Is globalization slowing?

A persistent, dramatic trend toward accelerating international flows of goods, services and capital that has been a hallmark of the past 40 years or more may be coming to an end. CEOs who are looking to foreign markets to offset weakness at home may have to think again.

After reaching a peak in 1996, foreign direct investment in emerging markets has been in a continuous and worrisome decline. This slowdown in emerging market investment has broadened recently into an even more disturbing absolute drop-off in global investment patterns.

It's possible this trend is just the result of world overcapacity in manufacturing. Or maybe it is the global reflection of the collapse of the technology and communications investment bubble. Whatever the cause, this decline stands in sharp contrast to the early 1990s, when capital flows to emerging markets surged as businesses sought new market opportunities.

The severity of the slowdown may signal a fundamental break in the process of "global arbitrage"--or how companies sort through market and production opportunities to optimize their market and cost structures. Today, it seems there is a greater "home bias," or a predisposition to invest and grow in just a few chosen markets.

Unfortunately, the range of countries with strong economic performance and significant foreign investment gains appears to be narrowing. In the early 1990s, the economies of 60 countries were growing at more than double the global average. Today, only about 20 countries can boast such growth.

Overall, the level of private capital flows to emerging markets is currently about half of what it was before the Asian financial crisis of 1997-8. China, Brazil, Mexico and the countries of Eastern Europe account for more than 90 percent of all private capital flows to developing markets. China alone comprises 80 percent of the private capital flows to Asia.

The concentration of growth is also evident among industrialized countries. Australia, Ireland, Canada, New Zealand, Britain and the United States are growing faster than other developed nations. And even in these countries, growth rates are disappointing.

Against this backdrop, there are questions about the role of the large U.S. trade deficit. Not only is the U.S. responsible for about 20 percent of global demand, it is also the only major importer of goods and services. One would think that the world economy would be a mix of net importers and net exporters based on comparative advantage. But actually, everyone is more or less a net exporter, except for the United States.

Is this sustainable? In theory, yes; in practice, no. It is clear that the U.S. trade deficit is providing an important stimulus for the rest of the global market. But currency markets are already driving down the value of the U.S. dollar to force an adjustment. Indeed, the Bush administration appears to be hastening the process through its studied inattention to the dollar's decline.

While it is easy to talk about a significant cut in the U.S. trade deficit, it is difficult to identify markets where the United States could export an additional $200 billion or which could withstand a $200 billion drop in exports to the U.S. Like it or not, the U.S. market is providing tremendous growth support to the rest of the world at a difficult time. The U.S. trade deficit is equal to roughly 30 percent of the $1.7 trillion global Gross Domestic Product growth expected this year. In an accounting sense, of course, all imports and exports should net to zero--the world cannot have a trade deficit with itself. Nevertheless, just as a country uses its own credit and financing capacity to fund domestic programs that benefit domestic industries and incomes, the U.S. trade deficit benefits the incomes and growth of its trading partners.

As the U.S. trade deficit shrinks, possibly as a result of a weak dollar, the slowdown in global trade and investment will become more evident--and potentially more damaging to global growth and efficiency. American CEOs will need to adapt their expectations to reflect an increase in the relative importance of well-developed traditional markets. The global frontier will no longer be an easy escape from problems at home.

Gail D. Fosler is senior vice president and chief economist of The Conference Board in New York.