Why Regional Ties Win the Day
Aconstant and largely unquestioned refrain in foreign policy is that the world has globalized. Closets are full of clothes stitched in other countries; electronics and cars are often assembled far from where consumers live. U.S. investment flows into Asian markets, and Indians decamp to the United States for graduate school. The numbers show the magnitude of international exchange. Trade among all countries hovers around $20 trillion, a nearly tenfold increase from 1980. International capital flows also grew exponentially during that period, from $500 billion a year to well over $4 trillion. And nearly five times as many people are traveling across borders compared with four decades ago.
It is, however, misleading to claim that this flow of goods and services and people is always global in scale. Globalization, as commonly understood, is mostly a myth; the reality is far closer to regionalization. When companies, supply chains, and individuals go abroad, they don’t go just anywhere. More often than not, they stay fairly close to home.
Consider trade. If long distances didn’t affect international sales, the typical journey for any given purchase would be some 5,300 miles (the average distance between two randomly selected countries). Instead, half of what is sold abroad travels less than 3,000 miles, not much farther than a flight across the United States, and certainly not far enough to cross oceans. A study by the logistics company DHL and scholars at the NYU Stern School of Business concluded, “If one pair of countries is half as distant as another otherwise similar pair of countries, this greater physical proximity alone would be expected to increase the merchandise trade between the closer pair by more than three times.”
Companies’ forays abroad have been more regional than global, as well. A study of the Fortune Global 500, a list of the world’s largest companies, shows that two of every three dollars of their sales come from their home regions. A study of 365 prominent multinationals found that just nine of them were truly global, meaning that Asia, Europe, and North America each accounted for at least 20 percent of their sales.
Additionally, the oft-repeated term “global supply chains” is a misnomer. The making of things across borders tends to be even more regional than the buying and selling of finished products: the pieces and parts that come together in modern manufacturing are more likely to be shipped between neighboring countries than from farther away.
International capital flows are also more regional than global. Cross-border buyers of stocks, bonds, and other financial instruments don’t invest as far away as one would expect given how global their options are, on average going no more than the distance between Tokyo and Singapore. Foreign direct investment tends to follow trade. Over half of all cross-border financing circulates solely within the European Union. And lending, borrowing, and foreign direct investment in Asia by Asian banks and companies is on the rise.
People tend to orient their lives regionally, as well. Most people never leave their own countries. And for those who do travel abroad, well over half never leave their regions. The vast majority of travelers taking European vacations are European. The same goes for people in Asia and North America. Those who move permanently abroad also tend to stick close to their countries of origin; the majority don’t leave their immediate region. And although students who venture internationally tend to go farther than other travelers, 40 percent don’t leave the geographic area in which they were born.
Over half the international flows of goods, money, information, and people occurs within three main regional hubs: Asia, Europe, and North America. The economic rise of China, South Korea, Taiwan, and Vietnam began with regional investments and inputs. Eastern Europe’s fast-paced growth came from linking to western Europe. Between 1993 and 2007, Mexico’s economy more than doubled in size, thanks in large part to the North American Free Trade Agreement (NAFTA), reached in 1993 with Canada and the United States.
The overlooked reality of regionalization has implications for U.S. policy. Although NAFTA was revised in 2020—it is now the U.S.-Mexico-Canada Agreement (USMCA)—the North American hub is still not as integrated as that of its East Asian and European counterparts. In industries for which North American regional supply chains developed and solidified, such as vehicles and aerospace, local production maintained its edge. But in other sectors, including electronics and textiles, North America’s more limited regionalization led whole industries to move wherever regional links provided a leg up.
Ideally, the United States would be inking international trade deals to expand its market access and pursue its geopolitical aims, such as countering China’s rise. That does not appear politically possible at the moment, however. A more viable policy would be to fortify and tap the United States’ regional network. That would allow Washington to access a broader swath of the global marketplace and stave off losing more of its competitive advantage to countries that are expanding their own regional footprints.
