Economic Globalization

Sociology 2, Class 6

Copyright © 2014 by Evan Schofer

Do not copy or distribute without permission

Announcements• Announcements

• None!

• Agenda• Today: Economic Globalization

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”… challenged old regulations

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.

Global Trade 1950-2010

Trade: manufacturing vs agriculture• Red indicates exports of manufactured goods

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 woven 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.

Supply Chain: TV

Globalization of Production• Reich “Supercapitalism”

– 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 US”

• “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 (FDI)• Definition: Investing assets 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

– Recall: investment increases economic growth• Countries like to attract FDI…

Capital Flows

• 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

Labor (workers)

• Labor: people who work in the economy• 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

– Labor is an example of something that isn’t very globalized• Mainly due to laws limiting immigration.

Multinational Corporations

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 majority of companies are still local• But, multinationals have grow in number and size

– Some dwarf the economic capacity of entire countries…

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• Basic requirements for global economy

– 1. Inexpensive transportation & communication– 2. International financial (money) system– 3. Countries that are willing to participate

• Absence of legal or regulatory “barriers”• Shift from Keynesian policies free markets.

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 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• A 40 foot container can hold 10,000 pairs of

shoes• Cost to send a 40 foot shipping container with

10,000 pounds of cargo from Shanghai, China to the port at Long Beach

• Around $3,500• Taxes, insurance, etc. make it cost a bit more…

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.

International Financial System• Another barrier to the global economy: Money• Suppose I build and sell computers…

– What if someone from Japanwants to buy one?• They only have Japanese money: Yen

– Problems:• 1. Yen aren’t useful to me in the US• 2. How much is my computer worth in Yen?

– 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, Yen 1/300 ounce

The Gold Standard• The gold standard is one solution to trade in a

world of multiple currencies• If someone in Japan wants to buy my

computer, they can convert Yen to gold• International transactions paid in gold• Then, I can convert gold to US$

• Result: International trade is possible!

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 • The “New Deal” used stimulus to hire lots of workers &

build infrastructure– Goal was to boost the economy in the depression

• 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 Japan:– Person in Japan goes to the currency market

(bank) to buy US dollars• Current exchange rate: 103 Yen per dollar• Therefore, a US$ 1,000 computer costs 103,000 Yen

Currency Value ExamplesCountry Currency Number per US$

Europe Euro 0.73

Canada Dollar .987

China Yuan/RMB 6.05

India Rupee 62.08

Japan Yen 103

Mexico Peso 13.4

South Korea Won 1077

Thailand Baht 32.8

United Kingdom Pound .60

As of Jan 23, 2014

Trade & Exchange Rates• Currency values affect trade:• Example: Suppose the Yen becomes more

valuable relative to the dollar:• From 103 yen per US$ 10 yen per doller• How much would a US$ 1,000 computer cost to a

European?• Answer: 10,000 Yen (as opposed to 103,000)

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

• If currency value drops, imports become expensive.

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

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

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

Japan

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

more• 2. Japanese 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

• Japanese will sell 103 billion Yento banks in order to purchase 10 billion US$…

– If banks (currency markets) are flooded with Yen, supply increases, value drops…• Currency markets don’t want more Yen• 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• 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