Canaries in the coal mine

IF YOU look only at the headline numbers, populism and protectionism seem to be weirdly good for global business. Since 2015 there has been Brexit, the rise of fringe parties in the euro zone, the election of President Donald Trump and a more nationalistic China under Xi Jinping, its president. Yet over this period the profits of the world’s biggest 3,000 listed firms have risen by 44% in dollar terms. Share prices have soared. As for tariffs, for now they are little more than an irritant for most bosses. Plenty of Western firms are still keen on exotic thrills far beyond their borders—in May, Walmart bid $16bn for Flipkart, an Indian e-commerce company. Starbucks is opening a new shop in China every 15 hours.

Look more closely, however, and you will see that the decay of globalisation is accompanied by a steady demoralisation of multinationals. Between the fall of the Berlin Wall in 1989 and the subprime crisis some 20 years later, a few thousand corporate cosmopolitans became ever more powerful, acting as the brains of the global economy, controlling intellectual property as well as international supply chains. During the past decade, however, they got stuck in a rut. And, as a new report from UNCTAD, a multilateral body, underlines, that rut deepened last year.

Consider cross-border investment by firms, which consists of takeovers and greenfield investments such as factories. It fell by 23% in 2017. The sums flowing to Asia and Latin America were stable, but dropped in all other regions. As a share of global GDP, such investment has fallen by half compared with 2007, to 2.4% last year—the lowest ratio since the financial crisis. And global supply chains have stagnated. One gauge is the share of all exports that comes from cross-border inputs. Having steadily risen from 26% in 1995 to 31% in 2010, it has since dropped to 30%.

Multinationals’ malaise has deep causes. Many global firms succumbed to indiscipline and poured money into vanity projects abroad. Plenty relied on arbitrage, basing production in places with cheap labour and booking profits in countries with low taxes. But Chinese wages have risen. European countries and America have made it harder to dodge taxes. In many industries local scale is more important than global reach. Walmart, for instance, is selling control of its business in Britain to J. Sainsbury, a local company, after years of dim performance.

As multinationals’ advantages have eroded, so has their claim to supercharged performance. Schumpeter has grouped the biggest 500 companies by market value into local firms and multinationals (firms which make over 30% of their sales outside their home region). Since 2015 the globetrotters’ profits have increased by 12%, compared with 30% for the homebodies. Multinationals once had glittering returns on equity; last year they managed only 11%, compared with 12% for local firms. UNCTAD measures the returns of just the foreign operations of multinationals, excluding their domestic businesses (which for American firms can be lucrative). Such returns dropped to 7% last year, from 9% before the financial crisis—probably below their cost of capital.

Faced with soggy profits, bosses are being more cautious, an impulse further amplified by trade tensions. For one thing, regulators are more likely to block deals. Chinese buyers in particular are effectively playing roulette. Even saintly Canada prevented a $1bn takeover of a construction company, Aecon, by a Chinese firm in May. America’s security watchdogs recently kiboshed the takeover of Qualcomm by Broadcom, a rival semiconductor firm then domiciled in Singapore. And who wants to build new cross-border supply chains while the world’s trade regime is in flux?

Perversely, protectionism can sometimes stimulate cross-border investment. After the 1930s, some firms “tariff hopped” by building factories within countries to avoid exporting to them. The White House doubtless hopes this will happen in America, which Mr Trump says is “open for business”. There are a few examples—some foreign solar-panel manufacturers made plans for new plants in Uncle Sam’s backyard after tariffs were announced in January. But across all industries, inbound investment into America fell by 39% in 2017, according to the Bureau of Economic Analysis. The number of greenfield projects in the United States announced by foreign firms fell by 29% in the first quarter of 2018 compared with the prior year, according to fDi, a data firm.

Perhaps digital flows could provide a new leg for globalisation, a view backed by McKinsey, a consulting firm. Netflix now has more subscribers abroad than at home, for example. But these flows are fragile. They tend not to create lots of jobs, exports or tax revenues for the recipient countries, which is their main motivation for welcoming multinationals. And protectionism has gone digital, too. The control of tech innovation is at the heart of the rows between America and China.

Fade away

The base case is that cross-border investment will be subdued until Mr Trump leaves office. The weight of multinationals in the pool of global investment (including takeovers) will fade. It has already dropped to 6% last year, compared with a 20-year average of 8% and a peak of 10% in 2007.

But if trade tensions persist beyond the American presidential election in 2020, firms may seek a more radical rethink. One option would be to separate the flow of investment from control. In the 19th century global firms often gave contracts to local managing agents to run their foreign businesses. These could be revived. Or multinationals could seek only minority stakes in their operations abroad, guaranteeing them local autonomy.

Such structures could muffle political risks but are far less efficient than the model of globally integrated firms that thrived in the 2000s. Consumers and productivity will both suffer, and investors might, too. But after the past few months it is the duty of anyone running a multinational firm to consider how to redesign their business for a pricklier, nastier world.