Wednesday, December 3, 2008

Local consumers and world trade parity

For decades, for much of the developing world, the principal strategy of economic development has been to run trading surpluses, and to use this surplus as the fuel for domestic economic growth. Continuous trade surpluses were possible for these nations when much of the high valued –added manufacturing of the most commonly-demanded goods of the world have been outsourced to their domain. Outsourcing production to low wage countries grew out of Western corporate strategy of increasing shareholder returns on investment, by constantly lowering over-all expenses of the firm. Major activities were uprooted from their home countries and transferred to other countries that could offer lower input labor costs.

Low wage advantage resulted in more and more processes being outsourced to these low wage countries, resulting in economic growth for their nations as a whole. But low wages is a double-edged sword. Low wages meant that, on an individual level, most of these same workers toiling to create most of the world’s goods did not earn enough to afford these same goods for themselves. So no significant market arose in the developing 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.

This is how it's always been in much of the developing world. Years of economic growth may have resulted in constantly improving national accounts, but comparative advantage that comes from maintaining low wages across the board for entire swathes of the local population, instead of true value creation, does not a vibrant domestic consumer economy make. So their countries’ continued growth has rested on the Western, and particularly, the American consumer continuing to buy their excess production.

The displaced workers in the developed countries likely found new jobs in other companies, but the transition wasn't equally easy for everyone. Moreover, because of the downward effects of the globalization, many of the displaced 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. But now, with a full-blown credit crisis, and a rollback from the longest over-expansion in the world economy, the reverberations in the consumer side of the economy are only beginning to be felt.

Hence, with the fallback in American spending, who is left to plug the gap in orders? Certainly, it’s not going to be their still poor domestic consumers of the developing world. So for as long as the American consumer remained the principal source of growth for the rest of the world, there was to be no decoupling of the global economy from the American economy. In fact, now more than at any time in the world’ history, if America sneezes, the rest of the world will catch cold. The hardest hit will be the developing countries.

Many developing countries therefore need to change their mindset. They need to refocus from encouraging only businesses that strive to be the lowest-cost producers of everything, into encouraging businesses who can transform their countries into more innovative, technology-building centers.

Therefore, they need to develop more local entrepreneurs who will be willing to pay better than low wage, and focus their business-building efforts on developing niche markets in the domestic economy. The goal of becoming the back-end supplier of finished goods for the developed world is now insufficient to guarantee continued economic prosperity. To maintain economic prosperity for all, all countries need to develop DOMESTIC CONSUMERS.

Both the developed and developing worlds will each have to become more equally divided into being both consumer and producer economies. However, these developing country companies will have a natural limit to their growth, and that limit is what local demand can sustain. This limitation is a crucial constraint to how much higher current levels of local wages can increase.

Hence, for this national reorientation to work, change efforts need to be national in scale. Only in an environment where all businesses will be focused on creating greater value for the local consumer, while at the same time creating a local consumer able and willing to buy their goods, will this change work.

When the developing world has succeeded in getting much of its local wages and standards of living to world parity, then maybe globalization can start to work. Because only in such an environment will true comparative advantage among nations exist. Right now, what we have is absolute advantage. And the advantage goes to multinational companies who benefit by pitting off populations against each other.

In 1913, Henry Ford reputedly increased pay for his workers, so that he could create a new class of middle class people who could go out and buy his cars. Now more than ever, the world needs an army of “Henry Fords” the world over, to get itself out of recession. Are they being constrained by world-dominating multinational pricecutters?

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