Revised version of Paper for NZIIA Seminar “The Economic and Social Impacts of Globalisation” 21 September, 2005.
Keywords: Globalisation & Trade;
The Economics of Globalisation: An Introduction is a version of this paper with a more detailed economic analysis
Introduction
The Royal Society of New Zealand awarded me a Marsden Fund grant to study globalisation. The study is a continuation of my earlier research program, especially that which is summarised in my book In Stormy Seas with its central message 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 those events create.
The study is founded on five themes.
1. Globalisation is the economic integration of economies – regional and national economies.
2. Globalisation began in the early nineteenth century, so the phenomenon is almost two centuries old. Since globalisation is an historical phenomenon, focusing on the last few decades throws away a rich source of insights.
3. Globalisation is caused by the falling cost of distance: transport costs, plus the costs of storage, security, timeliness, information, and intimacy. This gives a driver for the globalisation process.
4. Globalisation is not solely an economic phenomenon. It has political, social and cultural consequences.
5. The policy issue is not being for or against globalisation, but how to harness it to give desirable outcomes.
The structure of the program is it first develops the economic analytics, and then explores political and social consequences such as nationalism, sovereignty, policy convergence, cultural convergence, and diasporas.
The Underlying Economics
Much of New Zealand economic thinking is trapped in economic models which have been superceded in the last thirty on years. This does not mean the old theories are wrong, so much as that they can be advanced. Many of the policy stances that are derived from the superceded theories are still valid, but the current understandings are richer and more nuanced. In particular, I know of no reason to abandon the strategy of global connectedness, which is one of the principles of the government’s growth and innovation framework.
The new analysis focuses on economies of scale and the costs of distance, phenomenon which are largely ignored by the superceded theory. Their interaction generates outcomes which can be quite different from the standard theory without costs of distance and only diminishing returns. Sometimes the outcomes are not obviously intuitive to the well trained economist.
The Costs of Distance
The costs of distance are more than transport costs. They include storage, security, timeliness, information, and the loss of intimacy that separation causes. A paper ‘Trade Costs’ by James Anderson and Eric von Wincoop, calculates that the average American manufacture has a mark-up of 55% from the factory door to the final domestic retail price. The price of an export involves a 170% markup, or 74% more than the domestic sale.
Analytically the costs mayf distance (or trade costs) may be treated as a tariff. (Recall that costs of difference are sometimes called ‘natural protection’). Total costs of distance far exceed tariffs.
Moreover, they are coming down. While we can not measure the fall in the costs of distance precisely we can observe it schematically. In 1855 it took around three months to get from New Zealand to Britain, whether it was sending a package, a person or a message. Let’s represent the time by a line across the page:
************************************************
Today it takes only a month to get to Britain by ship. That’s because ships are faster, and they can go through the Panama Canal. That line now looks like:
**************
But that is misleading in regard to people and light valuable goods. Once they went by ship to London too. Today they can fly to London in less than two days. Compared to the 1855 their world looks like:
*
Yet information can be sent in vast quantities almost instantaneously via the world wide web. On the same scale that time is represented by something smaller than the full stop which ends this sentence.
A practical illustration of the implications of the falling costs of distance is that New Zealand’s second largest import port by value and our third largest export port by value is Auckland International Airport. Even that underestimates its importance, because it does not include the value of the tourism that passes through it. Perhaps one day Auckland International Airport will be our largest export and import port. It may not hold that position for long, when the broadband connection with the rest of the world generates an even greater flow of business.
Some Economic Analysis
I now skip through the economic analytics by referring to some, but not all, of it.
One describes how falling costs of distance changed an entire political economy, using the impact of refrigeration on New Zealand, which changed the effective cost of distance for meat and dairy products from prohibitive to negligible. That shifted the New Zealand political economy from the quarry to the sustainable settlement based on processed grass which dominated 80 years of our history.
