Economic Globalization

Sociology 2, Class 6

Copyright © 2013 by Evan Schofer

Do not copy or distribute without permission

Announcements

• Announcements• None!

• Agenda• Today: Economic Globalization

In the news: Interest Rates

• NY Times: Fed Sees Rates Staying Near Zero Through Late 2014

• “The Federal Reserve said Wednesday that it intends to hold short-term interest rates near zero “at least through late 2014,” extending its most basic and longest-running response to the financial crisis by at least another 18 months.”

• “The decision means that the Fed does not expect the economy to complete its recovery from the 2008 crisis over the next three years. By holding rates near zero, the Fed hopes to hasten that process somewhat by reducing the cost of borrowing.”

• Recall: Low interest rates “boost” the economy– But, even zero rates aren’t enough… we’re in a “liquidity trap”!

Review: States and Markets

• Question: How can states affect markets?– 1. Fiscal policy – taxes and spending– 2. Monetary (money) policy – printing & lending

money– 3. Laws and Regulations– 4. Direct ownership of production

State Ownership• Governments can own factories, railroads,

electric power plants, hospitals, etc.

• Nationalized or “state-run” industry: a business or industry that is run by the state– “Nationalization” is when the government takes

over formerly private companies or industries• Example: airport security screeners after 9/11

– Privatization: when a government-run business is sold to private owners

• Examples: many prisons, even some schools• Heavy industries in Britain & Russia (historically).

State Ownership

• Advantages of state-run industries:– Highly stable – no bankruptcies

• Tax money can keep them afloat in hard times

– Works in collective interests (usually)• Not driven by greed; nicer to workers (usually)• Won’t try to co-opt the state: Bribes/lobbying…

– Greater accountability (sometimes)• Government organizations are often subject to greater

scrutiny and accountability, compared to private firms– Ex: monitoring by government accounting offices; FOI Act

• Private firms that do terrible things usually just go bankrupt and leave others to clean up the mess

– Ex: Mining companies that damaged the environment.

State Ownership• Disadvantages of state ownership

– Little or no competition: • Less pressure to be efficient or innovate• Though in some cases, they can be very efficient

– Ex: Social security vs. private savings funds– Ex: State-run health systems vs US system of private insurers

– State firms can become corrupt or under influence of government elites…

• Ex: Oil companies in Nigeria and Russia– Some have stolen the oil wealth of entire nations.

Reading Review: Quiggin 2010 Zombie Economics Ch 5: Privatization

• Some economic ideas are like zombies:• No matter how much evidence refutes them, they rise

up again and stumble onward

• Example: Ideology of Privatization• P. 186: “the claim that an economy in which all major

decisions on investment, employment, and production are left to private firms will outperform an economy where governments play a significant role in such decisions.”

• More simply, due to market competition, companies area always more efficient than governments

Reading Review: Quiggin 2010 Zombie Economics Ch 5: Privatization

• Quiggen reviews the evidence:• P. 195 “Privatization has been a central component of

market liberalism for more than thirty years. In that time there have been sufficiently many failures to give us a reasonable idea of when privatization is likely to work and when it is not.

– Examples where privatization often does badly:• Railroads, telecommunications• K-12 Education, health, police/prisons• Ex: Privatized prisons: No cost savings, but much less

accountability to the public.

Reading Review: Quiggin 2010 Zombie Economics Ch 5: Privatization

• Examples where privatization often does well• Electricity, retail• And, firms that have been “rescued from death”

– Example: General Motors was nationalized in 2008… and then privatized again.

– P. 197: Privatization works best when:• “Where a competitive market can be sustained, and

there is no special requirement for close regulation, privatization has usually been successful.”

• “… and when undertaken by governments that are competent, efficient, and accountable, but this is precisely the case when the benefits are smallest.”

