Paper to NZIIA Seminar ‘Addressing the Global Agenda’, 20 October 2011

Keywords: Globalisation & Trade;

My message today is both simple and troubling.[1] The simple version is that the unipolar world is coming to an end, and is being replaced by a multipolar one. The change reflects a new phase in the globalisation of the world economy, in which economic power is moving from a concentration in the North Atlantic to where the population is concentrated, especially – at the moment – in East and South Asia. But it is a troubling change because we know little about how a multipolar world will function; particular troubling because it is not clear how New Zealand fits into such a world.

This future is not simply a projection of past trends. Indeed as we shall see, the past is misleading in a fundamental way. The underlying analysis is based upon a formal theory of world economic development best expounded by Masahisa Fujita, Paul Krugman and Tony Venables which I adapted and extended in my Marsden-funded Globalisation and the Wealth of Nations.[2] The underlying model is non-linear – with a strong interaction between economies of scale and the costs of distance – which is why a past trend may bend sharply, despite the model being well calibrated to the past.

The story is an evolving one, and its evolution is uncertain, with perhaps one exception. For the first time in the history of the modern globalised economy there will be no hegemonic power. We are so used to one country regulating the world, that we tend to think of it as an inevitable norm. If there is one message I hope to convey today, it is that we have got to stop repeating the thinking habits of the past, stop looking for the hegemon, and start thinking about what happens in a world in which there are five countries contesting for leadership, but none can succeed.

The Evolution of the Global Economy

First to explain what is happening to the world economy. About two hundred years ago the falling costs of distance triggered a new phase of globalisation where industry developed faster in North West Europe and later in eastern North America, while the rest of the world became suppliers of foodstuffs and raw materials to these industrial centres. This geographical concentration was caused by the economies of agglomeration, the major productivity gains from industries being close to one another. This meant that those industrial centres could pay higher wages: with the industrial concentration there was increasing global inequality of incomes.

However concentration also generates congestion and so the industry spread out to nearby locations – the rest of the Europe and North America. That is still happening, but a new phenomenon was the industrialisation of Japan which was much poorer than Europe at the beginning of the twentieth century, and had caught up at the end. Further falls in the costs of distance enable low wage countries to undercut the high wage economies, especially if they have concentrations of population.

In the last three decades we have seen that relocation of industry occurring in east and south east Asia, and now in India. As the costs of distance fall further, industry, including relocatable services, will move to where the population is. Given that the population is not concentrated in any particular country, economic activity becomes more internationally dispersed.

An Aside: The Future of Food

As a very important aside. the first phase of globalisation was associated with falling terms of trade for foodstuffs, with food prices rising more slowly than the price of manufactures. That – and the falling terms of trade of wool – was a dominant context of the New Zealand economy for most of the twentieth century. However in the second phase, when manufacturing switches to low wage countries whose workers have a high demand for food, the food terms of trade start rising. And so it has been for New Zealand now for almost two decades, coinciding with the East Asian economic boom. That is good news for the prospects of the New Zealand economy, although we have yet to work through the implications for our economic and social development, a topic for another day.

The End of the Global Hegemon

There are numerous nuances to this story of the dispersal of economic activity, but for today’s purposes, this dispersion will lead to a dispersal of the political power which underpins international relations. This is not a pure economic deterministic argument; it observes that in order to be internationally powerful a country needs an economic surplus in proportion to its ambition. It can, for a while, punch above its weight, say as Britain did militarily in the mid-twentieth century, but the cost is to divert its surplus from strengthening the economy and eventually it gets behind those who deploy their surplus more frugally.

For most of the last two hundred years, there was one economy which was so powerful that it regulated the world. Britain did so until the early decades of the twentieth century, America subsequently. The hegemon did not have unlimited power while there was a period in the interwar era in which there was a transfer of the dominant power. The hegemon played a crucial role in orderly international relations, not least in international economic relations.

The existence of the hegemon derived from the high degree of affluent industrial concentration that the falling costs of distance made possible. As this concentration becomes more dispersed, then the political power that goes with it becomes more dispersed too. The sums suggest that there are likely to be five large powerful economies in the medium term: China, the European Union, India, Japan, and the United States of America. None will be large enough – that is, have enough economic surplus – to dominate the other four. (Brazil, Russia and South Africa are each less than half of the smallest of the Big Five. They will each have a significant role in the multipolar world – in part because there is no hegemon – but they are not placed to contest for dominance.)

This is a very different world from that which we are used to. The anxiety of the hegemon is that it will be replaced; there is a huge popular American literature in which each of the other four challenges the United States. The fear is based on the fallacy that necessarily there must be a hegemon. The likelihood is that there will not be, at least in the lifetime of this audience. Instead there will be a group of countries contesting for power.

The era is ending more quickly than one might have expected. You see this in various international negotiations – the Doha Round, on global warming, on sorting out the current financial crisis – where America can no longer provide the leadership that a couple of decades we would have thought normal. That is why the world cannot get a proper settlement on any of these issues.

In simple terms, as America’s dominance diminished, its reaction has been to pursue policies which have accelerated the decline – as Britain did as it lost its hegemony. One may regret some of those policies, but an even greater regret is the speed of the decline, for a rapid decline is making it so much harder to adjust.

New Zealand in a World without a Hegemon

I have not time to discuss how the world might adjust, but I want to use the second half of my presentation to consider how New Zealand might adjust. Our experience has been in a world dominated by a hegemon, and our broad strategy has been to pack in behind it, recognising that generally we are too insignificant – by size and location – to go it alone. Even so we have not been an uncritical acolyte, for our interests have not always aligned with those of the patron-hegemon; moreover sometimes we have, as a good friend, drawn attention to where we think the approach of our patron-hegemon has been wrong.