The New Zealand experience can be explained by the traditional comparative advantage model. It does not explain urbanisation which depends on industry economies of scale (agglomeration), where as an industry increases in size in a location it experiences falling costs. Agglomeration is a super-multiplier, which enhances any initial superiority of location, although it can be offset by congestion costs. The cost and quality of future governance is also important. The book’s illustration is New York, but recently I have been applying the analysis to Auckland.
A later chapter describes how many services have become internationally tradeable. In recent years, as telecommunications costs have collapsed, so parts of the service industry need no longer be located near the customer. Such offshoring is not a new phenomenon, but an extension of the relocation of manufacturing which has been going on for a couple of centuries. Thus the offshoring of ICT services to Bangalore parallels the offshoring of manufacturing to China.
One of the peculiarities of the new theory is the location of some industries are not determinant but accidental. Why should Nokia, the world’s largest mobile phone company, be located in Finland? The answer may be that economies of scale and low distance costs creates the possibility that some industries simply occur in particular locations as the result of accidents of history and path dependence. (Fisher and Paykel is a New Zealand parallel. Why should we be good at whiteware?)
This explains the role of competitive advantage. In contrast, comparative advantage generates deterministic locations. But suppose accidence results in industry starting up in a particular place. How does it maintain its predominance, when other businesses and locations can replicate its production processes? Dominance can be maintained by the first mover if it continues to innovate ahead of its rivals. That is the core of competitive advantage.
Another peculiarity of this theory, and the modern world, is intra-industry trade (IIT), which traditional theory based on comparative advantage does not predict. IIT occurs when two economies export and import the same product. Whereas it hardly existed internationally in 1950, it is now thought that about a quarter of the international trade in goods is IIT. (The other quarters are oil, primary commodities, and other manufactures). We need to be aware that New Zealand has one of the lowest levels of IIT among rich economies.
In preparation for my final discussion in this paper, I need to mention the chapters on technology transfer and the related Convergence Club where countries which are high income at one point in time, tend to remain high income thereafter. In contrast, very few companies which were top a century ago, or even a quarter of a century ago, even exist today. Economists are comfortable with this high business turnover. Why dont countries experience a similar turbulence in their ranking? Again this is not predicted by comparative advantage.
Prospects and Strategy for the New Zealand Economy
Before concluding this part I want to say something about its implications of the theory for the New Zealand’s economy’s prospects and strategy.
In their The Size of Nations, Alberto Alesina and Enrico Spoloare argue that middle sized countries (New Zealand would be on the lower end of the group) tend to have a better economic performance than larger economies, because they are simpler to govern. Much of the research on economic growth focuses on the market sector ignoring the public sector, or seeing it as a handicap. Instead, they argue the public sector is important, and that the less heterogeneous the population the more efficient the sector is. In simple terms New Zealand has a comparative advantage in its public sector.
Middle sized countries face a tradeoff of a more efficient public sector with less economies of scale in market production. The resolution is specialisation in production, with international trade converting the production into a more general mix of consumption. The paradox, lurking throughout the book, is that smaller nation-states may be able to survive, but only by abandoning some sovereignty by participating in international trade. Global connectedness is critical.
The Consequences
The second part looks at the consequences of the economic processes I have just described.
It begins with nationalism. The nation-state is a relatively recent phenomenon, no more than a couple of centuries old. Germany did not exist as a state in 1805. Two hundred years later it has many of the state’s ‘traditional’ functions subordinated to the European Union. Nation-states are a response to the falling costs of distance, which made smaller communities part of larger communities. I discriminate between ethnic nationalism and civic nationalism. The former defines national identity by membership of a racial, ethnic, or religious type. The latter defines itself by membership of the community, and is far more tolerant of diversity. Although the nation-state is changing, thus far the research suggests it will continue to play an important part in people’s lives. Hopefully, it will be increasingly based on civic nationalism.
So I have to explore the meaning of sovereignty, making the distinction between de facto and de jure sovereignty, which often gets lost in popular discussions. The example is the measurement of time. New Zealand has the de jure power to opt out of the international calendar and time system. In practice it would be so unwise that it lacks the de facto power to do so. The same applies to international economic agreements, such as the aborted Multilateral Agreement on Investment, once they are implemented.