Keynesianism vs. Free Markets

• The Keynesian state:– Fiscal Policies: Higher taxes, higher spending

• To support health care, welfare, keep full employment

– Monetary policy: Expansionary (low interest rates)• Low interest rates keeps unemployment low

– But, inflation & debt tends to be higher

– Regulation: Expanded, elaborate• Industries and markets are stabilized, controlled

– Ownership: Some industries may be nationalized• “Private sector” is smaller.

Keynesianism vs. Free Markets

• The Free Market state:• States that put on the “Golden Straightjacket”

– Fiscal Policies: Low taxes, low spending• Corporations & international investors are attracted by

low taxes

– Monetary policy: Conservative (high interest rates)• High interest rates keep inflation low

– As a consequence, unemployment is higher

– Regulation: Minimal• Companies are free to do as they please

– Ownership: Privatized• The state doesn’t own industries; it is all “private”.

States, Markets, Globalization• Since around 1980 governments have shifted

• Keynesian / Welfare-state systems free markets

• Why?– Commanding Heights:

• Success of Hayek’s ideas; Elections (Reagan/Thatcher)

– Reich (Supercapitalism)• New technologies & greater competition• New/smaller companies could compete with the

“giants”… caused firms to challenge old regulations

– Friedman (Golden Straightjacket)• New transportation/communication technologies• Adapting to global competition; golden straightjacket.

Economic Globalization• Economic globalization:

• Simple definition: When economic activity that was formally local or national scale becomes organized on a global scale

– Spanning countries, rather than contained within them

• Examples: Globalization of…• Trade / exchange• Production• Corporations• Labor• “Direct” Investment• Capital

– I’ll define & discuss each.

Globalization: Trade• Trade: The exchange of goods & services

• Historically, trade was local• But, the word has become synonymous with

“international trade”, which is global by definition

• History:– Global trade was common in the late 19th century

• International trade amounted to 8% of GDP by 1913• But, trade collapsed during WWI, Depression, WWII

– Since World War II, trade has grown rapidly• Trade surpassed 17% of world GDP in the 1990s• NOTE: trade is concentrated among wealthy nations.

Globalization of Production

• Production: Creating products and services

• Example: Building a car• Where do the raw materials come from? Where are

parts made? Where is assembly done?

– In the past, auto production was primarily local• Ex: raw materials were imported, but rest was local

– Now, it is common for auto production to span dozens of nations

• Parts made in various places, assembled in various places…

– Ex: Toyota’s globalized production system (on next slide).

Toyota’s Global Production System

Globalization of Production

• Global supply chains• A “supply chain” refers to the steps through which raw

materials are transformed into components and finally into a final product

• Cotton cloth shirt• Because of decreased transportation costs, “The old

[mass] production system could now be fragmented and parceled out around the world to wherever pieces could be done best or most cheaply.”

– Reich, ch 3 p 62.

Globalization of Production• Reich, in the book “Supercapitalism”, makes

some important observations:– With globalization, America began to import much

of what it consumes• BUT: Aggregate trade statistics hide the fact that much

of the trade occurs WITHIN American companies– Part of supply chains…

– Implication: It is an oversimplification to say that foreign companies are ‘outcompeting’ US firms

• “Rather than American companies ‘losing their competitiveness’ … America started losing solely American companies.”

• The success of American companies no longer implies better wages & conditions for US workers.

Globalization of Production

• The globalization of production has limitations

• Issue: Economies of Agglomeration• Geographical concentrations of knowledge, expertise,

and production capacity create big benefits

– When you get lots of production concentrated in one place, companies can coordinate better

• 1. Detroit, Michigan (auto industry), 1950s-1970s– Parts suppliers/factories/skilled workers all plentiful

• 2. Silicon Valley (computer industry) – Stanford U (engineering expertise), venture capital, factories

• 3. Shenzen, China (electronics manufacturing)– Engineering expertise, cheap labor, factories

Economies of Agglomeration• Why are iphones made in China?

