III. Making the most of globalisation

OECD Economic Outlook, May, 2007 by Jean-Philippe Cotis

Globalisation creates benefits and challenges for public policy

This chapter provides a synthesis of the work undertaken by the Economics Department on the economic effects of globalisation, while also draws on other OECD and non-OECD research. (1) It begins with an overview of the main trends that have characterised the globalisation process. The second section then describes its potential effects on employment and wages. Globalisation also has had an impact on inflation and has been accompanied by distinctive trends in international capital flows, which are discussed in the third section. The chapter concludes by examining the benefits and challenges that globalisation creates for economic policy.

Drivers of globalisation

International integration has historical roots but has entered a new stage ...

Globalisation may be defined as the process whereby domestic product, capital and labour markets become more integrated across borders. It is a process that has deep historical roots. Indeed, an early manifestation was the integration of markets for goods, labour and capital in Europe, the Middle East and Northern Africa during Roman times (Temin, 2006). However, a distinguishing feature of the current period is the size of the ongoing "globalisation shock". In comparison with earlier phases of globalisation, the countries now coming in have relatively larger populations and lower incomes (Figure III.1).

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... spurred by advances in transport and communication

In addition to lower tariff barriers, key forces behind globalisation have been technological progress and the induced fall in transport and communication costs (Figure III.2). Over the past 50 years, passenger air travel costs, measured by the ratio of airline revenues to miles flown, have been reduced fourfold in real terms. The decline in international communication costs has been even more dramatic. For instance, expressed in 2005 US dollars, the charge for a three-minute New York-London call has dwindled from $80 in 1950 to $0.23 in 2007. Moreover, advances in computing power and the emergence of the internet have drastically cut the costs of processing and transmitting information, thereby further facilitating international transactions and trade.

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Production has been internationalised ...

Falling costs of trade and communication have encouraged not just strong trade in final products but also the greater internationalisation of production (Figure III.3). To a large extent, trade now occurs within industries and firms, as producers "trade in tasks" and develop global supply chains. Countries specialise in activities that cut across industries rather than focusing on producing certain categories of final goods.

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... and localised services can now be provided across borders

Another recent trend, facilitated in particular by the internet, is that services that had long been considered of a local nature can now be provided across borders. Recent research indicates that in the OECD area nearly one in five workers carry out service tasks that are now potentially internationally footloose (van Welsum and Vickery, 2005). (2) So far these possibilities have materialised only to a limited extent. Despite a rapid rise, in the United States the international outsourcing of services still accounts for less than 1% of intermediate service inputs (Amiti and Wei, 2005a). Moreover, the United States and many other OECD countries are net exporters of intermediate service inputs (Amiti and Wei, 2005b).

Financial markets have become global

Increased trade in products implies that factor markets have become more integrated, a strengthening of direct international links being especially evident for capital (OECD, 2005a). Over the past decade cross-border capital flows have been growing strongly, tripling as a ratio to world GDP (Figure III.4). The composition of cross-border investment flows has been changing markedly. Foreign direct investment and international equity flows, which were very strong in the late 1990s, have been comparatively muted in the aftermath of the stock market decline in 2000-01. In contrast, international transactions in more liquid assets have surged in recent years, accounting for most of the increase in global capital movements.

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Labour has become more internationally mobile

A strengthening of international labour market links has also been evident, resulting from increased immigration (OECD, 2006a). Foreign workers have become a more important component of the workforce in most OECD countries since the mid-1990s (Figure III.5, upper panel). Migration of highly skilled workers has been part of this trend (Figure III.5, lower panel).

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Effects on material living standards

Trade contributes to a more efficient use of resources

Material living standards have increased with trade openness (Figure III.6). Openness to cross-border product and factor flows boosts growth and income because it contributes to an efficient allocation of resources through various channels. (3) First, trade enhances the division of labour as countries specialise in their areas of comparative advantage. Second, integrated markets enable producers and consumers to reap the full benefits of economies of scale. Third, stronger competitive pressure prompts producers to reduce their mark-ups, tackle sources of inefficiency and invest in productivity-enhancing capital and innovation, leading to lower prices and higher output and employment. There is ample empirical evidence that the overall impact of trade on growth is positive and strong. (4) The OECD Growth Project found that a 10 percentage-point increase in trade exposure was associated with a 4% rise in income per capita (OECD, 2003).