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Globalization: There’s More to Trade Than What Meets the Eye

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by Richard Buczynski, Ph.D.
Dec 01 2020

The second installment of this mini-series digs deeper into “economic globalization,” although remember that the economic, political, and cultural elements of globalization are intertwined. And, considering the recent resurgence of COVID-19 in many parts of the world, the intermingling of these three forces has tightened, ushering in an unavoidable randomness to the decision-making equation.

What to make of all this?

Within many corporations I have worked with over the past forty years, I have noticed a perpetual tussle between long- and short-term strategic views, and the decision-making they command. In these seemingly apocalyptic times, if we keep looking at our feet while walking and forget where we are headed, we will surely get lost.

I am reminded of Andrew Grove, Intel's co-founder, describing the concept of a strategic inflection point – "an event that changes the way we think and act."

This defines a crossroads where an organization’s decisions, or reluctance to make hard choices, paves the way to grander success, ultimate demise, or perhaps a purgatory of stagnation. In this ongoing COVID-19 battle, there are clouded risks and promising opportunities. We’ll explore both as we continue to press on discussing globalization.

Globalization, International Trade and Foreign Direct Investment

What drives globalization and international trade?

There has been a steady evolution of theories dating back to the 18th century, with many key points that I will summarize today. An excellent reference is this online International Business textbook. I am including these as a point of reference to help frame my opinions in this installment of the series and subsequent chapters.

Friedman’s Three Phases of Globalization

For starters, I find it useful to cite the book “The World is Flat” where Thomas Friedman identifies three distinct globalization stages:

  • Globalization 1.0 (1492 to about 1800) was driven by nationalism and the degree of industrial power a country could exert.
  • Globalization 2.0 (from around 1800 to 2000) was characterized by the emergence of multinational corporations seeking out new markets, raw materials and, of course, cheap labor.
  • Globalization 3.0 (commenced about 2000) was spawned by technological advances in worldwide electronic interconnectivity, ushering in an era where people could communicate easily. This opened the door for the interlinking of work forces on a global scale.

 

I would argue that Globalization 2.0 and 3.0 currently coexist.

Let me build on this with a summary of academically-based trade theories. This should provide further context to analysis that follows in this and forthcoming newsletters.

Country-Based Trade Theories

  • These include the concepts of Absolute Advantage and Comparative Advantage, which found their origin in the writings of Adam Smith. Absolute Advantage focused on a country’s ability to produce a good more efficiently than another, attributed to specialization of either labor skills or resource endowments. The theory of Comparative Advantage is similar in scope, with the stipulation that even if a nation possesses an absolute advantage, it will still trade based on relative productivities.
  • Factor Proportions Theory, attributed to Heckscher and Ohlin, suggested that a nation could gain comparative advantage by producing products that used factors that are processed in abundance (such as land, labor, and capital).

 

Corporation-Based Trade Theories (Firm-Based)

Corporation (or firm or modern) based trade theories evolved with the growth of multinational corporations. I am most interested in:

  • The hypothesis in Raymond Vernon’s Product Life Cycle Theory. Vernon suggests that a product life cycle has three distinct stages: (1) new product, (2) maturing product, and (3) standardized product. In the new product phase, manufacturing occurs only in the innovating country but by the standardized phase, production has moved offshore, often in search of lower labor costs.
  • Global Strategic Rivalry Theory, based on the work of Krugman and Lancaster, states that through barriers to entry a firm can gain a sustainable competitive advantage over its competitors, referring to obstacles a rival firm may face when attempting to enter a market. Common examples include technological expertise associated with the ownership of intellectual property rights, the control of factors of production, economies of scale, or something as simple as long-held experience in a market.
  • Michael Porter’s National Competitive Advantage Theory stressed that a nation’s competitiveness in an industry rests on its ability to innovate and upgrade. He acknowledged the importance of the Factor Proportions Theory, such as the availability of natural resources and labor, as crucial in determining the mix of products a country exports or imports. Competitive sustainability also hinges on well-developed support industries that supply essential inputs to an industry.

Foreign Direct Investment Precedes and Drives Globalization and International Trade

As I mentioned in my previous newsletter, there is a financial side of the globalization/trade equation that requires consideration. Even Christopher Columbus’s quest to find a western ocean route to China, India and the rest of Asia required financing sponsored by Isabella and Ferdinand of Spain. Perhaps this is one of the earliest forms of FDI, evidenced in Freidman’s first stage of globalization.

