Globalization; on hold or in reverse

Country after country has now imposed restrictions on international travel, and foreign trade is collapsing in tandem with falling demand and disruptions in supply chains.

The coronavirus has put globalization on hold. But will globalization be reversing in the longer term? Magnus Lodefalk provides perspectives from research in international economics.

In 1665 the plague ravaged the United Kingdom and as a precaution, the University of Cambridge was closed for just over a year. During his leave from the university, student Isac Newton arrived at the Law of Gravity, which describes how the force of attraction between two bodies depends on their mass and the distance between them. In fact, the Law of Gravity has also been applied in the social sciences. And it is useful for analyzing the corona pandemic's effects on globalization.

By globalization, I refer to an economic process of integrating the world economy through increased trade, but also increased cross-border investment. In the international economy, the gravity model means that two countries trade more with each other the greater their economic "mass" and the closer they are to each other. The measures to combat the coronavirus pandemic can be expected to cause a substantial economic decline, which, under the gravity model also decelerates foreign trade.

The downturn affects small, open and highly trade-dependent countries like Sweden and Belgium as well as large countries like the United States and China. In the financial markets, we have already seen double-digit stock prices that are larger than, or at least in par with, the stock market fall of 1987 and the stock market crash of 1929. In March, the US Dow Jones Average Index lost just over a third of the share value within a couple of trading days. Although the stock markets have now recovered somewhat, we can expect continued large price movements during the pandemic. Down the road, we can also expect strong economic effects in terms of increased unemployment, falling real wages and more bankruptcies. Perhaps the downturn will subsequently be compared with, or rather be significantly more severe than during the financial crisis in 2009.

Emergency measures and foreign trade

It is very uncertain how well countries will be able to mitigate the sharp economic downturn, thereby also preventing an extreme slowdown in foreign trade. Both in Sweden and abroad, a number of measures have been taken to counteract the economic effects of the pandemic and of its medicine.

Central banks around the world are now pursuing increasingly expansionary monetary policies by purchasing government bonds to increase the amount of money in circulation and they have been given increased opportunities to lend to the banks. On the other hand, many of them can hardly lower the policy rates from the already low levels so that it has a greater effect. Governments have announced a range of fiscal measures - ranging from "helicopter dropping" where every individual receives a certain amount of money, to business loans, and to governments paying for laid off personnel.

Further government measures are expected and they will probably include both support to individuals, different types of businesses and industries, as well as support for regions that are particularly hard hit. At the same time, governments need to be clear that the restrictions imposed to prevent the spread of the infection will be brief, to avoid severe long-term consequences in the form of persistently high unemployment and the death of fundamentally viable companies.

Policy Brief by Magnus Lodefalk, PhD Associate Professor in Economics Örebro University

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Tagged in Trade and Investment in Services Associates

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