Globalism goes backwardNovember 20, 2012: 5:00 AM ET
They forgot to tell us globalization has a reverse gear. Now companies and countries need to get ready for the 'inside economy.'
By Joshua Cooper Ramo, contributor
FORTUNE -- One morning this past September, Pascal Lamy, the energetic Frenchman who heads the World Trade Organization, stood in front of a room of economists and began his annual recitation on the health of the world's economy. "This year, like last, has been marked by extraordinary economic turbulence," he began. "Sluggish economic growth rates, high unemployment, and newly released figures on world trade that are just as worrying." It was not an unfamiliar diagnosis. But that last bit, the mention of the worrying new trade data, caught a number of ears.
For most of the past 20 years trade has raced ahead of global economic growth, usually at about double its pace. GDP grew by 3.5% in 2006, the last healthy, pre-crisis year, and trade at 8%. This was, it seemed, a golden ratchet binding the planet ever closer. But the most recent 24 months show something that looks an awful lot like a trade shock. It isn't just that trade is no longer doubling -- it's slowing. In some crucial areas trade growth has slipped below GDP growth -- and this year, globally we'll be below the 20-year average rate of trade growth yet again. Figures on investment in assets held overseas, probably the best indicator of enthusiasm for globalism, are drifting down toward 40%, from more than 50% in 2008. The move is serious enough that economists have begun to ask: Is globalization running backward?
Given that the idea of a more interconnected world has been at the heart of our assumptions about our future, such figures are, as Lamy said, worrying. They echo in our politics as loudly as they do in our markets. People remember a world of protectionism, understand the consequences of no international cooperation, and nervously consider the icy historical proposition of 18th-century French economist Frédéric Bastiat: "When goods don't cross borders, armies will." Watching the country that in recent years has benefited most from an open world-trading order rebel against it is like hearing that people are looking for ways to opt out of gravity. But here it is: Two-thirds of Americans now believe more trade is bad for the country.
What I want to do in the next few pages is start with those chilling trade numbers to tell a larger story, the story of a deep shift now under way: The rise of the inside. The past 20 years of globalization delivered a quantity of connectedness that produced a whole new quality of global life. At the end of the Cold War, the world released a big, tense breath and began stretching out. Our companies, our instincts, our vacations -- all led us to the farthest corners of the planet. Now, all around us, we see something different. We find everywhere signs of a world turning inward and of an era when the inside will define success and deliver growth -- for companies, for nations, even for your career -- in the way the outside once did. Consider:
• For most of the past 20 years China's development was driven by opening to the outside and by low labor costs that made it the world's factory. But the next 10 years will be defined by fixing, urgently, its broken internal systems. As officials in Beijing noted last year when explaining their new five-year plan: "The golden age of globalization may come to a halt."
• In the world of finance the strongest banks are now relentlessly local. They know their customers and their customers' kids, by sight and not just by balance. The once-appealing efficiencies of financial scale, of ever-outward-reaching banks, brought risks that all but obliterated their economic advantages. Describing the origins of the 2008 crisis in terms that read like nothing less than an insider-era manifesto, University of Chicago economist Raghuram Rajan explained, "Modeling that took the plumbing for granted ensured the breakdown of the plumbing."
• Even in the quotidian -- what we eat, what we wear -- we find evidence of this shift. If the past few decades featured a globetrotting, chef-flavored renaissance (think Mario Batali and Anthony Bourdain) that brought global tastes to our doors, the buzz now is all about a new logic of local consumption: locavore food at Noma in Copenhagen, for instance. Or the rise of the home crafts movement for everything from bacon to beer, and sewing, knitting, and jewelry. Think of the insight of the team at Kind Snacks that set it apart from PowerBars and fueled its growth: transparent wrappers. People want to know what is inside their food.
Masters of disaster
The outside isn't going away, to be sure. We live in a world where hundred-year storms seem to occur every few years and "once in a lifetime" financial debacles come along, well, more than once in a lifetime. It is becoming unnervingly apparent that, even with the best intentions, many of our institutions and leaders are running on ideas built for a different age. First, they can't predict the outside: Recall New York MTA head Joseph Lhota's baffled admission that Hurricane Sandy was "worse than the worst-case scenario."
Then they can't grasp the turbulent dynamics inside either. "The impact on the broader economy and financial markets of the problems in the subprime market," Federal Reserve chairman Ben Bernanke assured Congress in 2007, "seems likely to be contained." It makes you wonder: Can we adjust to this new order?
