Presentation to Hamilton Branch of the NZIIA, July 20, 2004.
Keywords: Globalisation & Trade;
In late 2003 I was awarded a three year Marsden Grant to study globalisation and New Zealand’s role in it. Globalisation is a topic I have been long working upon, developing out of my earlier study of the New Zealand economy summarised in my book In Stormy Seas: The Post-War New Zealand Economy, whose theme was that the fate of New Zealand will be largely a consequence of what happens overseas, together with our ability to seize the opportunities and manage the problems. This paper sketches the research program, and looks at one of the issues – international trade.
What is Globalisation?
Many writers avoid defining globalisation analytically, instead characterising it by a series of phenomenon such as increasing trade, or capital flows, or logos, or international inequality; or to particular international institutions such as the World Trade Organisation or the International Monetary Fund and the World Bank or the European Union, or multinational corporations; or to particular policies such as free trade, liberalised capital movements, and so on. The London Economist described globalisation as ‘international capitalism’: many anti-globalisers might agree, perhaps adding ‘together with US hegemony’, or even ‘imperialism’.
Stanley Fischer, one time chief economist at the IMF, describes globalisation as ‘the ongoing process of greater interdependence among countries and their citizens’. Joseph Stiglitz, who held a similar position at the World Bank, defines globalisation as ‘the closer integration of countries of the world as a result of lowering transportation and communication, costs, and the removal of artificial man-made barriers.’ Both are focussed on contemporary phenomenon. But it is important to take a historical perspective. Scholars argue that nineteenth century globalisation was in many ways a more powerful and pervasive phenomenon that late twentieth century, at least among peoples of European origin because their migration was unrestricted.
Moreover it was not just an inter-nation phenomenon. Indeed it would be ahistoric to think of the states of the beginning of the nineteenth century to be similar to those of today. The modern nation-state was a creation of the globalisation process of the times, as it integrated regions and made central government and national markets possible. The ‘United’ States of American became a more meaningful concept when canals and railways brought the states together.
In the end a simple phenomenon-based definition like Fischer’s, may be the most fruitful. We follow Stiglitz, albeit also covering the nineteenth century, with globalisation is the closer integration of nations and regions.
However, for an economist, a definition is not sufficient. We need a process, a mechanism which underpins the phenomenon. The Marsden research program is organised around the analytical proposition of globalisation is the consequences of the reductions in the costs of distance.
That these falls have been dramatic is easily demonstrated by considering the world centred on New Zealand. One hundred and fifty years ago it took three and more months to sail from Britain to New Zealand – carrying goods, people and information. Changes since then has reduced the shipping time to about three weeks, quartering the effective distance in the world. But people, and light valuable goods can fly to Britain in under two days, a reduction of more than 98 percent. Information can be zipped around the world virtually instantaneously.
If these changes do not seem spectacular enough, think of the changes for meat and dairy products. One hundred and fifty years ago, one could not ship them to Britain at all. The introduction of refrigeration reduced the cost of distance from – effectively – infinity, to a small proportion of the products’ costs of production, and transformed New Zealand’s economy and society.
This recognition of the crucial role of the costs of distance provides an analytic foundation which allows one to explore rigorously many aspects of the modern world from a historical perspective, and to consider possible scenarios for the future of the world and of New Zealand. Not only economics scenarios: among those on which I am pondering are:
– the role and future of nationalism since it largely began as a nineteenth century phenomenon associated with the regionalisation and globalisation. The leads to a practical question of the possibility of cultural convergence in the future – that is that national and regional differences will largely disappear.
A related, but partially distinct issue is
– the role and future of the state which, as we know it today, is dependent upon a reach over its region and therefore accumulated power as falling costs of distance increased its practical reach. What will happen to the state as costs of distance fall and policy issues become international rather than national? Will the state continue to exist? A better form of the question might be what kind of states will we have in the future and what kind of supra-national organisations? The immediate practical question is that of policy convergence, the possibility that in the future all countries will have largely the same policies, at least in some areas – especially economic ones.
I have some tentative views on these issues, but fortunately the Marsden grant is for three years, so I can spend a lot more time reading and investigating and thinking before I come to a definitive conclusion. Perhaps you would like to invite me back then to tell you what I think.
Why Is There Trade?
In the interim, I want to talk about the narrower issue of trade policy, where I can use the formal models of economics to progress our understanding. My focus tonight will be on ‘global connectedness’ which is at the centre of the government’s economic policy: The Growth and Innovation Strategy. For those interested in international relations, trade and trade policy is at the interface with domestic economic relations.
