An important transition is at hand for the world economy. Globalisation could be giving way to a new era of localisation. The self-interest of individual nation states is in the ascendant, whereas the collective push for cross-border integration is on the wane.

This could be a treacherous development for the global economy and world financial markets. At the core of this change is an extraordinary tug-of-war between capital and labour in the rich countries of the developed world. As can be seen in the accompanying chart, corporate profitability as a share of national income is at historic highs for the “G-7 plus” nations. At the same time, the labour compensation share of national income has fallen to a record low for the same economies.

This unprecedented divergence between soaring returns to the owners of capital and lagging rewards of workers emphasises a destabilising asymmetry to the so-called win-win globalisation paradigm.

The first win is an unmistakable plus for low-wage workers in the developing world. The second win is supposedly accruing to high-wage workers in the developed world — widely presumed to be reaping the benefits of buying things cheaply from poor countries while, at the same time, getting compensated for producing and selling increasingly sophisticated exports.

It has not exactly worked out that way. Instead, the benefits of the second win have showed up in the form of surging corporate profits in the industrial world. Increasingly, multinational companies have taken advantage of a new IT-enabled connectivity to link global distribution platforms to low-wage pools of labour in the developing world. The result has been a powerful global labour arbitrage bearing down on workers in the big developed economies — pushing employment growth well below historical norms and squeezing real wages as never before.

Yet there is a new and important twist to this globalisation. Unlike previous periods of trade-related pressures that were directed exclusively at blue-collar workers in the factory sector, the new globalisation is also bearing down on white-collar workers in the vast and once non-tradable services sector.

Courtesy of the internet, the click of a mouse delivers the knowledge content of an increasingly broad array of white-collar workers to desktops anywhere in the world. As white-collar offshoring spreads from data processing and call centres to increasingly high-value-added tasks, such as software programming, engineering, design, medical and legal advice, consulting and financial services, the global labour arbitrage has migrated at hyperspeed to the upper echelons of the occupational hierarchy.

The squeeze on labour in the developed world has translated into a bonanza for corporate profitability. Heightened competitive pressures drive cost- cutting and restructuring strategies that continually squeeze labour costs. The problem is that the pressure on labour in the high-wage industrial countries has gone to excess.

Nowhere is that more evident than in the United States. Economic theory holds that workers are paid, ultimately, in accordance with their marginal productivity contribution. Yet in the US — the leader in the productivity revolution — gains in real compensation per hour of 1.4 per cent over the past five years have been less than half the 3.1 per cent average rate of productivity growth over the same period. Moreover, academic research indicates that only about 10 per cent of the American workforce realised gains in labour income that were in excess of underlying productivity growth — meaning that 90 per cent of the workforce has been on the outside looking in. Widening income disparities are another worrying and destabilising characteristic of the global labour arbitrage.

A backlash is at hand. The pendulum of economic power, which has swung to excess in favor of capital, is about to swing back in a pro-labour direction. Workers lack the bargaining power to execute this change themselves. Instead, they are exercising their power at the polling booth and demanding action from their elected representatives. The result has been a comparable swing in the political pendulum from the Right to the Left — in the US, France, Germany, Italy, Spain, Japan and even Australia.

Led by Democrats for the first time since 1993, the new US Congress has already put down a pro-labour marker — a 41 per cent increase in the minimum wage. Look for further actions emanating from Washington along this same general theme — namely, increased taxes on the energy industry, scrutiny of executive compensation and intensified China-bashing. Similar pro-labour initiatives are likely to take root elsewhere in the developed world.

Financial markets are unprepared for this sea change. As real wages rise in response, corporate profits and equity markets could come under pressure. With cost pressures mounting and protectionism on the rise, inflation could also begin to rise, posing a serious problem for bond and ever-frothy credit markets. And, as globalisation gives way to localisation, the dollar could finally come under assault as America’s lenders seek a safer haven for their huge stash of foreign-exchange reserves. It is as if the film of the past 15 years is about to run in reverse.

The author is chief economist for Morgan Stanley.

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