• NYT article: http://www.nytimes.com/2012/01/22/business/apple-america-and-a-squeezed-middle-class.html

• “In part, Asia was attractive because the semiskilled workers there were cheaper. But that wasn’t driving Apple. For technology companies, the cost of labor is minimal compared with the expense of buying parts and managing supply chains that bring together components and services from hundreds of companies. [It] “came down to two things,” said one former high-ranking Apple executive. Factories in Asia “can scale up and down faster” and “Asian supply chains have surpassed what’s in the U.S.”

• “The entire supply chain is in China now,” said another former high-ranking Apple executive. “You need a thousand rubber gaskets? That’s the factory next door. You need a million screws? That factory is a block away. You need that screw made a little bit different? It will take three hours.”

• “Another critical advantage for Apple was that China provided engineers at a scale the United States could not match. Apple’s executives had estimated that about 8,700 industrial engineers were needed to oversee and guide the 200,000 assembly-line workers eventually involved in manufacturing iPhones. The company’s analysts had forecast it would take as long as nine months to find that many qualified engineers in the United States.” In China, it took 15 days.

Foreign Direct Investment• Foreign Direct Investment (FDI):

• Definition: Investing assets (i.e., money) from one country into organizations, structures, and equipment in another

• Example: building (or buying) a factory in another country

• FDI does not include “intangible” investments, such as buying stock or currency in another country

• Note: Most FDI occurs between wealthy, industrialized countries.

Econ Globalization: Capital• Capital Flows: Movement of assets (money)

across national borders to purchase intangible investments

• Also called: Financial flows, globalization of capital markets, capital market integration

• Example: Buying stocks & bonds in another country• Example: Buying other currencies for purposes of

speculation (i.e., profit)

– Unlike FDI, capital investments can move quickly… flowing in and out of countries

• Elwood reading: “Pinball capital”• Can precipitate or worsen economic crises• We’ll discuss this later…

Econ Globalization: Labor• Labor: people who work in the economy

• Like capital or goods, people can move across national borders: Immigration

– Historical perspective:• Like trade, immigration was common in the late 19th

century, but dropped in the mid 20th century• Due to immigration laws, migration remains constrained

– Migrants represent a small fraction of the global population– Moreover, labor flows tend to be regional.

Econ Globalization: Corporations• Corporations can span national nations…

• Called: Multi-national corporations (MNCs); Multi-national Enterprises (MNEs); Trans-national corporations (TNCs)

– Firms can vary in extent they are global• Sometimes only 1 or 2 factories overseas• Or, they can be spread literally across the globe

– The vast majority of companies are still local– And many multinationals are concentrated in a few countries

• But, multinationals have grow in number and size– Some dwarf the economic capacity of entire countries…

• More on this later…

What is most globalized?• Some things are more globalized than others…

How Global?

Extremely Capital flows

Very Trade

Moderately Corporations, FDI, Production

Not so much Labor (workers)

Video: Commanding Heights

• Episode 3, chapters 3-6• Time: 3:30 (or 6:15) to 28:00• Basic issues regarding trade, capital flows• Global link:

http://www.pbs.org/wgbh/commandingheights/lo/story/ch_menu_03.html

• Local link: Video\PBS.Commanding.Heights.Ep3.The.New.Rules.of.the.Game.DivX6.avi

Economic Globalization: Origins• Question: What are some basic things that

are absolutely required in order to have a global economy?– 1. Inexpensive transportation & communication– 2. International financial (money) system– 3. Countries that are willing to participate

• Absence of legal or regulatory “barriers”

– For a related discussion, see Greico and Ikenberry “Economic Globalization and Political Backlash.” pp. 220-223.

• Emphasizes role of technology, as well as political changes that permitted globalization.