WHY REGIONAL TRUMPS GLOBAL
The major reason networks skew regional is simple: geography matters. Even with massive container ships, moving things across oceans still costs time and money. A transatlantic voyage adds a week to delivery, and a trip across the Pacific Ocean adds a month before parts or goods show up in U.S. warehouses and factories. That means producers and stores need to maintain larger inventories of goods that come from far away.
And it is not only cargo that can be delayed or lost when trade takes place over great distances. Even with virtually free calls, video, and file sharing, the inherent difficulty of communicating and coordinating across space and time can add to the costs of doing business. Language and cultural cues vary by country, and these differences often grow with distance. (This is one reason that a quarter of trade happens among countries that share a language.) Legal codes and administrative norms also tend to be more similar the closer countries are, eliminating the need for duplicate teams of lawyers, accountants, and human resources specialists. And the intangible but vital task of finding things in common and building trust and understanding for teamwork can get harder as the distance between people grows.
The oft-repeated term “global supply chains” is a misnomer.
Trade pacts as well tend to be regional. Although the 1990s saw the creation of the World Trade Organization (WTO) and the expansion of its membership and oversight powers, what has been as important, if not more so, over the last 30 years has been the proliferation of bilateral and multilateral free-trade agreements, which tend to involve countries in the same region. European countries turned first to each other for trade. Brazil joined with Argentina, Paraguay, and Uruguay. After reaching a bilateral trade deal with Israel, the United States turned to Canada and Mexico and later to ten other nations in the Western Hemisphere. Asian nations banded together through the free-trade area of the Association of Southeast Asian Nations and later the Regional Comprehensive Economic Partnership (RCEP). Global arrangements such as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), the successor to a pact that was engineered by Washington but that the United States later abandoned, are so far more the exception than the rule.
Companies see differences in their bottom lines depending on their geographic dispersion. Many have gone abroad to boost their earnings, benefiting from the cross-country advantages of differential skills and wage costs. Yet go too far, and costs begin to rise again. In 2010, an academic study of 123 U.S. multinationals found that returns on assets improved as companies expanded internationally within their region but declined when they ventured farther from home. The management consulting group McKinsey & Company dubs this “the globalization penalty,” finding in a survey of 500 multinational corporations that earnings diminished as operations spread out. It seems the optimal distance for private-sector profits is a Goldilocks zone: not too close but not too far.
THE RULE OF THREE
The strength of the regional networks that a country belongs to are therefore particularly important. And in this regard, European countries are well situated. Although Brexit and mounting populist Euroskepticism may make the EU appear fragile, the European continent is, in fact, the most integrated region in the world. The deep ties that connect its countries are rooted in over a half century of diplomatic bargains that created a single market, a common passport, and a shared currency. Today, Europeans make things together and sell to one another, with nearly two-thirds of EU trade staying within the union. Similarly, internal European investment exceeds that from the rest of the world by 50 percent.
Asia is not far behind in its integration. According to the Asian Development Bank, the proportion of the region’s trade that takes place internally has risen from 45 percent in 1990 to nearly 60 percent today, surpassing North America and closing in on Europe. Decades of export-oriented development propelled by Asian business leaders and backed by bureaucrats tied country after country together through production supply chains. Asian countries make things together and increasingly buy from one another: nearly one-third of Asian finished goods are sold to consumers in the region.
Extreme weather will upend logistics as ports flood and rails buckle.
North America’s countries have also deepened their economic ties to one another. In the wake of NAFTA, trade between Canada, Mexico, and the United States rose fourfold, outpacing that between those countries and ones outside the region. Investment, too, became more regional, particularly for Mexico, where since NAFTA’s signing in 1993, one of every two dollars flowing in has come from its neighbors. In particular, North America’s agricultural and advanced-manufacturing supply chains expanded and strengthened over the course of the 1990s, leading regional commerce to jump by more than a quarter.
This integration didn’t last, however; after China’s 2001 accession to the WTO, regional exchanges dwindled, falling from around 47 percent of the continent’s total trade in 2000 to a low of 39 percent in 2009, before recovering slightly to around 40 percent by 2018. Still, although North America’s internal connections remain significantly less robust than those in Asia and Europe, they far outstrip those among the countries of Africa, Latin America, the Middle East, and South Asia—regions where less than a quarter of trade and investment occurs between neighbors.