Big globalizing eras have snapped before -- think of the steam and rail revolution of the 1880s or the Silk Road of the Tang Dynasty. They generally take nations that don't adapt for a very unpleasant ride. But this time might be different. The dominant nation of globalization's recent expansive phase -- the United States -- does have the tools to dominate the next inside phase as well. After all, the guts of almost every system on the planet, from emergency rooms in Bangladesh to databases in Poland, run on American ideas. And the very logic of success in an inside world is an instinct to build platforms like those that power firms such as Apple (AAPL) and Google (GOOG). This hot fusion of innovation, trust, and commerce remains, for the moment, an American near monopoly.
Under the surface
The aesthetics of any age -- the way it looks, dresses, and sounds -- are, of course, a reflection of its instincts. A few bars of Mahler can evoke the wild tensions of the Viennese renaissance of 1900. In our age we can actually see the inside pushing to the fore. Consider the design of the Barclays Center in Brooklyn; critics call it the most important new building in the U.S. this year. It was conceived around a revolutionary inside-to-out gambit, with huge windows and screens that let passersby see who is singing, dunking, or practicing inside. The building marks a generational lurch as much as a structural one: Developer Bruce Ratner craftily swapped a too expensive concept by Frank Gehry, whose elegant and impenetrable façades were perhaps the best examples of the "outside is the new outside" revolution of 20 years ago, for one by the post-boomer collective firm SHoP. In the process, almost by accident, he built what may be the first great building of the Inside Age.
This shift from surface to inside in architecture follows a logic that is one of the most basic rules of network development. In the initial phase of most network growth, you can observe the spread of a thin but ever more extensive layer of connection. If you go back and examine old charts of the growth of electrical or telephone networks, this is exactly what you see: a few lines, then a few more, and eventually a thick web. But as the network expands, it hits a point where it begins to turn inward and firm up, almost like a muscle growing in strength. Think of the ties between a bunch of college freshmen in their first week or two at school, for instance: They go from knowing almost no one to connecting with hundreds of people at a very light level, learning their names and hometowns. But as time goes on, ties thicken. After a while knowing lots of new people is less interesting (and returns less value) than knowing a few people deeply.
Networks are the essential metaphor of our age, what assembly lines were 150 years ago. And we've now moved from an era of extensive network development -- that "Hi, nice to meet you" phase -- to something deeper, and often that means nearer and more local. This shift is being abetted by any number of practical factors: Prices of air and sea freight have inflated alongside fuel costs in recent years, for instance, putting a premium on closeness. The 2011 earthquake and tsunami in Japan exposed the fragility of the global supply chain, causing tech companies to rethink far-flung relationships. A renaissance of local manufacturing, driven by technology and cheaper energy from shale gas, seems to be on the horizon. GE (GE) is investing $1 billion in its U.S. factories and plans to bring all domestic appliance manufacturing back to the U.S.
But there's something else at work too: a sense that we may have gone too far, too fast, that we don't really understand the dynamics of the systems we've built. Perhaps you see this in your own Facebook or Twitter feeds: friends shutting down, uneasy with so much outside exposure -- a sensation even younger users are feeling. A world with no privacy -- with no inside place to grow and learn and make mistakes -- is a sort of self-created panopticon.
To be honest, we entered the first flush of globalization with the wrong tools. We didn't know how to manage interconnected bank risk, couldn't imagine the danger of asymmetrical threats like terrorism, and really believed that every time we tipped over a government in some other country, an American-style system would grow back in its place. In any revolutionary period, leaders, confronted with the radically new, usually miscalculate. How they adjust is the test that history offers to generations facing revolutionary change. It marks the distinction between the revolutionary and the reactionary temperaments, between Apple and Dell (DELL), say, or between Voltaire and Edmund Burke. The right answer is to pause, and to reengineer. Think of the Council of Trent, for instance, when the Catholic Church tried to grapple with the contagion of independent knowledge in the Renaissance. Or the Corn Laws of 1815, as Britain struggled with the intense global trade that an industrial age had bred.
Champions of the inside world
Nowhere is this fast shift to the inside more dramatic than in the bellwether of our age: infotech. If the decade and a half since the first BlackBerry was marked by companies' building smartphones and getting them into every palm on the planet, the struggle now is over what happens inside those devices: a battle fought app by app and patent by patent. It's perhaps no surprise that the most talked-about feature of the latest Google Maps release is that it shows you, like some sort of magic trick, the insides of buildings.