Transportation• Historically, people only traded lightweight,

valuable items… spices, silk, ivory, etc…• Things that could be easily carried long distances

• Global economic activity requires cost-effective transportation systems

• Otherwise most business activity remains localized• Most changes are pretty obvious: increase in cars,

trucks, planes, trains, ships… • But, one change matters more than others:

containerized shipping

Transportation• Containerized shipping = a huge revolution

in global transportation• Started in the 1970’s

• Shipping containers: a standard 40ft long box

• Easy to load and unload onto ships, trains, trucks• Drastically reduced cost of shipping

• Huge ships can hold thousands of containers!

Containerized Shipping: Pics

• Ships can hold hundreds of containers!

Containerized Shipping: Pics

• Containers allow mechanical loading

Pics: from Maersk Sealand Website

Containerized Shipping: Pics

• Containers can be transferred to trains, trucks

Containerized Shipping

• Question: Guess how much it costs to send a 40 foot shipping container with 10,000 pounds of cargo from Shanghai, China to the port at Long Beach?

• Answer: Less than $3,500• Taxes, tariffs, etc. make it cost a bit more…

• Question: How many pairs of Nike shoes fit in a container?

• Answer: over 10,000!

Containerized Shipping

• Consequence: Containerized shipping resulted in a dramatic increase in global trade

• Example: Container holds 10,000 pairs of shoes• Container costs $3,500 to ship (including taxes)• Total cost of shipping per pair: 35 cents!

• If cost of making a shoe in China is 36 cents less than in US, then there is an incentive to ship…

• Higher costs might come from: more expensive labor, costs of adhering to environmental laws, etc.

Containerized Shipping

• Containerized shipping has indirect consequences for the environment… – Some examples:– Companies can dump garbage in other countries

• Anything that is costly to dispose of in the US• Hazardous waste; Old computers

– Mass shipping leads to spread of “invasive” non-native species

• Examples: Asian Tiger mosquito, Zebra mussel arrived in cargo ships.

International Financial System

• Another barrier to the global economy: Money

• Suppose I build and sell computers…– What if someone from Europe wants to buy one?

• They only have European money: Euros

– Problems:• 1. I don’t want Euros – they are useless to me• 2. How much is my computer worth in Euros money?

– Even if I would accept the money, I don’t know the value…

International Financial System

• In order to conduct trade, there must be an international system to handle currencies

• Example: The Gold Standard– For every dollar the government prints, they hold a

corresponding amount of gold in the bank• Value of all currencies = tied to a common “standard”• Example: US$1 = 1/35 ounce of gold• Other currencies might have a different value:

Example: Euro = 1/20 ounce.

The Gold Standard

• The gold standard is one solution to trade in a world of multiple currencies

• To sell a computer to someone in Europe, I can directly convert price

• US$ 1,000 computer = 35 ounces of gold = 700 Euros• European gives 700 Euros to his bank… converts to

gold• Gold is given to US central bank; US$ 1,000 given to

me

• Result: International trade is possible!

The Gold Standard

• Issue: If trade is one sided, gold drains from one country to another

• A “trade imbalance”, or a “current accounts deficit”

• Consequence– European banks have less gold, issue fewer

Euros• Money supply shrinks

– European economy slows down, imports reduce…• Result: System prevents asymmetric trade; system

stays in equilibrium.

The Gold Standard• The gold standard fell apart in the depression

• Governments wanted to boost their economies…• Question: What are some ways the government can

boost their economy?

– Governments increased spending (e.g., hired people to build roads) to increase consumption

• This required printing more money… even though gold supply didn’t expand

• Currencies were no longer tied to gold…• Trade became difficult.

Bretton Woods• Plan B: The Bretton Woods agreement

helped to re-establish an international financial system

• New plan: U.S. Dollars would serve as the currency for international transactions

• US dollars would have a fixed value vs. gold• Other currencies would have a fixed exchange rate

versus the dollar

• Everybody was happy again… for a while…

Bretton Woods• The Bretton Woods system also fell apart

• Basic Problem: The fixed exchange rates works only if trade and capital flows are small

• … compared to the size of the US economy• Eventually, when global trade flows harmed the US

economy, the US changed the system…– The process is described by Herman Schwartz:

“International Money, Capital Flows, and Domestic Politics.”