JUST IN TIME
During the COVID-19 pandemic, border closures and rising transportation costs have prompted companies to consider bringing production closer to home. Governments have suddenly become keen to exercise more control over international supply chains for pharmaceutical and medical products. At the same time, ongoing technological innovation has made it easier for the private sector to expand production in different geographic neighborhoods. Automation, in particular, is making far-flung factories and supply chains less vital and less profitable than in the past. As sensors increasingly monitor assembly lines and equipment and robots and other forms of mechanization take over many manufacturing processes and tasks, wages make up a smaller part of operating costs. That development has diminished, at least in part, the once strong draw of locations with cheap labor.
New ways of making things, such as 3-D or additive printing, are also changing manufacturing processes, making small-batch production runs more affordable and reducing the need for specialized factories. These advances lower the numbers of workers that companies need and change the skill sets they seek: in many sectors, skilled (and higher-paid) technicians have become far more important than line workers. That shift diminishes the advantages of economies of scale, enabling at least some companies to move production closer to consumers without sacrificing profits.
The value of time is growing, too. As consumers expect faster delivery and near-immediate gratification, the longer lead times for goods produced by factories thousands of miles away can mean lost sales. The popularity of customized products also makes mass-producing facilities abroad less relevant than in the past.
Moreover, demographic shifts are raising the low wages that once drew so many companies to developing countries. In China, the great migration that brought over 200 million workers from the hinterlands to manufacturing centers has largely ended. After decades of strict family planning, more workers are now exiting the labor market than entering it. This trend looks set to accelerate: the national workforce is expected to shrink by 100 million people over the next 20 years. Working-age populations are contracting throughout much of Asia, limiting labor pools and driving up wage rates across electronics and other supply chains. In Europe, working-age populations are in decline or appear to be headed that way. Millions of Hungarians, Romanians, and other eastern Europeans have headed to their western neighbors in search of better pay and opportunities, and an influx of migrants—and, more recently, refugees—is only partly replenishing workforces.
Another factor curbing globalization is climate change. Extreme weather will increasingly upend logistics as ports flood, rails buckle, and airplanes are more frequently grounded by storms. Longer supply chains increase these vulnerabilities and potential costs. Meanwhile, policies designed to slow the planet’s warming by cutting emissions are raising global transportation prices, incentivizing companies to manufacture goods closer to consumer markets.
THE POWER OF POLITICS
It’s not just technological and demographic shifts and climate change that will curb globalization and favor more regionalization; political change is playing a role, as well. After decades of opening up to the world economy, many countries are pulling back. The Global Trade Alert, a nonprofit that tracks and collates trade policies from official sources around the world, has calculated that since the 2008 global financial crisis, new protectionist measures have outpaced liberalizing ones three to one.
Meanwhile, the WTO has been sidelined. It is no longer the forum to negotiate new trade rules. Its efforts to reshape global trade ended in 2015, when the so-called Doha Round of talks sputtered to a close. More niche efforts, such as attempts to reduce fishing subsidies in mostly rich nations, are struggling. Since 2018, the WTO has been unable to punish countries that break the rules, as the United States, under both the Trump and the Biden administrations, has refused to approve new judges to its Appellate Body.
Instead, regional accords have stepped in to govern international trade. The USMCA regulates North America’s trade ties and arbitrates disputes. In Asia, the RCEP now governs commercial exchanges among 15 countries, removing most tariffs and combining rules of origin requirements to favor regional supply chains. The African Continental Free Trade Area agreement aspires to do something similar, replacing a tangle of bilateral rules and regulations with a single, almost continent-wide commercial system. Regional accords now set the rules for more than half the world’s trade.
Regionalization, not globalization, will set the corporate agenda in the coming decades.
Geopolitical tensions threaten to fragment international commerce even further. Economic competition has become a pillar of great-power rivalry. With industrial policy back in vogue, many countries, including the United States, are throwing up protectionist barriers. The U.S. government has identified semiconductors, large-capacity batteries, pharmaceuticals, and dozens of critical minerals as vital to national security and is now implementing policies and spending tens of billions of dollars to expand stockpiles, beef up manufacturing capacity at home and in friendly nations, and redraw global supply chains in these designated sectors. Countries everywhere are drawing up their own lists, some of them adding information and data flows, fragmenting cross-border flows of services. As governments work to reshape the business environment across more industries, they are also implicitly or explicitly asking other countries to choose sides through export controls and other mechanisms. This will further limit international ties.
