The $74 Trillion Global Economy in One Chart

Global executives see geopolitical issues as a rising risk to growth, but they remain more buoyant than downbeat in their outlook for both the global and domestic economies. The shares of executives citing geopolitical instability and terrorism as threats to the global economy have grown notably. In every region, geopolitical instability is the risk that respondents most often identify as a threat to near-term global growth. For the long term, they say instability in the Middle East and North Africa and terrorist attacks pose outsize threats.

Still, executives remain more positive than negative about the state of the world economy, and they are increasingly buoyant about economic conditions in their home countries. At the same time, respondents in emerging markets and developed markets report new divergences in their views on trade, company profits, and customer demand.

Many global enterprises today have succeeded by following a simple recipe: procure, manufacture, and assemble in the lowest-cost locations, link these using reliable, standardized logistics and information technology, market the resulting products globally, and book profit in low-tax havens. This powerful formula for economic arbitrage enabled by technology and supported by the politics of open borders is the fruit of several decades of globalization. Today, all three elements of the equation not only are changing but also are subject to unprecedented levels of uncertainty. Multidimensional uncertainty has profound implications for the standard operating model of global business.

The potential for economic arbitrage is decreasing as a result of narrowing labor cost differentials across nations and increasing capital intensity of production, leading to a discernible trend of reshoring production. Direct-cost differentials in manufacturing between the US and the Yangtze River Delta in China, for instance, are now estimated to be only 1%. When indirect costs such as logistics are considered, many goods destined for the US market can now be manufactured more cheaply in the US. Whether this trend will persist or strengthen, however, is impossible to say given other uncertainties.

For the past year, respondents have identified geopolitical instability as a top risk to global economic growth. But relative to recent surveys, the share citing it has grown to 65 percent—up from half of respondents who cited geopolitical issues in the previous survey, and the largest share in 18 months.

As a risk to growth in the next 12 months, geopolitical issues are cited most often by respondents in every region, with the biggest share in the Middle East and North Africa. Overall, transitions of political leadership and changes in trade policy remain top-three risks, as they were in March, while social unrest has emerged as a top-five risk for the first time. Respondents in developed Asia, India, and North America are the most likely to cite it. In fact, the share in Asia identifying social unrest as a global risk has more than doubled since March (32 percent cite it now, up from 14 percent three months ago) and tripled in other developing markets (12 percent now, up from 4 percent).

In the long term, too, respondents report outsize concern over geopolitical instability, specifically in the Middle East and North Africa. Terrorist attacks have become the number-two concern, with executives citing this threat more often than in any previous survey. Thirty-one percent of respondents identify terrorist attacks as a threat to global growth in the next decade, more than double the share who said so in the previous survey.

Across regions, executives in the Middle East and North Africa, Europe, and North America are the most likely among their peers to cite geopolitical instability as a long-term risk to global growth, as well as rising income inequality, which remains a top-five risk for the long term. Respondents in developed Asia, meanwhile, most often express concern about terrorist attacks; they are five times likelier to cite it now than they were in March.

These emerging risks, though, don’t seem to have dampened executives’ views on the economy as a whole. Respondents are as bullish on the global economy as they were three months ago: nearly half say global economic conditions have improved in the past six months. On the global economy’s prospects, too, respondents are more positive than negative. Nearly equal shares of executives say global conditions have improved (45 percent) and expect conditions will continue improving in the next six months (41 percent).

Technology promises to further reshape the conventional wisdom of global organization. Advanced manufacturing technologies with flatter supply curves create the possibility of more customization, closer to the market. We already see this in Adidas’s restoring of shoe production to Germany. In the near future, blockchain technologies, sensors, and the industrial Internet of Things promise smarter, more interconnected supply chains, likely leading to more competition on responsiveness. Furthermore, an increasing proportion of traded value will consist of data and digital services, whose economics are very different from those of physical products. When and exactly how these technological shifts will reshape global supply chains is likely to remain unknowable for some time.

The political context has become considerably more complex. In spite of the tremendous aggregate economic impact of globalization, inequality of income and opportunity has increased within nations enough to stoke nationalist sentiment. That in turn shapes political outcomes in ways that directly and materially affect trading arrangements. As a result, the UK voted to exit the European Union, and the new US administration announced the country’s withdrawal from the Trans-Pacific Partnership and threatened to impose tax penalties on imports. While these decisions are known, the terms and details of Brexit, renegotiated US trade deals, and new taxation arrangements are all currently unknown, and the reactions of trading partners to these and the knock-on effects on exchange rates and economic growth are essentially unknowable.

The unpredictability stemming from these economic, technological, and political shifts is unlikely to decrease anytime soon, given the continued momentum of technology and the arithmetic of election cycles. The formula for the global enterprise itself—where to make what and how, as a function of technology, taxes, exchange rates, and trading arrangements—is up in the air.

The practice of supply chain management already tells us much about how to manage for short-term fluctuations—using buffers, keeping supply chains short, creating feedback loops, reducing cycle times, and reacting quickly, for example. These approaches, however, will be insufficient for managing deep systemic uncertainties on longer timescales. In such complex environments, uncertainty is multidimensional and change is continuous. As a result, the right response is not knowable in advance.

The paradigm for global business therefore has to change, at least for the time being. Leaders need to shift their attention from incrementally optimizing the efficiency of known, stable arrangements to addressing unknown and unknowable factors. They need to create organizational resilience and strategic optionality. Biology can provide some inspiration. Biological systems, which have evolved the property of resilience on multiple timescales, offer valuable lessons on how to manage under extreme uncertainty.