This leads to two questions, whose answers to seem to be intimately tied up with the future of the nation-state.
The first is whether cultural convergence is inevitable? Will eventually the entire world – or perhaps initially just the rich world – have a common culture? That Canada has a long and large trading history with the US, and yet remains culturally independent suggests ‘not necessarily’.
The second question is whether there is policy convergence under globalisation. Does everywhere end up with essentially the same policy? It appears that policy convergence in some areas seems all but inevitable, although it can be very slow, as in the case of international trade in agricultural products. However there are some areas where policy convergence appears to be unnecessary, as in much of the health system. And there are policy areas where the outcome is not obvious. Is the social market economy a phase which globalisation will drive out of existence as countries compete to the bottom of raw market solutions? I have yet to answer that question.
The final chapter in this sequence reflects on the role of borders. While jurisdictional authority seems important, I am increasingly thinking that labour mobility is key to many of the politico-economic policy issues which globalisation raises.
That leads to a discussion on kinds of nations. Should New Zealand join Australia, the United States or the European Union or stay outside? What are the viable options for nations in a globalised world? My preliminary thinking is, that in economic terms anyway, it is not necessarily in New Zealand’s interests to abandon its de jure sovereignty, nor is it necessarily inevitable.
Patterns of World Development
I have yet to disentangle the story of gainers and losers from globalisation. So here I onlly look at patterns of world development.
To begin with two long term well-established trends. The first arises from the sharp divergences in income and productivity in the world today. We might expect their distribution to be clumped in the middle with a few extremes at the top and bottom. Instead it is U shaped: a lot of people and countries are at the bottom, more – albeit fewer – at the top, but very few in the middle.
As the convergence club recalls, the reality is that those countries which were poor a hundred years ago, are typically still poor, unlike the era before globalisation, when the relative differences between the top and bottom income countries were tiny in comparison to what they are today. We might have expected economics forces – international trade, international migration, international investment and technology transfer – to have diminished the differences. That is what the advocates for tree trade say. But the convergence club persists. Why?
The second long term trend is that the shifts in the geographical distribution of manufacturing. As the following table shows before globalisation began two countries, India and China produced more than half of the world’s manufactures. Two hundred years later the contribution of the two countries was insignificant. This contrasts starkly with the far greater stability of world population shares.
Manufacturing Output (By World Share: Percent) 1750-1938
| Year | India | China | Rest of Periphery |
Developed Core |
| 1750 | 24.2 | 32.8 | 15.7 | 27.0 |
| 1800 | 19.7 | 33.3 | 14.7 | 32.3 |
| 1830 | 17.6 | 29.8 | 13.3 | 39.5 |
| 1880 | 2.8 | 12.5 | 5.6 | 79.1 |
| 1913 | 1.4 | 3.6 | 2.5 | 92.5 |
| 1938 | 2.4 | 3.1 | 1.7 | 92.8 |
Source: Simmons (1985), p.600.
It would be easy to dismiss the change as a consequence of the transformation from handcrafts industry to factory production. But the location of manufacturing type activities may be driven by accident and time dependence.
We can, albeit clumsily, provide a simple model which describes what happens as the costs of distance falls to the manufacturing (relocatable industry with economies of scale) in two identical countries. Initially, the two economies have the same level of manufacturing, but as trade costs decrease, the share of manufacturing goes through a critical point and suddenly one country (arbitrarily) ends up with all the manufacturing, and the other with none.
The manufacturing country is better off. In the formal model the labour force qualities are identical but after the bifurcation workers in one gets paid more than the other, because of the higher productivity of manufacturing and the restriction on labour migration between the countries. In effect, the costs of distance enable the prosperous workers to capture some of the rents from the economies of scale. There are bells and whistles – physical capital, technology, human capital, governance – that can enrich the story. One might speculate that it is not impossible that incomes in the loser economy may stagnate or even decline. Paul Samuelson’s recent paper on offshoring shows that this can happen in the standard model, via terms of trade shifts.