The push to reshore critical products and services is underway almost everywhere. But what most countries will find is that outside of a few highly sensitive or vital products, companies can’t or won’t bring production back home. Those that try to do so are more likely to go bust as costs rise and innovation falls. The most probable scenario is that multinationals will turn away from globalized supply chains in favor of shorter, more duplicative regional ones. Regionalization, not globalization, will set the corporate agenda in the coming decades.
AMERICA’S ADVANTAGE
Many of these technological, demographic, and policy shifts favor the United States. The declining importance of cheap wages and the rising role of skilled labor should advantage better-paid U.S. workers. A trove of intellectual property and intangible assets, including several of the new technologies transforming work and workplaces, will allow many U.S.-based companies to reap outsize benefits. Abundant financing means more discoveries, more patents, and more products. The United States also boasts clear laws and regulatory regimes—which is why so many investors prefer stocks and bonds issued under New York law—and a generally receptive and entrepreneurial business environment. For all these reasons, the U.S. economy should fare well in this next round of globalization.
Still, Washington’s advantages aren’t immutable. Other countries are also investing in education, research, and development and advancing their own technologies and national corporate champions. Moreover, the next billion new buyers of cars, clothes, and computers will be in Asia, where middle classes are growing faster than in any other region. To tap into this growth, U.S. multinationals and exporters will need to adapt.
To effectively compete, the United States should pursue reforms at home to take better care of its people and workers and to prepare them for a more fluid and volatile economic future. This will require expanding safety nets, ensuring labor rights, and improving educational opportunities that upgrade Americans’ skills. Domestic infrastructure also needs an upgrade to lower logistical costs that weigh down American-made goods. The $1.2 trillion set aside in the 2021 Infrastructure Investment and Jobs Act to pay for improvements to highways, bridges, electric grids, and broadband is a good start. More public spending for basic science and research and development should follow to usher in cutting-edge scientific breakthroughs and technologies.
In addition to getting its own house in order, the United States needs a more strategic approach to trade. One of the country’s challenges is the eroding price competitiveness of its exports in an increasing number of international markets. The countries to which the United States enjoys preferred access account for less than 10 percent of the world’s GDP, and few of them are among the fastest-growing markets. As other countries have formed and joined trade accords, the cost of U.S. exports has risen in relative terms. Because of the RCEP, cars assembled in Japan and South Korea no longer face the double-digit tariffs that U.S.-manufactured alternatives still confront in the region, and Chinese steel, chemicals, and machines all face lower levies than options made in the United States.
In an ideal world, the United States would pursue a robust and comprehensive trade agenda. Joining the CPTPP; restarting negotiations over the Transatlantic Trade and Investment Partnership, which would have linked the U.S. and EU markets; and revitalizing the WTO would open up more markets to U.S. goods and services and reinforce more transparent, fair, and environmentally friendly ways of doing business. The United States would also do well to regain its leadership in international standard-setting bodies, restoring its traditional role as a rule-maker and not just rule-taker.
But until the politics of trade change in the United States, none of that is likely to occur. In the meantime, Washington can benefit by turning to its neighbors. Canada and Mexico have preferred access to many global markets where the United States pays full fare. Their respective portfolios of free-trade agreements each cover some 1.5 billion consumers, representing nearly 60 percent of global GDP. Feeding into Canadian or Mexican manufacturing supply chains can give U.S. producers and parts makers preferential access to the world’s consumers, which they currently lack on their own. For instance, Mexican-made cars sold in Europe dodge the ten percent tariff U.S.-made models face, lowering the sticker price by some $3,000 on a Ford Focus and by over $4,000 on an Audi Q5, a savings that makes it hard for U.S. carmakers to compete. The opposite is true for U.S.-based parts makers: Mexican plants can source up to 40 percent of their Europe-bound models from suppliers in countries that are not part of the bargain. That means imported Mexican-made cars sold in France or Germany also keep U.S. factories humming.
