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The pandemic, Ukraine, geopolitical stress, climate change, and macroeconomic uncertainty: These are turbulent times. No wonder business leaders and policymakers are re-examining everything from their supply chains to their trading patterns. The overarching question, as we see it, is what this means for globalization.
The simple fact is that globalization is not going away. No nation can stand alone. The world is and will continue to be a dense web of interconnections. McKinsey Global Institute (MGI) research found that every major region relies on others for important manufactured goods or resources. More than half of Europe’s energy, a quarter of China’s minerals, and the majority of electronics for Central Asia, Eastern Europe, Latin America, and sub-Saharan Africa are imported. Even the United States, which is less dependent on trade than most countries, relies on imports for more than 30% of the value embedded in the goods it consumes.
These connections have brought broad benefits, such as fostering economic growth, improving efficiency, reducing prices, and increasing the availability of goods. At the same time, the economic logic of scale and specialization has created vulnerabilities. About 40% of global product trade is concentrated in its origins–meaning that the importing economies rely on three or fewer nations for things they need, like laptops, mobile phones, cobalt, and palm oil.
Concentration sometimes arises because a product is only produced in a few places. For example, Brazil and the U.S. supply more than 90% of soybeans. However, three-quarters of concentrated trade–or 30% of all global trade–is a matter of choice, with individual countries sourcing from only a few places, even though there are other options.
Such “economy-specific concentration” can be observed widely, from natural resources (iron ore and wheat) to intermediate products (televisions and memory chips) to final goods (vaccines and aircraft). There are many reasons for this, including geographic proximity, consumer choice, comfort with established trading partners, market structure, and trade barriers and preferential arrangements.
While such concentration can be efficient, it can also bring troubling side effects. If concentrated trade flows are disrupted, products are harder to replace on short notice.
When the pandemic and stressed supply chains cut semiconductor chip production in Asia, for example, that affected automakers in Europe and the U.S., too. In sensitive sectors associated with national strategic interests, concentrated trade relationships can result in uncomfortable levels of risk.
In response to these concerns, some have called for “decoupling” to reduce dependence on certain foreign countries. However, in practical terms, severing connections costs time and money. Plus, reducing sources of supply tends to increase concentration.
Instead, we would argue for increasing diversification. It just makes sense not to have all the important eggs in two or three baskets. Companies and countries that thoughtfully manage their concentrated exposures are likely to be more resilient–not only able to absorb a supply disruption but to bounce back better. Singapore, for example, realized that it was depending on a handful of pipelines for its critical imports of natural gas. Over the last decade, it has systematically diversified its supply, building a liquefied natural gas terminal to access the seaborne market.
Greater diversification could also promote a more inclusive trading system and economy. The connection between trade and wealth creation is strong: diversification could enable more countries to participate more fully. Picture a world in which countries ranging from Vietnam to Poland, India to Mexico, and Venezuela to Egypt play a larger role in global trade.
Is diversification happening? It’s complicated. An MGI analysis of a range of large economies found that their concentration patterns across sectors hadn’t changed much from 2016 to 2021.
In April 2022, though, 81% of global supply-chain leaders surveyed said they had initiated dual sourcing of raw materials, up 26 percentage points from the previous year. So, change could be in the making.
Globalization has played a significant role in the sharp decline in extreme poverty–from 36% of the world’s population in 1990 to less than 10% in 2017. However, the benefits have not accrued everywhere or nearly enough. There have certainly been losers.
By focusing on resilience and diversifying sources of supply, we believe it is possible to re-imagine globalization and build the foundation for sustainable and inclusive growth.
Bob Sternfels is the managing partner of McKinsey & Company. Olivia White is a director of the McKinsey Global Institute.
The opinions expressed in Fortune.com commentary pieces are solely the views of their authors and do not necessarily reflect the opinions and beliefs of Fortune.
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Bob Sternfels, Olivia White
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