Floating Exchange Rates• Plan C: The system of floating exchange

rates• Value of currencies is determined by market• Like the price of commodities: oil, wheat, etc.

• Selling a computer to someone in Europe:– European goes to the currency market (bank)

to buy US dollars – to pay me for the computer• Current exchange rate: .75

– European pays .75 Euros to get each US$

• Therefore, a US$ 1,000 computer costs 750 Euros…

Currency Value ExamplesCountry Currency Number per US$

Europe Euro 0.748

Canada Dollar .987

China Yuan/RMB 6.60

India Rupee 45.04

Japan Yen 82.71

Mexico Peso 12.09

South Korea Won 1112.06

Thailand Baht 30.38

United Kingdom Pound .63

As of Jan 12, 2011

Trade & Exchange Rates• Currency values affect trade:

• Example: Suppose the Euro becomes more valuable relative to the dollar:

• Value of dollar drops from .70 Euros to .10 Euros– Euro worth 1.44 US$, goes up to 10 US$

• How much would a US$ 1,000 computer cost to a European?

• Answer: Only 100 Euros!

• When a currency goes up relative to others, it is cheap to import

• If currency value drops, imports become expensive.

Trade & Exchange Rates• Who benefits if Euro goes up relative to the

US$?• 1. European consumers – they can buy American

products cheaply• 2. American exporters – they can sell lots more to

Europe

• Who Loses?• 1. American consumers – European imports costs

more• 2. European companies – can’t compete with cheap

US imports

Floating Exchange Rates• Why do currency values “float” (change)?

• What forces affect supply and demand?

• 1. Asymmetric trade• If a country imports more than it exports, its currency

drops• Ex: US has a current accounts deficit with Japan

(imports more than it exports)• To purchase Japanese goods, Americans must sell

dollars, buy Japanese Yen– Demand drives up value of Yen relative to the dollar.

Floating Exchange Rates• Example: The effects of asymmetric trade

on currency values

• Suppose I sell 10,000,000 computers• Europeans will sell 7.5 billion Euros to banks in order

to purchase 10 billion US$…

– If banks (currency markets) are flooded with Euros, supply increases, value drops…

• Currency markets don’t want more Euros• Banks will give fewer US$ in exchange

Floating Exchange Rates• What forces affect currency values?

• 2. Asymmetric capital flows• If capital moves into a country, its currency goes up

– Ex: In early 1990s, global investors moved money into Thailand, Mexico… raising the value of currency

• If capital moves out of a country, its currency goes down

– Investors feared problems in Mexico, Thailand… pulled money out

– Thai Baht and Mexican Peso dropped in value

Floating Exchange Rates• What causes asymmetric capital flows?

• 2. a. Interest rates• If a country raises interest rates, its currency goes up

– Reason: Foreign investors prefer high rates– The “electronic herd” is attracted to high rates…

• If a country cuts interest rates, its currency drops– Investors would prefer moving money into countries where

banks pay higher interest…

– Important issue: Globalization limits the ability of governments to control their own monetary policy

• Sometimes countries want to lower interest rates to boost the economy…

– But can’t because it would hurt their currency

Floating Exchange Rates• What causes asymmetric capital flows?

• 2. b. Anything else that “scares” investors• Government instability• Concern that an economy isn’t going to do well

– Ex: Fears that Thailand was going “bust”

• Policy changes that investors don’t like– Ex: big increase in taxes– Shift away from free-market policies (“golden straightjacket”)

• All of these things can cause investors to pull their money out of a country quickly, harming currency values.

Floating Exchange Rates• What forces affect currency values?

• 3. Countries can intervene strategically to alter their currency values

• Governments can sell their currency to lower its value– They buy other currencies on global markets

• Governments can buy their own currency to raise its value

– They spend “reserves” of gold or other currencies on global markets

• This requires lots of money, so rich countries can do it more.