A fuller more complex model might have many bifurcations. The accelerated growth we see among some East Asian economies in the last two decades may be an example of this shifting from one branch of the overall bifurcation to another. Perhaps the economic dominance of the developed core is but a transition in the history of the world economy.
One is reluctant to push the model too far, and the practical world is smoother than its sharp changes. But it might explain the transition from the beginning to end of the nineteenth century as reflecting two sides of the bifurcation.
Models with bifurcation are not common in economics, and their properties are not well understood. In this case as the costs of distance falling, suddenly the model’s bifurcation snaps back, to equal shares of manufacturing for the two idealised countries. The intuition is that when costs of distance are near zero, manufacturing settles to where the population is, and where there are lower wages.
Assuming this is the underlying process, we cannot be sure how long it will take to return to the end outcome of manufacturing shares more closely reflecting population shares. Given that it took over one hundred years to create the developed core, it seems likely that it will take at least a hundred years to end it if that be the destiny. The latter transition may take even longer for today’s core economies have accumulated advantages in physical, social and human capital. But that need not persist forever.
And some other factors may slow down or reverse the process. There may be an minimum to how low distance costs can go. Perhaps costs will rise with higher fuel costs or the needs for security against terrorism. Path dependent theories of growth precipitated by exogenous events leave open many possibilities. It will be our descendants, four and more generations on, who may be able to be more definitive.
China and India
Certainly this chapter will be speculative, but it is a speculation constrained by the discipline of modelling. It reinforces the suspicion that China and India are going to play a more prominent role in New Zealand’s and the world’s future.
So let me a couple of caveats. If China and India are going to become relatively more important in New Zealand’s economic future, which countries are going to become relatively less important? The obvious candidate is Australia.
That is likely to happen with current developments in trading arrangements: China joining the WTO, the Doha round, and free trade agreements with China. If we stop thinking in terms of a two country world, but a three country one – a shift from bilateralism to multilateralism in our modelling and thinking – we see that New Zealand is likely to lose market share for Australian manufactures to China as well as some manufacturing activities in New Zealand.
To go a step further, suppose China and India become major suppliers of general manufactures (including relocatable services) to the world. General manufacturing will almost cease in New Zealand, the exceptions being products that have to be manufactured close to consumers, and the early processing of natural resources to reduce the costs of transport (like stripping water out of milk). Is there room for any other manufacturing? Or will New Zealand revert to being a natural resource exporter (including tourism) with domestic production dominated by services that cannot be relocated.
The analysis is complicated by that the individual phases in manufacturing processes may no longer be under one roof, with components, sourced from different businesses and even different countries given the falling costs of distance, assembled elsewhere. New Zealand may get into some parts of the action, but not others. The offshoring of the manufacturing of swandri clothing to China, while the design and royalties are retained in New Zealand may be a precursor of the future economy.
This challenge is not peculiar to New Zealand. It seems possible that at least in the medium run technologically advanced, highly skilled, innovative manufacture will remain in rich countries. What are we going to do about ensuring New Zealand has such a sector? That, in my opinion, is one of the key objectives of the government’s Growth and Innovation Framework.
Conclusion
Globalisation is going to change dramatically the New Zealand economy. We can resist it temporarily with protection, but that is not a long run solution. Better to engage. To do so requires a more sophisticated understanding than we currently have. Certainly scholars are struggling with the underlying issues, but my impression that policy makers are hardly addressing them, trapped in economic theories which are as Maynard Keynes famously described as ‘defunct’.
I am not yet sure of the study’s policy implications. Anyone with a policy agenda can use the currently available analysis on globalisation to support theirs.As always, my approach, is to push the analysis as far as I can, before coming to policy conclusions, if any.
Ultimately, the cheerful conclusion may be that size need not be a handicap to New Zealand (and any distance handicap is diminishing). However to seize the opportunities, we need to understand better the processes causing them and try to avoid being entrapped by old theories which poorly describe the rich complexity of the world in which we live.