary Fund.
There is, of course, a huge distorting factor in the FDI figures – the repatriation of billions of dollars of overseas earnings by large corporations such as Amazon, Apple and Google to the US in the wake of President Trump’s tax reforms.
Nevertheless, if one-off factors are stripped out, FDI growth over the past decade still only averaged 1% per year, compared with 8% between 2000 and 2007, and more than 20% before 2000, according to the United Nations Conference on Trade and Development (UNCTAD).
The organisation’s Investment and Enterprise Director, James Zhan, said: “The stagnating trend of the decade is ascribed to a range of factors that include declining rates of return on FDI, the increasingly asset-light forms of investment and a generally less favourable investment policy climate.”
In political terms, globalisation has been under attack as never before, with the widespread perception that it has provided an opportunity for large corporations to pay as little tax as possible and an incentive for individual countries to compete with each other in a ‘race to the bottom’ to lower their corporate tax rates.
Champions of globalisation, on the other hand, point to its role in lifting hundreds of millions of people out of poverty, while FDI has been instrumental in helping developing countries to become increasingly powerful emerging economies.
Increased wariness
Whether declining economic indicators and public suspicion add up to a reversal of globalisation is a moot point. There is a school of thought that globalisation is simply inevitable. As former UN Secretary General Kofi Annan once put it: “Globalisation is an irreversible process, not an option.”
Cook is less sanguine: “I think it is in danger of stalling.” As well as the geopolitical forces that have weakened the amount of money crossing borders, he points to the increased wariness of the US and Europe to give China access to their intellectual capital.
“The big-ticket high-profile acquisitions have slowed significantly as Europe and America start to get edgy about IP,” says Cook. American attempts to constrain Huawei’s involvement in developing 5G also suggest a cooling off in the global exchange of technology.
So what does this mean for IFCs? Two years ago, corporate services firm Vistra, which has offices in Jersey and Guernsey, surveyed almost 600 corporate services executives and found that “71% consider globalisation to be at least somewhat under threat”.
Jonathon Clifton, Group Managing Director of Vistra’s company formation division, said: “For globalisation to be under threat inevitably unsettles the trust and corporate services industry, an industry that hinges on cross-border transactions and international supply chains, as well as free trade and investment.”
However, there seems to be little sign of any adverse effect so far in the Channel Islands. Jersey Finance has recently reported a record number of people working in the finance industry – just under 14,000 – with business confidence in the finance sector “strongly positive” at +39%.
And figures released by the Guernsey Financial Services Commission earlier this year showed that the value of private equity business in Guernsey reached its highest-ever level at the end of September 2018, passing the £120bn mark for the first time.
Risk mitigants
Geoff Cook believes any slowdown in global investment does pose a risk to the Channel Islands, but that two factors mitigate that risk.
“First, I think trade will regionalise, rather than resort to being nationally focused. So I think the Channel Islands will still prosper with that, because we are one of the big channels of investment into Europe and within Europe; we raise capital from pension funds and endowments and high-net-worth individuals and then invest that into infrastructure and private assets throughout Europe and further afield.”
The second mitigant, says Cook, is a “flight to quality”. The EU recently reviewed the tax systems of 92 countries with a view to achieving a level tax playing field. Jersey and Guernsey were given a clean bill of health and deemed “co-operative jurisdictions”.
Both have been at the forefront of adapting to keep up with international standards and regulation, says Cook, at a time when others have struggled. “We’re getting a commercial dividend for being strong on governance and early adopters of international regulation.”
His conclusion: the pie may eventually be smaller as the result of the reining back of globalisation, but the Channel Islands will enjoy a bigger slice.
Brexit is a specific area of concern for the financial sector worldwide, but with more than 50% of capital flows to the Channel Islands coming from outside Europe, let alone the UK, it is far less of a threat than some people believe.
Looking ahead, few would write off globalisation, even if it looks less certain that it will be quite the dominant trend that it has been for the past few decades. However the future shapes up – whether Trump’s trade wars prove a temporary setback or the world adopts a more regional-centric economic outlook – few would bet against IFCs finding their own part to play and continuing to prosper.