Less globalisation may not mean higher U.S. inflation

By Kevin Khang, Vanguard Senior International Economist

Markets and economy

Why slowing globalisation is unlikely to lead to worrying inflation.

Low inflation in the decades before the COVID-19 pandemic has often been attributed to globalisation.

So, it would be natural to think the opposite—that less international trade, particularly with China, might lead to higher inflation. However, our latest Megatrends research suggests that the impact of slowing globalisation on inflation will be modest.

It’s a compelling narrative: The low inflation that we’ve seen for most of the past 30 years has been a consequence of lowered trade barriers thanks to the ratification of the North American Free Trade Agreement (NAFTA) in 1993 and China joining the World Trade Organization (WTO) in 2001. The ready availability of cheap imports from China has largely driven the narrative.

Given today’s geopolitical tensions and rising trade barriers, it’s understandable if some might think that globalisation is in full reverse and that inflation might again rise to the alarming levels we saw post-pandemic or in the 1980s before globalisation’s rapid rise.

Indeed, the glory days of globalisation are likely behind us. But the worst-case inflation scenario is not likely, particularly in the U.S. To understand why, we need to look back over decades.

Globalisation’s impact on inflation is milder than you might imagine

First, contrary to popular belief, globalisation has had only a modest impact on inflation historically. The chart below illustrates this point.

 

Globalisation has mildly lowered inflation, but “slowbalisation” is not to be feared

^{Notes: Figure shows year-over-year inflation from 31 March, 1987, through 30 September, 2023, and hypothetical inflation, assuming that the globalisation driver neither added to nor subtracted from inflation during that period. The shaded area represents the difference between the two lines. A negative value indicates that realised inflation was lower because of the impact of the changes in globalisation. NAFTA stands for the North American Free Trade Agreement, and WTO stands for the World Trade Organization.}

^{Source: Vanguard’s Megatrends paper, AI, Demographics, and the U.S. Economy: Quantifying the Coming Tug-of-War, June 2024.} 

 

The chart covers 1987 through late 2023, a period which included cycles of both accelerating and slowing globalisation. While globalisation helped contain inflation in the 1990s and 2000s, the magnitude of its impact was modest—far less than that of monetary policy, according to our research. Even as globalisation has slowed over the last 15 years (a trend we sometimes call “slowbalisation”), its impact on inflation has, again, been very modest. The reason? It’s the makeup of the U.S. economy.

 

The U.S. depends less on trade than most developed economies

The U.S. economy is more self-sufficient than some may realise, with almost 90% of its goods and services produced within its borders—a much higher proportion compared with most other countries.

Take personal consumption as an example. By dollar value, only about 10% of goods and services consumed in the U.S. are imported. This may seem surprising if much of your wardrobe was made in China or Vietnam, but imported nondurable goods like clothing and footwear make up just around 4% of the consumption basket.

Almost 70% of total U.S. consumption is in services—health care, education, housing, and so on—the vast majority of which takes place in the U.S. This is yet another reason why globalisation during its heyday in the ’90s and 2000s had only a modest impact on inflation. And it’s why we expect slowbalisation to have little impact on the U.S. economy and inflation going forward.

 

U.S. consumers don’t spend much on imported goods and services

^{Notes: The figure shows the composition of U.S. personal consumption expenditures (PCE) by category (durable goods, nondurable goods, and services) and by source (imported or domestic). We used data as of 2019, as disruptions from COVID-19 and its aftermath in the early 2020s caused consumption patterns to deviate significantly from the long-term trend.}

^{Source: Vanguard calculations based on data as of January 31, 2019, from the San Francisco Federal Reserve Bank.}

 

Economies adapt to changes in the global trade landscape 

Finally, we should not underestimate countries’ abilities to adapt. Since the 2008 global financial crisis, for instance, economies have been doing more “nearshoring” or “friendshoring”—shifting trade to countries that are closer geographically or geopolitically to reduce the risk of shocks like supply-chain disruptions.

As a result, the labels in your closet are more likely to say “Made in Vietnam” or “Made in Mexico” instead of the once-ubiquitous “Made in China.” Long before the latest trade disputes and pandemic-related supply shocks, these shifts have mitigated inflationary pressures stemming from any one region.

Given these forces—a domestic production base, service-based consumption, and adaptive strategies such as friendshoring—we believe the U.S. economy is well-positioned to adjust to shifting global trade dynamics.

Globalisation has slowed, and it may slow even further, but in the U.S., any resulting inflationary pressures should remain marginal.