Historically, until perhaps a couple of hundred years ago, most international and inter-regional trade occurred on the basis of absolute advantage, that is the trade occurred because the purchasing country was not able to produce the product very efficiently itself. Examples include spices from East Asia, gold from the Americas and wool from Britain. The costs of distance – the acquiring of the unique products from distant lands – added to the end price, but it did not affect the location of production.
Two or three hundred years ago, trade based on comparative advantage began to develop in which a particular country or region chose not to produce something it could, but produce something else which it could do more efficiently and which it would exchange for the first product. So New Zealand could produce machinery, but instead it specialised producing pastoral products which it exchanged for machinery produced in Britain, which similarly specialised by not being self-sufficient in food.
The costs of distance are important for such international trade, because they influence location of production. For instance, New Zealand had negligible prospects as a meat or dairy exporter until refrigeration which, in effect, reduced the cost of transporting the products to Britain from infinity to a tiny fraction of the costs of production (especially with the addition of telegraph and steamships).
I used the expression ‘chose’ to describe the exchange arrangement. Practically the market signals favour the exchange, so it is individual consumers which ‘chose’. However there is also choice in public policy, because a country can suppress trade by border regulation via import controls and tariffs. Many did. New Zealand was lucky that for much of the last two centuries the British food market was open to it, although equally potentially lucrative markets in North America and Europe have been and still are closed, as has increasingly the British market since the Second World War.
New Zealand policy has been fixated on comparative advantage trade. Any economist who has mastered its formal theory cannot be impressed by the elegance of the central idea that specialisation is beneficial, and there are gains from allocating resources to the specialist industries. Many who have not mastered the theory support the policy conclusion of free trade either for ideological reasons or because they or the employers are personal beneficiaries – or both.
However when we come to measure the gains from improved allocation arising from the removal of tariffs and import controls, we find they are generally small, say less than 1 percent of total output. To give an example where economic policy based on this theory came a terrible cropper, one only has to recall the reforms of the 1980s where a 25 percent increase in GDP was promised from improved allocation, but never delivered.
It is true that reductions in tariffs will benefit some activities and people, but only at the expense of detriment to others. Which is one of the reasons why the protection is fought over so bitterly. (Sometimes a large industry in one small country can be markedly damaged by protection and export subsidisation in another, to the detriment of the first country as a whole. Nothing I say here implies that New Zealand will not markedly benefit from a reduction in world agricultural protection, a topic to which I return.)
The Case for the Open Economy
If the allocation gains from the ‘free’ trade are small why pursue it if one is not ideologically or self-interestedly inclined? At is issue is that of an open economy strategy, which is not the same as a free trade one. However, one may have to practice the latter in order to pursue the former, for unless there is some mutual disarmament of protection no one country can have a viable external sector. I give two arguments for the open economy which do not rest upon the formal models of comparative advantage.
The first involves consumer choice. Economists are having a lot of trouble measuring consumer choice, so let me give an illustration of how it works. I was struck when I was in Washington on my Fulbright fellowship, that none of the three grocery stores I used sold soft cheeses such as Brie and Camembert (although at a mega-store the choice was greater — probably about as much as in my local New Zealand supermarket). The choice was limited to hard cheeses and Philadelphian. Apparently most American cheese goes into pizza, but additionally the payment system to American dairy farmers gives little incentive to develop new cheeses.
External interference also reduces choice. The US recently tried to restrict further the entry of imports of New Zealand lamb into their domestic market. To shorten a long – and, for our diplomats, difficult – story, following a WTO ruling the US was not allowed to. The outcome is that the NZ lamb industry is now working with the US lamb industry to jointly expand the market for lamb, thus increasing the choice of meat on the American dinner table.
It hardly need be added that no country generates all the world’s new products – all the new possibilities, all the new varieties – so restricting their supply from imports is to the detriment of consumer choice. That gives one benefit of an open economy.
The second benefit arises from the choice aspect and some further factors I will discuss shortly. The result is that exports (and imports) grow faster than GDP. In the last 25 years they have grown about twice as fast. Now the basic rule – be it in economics or the TAB – is bet on fast horses. Over time economic sectors grow at different rates, some above average, some at the national average and some below. The above average growth sectors pull the rest of the economy along. Suppose you have an sector which is about a third of the economy and growing twice as fast. Of course you should back it. And that is what an open economic strategy is about – betting on a fast horses.
(Not to mention that the import sector is also growing twice as fast as the economy – you try to stop the locals demanding all the choice of the rest of the affluent world has, you try to stop them not travelling. To pay for those imports of goods and services, we need exports.)
