The truth about globalization

Public Interest, Spring, 2002 by Timothy Taylor

To keep my economist union card, I am required every morning when I arise to place my hand on the leather-bound family heirloom copy of Adam Smith's The Wealth of Nations and swear a mighty oath of allegiance to globalization. I hereby do asseverate my solemn belief that globalization, taken as a whole, is a positive economic force and well worth defending. I also believe that the economic and social effects of globalization are exaggerated by both its detractors and supporters.

In media coverage of anti-globalization protests, "globalization" often becomes a catch-all term for capitalism and injustice. (Indeed, for some protestors, referring to capitalism and injustice would be redundant.) But economic globalization in fact describes a specific phenomenon: the growth in flows of trade and financial capital across national borders. The trend has consequences in many areas, including sovereignty, prosperity, jobs, wages, and social legislation. Globalization is too important to be consigned to buzzword status.

One world?

The degree to which national economies are integrated is not at all obvious. It depends on your choice of perspective. During the last few decades, international flows of goods and financial capital have certainly increased dramatically. One snap measure of globalization is the share of economic production destined for sale in other countries. In the U.S. economy, exports of goods and services were 4.9 percent of the gross domestic product (GDP) in 1965, but 10.8 percent of GDP in 2000. From a global perspective, exports rose from 12 percent of world GDP in 1965 to 22 percent of world GDP in 2000. In round numbers, international trade of goods and services has doubled in about four decades.

International financial markets are not tracked as easily as cross-border flows of goods and services. But by a variety of measures, they have also expanded considerably, especially in the last decade. Total assets held by U.S. investors in other nations nearly tripled from $2.3 trillion in 1991 to $6.2 trillion in 2000. Conversely, total foreign-owned assets in the U.S. economy quadrupled from $2 trillion in 1991 to $8 trillion in 2000. Annual global flows of "foreign direct investment"--that is, investment that creates a lasting management interest, often defined as more than 10 percent of voting stock in a company--rose from $200 billion in 1990 to nearly $900 billion in 1999. A 1998 survey by the Bank of International Settlements found that $1.5 trillion per day was traded on foreign-exchange markets. Since foreign-exchange trading has been growing at double-digit rates, its volume now must exceed $2 trillion per day.

For many countries, international financial markets feel more like an anvil on their toes than a parade of dry statistics. Argentina in 2002 has no remaining doubts about the size and power of international capital movements. A number of countries and regions have recently suffered through economic instability and recessions caused by rapid outflows of international capital: Russia in 1998, East Asia in 1997 and 1998, Mexico in 1995, and European countries in 1993, when international financial speculators blew down the mechanism for coordinating their exchange rates.

But while international flows of goods, services, and financial capital have increased dramatically in the last few decades, the term "globalization" implies more. It implies that the world is a single market--or nearly so. In a fully globalized economy, goods and investments would flow across national borders with no more difficulty than that encountered by a company from California selling its products or taking out a loan in New York. But studies testing the importance of national borders in determining the flows of goods and services have shown that we are still a long way from a single world market.

Indeed, national borders continue to play a significant role. For example, the Canadian province of Ontario is an equal distance from Washington state and the province of British Columbia. In a borderless world, one might expect Ontario's level of trade with Washington state and with British Columbia to be about the same, at least after adjusting for the size of the local economies. Yet this is not the case. The levels of trade have been measured between pairs of Canadian regions, pairs of U.S. regions, and pairs of U.S.-Canadian regions, and it turns out that trade between regions of Canada, and between regions of the United States, is commonly 12 times higher than trade between equivalent regions across the U.S.-Canadian border. In Europe, similar studies have found that trade between regions within countries is three to ten times higher than trade that crosses national borders, even after adjusting for factors like size of local economies and geographic distance.

A second convincing piece of evidence that the world economy is far from borderless comes from price comparisons across countries. When goods are sold within a single, borderless market, their prices tend to adjust together. For instance, when gasoline prices rise in the United States, they tend to rise across the country, although the exact amount and timing of the rise depend on local circumstances. But many studies have found that prices of internationally traded goods like gasoline, computers, cars, and televisions do not rise and fall together across national borders. One study of this type examines how movements in exchange rates affect relative prices of goods. When the exchange rate between two countries changes by, say, 10 percent, then prices of goods in those countries must also adjust by 10 percent if the prices in the two countries are to stay in the same relationship. Instead, when the exchange rate moves, it often takes three to five years for just half of that change to "pass through" into th e relative prices of goods. Thus relative prices of goods across national boundaries do not behave as if there were a single, borderless market.