In today’s more regionally focused world, exports are more competitive when countries make them together. Much of Germany’s touted international commercial success has resulted from its regional manufacturing ties. By seeding plants and operations throughout eastern Europe, Germany’s private companies—the famed Mittelstand—have bolstered the country’s manufacturing base and created jobs at home as their products have thrived on global markets. China’s spectacular rise and export dynamism similarly has depended largely on its incorporation into regional supply chains.
If the United States wants to help its companies replicate these successes, it also needs a regional approach. Regionalization brings competitive advantages that a single country, even one as large and wealthy as the United States, cannot match on its own. To make products as good, affordable, and fast as the competition, U.S. companies need to be able to source parts from many places and complete some tasks and processes in other countries.
A regional commercial strategy will also help more work stay on the continent—and thus in the United States. When part of production is located in Canada or Mexico, U.S. suppliers are more likely to keep or gain contracts and remain in business than when production moves overseas. And when orders rise, so do jobs all along the supply chain. The Organization for Economic Cooperation and Development estimates that, on average, nearly 40 percent of the value of U.S. imports from Mexico is created in the United States. For Canada, that figure is just over 25 percent. Conversely, U.S. input into imports from the rest of the world averages just 4.4 percent, reflecting how few U.S.-based suppliers are part of the global production process.
To enhance North America’s regionalization, the continent needs to improve its linking infrastructure. This means adding land crossings, upgrading thoroughfares that lead to and away from the border, expanding rail lines and depots, and investing in people and technology to staff and to support ports of entry. With faster connections and lower logistical costs, manufacturers in North America can make products that are more globally competitive.
A more competitive North American economy is possible.
As parts and components move between the three countries, workers must be able to follow. More and easier legal work-based migration paths are needed to make the region as a whole more productive, and they will require transferable credentials, licenses, and diplomas; business visas; and longer-term migration avenues. Greater coordination in education and training can help address gaps in skill and improve work environments to ensure that North America’s population growth, already a bright spot for the region, continues. Educational exchanges, language learning, and cross-border apprenticeships and skill development programs can all help build a continental workforce better able to entice new businesses and investment. Stiffening migration barriers will just lead more firms to go elsewhere.
And as the U.S. government rolls out industrial policies to increase the resilience of and access to a host of critical supply chains, its neighbors can help. Geographic diversification can offset the risks that natural disasters and accidents pose to stockpiles and production capacity. Regional manufacturing can lower the public financial burden of subsidies, as goods are more likely to attain a higher quality at lower cost when drawing on a cross-border network of suppliers.
North America’s regional trade has recovered, albeit slightly, from a 2009 nadir of just 39 cents of every dollar thanks to expanding textile, machinery, and produce supply chains. But no North American leader is prioritizing a continental commercial future. Mexico is turning inward, with energy and natural resource nationalism threatening its manufacturing base. Canada is looking to diversify its international commercial ties by reaping the benefit of trade deals with the United Kingdom and the European Union and in Asia as a member of the CPTPP. And the Biden administration is guided by another repeated but unsubstantiated refrain, that NAFTA and other trade agreements hurt, rather than help, U.S. workers. That is misguided: most of the studies trashing NAFTA don’t calculate the better-paid export-oriented jobs gained as a result of more favorable terms in the United States’ two biggest export markets; nor do they consider how lower North American production costs kept industries, such as auto manufacturing, alive and even allowed them to thrive in the face of global price competition from vehicles manufactured in other, rival regional hubs.
Through integration, a more competitive North American economy is possible. Three decades of freer trade, the existence of sophisticated supply chains in specific sectors, and widespread cross-border ties between communities and workers due to the movement of tens of millions of people could be energized and expanded. But deeper, more sustainable regionalization will also require a change in mindset. It will require recognizing that the United States’ middle and working class would prosper more from engagement in the global economy than they would from a retreat to the domestic market. Americans could gain more jobs, profits, and financial security if their country decided to take what is on offer: a slice of a large and growing economic pie.