Trade & Exchange Rates• Recent news article:

• WASHINGTON (AP) -- America's beleaguered manufacturing companies, chafing over the loss of 2.7 million jobs over the last three years, vowed Wednesday to press ahead harder to get China to stop manipulating its currency to gain trade advantages. (Associated Press)

• Issue: China keeps value of currency low• Aids exporters, at expense of US companies

Trade & Exchange Rates• Issue: Countries can strategically alter their

currency values to gain an advantage in trade– Asymmetric trade with China should cause

Chinese Yuan to rise relative to the US$• The US imports much more than it exports

– But: China floods market with Yuan, buys US$• Yuan value stays low compared to US$• Result: Chinese exports remain cheap for Americans• Result: American manufacturing companies = Angry!

– Note: Only big/wealthy countries can do this• US did a similar thing in the 1970s• Thailand tried, but ran out of money… it’s currency

suddenly plummeted.

Financial Flows & Exchange Rates

• Issue: Trade & financial flows have same impact on currencies

• Asymmetrical flows cause currency values to change

– But remember: Investment flows are larger than trade flows, and they can happen much faster

• Elwood: “pinball capital”• Result: global investors can cause currency values to

change rapidly• Called: market volatility (rapid change in value)

• If a currency value falls too low, serious economic problems arise.

Exchange Rates & Volatility• Capital flows and resulting currency

volatility can produce severe crises

• Example: Mexico in 1994• Global investors bought lots of stock, investments in

Mexico over several years…– This caused a slow rise in the peso. Not a problem.

• A minor political crisis led to panic selling in 1994– The stock market began to plummet

• Global investors rushed to sell stocks, converted pesos to dollars

• Result: Selling of pesos made the value of pesos plummet!

Video

• Commanding Heights, Ep 3, chapter 7• Time: 27:50 – 32:45.

Exchange Rates & Volatility• Why was it bad for the value of pesos to drop

severely, rapidly?– 1. Suddenly, imports were very expensive

• Price of gas shot up• Businesses dependent on imports couldn’t afford

costs; potential for bankruptcies

– 2. Many Mexican companies had borrowed money from US banks

• US banks must paid in $, not pesos• If pesos are worth little, suddenly can’t afford to pay

loans• Result: More bankruptcies, economic recession.

Exchange Rates & Volatility• In the case of the 1994 peso crisis, the US

government stepped in• Provided emergency loans, etc., to prevent massive

bankruptcy• But, that was just a small crisis… It is clear that crises

could occur that are too large to stop so easily.

Asian Financial Crisis

• Commanding Heights Video:• In the 1990s, foreign investors moved capital into Asia• And, foreign banks lent money to Asian companies at

very low interest rates

– Consequence: Rapid economic growth• Economies “heated up”• But, capitalism is prone to boom-bust cycles…• Companies built more factories and housing than

needed– The “boom” ended

• But – global dynamics made the “bust” much worse!

Asian Financial Crisis• How did globalization prompt a crisis for Asian

economies in the 1990s?– 1. Investors pulled out quickly – affecting

currencies• Asian currency valued dropped…• Imports became expensive• Companies could no longer pay off loans to foreign

banks– Bankruptcies, unemployment…

Asian Financial Crisis• How did globalization prompt a crisis for Asian

economies in the 1990s?– 2. Contagion

• Worries about Thailand spread to other Asian countries– Self-fulfilling prophecy: fear of problems caused investors to

pull out, creating real problems

• Also, many US companies were invested in Asia (or had made loans)… Now they were losing money

– Lesson: Integrated economies mean that crises tend to spread…

• Example: US financial crisis caused economic disruption around the globe.

More Video: Commanding Heights

• Topic: Asian financial crisis, spillover to other regions…– Video: 40:48 to 48:10

• Asian economic miracle

– Video: 48:10-1:14:30• Asian financial crisis and contagion