Redundancy. Duplication of elements (factories, stocks) may be inefficient but can provide a buffer against the unexpected. Functional redundancy offers a smarter route to the same end: if elements (plants) can be repurposed rapidly, then the costs of duplication are partially offset.

Heterogeneity. Different types of elements (contract types, factory types and locations) make it possible to react to unexpected change and avoid correlated responses across a system, which can lead to total system failure. Diversity is also the substrate for evolutionary learning and adaptation to new situations, which increases strategic optionality.

Modularity. Separate modules (subsidiaries, plants), loosely linked, can act like circuit breakers to help prevent the collapse of a system. With modularity, as with firebreaks in a forest, one portion can sustain damage while the integrity of the others is preserved. All else being equal, a highly uncertain situation favors a network of loosely linked parts rather than a centralized and tightly integrated system.

Adaptation. Rapid adjustment to new circumstances protects a system against the negative effects of change. In the case of simple change, planned responses (such as contingency plans) can mitigate disruption if the system is sufficiently flexible and agile. For complex change, when the right response may not be analytically knowable, an adaptive approach comprising experimentation, selection, and amplification of successful outcomes can be effective. Global businesses’ supply chains therefore need to evolve to match changing circumstances, rather than being rigidly designed a priori.

Prudence. While the future may not be foreseeable, downside scenarios can often be plausibly envisioned. The worst-case scenarios for taxes and trading regimes can be posited and used to stress test supply chain designs for economic viability. Current levels of uncertainty justify the investment in simulation models to permit such stress tests as well as the investment of management attention in scenarios and contingency plans.

Embeddedness. Most systems are embedded in larger systems. A company is usually part of a multi-company system that converts inputs into products for end customers. And those larger systems are embedded in economies and political systems. Reciprocity and mutual benefit between levels are essential for stability and continuity. The impact on partner supply chains and on employment and skill building in local economies is therefore an important long-term consideration. The articulation of social purpose and contribution is also essential at a time when corporate capitalism is under scrutiny. Several US manufacturers are experiencing directly the importance of these broader issues as they run into strong political pressure to restore domestic manufacturing jobs allegedly lost to offshoring and technology.

Applying biological principles is an art that requires experience and judgment. Balancing the principles is much harder than solving for known variables in a stable equation. But uncertainty should not be an excuse for inertia or a status quo bias. Global companies that persist in optimizing the efficiency of a familiar, stable design, ignoring the shifts in the economic, technological, and political environment, risk becoming victims of change. Leaders should therefore embrace new biology-inspired ways to create resilient global organizations.

Looking further out, respondents report some newfound optimism about the world economy’s long-term prospects. For the past two years, when asked about four potential scenarios for economic growth in the next decade, executives more often identified the two scenarios characterized by low or weak global growth than the two higher-growth scenarios. Now respondents are equally divided between those who say the higher-growth scenarios are likeliest and those predicting weaker growth. The most popular scenario, selected by 39 percent of respondents (up from 33 percent in March and December), is “pockets of growth,” which is characterized by high but uneven and volatile global growth. Those in India are the most likely across regions to rank “pockets of growth” as the likeliest scenario (48 percent do so); they are also the most likely to believe global conditions will improve in the next few months.

With respect to their home economies, respondents continue to report more positive than negative views. Executives in India, who have long been the most upbeat, remain more positive than average about domestic conditions. But they are followed closely by their peers in Europe, 55 percent of whom say conditions at home have improved; those in Eurozone, where two-thirds cite improvements, are even more bullish. On the other end are executives in Latin America, the most likely respondents to say conditions have worsened: 39 percent say so, compared with the global average of 22 percent. Still, executives in the region are much more positive about current conditions than they were six months ago.

Likewise, the share of executives expecting improvements in the months ahead continues to grow; nearly half of all respondents (45 percent) now say so. Again, those in Europe are among the most optimistic: half of executives there predict conditions in their home economies will improve, up from 38 percent who said so in March. Meanwhile, respondents in North America are the least likely to say they expect improvements. Only 38 percent of executives now say so, compared with 48 percent in March and 53 percent in December. And though respondents in India report clear optimism, employment is a noteworthy concern. Four in ten executives there expect the unemployment rate will increase, up from 28 percent of respondents who said so six months ago. Respondents in India, along with their peers in other developing markets, are also the likeliest to expect their country’s workforce will shrink over the next six months.

Trade is one issue where the respective realities and challenges that respondents face in emerging and developed markets is evolving. Slowing trade was a commonly cited risk to global growth in the past five surveys. When asked about trade levels outright in March and December, respondents in emerging economies were much likelier than their developed-economy peers to report declining trade levels between their home countries and the rest of the world. Now the balance seems to have shifted. Forty-four percent of emerging-market executives (up from 29 percent in March) say trade levels have increased, compared with 35 percent of developed-market executives who say the same.

What’s more, emerging-market respondents are more upbeat than their peers about future trade prospects, and they are less likely to cite changes in trade policy as a risk to domestic growth, which was also true in March. Yet emerging-market respondents are more likely than their counterparts to say changing trade levels have negatively affected their companies’ business, which we also saw in the past two surveys: 35 percent of emerging-market respondents report a negative impact, compared with 20 percent in developed markets.

A shifting landscape between emerging and developed economies is also evident at the company level. For the first time since March 2016, a larger share of emerging-market executives than developed-market executives predict their companies’ profits will increase in the next six months. At the regional level, those in India and in other developing markets are the most bullish on their companies’ prospects.

And while emerging-market executives are just as likely as their peers to expect demand for their products and services will increase in the coming months, they are nearly twice as likely as developed-market respondents to expect demand will shrink. Executives in emerging markets are also more likely than others to cite decreasing demand as a risk to company-level growth in the next year.


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