Globalization: Where to from here?

Where is globalization headed, and are we on the right track with it? Many people are likely asking these questions right now, as they have always asked at its every stage.

Firstly, let’s try to see if we can re-trace how we got here, and precisely what aspects of globalization got us to this. Let me tell you though, this analysis will entail some subjective judgments on my part. I don’t have all the necessary data to make a fully informed description, and in any case, I’m pretty sure that even the bright boys of the Fed and the major think tanks will find it a strain to do a fairly accurate forensic analysis of globalization, since there simply is too much diverse data to crunch. In the end, you have to make your own conclusions on how to connect all the dots, based on what has been observed thus far.

Globalization as we experienced it in the last three decades has departed from the kind we have seen in previous periods in history. Prior to the last thirty years, we really had nothing more than global trade among nations. Nations with a comparative advantage in producing one good exported a surplus to other countries, in exchange for goods where these other countries had a comparative advantage. This increased the diversity of products available in all countries that participated, not to mention enriched many parties who facilitated such trades.

The globalization that we saw in the past three decades was more the distribution and outsourcing of business processes of large corporations into different countries. In other words, it is not the physical trading of end products, but the parceling of different corporate activities of single corporations into different locations, mainly to arbitrage differences in cost, expertise, and logistical practicality. More likely than not, it was to arbitrage cost.

It was the next logical step in the globalizing of business. Companies that traded in different localities would, in the process of conducting their businesses, discover different ways to enhance profitability, productivity, and to differentiate themselves from the competition. In the process of doing so, major activities were uprooted from their home countries and transferred to other countries that could offer lower input labor costs.

The first to be outsourced were basic manufacturing processes. Then it led to the outsourcing of more complicated production processes, eventually to the outsourcing of the back office work that facilitated the corporate administration of the business itself. The latest to be outsourced has included even the more expensive research, analysis, and design of the products of these companies.

Outsourcing has had a lot of enemies from countries from both sides of the deal – the ones that lost the jobs, and the ones that got them. We know what happened to the countries that lost jobs to outsourcing. Significant portions of their population lost jobs, and continue to be displaced by this phenomenon.

But the sourcing of corporate activities to countries where they could be done more cheaply has led to huge increases in the productivity of the outsourcing companies. These companies were able to lower the selling price of their products, thereby making them affordable to a larger number of consumers in their home countries. The lower cost likely also led to significant increases in profitability of these same companies, which translated into newly-created wealth for their shareholders.

In many cases, the displaced workers likely found new jobs in other companies. Since the increased productivity and lower prices led to new wealth in the developed countries, these became funds that could be released for new ventures and businesses. And because the prices of goods were going down in these developed countries, excess discretionary income was created for the consumer, which led to opportunities for newer businesses.

This influx of new businesses likely created new jobs for many of the displaced. These new businesses likely were not as labor-intensive as before, but rather smaller, and tended to focus on the small niches created by rising discretionary income.

The transition wasn't equally easy for everyone. Moreover, because of the downward effects of the globalization of processes, many of the displaced and existing workers in the developed countries could no longer demand increasing wages from their employers. Because much of the work they did could now be standardized, codified, and therefore, be done in any other place in the world, this constrained their ability to negotiate increasing amounts of compensation. For a while, the decreasing cost of goods mitigated this stagnation in wages.

In the meantime, corporate shareholders continued to enjoy increasing profits, whether they invested in developing countries directly, or indirectly, through their companies that outsourced to those countries. Much of this new-found wealth needed to be re-invested. Not everything was re-invested in the same business or to the developing countries. They needed to diversify, so they invested some in their own countries.

There were fewer investing opportunities available to them domestically because much of the capital-intensive production facilities were already being set up in developing countries. Yet new wealth continued to flow back to the developed countries in the form of profits. Because there were fewer business opportunities than available funds, money began to flow to speculative assets – stocks, property, financial instruments, etc. For as long as new money poured into these assets, they increased in value, and seemed to be sensible thing to do. Bubble after bubble therefore arose in many of these assets.

Surely, once a significant froth develops in an asset, there has to be a correction. These investible funds have grown exponentially, both because of continuing profitability of the globalized businesses, and because the continuing profits in assets that appreciated in value created more funds. Because of the current size of the outstanding investment, the froth has lately become very big, and very speculative. The sub-prime capital market that recently burst in the US, a market for an asset class invested in by funds in other developed markets looking for yield, is one such example.

Because of the size of the losses, and the growing inter-connectedness of the financial markets in the developed economies, this latest contagion has the potential to undermine the rest of the other-wise still humming economies of these developed countries.

So how about on the other side of the fence - the developing world?

Well, as new investment continued to flow into their countries from the developed world, this created new jobs and new opportunities for the locals. Many who would otherwise have wallowed in poverty working in the farm now found work in the new industrial sites being set up.

Globalization has been a boon for countries with rapidly growing populations. These population increases would have been catastrophic had it not been for globalization. There is only so much work to be done in the farm, and hence, many of these people would be unemployed if not for the new factories.

Low-cost labor was therefore in plentiful supply for the outsourcers. For as long as new people arrived to staff new capacity, these outsourcers could secure a continuous outflow of cheap goods.

Now, because this labor was plentiful, they were never paid the same as they would have been had they been in the companies’ home country. That was the point of locating the factory there in the first place, so they could secure cheap labor.

So no significant market arose in the developed markets for the very products these factories and companies were creaking out. For many of those toiling in the factories, the goods they made were a luxury they can only dream of.

That began to change when relatively more middle class range of services began to be outsourced – the back office work. This paid more than the traditional factory work. And this was a boon for the next generation of Third World workers – the ones who had gone on to higher education, thanks to the money earned by their parents or older brothers and sisters employed in the industrial factories.

When these higher-paying jobs began to arrive in the developing world, demand was created for more of the middle class luxuries previously unaffordable there. This increased demand led to inflationary prices for these goods. Because these goods were marketed globally, this led to global inflationary prices.

Then, because of years of trade surpluses enjoyed by their governments, much needed infrastructure developments projects finally got under way. If you were a nation whose manufactured goods were affordable in many developed nations, but had a citizenry who could not afford much of what was being produced elsewhere, you’re going to ring year after year of trade surpluses. For as long as this led to currency coming in to bolster economic development, everything went according to plan.

Now what happens when there are simply too many countries investing in infrastructure projects, all at the same time? Right. This leads to inflationary prices for all input costs.
This is where we are in the world right now.

Developed countries that have enjoyed years of increasing productivity gains due to outsourcing have morphed into consumerist economies. Outsourcing may have led to stagnant wages for many, but the declining price of goods immediately resulting from it has pretty much mitigated its effect.

They have an investor class increasingly bowed by an increasing pile of liquidity and cash, but not enough useful investments to put them into. In all likelihood, much of this wealth will be invested in low-yielding placements, or worse, in investments that will lose significant value.
Then you have the developing nations, whose people are only now beginning to afford First World luxuries, but not in significant enough numbers as to replace the loss of business with a major trading partner.

And then you have a newly increasing global inflation, due to the slowly increasing number of people demanding the same products, driving up the scarcity of certain commodities.
What might happen next? Not necessarily bad things, I think. I’ll try to offer up some speculations in my next post.