Emerging markets prove resilient despite ‘deglobalisation’ trend

New commentary from Franklin Templeton’s fixed income team has assessed the outlook for emerging markets (EMs) against the backdrop of growing deglobalisation concerns, triggered mostly by recent US policy moves tapping into economic nationalism.

The paper, Holding the line: Emerging markets and the evolving global order, said investor concerns of declining “global interconnectedness” could rightfully impact financial markets, leaving EMs particularly susceptible to economic and geopolitical disruption.

“Major drivers contributing to deglobalisation include economic nationalism and populism. Populist leaders often blame globalisation for economic difficulties, leading to a shift in focus toward protecting domestic industries, jobs and capital rather than pursuing international cooperation, as recent US policy shifts demonstrate,” the paper said.

“Economic nationalism connects with anti-immigration measures and cultural protectionism, exemplified by events like Brexit, which in some cases can result in a nation disengaging from global markets.

“Moreover, it appears escalating geopolitical tensions and national security concerns have accelerated this move away from global interconnectedness.

“Conflicts such as the Russia-Ukraine War and the US-China trade dispute have each disrupted supply chains in distinct ways, while the weaponisation of global institutions, such as the Society for Worldwide Interbank Financial Telecommunications (SWIFT), has introduced a new vector of vulnerability for sovereign fixed income markets that had historically depended on global market interlinkages.

“This has in turn been a catalyst for an evaluation of the traditional global market architecture. Additionally, the COVID-19 pandemic has prompted a fundamental re-evaluation of global interdependence, particularly in critical sectors such as semiconductors.”

However, the paper indicates “there is little evidence to suggest that the world is becoming fundamentally less interconnected”, with expectations that EMs will overcome the risks posed to them – in the form of disruptive policy moves and persistent geopolitical tensions – and continue to remain competitive via manufacturing costs, specialisation capability and scale, and a growing middle class loyal to EM dynamics.

“The availability of inexpensive labour in EMs has historically been a major catalyst for the expansion of global production networks,” the Franklin Templeton fixed income team said in the paper.

“Multinational firms based in the United States, Europe and Japan discovered they could significantly lower production costs by relocating labour-intensive manufacturing to countries with lower wage structures.

“In addition to cost advantages, these markets offered abundant labour, limited unionisation, more lenient regulatory environments and strong incentives for foreign investment – including tax breaks and other financial benefits. These advantages often outweighed the typical drawbacks of operating in EMs, such as lower labour force productivity, weaker infrastructure and higher transportation costs.

“Recent changes to the US import tariff regime provide a timely reason to reassess the relative cost competitiveness of manufacturing in EMs. Our analysis shows that, even after incorporating new tariff rates, EMs continue to hold a substantial manufacturing cost advantage relative to developed markets (DMs).

“Specialisation in trade is a natural byproduct of global competition in tradeable goods, but also an unavoidable necessity in a world composed of localised natural resources. EMs have historically played an important role in natural resource extraction, both because of the need for relatively low-skilled labour in commodity production and because of the prevalence of scarce resources in certain EM countries.

“This concentration of key commodity production – particularly within EMs – creates a geographic dependency that isolationist policies cannot easily offset by, as shifting production between countries is often not feasible.

“Beyond commodities, EM countries have increasingly specialised in production over the past two to three decades. Many have carved out niche positions within global value chains, often focusing on specific stages of the production process rather than full product assembly.

“This growing specialisation and the ability to achieve economies of scale are likely to underpin the continued resilience of EM trade.

“Over the last 20 years, EMs in general have undergone a period of strong economic expansion, marked by a sharp increase in real GDP. This growth has contributed to the emergence of a larger middle class, leading to higher levels of both consumption and savings.

“Leveraging off the wealthier consumer markets – further supported by favourable demographic trends – EMs started investing and trading on a more localised level. Interregional investment surged, and trade between developing countries expanded rapidly, driven by rising demand but also capitalising on regional competitive advantages.

“And so, while global exports stagnated, EMs strengthened economic ties among themselves and integrated their regions more closely. EM-to-EM trade has risen from low single digits three decades ago to around 20 per cent of total trade today, a shift reinforced by the increasing use of free trade agreements.”

The paper also recommends the introduction of more “supportive policies” to “facilitate trade” and strengthen investor confidence in EM opportunities.

“Infrastructure remains a key constraint in many regions, and further investment in logistics, transport and connectivity will be critical to unlocking additional growth. As a result, some countries may be better positioned to benefit than others. Overall, we believe concerns about deglobalisation having adverse effects on EMs appear overstated.”