Published daily by the Lowy Institute

Unbundling globalisation

The market can look after efficiency, but governments have to look after equity.

Unbundling globalisation
Published 6 Dec 2016 

Brexit and Trump’s victory have caused a reassessment of economists’ rose-tinted vision of globalisation. Richard Baldwin’s The Great Convergence provides another perspective on what has happened and why it has not turned out to be as universally beneficial as was promised.

Baldwin sees the evolution of production as a series of stages. In the beginning, people consumed what they produced. As transport developed and society evolved, people began to specialise, producing more of a particular good than they consumed themselves. Farmers produced more grain than they ate, and traded the surplus with manufacturers who produced other things the farmers needed: production and consumption were separated or 'unbundled', and living standards rose as a result.

Over time this process of specialisation became globalised. Initially global trade was limited to the most expensive goods such as exotic spices but, as transport costs fell and countries became more globally integrated, this practice of unbundling consumption and production became ubiquitous. International competition had a huge effect on production, enforcing productivity efficiencies and restraining prices. The threat that production could be moved offshore also reduced workers' bargaining power.

Baldwin wants to categorise this process into defined phases, but it is better seen as a continuum: politics, events, and uneven technological progress gave a syncopated rhythm to the evolution of production processes, but the shift was always towards greater integration and specialisation, both within national borders and globally. Transport costs fell inexorably, starting long ago with fragile ships on inhospitable oceans and camel-trains along the Silk Road. Similarly, ideas were disseminated globally as travellers ventured into new lands and seas.

Globalisation was a key driver of colonial empires, although the dominant role of the colonial power meant that the benefits of the first phase of globalisation (1820-1914) were overwhelmingly reaped by the colonial powers. Wars (notably the World War 1) and economic upheaval (the 1930s Great Depression) brought this first phase to an end, but only temporarily. The second phase of globalisation (1945-1990) was different, with manufacturing production shifting to a small group of emerging economies. The beneficiaries including a billion people in these emerging economies, lifted out of extreme poverty. The advent of containerised shipping and bulk cargoes brought spectacular reductions in transport costs, and trade grew significantly faster than GDP.

Baldwin believes another watershed took place in the 1990s, this time triggered by the widespread adoption of information and communications technology (ICT). This accelerated the unbundling of ideas and production processes. Technology and manufacturing practices developed in one place could be transferred at low cost across the world, coordinated through ICT. This facilitated the development of supply chains, where the production process is broken down into stages, each done in the country with the greatest comparative advantage for that particular type of production. Where dexterous cheap labour is available, this will be used for the labour-intensive assembly processes. Where clusters of high-tech workers are needed to foster innovation through creative interaction, this will occur where education levels are high and innovators find a congenial living environment. Geographical specialisation develops. Some workers benefit, others are left worse off. Trade is no longer confined to raw materials and finished goods, but consists increasingly of intermediate goods and services, such as intellectual property.

In fact, much of this rampant globalisation, with its attendant disruptions, occurred before Baldwin’s break-point in 1990. The fall in the wage share of GDP began decades before globalisation was a dominant factor in production. Even key subsequent events, such as China’s swift arrival as ‘manufacturer to the world’, were a product of many factors other than ICT (in China's case, its accession to the World Trade Organisation in 2001).

The spread of ideas also goes back much further than the 1990s advances in ICT. Since World War II, foreign investment has taken modern production ideas and processes to countries that could combine these with lower labour costs. Manufacturing in emerging economies often started with part-production of the final output, importing complex parts. All the development success stories (Singapore, Hong Kong, South Korea, Taiwan, Thailand, Indonesia, Philippines and Malaysia) illustrate the power of foreign investment to transfer ideas and production processes. The power of foreign ideas to transform an economy was demonstrated in Japan 150 years ago. In the reverse direction after World War II, Japan's 'just in time' production techniques were transferred to the rest of the world, long before ICT became an important element in the transfer.

Ideas and technology were important in the success of some emerging economies, but so too were institutions (including legal frameworks and government administration), financing, rational economic policies and many other factors. Supply chains could not have developed without these institutional changes. If the free flow of ideas were all that is needed, Africa would be full of rich countries.

Baldwin’s narrative may give too big a role to ICT but it also reminds us that politics lurks in every economic story. As production went global (not only through advances in ICT, but foreign investment as well), the politics of trade protection changed. Domestic manufacturers who have shifted some production offshore may no longer be lobbying for tariffs to shield themselves from foreign competition. They are more interested in extending the duration and reach of intellectual property rights and safeguarding their foreign investment with investor-state dispute settlement rules, as exemplified in the now-doomed Trans-Pacific Partnership

Baldwin doesn’t take us very far in explaining Brexit and Trump. Nor does he offer much in the way of new policy responses. We already understand that discouraging globalisation is an error. Conventional wisdom told us that tariffs were a bad idea, long before Baldwin confirmed this. We know that not enough has been done to compensate the losers, and we understand that some forms of compensation are better than others. But we also know that globalisation is not the main culprit for the current discontents. The advance of technology, that replaces workers with robots and computers, has eliminated more American manufacturing jobs than Chinese imports. Who wants to wind back technological progress?

We also know that when production processes went through huge changes in the past, economies adapted with a degree of success. In most advanced economies, a century ago half the population was engaged in agriculture; today that proportion is tiny. Demobilisation after World War II was a massive disruption to the fabric of production and workers’ daily lives, but it also heralded an era of near-universal rise in living standards in advanced economies. In the right circumstances, these seismic transitions can be achieved and the sharp edges softened by good policy. To lessen the pain, more government involvement is required: the market can look after efficiency, but governments have to look after equity. The failure of effective government action to provide active labour policies does more to explain the genesis of Trump’s win than does the export of ideas.

The deep-seated discontent that resulted in Trump’s win goes far beyond trade. The 2008 crisis and its feeble recovery left voters – including those who still had jobs – aggrieved with the rise of ostentatious wealth reflecting income distribution trends that defy any notion of social contribution or equity. Financiers who had caused the 2008 crisis not only went unpunished: they were extravagantly rewarded. The globalisation of taxation rorts has become common knowledge. Immigrants are always an easy source of resentment when the economy is slow. We need sociologists, as well as economists, to understand what has happened.

Baldwin has nothing to offer on resolving these issues. He does, however, reinforce the accepted wisdom that responses such as Senator Xenophon’s ‘buy Australian’ initiative for government purchases are as inappropriate as giving antibiotics to repair a broken leg.

Photo: SeongJoon Cho/Bloomberg via Getty Images

Related Content

You may also be interested in