If value in the first era of networking was about connecting us all together, power now emerges from what goes on inside the resulting webs. Database mining, for instance, means that each of us can be understood (often without our knowing it) from the inside of our habits: What we buy at Amazon (AMZN), where we check in on FourSquare, or the pictures we leave on Instagram confess hopes and needs that reveal more about our souls than hours on an analyst's couch might.
This massive assembly of data -- and the need to make sense of it -- has led to a revolution in artificial intelligence, the moniker we give to machines that think on their own. And this may be the most unnerving inside revolution of all. The very first computers, you'll recall, were built to do calculations humans could do, just faster. But plugged in all around us now are machines running on their own logic, free from much external control. Markets crash, companies fail, risks emerge not only from the outside world but also from invisible (to humans) perversions of the internal logic of these sorcerer's apprentices -- bugs. This sort of inside twitch triggered the "flash crash" of May 2010, when the Dow fell 9% in minutes because of -- well, no one can quite say. The whole setup is starting to call to mind a flinty pilot's joke: In recent years pre-crash cockpit chatter on airplane black boxes has shifted from one pilot yelling at another "What the hell are you doing?!" to both pilots yelling at the plane, "What the hell are you doing?!"
But there is something revealing and important in what is going on with firms like Google, Facebook (FB), and LinkedIn (LNKD). Once they get a foothold in a market, they become nearly impossible to dislodge. This violates a standard rule of economics -- that markets should become more competitive over time, not less. How do these firms win? Why? After all, there's no shortage of outside competitors.
The answer, it turns out, is on the inside. These companies have built platforms that run on an economic logic known as "increasing returns to scale." The more people who use Google, the smarter its system gets, which means more people use it, which means ... This is why we have one Google, one Facebook, one eBay (EBAY), and so on. Get the inside algorithms right, and you'll become an irresistible magnet. The costs of being excluded from your network? They grow exponentially as time passes.
This logic of increasing returns tells us a lot about exactly what America needs to do next. Think of it this way: Every time you use a dollar bill, reach for a credit card, dial your cellphone, check your GPS -- nearly anytime you finger something with a network connection, what you are really doing is touching the outlines of a global system of interconnection that has been built with U.S. values. You're connecting to a system where we've been able to lock in the rest of the world. It's the reason that there is one Silicon Valley and one Wall Street -- and also why it is ridiculous that we are letting our dominance of those systems leach away not to external competition, but from the inside out. Whether it be ever more challenging visa regulations for engineers or ever greedier pollution of the use of finance, we're rotting away the basis of what has let us prosper. Maintaining a standard like the U.S. dollar as the global reserve currency is, in a world of locked-in systems, the greatest possible strategic advantage. Losing it would hurt our national security far more than almost any other international threat. Are we really defending it urgently enough? We shouldn't be worrying so much now about losing our future to China and India -- countries that relied on outside-led growth for their economic muscle tone -- but rather about losing our future to our own inability to adjust.
I suspect this outside-to-inside change also affects how we should think about brands and our careers. The last era was about the notion that companies won because they had big brands, that careers were built on "The Brand Called Me." But now we've found that the firms that function best do so because of values and cultures; megabrands are suffering a collapse in legitimacy as we find that what looks good outside (Enron, Lehman, the State of California) is often weak on the inside. And research shows that firms and countries that put values first last longer and do better. One recent study looked at why Silicon Valley grew while Route 128 outside Boston withered. The answer: Both had money and brains, but the Valley had an insider culture of cooperation.
The inside turn is a control reaction. Some of the turn is a predictable and adrenal twitch in the face of the unknown; some a chance to innovate and reform ourselves after an exhausting few decades and turbulent few years. There's no question that success in the networked future will come from the inside out. But this turn must serve a larger purpose. Too far inside -- as we've just seen in the most insider, zip-code-by-zip-code presidential race ever -- can rob us of the chance for the real vision leadership demands. What we're aiming for here is not retreat, but to reset our ideas for a new age. It points up the fact of an urgent need for change at the most difficult, insider place of them all: ourselves.
--Reporter associate: Omar Akhtar
This story is from the December 3, 2012 issue of Fortune.