Competitive Advantage and Inter-Industry Trade
As mentioned there are other factors as well as choice which has been driving that rapid growth of exporting, and which generate trade quite different from that based on absolute or comparative advantage. What we call ‘competitive advantage’ was happening in the nineteenth century, but we have only recently seen it significant on an international scale. Reductions in the costs of distance facilitated regional integration, the precursor of global integration.
The regional integration generated inter-regional trade on the basis of comparative advantage, that is there was regional specialisation. But it also generated a different sort of inter-regional trade, which is much less intuitive. You can see this in New Zealand by the location of the industrial breweries. Once, when the cost of carting barrels around was expensive, every reasonable sized town had one or two breweries, which provided for the local region. Today there fewer – especially of the bigger ones – and each supplies the whole country. Thus Dunedin based Speights trucks beer to Auckland consumers and Auckland breweries sell their products in the South. This is counterintuitive: imagine beer tankers passing each other on the Desert Road taking their marginally different products in opposite directions.
This sort of trade requires low costs of distance, but it also requires economies of scale in production (they are virtually prohibited in the theory which justifies comparative advantage), and it requires consumers wanting variety – of wanting choice. The differentiation is quite small. If there is no Speights the Auckland imbiber does not give up drinking beer altogether but switches to what he considers a marginally inferior product.
This regional trade of almost likes is so common we hardly think about it. But in the last fifty years a similar phenomenon as been happening internationally. Two countries may trade almost identical products. US airlines fly Airbuses, while European ones fly Boeings. Of course they are different planes, but the world would not come to an end if only one is available. (Note however economists argue that the competition between the two producers results in innovations which benefit the consumer, so that separate companies produce much the same product is not a case for amalgamation and monopoly.) Another example is that Germans buy Renaults and the French Volkswagens. Wine stores in New Zealand or any other wine producing country produce further examples.
This trade between countries of almost like products is called ‘intra-industry trade’. Internationally, it hardly existed before the second world war, but has been rapidly growing since, and today makes up about a quarter of merchandise trade. (The other quarters are oil, other primary products, and manufactures traded for primary products.)
Most rich nations participate in intra-industry trade. However among the industrial nations New Zealand is near the bottom (on some measures Australia is a little lower), more like a developing country than a rich one. In public policy, intra-industry trade is almost off our radar screen.
The economics of competitive advantage is curious. It is easy to explain why New Zealand exports meat and dairy products in terms of the natural advantages of climate and geography, but how does one explain that the world’s biggest mobile phone producer is based in Finland? (Finnish boys were too shy to speak directly to girls so they needed mobiles is one implausible explanation) What the theory of competitive advantage suggests is that very often an industry will settle in a particular location almost by accident. Once it is there it will remain in the region, providing the business continues to innovate, to maintain its competitive advantage.
Can New Zealand get into the intra-industry trade business more effectively than it has in the past
can it get a better balance between comparative advantage and competitive advantage? In my view that is much of what the government’s Growth and Innovation Strategy is about. Its vision has New Zealand exporting pharmaceuticals to Europe, IT to the US and films to Hollywood as well as importing pharmaceuticals, IT and films from them.
The strategy’s difficulty is that it is not obvious how to identify the future Nokias. Perhaps we should not even try, but instead make sure that we provide the right environment for such businesses to germinate, grow and flower. Much of this environment is the same as one would apply to comparative advantage industries: good low compliance cost governance, a quality labour force, well functioning and generous capital markets, a great environment for science technology and innovation, and the right support (and profitability) for selling overseas. But there are differences reflecting the peculiarity of the new businesses.
The Consequences of China
By way of background we need to consider the impact of China on world trade. It is likely that China is going to set the international price level for general manufactures in the future, although of course other events such as political turbulence, could invalidate that prediction. However their costs will probably not rise, because manufacturing workers can be supplied from the Chinese rural hinterland in unlimited numbers.
Why does not China – or more precisely Chinese price levels – already dominate the world? First China is only just learning to be a manufacturing exporter. Second, it has only just joined the WTO, which means it has only just got entitled to the lower tariffs associated with most favourable nation status. Moreover, soon these manufacturing tariffs will come down as a result of a successful Doha round. They may come down even further insofar as China enters into Free Trade Agreements – . not just what New Zealand is negotiating, for Australia is standing outside the door.
So whether we have just a Doha round settlement, or whether it is compounded but an Australian-China FTA (and a New Zealand-China one) the prospects for our general manufacturing industry are not optimistic. New Zealand’s strong intra-industry trade relationship – with Australia – is largely based on general manufacturing exports. At the moment we get preferential access to Australia, and they to us. As Australia’s MFN tariffs come down, as Australia negotiates other FTAs, New Zealand loses that preferences, It looks like that New Zealand’s exports of general manufactures to Australia may decrease in importance.