FDI lives on in modern times. It is the driving force behind industrial development, the location of productive activities and the trade of goods and services regardless of the genre of trade theory you subscribe. The investment may take the form of a direct purchase of or investment of/in an enterprise in another country or through the expansion of operations of an existing business.

FDI also can take the form of a joint venture with a foreign company and can assume various shapes:

  • horizontal
  • vertical
  • backward
  • forward
  • and product extension (to name a few)

 

The key point is that current FDI flows determine future trade flows. I am probably as foolish as Icarus, flying too close to the sun with my opinions, but this is an issue of the direction of causality.

So here you go: Government policies and corporate strategies regarding FDI may be equally as revealing as trade policies in understanding the risks and opportunities of engaging in international business. Think of China’s Belt and Road Initiative which I will entertain in a future installment.

Finally, according to the Wall Street Journal, the United Nations Conference on Trade and Development reported that globally foreign investment dropped by nearly half on a monthly average during the first six months of 2020, with inflows to the US and the European Union falling 61% and 29%, respectively. Inbound investment in China was off a scant 4%, indicating their relative success in managing the pandemic.

Shifting Patterns of International Trade and Globalization

Merchandise exports are dominated by manufacturing (see Figure 1) – a pattern underway since the mid-1700s that defined the start of First Industrial Revolution. The overall advance of trade was disrupted by the Great Recession, and recently by COVID-19. According to an October report by the World Trade Organization, “The WTO now forecasts a 9.2% decline in the volume of world merchandise trade for 2020, followed by a 7.2% rise in 2021. These estimates are subject to an unusually high degree of uncertainty since they depend on the evolution of the pandemic and government responses to it.”

Figure 1: Merchandise Trade Dominated by Manufactured Goods

Source: WTO

As Figures 2 and 3 below illustrate, and to no surprise, China is the world’s leading exporter of goods and manufactured products.

What does surprise many people is that America is still a top-exporter, selling many key items like machinery, mineral fuels (yes, the US became a net exporter in recent years), aircraft/spacecraft, optical/technical/medical apparatus, plastics, organic chemicals and pharmaceuticals. Many of these segments employ STEM (science, technology, engineering, and math) workers and are high value-add.

Figure 2: China Leads the Way in the Exports of Goods

Source: WTO

 

Figure 3: China Also Dominates in Manufacturing Trade

Source: WTO

China’s audition on the world stage arrived in 1978 with the reform-minded Deng Xiaoping. Currently, China's top exports are: electrical machinery including computers, light manufactures (furniture, bedding, lighting), plastics, vehicles, optical/technical/medical apparatus, clothing, and accessories, iron/steel, and toys/games.

See the overlap with US exports? Much of this is a result of inbound FDI from America and Japan. This led to a sourcing-out of production. And still, value-add in many segments is low, and some of these areas are being sourced to cheaper producers, many in Southeast Asia. Incidentally, if there is a trade war going on, it is all about technology! More about this when I turn to trade in services.

Here is an important side-issue when looking at merchandise trade data – entrepôt trade (or re-exports): “a form of INTERNATIONAL TRADE, mainly confined to COMMODITIES, where goods are temporarily imported into a country and then subsequently re-exported to other countries as part of a complex chain of physical distribution and financing deals.”

Top re-exporters are Hong Kong, Amsterdam and Singapore. Entrepôt “revenue” can be considered trade in services. Note that this is the second time where I mentioned “trade in services.” I am headed in that direction as there are opportunities afoot.

Trade in Services? Setting the Stage

It is common knowledge that the growth of the service sector is far outpacing that of the goods and materials producing sectors worldwide. This extends to the international trade in services.

I will dig deeper into service trade in my next newsletter, but first consider a quote from Charles Darwin:

"It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is most adaptable to change.”

If your enterprise is exposed to international trade in goods, you are likely unsheltered from the risks associated with service trade, and perhaps have overlooked some opportunities. If so, it is time to adapt.

If you are a policymaker, I suggest that the ultimate globalization tug-of-war involves services, typically high value-add involving a host of national security issues. Figure 4 provides a convenient segue to my next newsletter.

Figure 4: America Leads in Service Trade: Did You Know That?

Source: WTO

Where We Are Going from Here?

There is much more to untangle on the globalization of service trade, this being related to the possible reemergence of trading blocs (regionalization) and the fate of multilateral trade agreements. I have also been thinking about supply chain issues in this context.

Stay tuned for the next installment …