Globalization, once a somewhat esoteric economic issue, has gained prominence in recent years. Political developments in the United States, the Brexit tangle involving Britain and Europe and a flurry of international trading agreements are a prominent few among many issues worldwide.
Greg Ip, the author of "The Little Book of Economics: How the Economy Works in the Real World," wrote in chapter six about the gravitational pull from other nations and regions. “When you study economic growth, jobs, and interest rates you have to keep in mind that globalization is exerting an often hidden influence, the way a distant planet’s gravitational pull alters another planet’s orbit,” he wrote.
Ip noted that global trade has outpaced world gross domestic product since the 1950s; some countries—including China, Germany and Israel—get more than 40% of their GDP from international sales. Ireland gets more than 80% of its GDP from exports.
The U.S. does not depend as much on international trade; nevertheless, its exports rose from about 5% of GDP in the 1960s to 14% in 2012. That near-tripling of growth has gone hand in hand with the growth of many formerly poor countries, which now want—and can afford—American products. Those economies now represent more than a third of the world’s GDP, nearly double the number in 2000.
But looking only at the export side misses something important. Ip explained:
“We usually think the benefit of international trade is more exports. But that’s a blinkered view. Imports are just as important, perhaps more important, because they enrich consumers. Think of all the things you’d forsake if borders were closed: fresh fruit and tropical flowers in the dead of winter, British novelist J. K. Rowling’s Harry Potter novels, cheap oil from Saudi Arabia (okay, a mixed blessing), Hyundais.”
The author next moves to the issue of comparative advantage among nations. Offering a couple of analogies, Ip noted that parents hire nannies so both parents can work and earn more than they could if one of them stayed home to mind the child or children. Similarly, rich countries buy toys and clothing from poor countries, so their workers can earn more by doing more complex and financially rewarding work. Again, the people of a trading nation become more prosperous.
They also get more choice as consumers when, for example, French companies sell Renaults to Germany, while Germany exports Volkswagens to France. So globalization isn’t just about access to cheaper products, it’s also about giving us buying options that otherwise would not exist.
And then there is the contentious issue of outsourcing, of getting jobs done in other countries; for example, Ip noted that foreigners read Americans’ X-rays, take their hotel reservations and report on town council meetings.
Americans have found this even more disturbing as foreigners expanded their outsourcing capabilities from manual labor to intellectual labor. Again, the obvious is not the full picture:
“A study by Ashish Arora, Lee Branstetter, and Matej Drev argues that the American technology industry recaptured the lead from Japan’s in the 1990s by tapping cheap foreign talent either in India, or working in the United States on temporary visas, for routine software programming. This freed up their more innovative engineers to work on transformative projects, raising their productivity.”
So why would anyone pay American workers more than a Chinese or Indian worker? Because of their greater productivity, which includes not only the American worker’s education and tools, but the broader social, economic and political infrastructure. Ip cited these advantages enjoyed by American workers:
- Advanced equipment, including high-quality telephone and internet cables.
- Highways that get them to work and their products to markets.
- Trustworthy courts to enforce contracts and settle commercial disputes.
Ip added that American workers are especially strong when the products include lots of intellectual content; music and film, for example, make up roughly a third of American exports. Consider, too, that three of the world’s tallest skyscrapers were designed by American architects and structural engineers.
He also gave readers the Apple (AAPL, Financial) iPods case, as described by the Personal Computing Industry Center: It has far more employees in China than in the U.S., but Americans collect 70% of Apple wages, while Chinese workers get just 2%.
Next on the list of globalization topics was trade balances, deficits and surpluses. Ip reported that countries may swing from trade deficits to surpluses, and vice versa, because of several short-term influences:
- Consumer health: For example, if European consumer demand is weak while demand in the U.S. is strong, Americans will import more from Europe and export less.
- Export and import prices: Ip used the example of Russia’s trade surplus soaring in the decade of the 2000s because of its oil and gas exports. But when those prices sour, Russia is more likely to suffer a trade deficit.
- Exchange rates: Lower currencies make exports less expensive and imports more expensive, so a lower currency rate will shift a country toward a trade surplus and away from a trade deficit.
In addition, different countries have different saving and spending habits, which will make a difference in trade balances. Ip noted that Americans consistently consume and invest more than they produce. Because of the extra consumption, Americans are more likely to have a trade deficit. On the other hand, Germany, with an aging population and an “obsession” with saving, will be more likely to have a trade surplus.
So is globalization good for Americans overall? According to a study by three academics, the average U.S. household is $10,000 per year richer because of the expansion of trade since the end of World War II.
Despite that, protectionism is still preferred by many. That makes sense when we realize that free trade involves a trade-off between the benefits to consumers and the costs to producers. Lowering tariffs or loosening import barriers is good for all consumers who will each receive a small benefit. But while there are far fewer producers and employees of the producers, they pay a high cost and quickly complain to their political representatives.
A dramatic illustration of such thinking occurred in 1930 when President Hoover signed the Smoot-Hawley Tariff Act. It raised tariffs on thousands of products and worsened international trade, to the detriment of consumers. It also accelerated the economic collapse and helped turn a recession into the Great Depression.
In the wake of World War II and the Great Depression, world leaders created the international body that later became known as the World Trade Organization. Member states in the organization agree to common rules about exporting and importing, thus keeping a leash on protectionism. In addition, there are many trade agreements such as NAFTA (the North American Free Trade Agreement) and the European Union, which are regional trade agreements, as well as many bilateral agreements between specific nations.
Globalization, for new investors
Almost all economists agree that globalization, and free trade among nations, is a good thing, primarily because of the benefits to consumers (who are essentially all the people) and despite the losses suffered by some producers and their employees.
Globalization is also good for investors. It allows them to search out risk management opportunities by investing in equities with different foundations. For example, bank stocks in India are unlikely to have the same risk profile as banks in North America; this is a form of diversity that protects investors (although that idea now comes with caveats, thanks to the subprime crisis of 2008).
It also allows investors to search for bigger and better opportunities. For example, there are growing middle classes in many emerging nations, and in countries such as China and India the middle classes are becoming massive. The consumers in these nations have a voracious appetite for the goods and services taken for granted in the economically developed nations.
The rise of globalization also allows investors to add international flavors to their domestic stocks. Companies such as Coca-Cola (KO, Financial), Microsoft (MSFT, Financial) and Federal Express (FDX, Financial) all do business around the world. As a result, they have new opportunities for growth and diversification.
In summary, chapter six of Ip’s book, "The Little Book of Economics: How the Economy Works in the Real World," provided a look at globalization and some of its many facets. In addition, I added a section on globalization and investing.
(This article is one in a series of chapter-by-chapter digests. To read more, and digests of other important investing books, go to this page.)
Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.
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