In part it will be replaced by food and other commodity exports to China (and the rest of Asia). Were that all to happen, we would see a considerable contraction in the manufacturing sector (an effect reinforced by reduced New Zealand tariffs as a result of the Doha round and any Free Trade Agreements we enter into). The government has a more challenging objective than to let manufacturing contract. It aims to shift the sector into the part of the market where there is not direct competition with low wage Chinese and other such manufacturers.
Typically such enterprises will depend upon high skills and high technology, and continually advancing skills and advancing technology. That is what the manufacturing component of its Growth and Innovation Strategy was about, indeed that is its ambition for all sectors. Now this presentation is not one on industrial policy – although you can see it that is integrally a response to twenty-first century globalisation. So let me then make but three comments about it.
The first is that it is clear the new industrialisation requires a different government support strategy. A high tech industry like biotechnology is quite different from general manufacturing like making paper cups. We still to get our policy head around this, but so do most other countries. It is always easier to think about the well established past than the future.
My second comment is that the new industries will be more into intra-industry trade and competitive advantage than the current ones. Given the sorts of products they are likely to be, we will be exporting them more to North America and Europe, so the Australian market share will diminish.
Third, I am unsure whether the distinctions between primary, secondary, and tertiary industry are as useful as they were once. When Fonterra uses a component of milk to make a pharmaceutical is it in the primary or secondary sector? If it sells the intellectual property in the process to another company in exchange for royalties is it in the service industry?
(There may be a more general point here. Very often international definitions ones have to be carefully adapted to New Zealand’s circumstances. We are wrong to do simple comparisons of ourselves with other economies without adjusting for circumstances.)
Globalisation Trends and their Impact on New Zealand
Trends already evident in globalisation to suggest where New Zealand might be going. Centrally, the costs of distance are likely to continue to fall, even if it only involves consolidation of known technologies and no new ones. There are a couple of caveats. First the costs of distance have been raised by the additional costs from the prevention of terrorism. The second caveat is we have to assume that liquid fuels continue to be plentiful. This is not so much the danger of a temporary shortage due to, say, terrorism, real enough though they are, but the world’s oil reserves are not unlimited, and alternatives such as bio-fuels may not be cheap when the hydrocarbon reserves run out.
What will the falling costs of distance mean? Different products face different costs of distance, and those costs change differently. At the very least New Zealand needs to distinguish between:
– the costs of moving information (broadband);
– the costs of moving people (such as tourists);
– the costs of moving high valued relatively light products (airfreight);
– the costs of moving dense products (shipping).
The implication is that the balance between different exports will change. (And we can influence their fall via our external infrastructure: the broadband, the airports and the seaports.)
There is another cost of distance which is also coming down: the cost of protection. We will see further reductions in tariffs and the removal of other interferences to trade as a result of the Doha Round. It should also eliminate dumping of agricultural surpluses including those of dairy products into third markets, although the barricades against agriculture imports in Europe, North America and Japan will not be entirely eliminated – we will have to wait for the next trade round for their full elimination.
Putting together all these effects results in the likely outcome that exports will be a great proportion of New Zealand production, and imports a greater proportion of its expenditure. Moreover, a greater proportion of exports will be of services – with tourism being supplemented by broadband services (many of which we cannot even envisage today) and receipts from royalties on intellectual property. Service exports already make up a quarter of our export revenue. In the not too distant future it may make up about a third.
More controversially, my expectation is that the contribution of the primary sector, including further processing, will decline from its current 45 percent of all export revenue to nearer a third too. This reflects my historian’s sense of the long term decline. As recently as 1965 pastoral products alone generated 95 percent of export revenue.
That means the remaining (roughly) third will come from intra-industry trade, mainly from the manufacturing sector. Mind you, that prediction is partly obscured by the ambiguity of definitions between primary and secondary industries.
In this presentation I have only had time to explore some aspects of international trade. I have not been able to report on the work I have been doing on the service industry, or on international capital flows or on international migration. I have only hinted that there is important work to be done on cultural nationalism and on the nation state and its relation to supranational organisations. You will have guessed that I am approaching these issues from both an analytic and a descriptive perspective, and a historical and contemporary one together with some account of likely future trends.
All I can hope in a limited presentation such as this is to demonstrate the Marsden Fund’s wisdom in backing research on the exciting topic of globalisation, and indicate how lucky I am that they allowed me to do that research.