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October 14, 2012 | Wall Street Journal

The Retreat of Globalization

Some say the world is flat, but it sure doesn't look that way from the hole we're in.

The popular wisdom has it that trade and investment continue apace across national borders. After all, globalization—connecting capital and labor, producers and consumers, emerging economies and their more mature counterparts—has led the world-wide surge in economic activity for the last three decades. It brought hundreds of millions out of poverty. It created hundreds of billions in shareholder value. Productivity and aggregate standards of living rose markedly. Companies, large and small, competed as never before.

In the United States, as in other mature economies, some workers were displaced. But the overall economic pie expanded. So the debate focused on how best to divide the spoils and prepare those displaced for a world ripe with new opportunity.

Yet globalization is now showing signs of retreat. And so is the structural fillip that amplifies economic growth and individual opportunity for all Americans.

Cross-border, private-capital flows continue to be disappointing. Flows to emerging markets, for instance, fell sharply in the summer last year and remain stalled. Investors appear cautious, notwithstanding central bankers' ceaseless efforts to tempt them to buy riskier assets by suppressing yields of government-backed securities.

Investors are also demonstrating increasing home-country bias, disproving the theories that emerging economies would be immune to global weakness. Companies are similarly exercising considerable self-restraint in their investment in long-lived assets, such as factories, at home and abroad. The massive provision of public funding cannot mask the shortfall in private investment flows.

Many of the world's largest banks are forgoing their global ambitions. Conflicting capital requirements and massive regulatory complexity across jurisdictions render global banking a less attractive aspiration. Serial bank bailouts have given greater impetus to governments to direct the activities of their domiciled banks. Many big banks are now state-owned, and many more find themselves in limbo. They are quasi-public utilities, trying to serve the wants of their governments and the demands of their supervisors, leaving the remnants for private shareholders. The resulting bank deleveraging is reducing credit to the real economy, exacerbating economic weakness.

Trade is the glue that connects the global economy. Trade has grown much faster than economic growth for most of the last few decades, thanks largely to the globalization wave. Only twice since 1982 has global trade growth trailed economic growth.

But trade has weakened over recent quarters. According to the International Monetary Fund, trade growth volume is projected to slump to 3.2% this year, down from 5.8% last year and 12.6% in 2010. The World Trade Organization recently cut its forecasts for global trade by more than a full percentage point for this year and next. Absent fundamental policy changes, these data mean that the IMF's global GDP forecasts for this year (3.3%) and next (3.6%) are challenging to meet.

Yet even this cyclical weakness is not the gravest concern. What if the cyclical has become structural, and economic potential is falling? What if the world is getting more fragmented and the gains from globalization are being forgone and forgotten? What happens if policy makers remain preoccupied with short-term urgencies to the exclusion of long-term priorities?

We see fragmentation happening most acutely in Europe. Recent data indicate less cross-border investment, a pullback in interbank lending, and a withdrawal by some large non-European Union banks from much of the Continent. European export and import data are also down. Only labor markets seem to have largely avoided fragmentation, as workers travel the Continent in search of opportunity.

The European Central Bank appears fully prepared to do whatever it takes to ensure the survival of the euro zone. There is no reason to doubt its commitment. Yet even poised and powerful central banks cannot alone counter market fragmentation and economic malaise. So other European leaders are pushing for fiscal and banking union to match their experiment in monetary union. Investors are awaiting final resolution, but their patience is being tested.

Developments in Europe are of great consequence to the rest of the world. And these may prove a telling indicator—or a further catalyst—of a broader, growth-defeating trend away from globalization.

The G-20, comprising leaders of the largest advanced and emerging economies, should confront the threats of de-globalization head-on. Yet the G-20 agenda, established in the depths of the crisis in 2008, seems to have stalled. Leaders must resurrect their commitment to knocking down barriers to growth, increasing global trade, and coordinating policy actions to grow economic potential.

The U.S. economy, in dire need of sustainable growth, cannot afford to squander this opportunity. American leaders must find their voices in championing free markets, free people and free trade. Unless we reaffirm these first principles for economic growth in a globally connected economy—and act on our own prescriptions—the gains from globalization will be lost. This is no time for small ball and short-term fixes.

Trade is just one area where the U.S. should act to reverse the de-globalization trend. Recent trade agreements with South Korea, Colombia and Panama—and the vaunted promise of an agreement with the Asia-Pacific—are steps in the right direction. But we need to do much more. We should aggressively fast-track a new, robust free trade agreement with Europe. This would strengthen the world's two largest economies and demonstrate our mutual commitment to economic growth.

Ultimately, it may not be the anti-globalization brigades—those with placards in hand whenever multinational institutions meet—that reverse the rising tide toward globalization. The causes of the reversal may be more the policies of the practitioners than of the protesters.

Mr. Warsh, a former Federal Reserve governor, is a distinguished visiting fellow at Stanford University's Hoover Institution and is on the board of directors of United Parcel Service Inc. Mr. Davis is the chairman and CEO of UPS.