But we are entering a world in which there is no hegemon. Who is to be our patron now? Can we go it alone? I doubt that course would be easy, for while we may be insignificant we still have international interests. Do we follow one of the Big Five, or try to straddle more than one?

My guess is that if this room were to break into groups each of which was to consider the issue from a particular perspective – capital flows, culture, diplomacy, human rights, law, migration, refugees, security, trade flows and so on – the groups would report back with strategies which were not entirely consistent.

There would be some commonalities. Our relations with Australia would loom large, but in truth while their economy is bigger than ours and they are better located geopolitically, Australia is not particularly significant in the world either and faces challenges similar to those we do. There might also be some agreement that we should work through multilateral institutions, although despite the collapse of the hegemon, many of the most important multilateral institutions are likely to be ineffective for some time to come. So what should we do?

Aside: The Future of Economic Sovereignty

In order to stay within my time constraint I am going to confine my remaining remarks to trade policy. Before doing so I need to say something about the integrity of national boundaries and sovereignty. The fall in the costs of distance is playing a key role here.

The phenomenon of chaining, in which components made in a number of different countries are assembled in yet another one, is no more than the global equivalent of the factory which outsourced production of components to other factories in the town, and later to factories in other towns as the costs of distance (and the economies which come from scale and specialisation) made that efficient.

The new issue from chaining is that different jurisdictions are involved; it is instructive that so powerful are these cross-national outsourcing forces that much of trade policy is about aligning jurisdictional arrangements. What is important is that the jurisdictions are still necessary, not least because businesses need a framework in which to resolve their disputes. That is almost certainly the reason that financial institutions have not created artificial locations to hide from local laws – except for tax avoidance, which involves transactions between related parties. But while international business needs sovereign jurisdictions, the ability of an individual nation to run a totally independent economic and legal policy is being undermined. What this means in Westphalian terms I am unsure, but it certainly means that the functions of the independent nations which have evolved under the Westphalian arrangements will have to adapt.

Future Trading Policy

I begin my focus on trade policy with the platitude that New Zealand is a specialised economy and will have to participate vigorously in international trade. Past experience – from when we were once over-dependent upon Britain – suggests that we should go for diversification, rather than depending on a single market. This may apply as much for a sector as for an economy as a whole. Should general manufactures be too dependent upon Australian markets? Fonterra must worry about becoming over-dependent upon the Chinese market.

That is one of the reasons we are negotiating a trade deal with India, which is likely to be another major market for our food. Indeed we shall have to be opportunistic seizing opportunities for improving trade as they come up. A major caveat is that we dont get into a negotiation the way the Australians did with the United States, where they committed themselves to a deal when hardly anything was on offer.

Because we are such a small player we cannot rely on bilateral deals, say, with each of the Big Five. Meanwhile the multilateral Doha round seems to be comatose. That suggests we will be looking at plurilateral deals, such as the Trans-Pacific Partnership. Again to say the obvious, I would be more comfortable were Japan a part of the negotiations. But the TPP is an opportunity, not a long term strategy. What are we going to do when it is complete; hope another opportunity will occur?

We need to be proactive. Having ruled out a special relationship with any of the Big Five – China, Europe, India, Japan and the US – although of course we want to have as strong relationship with each as our size allows, I want to suggest that there is a case for a special relationship with the ASEAN group. We have a free trade agreement but can we get closer?

The Importance of ASEAN in New Zealand’s Future

To highlight the issue let’s go to an extreme and consider joining ASEAN, although we would need to do that with Australia (and, no doubt, Timor Leste). ASEAN describes itself as equivalent to the ninth to largest economy in the world, although that depends on how the economies which make up the European Union are treated. If Australasia were to join, ASEAN would make a (growing) contribution of between 6.5 and 7.0 percent to the world GDP (measured in purchasing power parity terms). That is about the same contribution as India and Japan, currently the smallest of the Big Five.

Of course ASEAN with or without the extra three, is a much looser political federation than any of the Big Five, which has some advantages to us because it avoids activities, like military adventures, we may not want to get involved in. On the other hand the looseness may limit ASEAN’s effectiveness.

I have used joining ASEAN with Australia only as illustrating a possible strategy. They may not want us, the Australians may not want to, on closer inspection the downsides may be too great. Nor other than size (and implicitly location) have I set out the various attractions of the ASEAN grouping. But it strikes me that we probably need to get closer to ASEAN not only because of the trade potential there, but because the grouping with Australasia is likely to have some significant leverage in international trade diplomacy. And yet that closeness will not infringe our ability to trade with the Big Five or any other grouping or economy in the world.

What is the alternative? I cant answer that, so let me repeat my main message. The international economy which was dominated by a few high wage economies in the North Atlantic and Japan is coming to an end; manufacturing and tradeable services are going to be more dispersed; if they are concentrated it will be in low wage populace conurbations. That is good news for New Zealand as a food exporter, but less cheerful is the likelihood that the new world regime will have no hegemon to regulate international relations. Instead there are likely to be five big players, contesting for leadership, with none able to dominate the rest as the British and the Americans did in the past.

New Zealand faces an enormous challenge in this rapidly evolving international environment; something which will preoccupy us for the next two decades. I have made some tentative suggestions, the most important of which is that Australasia probably needs to get closer to the ASEAN grouping.

[1] While self-contained, this paper is also a continuation of B. H. Easton (2011) ‘The Coming World Economic Order’, New Zealand International Review, September, October, p.7-11.

[2] M. Fujita, P. Krugman & A. J. Venables (2001) The Spatial Economy: Cities, Regions, and International Trade; B. H. Easton (2007) Globalisation and the Wealth of Nations.