LOSING CONTROL (7 page)

But it’s not just borders that are being redrawn.
International relations are also constantly evolving.
If we go back to the late 1960s, when China was completely shut off from the rest of the world, where the Cultural Revolution was at its height and when President Nixon’s visit to Beijing was still fantasy rather than fact, we go back to a time when US companies built factories mostly in the US.
US workers didn’t have to worry about competition from Chinese workers because the Chinese had no access to the world’s best capital (and, even if they did, it would presumably have been destroyed in the madness of the Cultural Revolution).

Now move forward to the 1980s.
In a new spirit of openness, the Chinese authorities welcomed an influx of capital from the West.
Suddenly, companies that previously had to tie their capital to expensive Western labour could, instead, relocate their capital to China to take advantage of cheap Chinese labour.
The exodus of capital enabled companies to produce products more cheaply (which is why the price of manufactured goods, in particular, has come down so rapidly in recent years), clearly benefiting consumers all over the world.
But falling goods prices meant that companies and workers still operating in the US found themselves suffering a persistent deterioration in their terms of trade.
No matter how hard they worked, their profits and wages came under persistent downward pressure (the slow demise of General Motors and Chrysler owes much over the long term to this process).

The Ricardian model of comparative advantage thus works best if each country is endowed with a certain mix of factors of production that cannot easily be transferred (Portugal has a comparative advantage in the production of wine because its climate and soil offer better opportunities for wine producers than wet and windy England).
If, however, these endowments can shift, it’s no longer clear that comparative advantage works so well: shifting factors of production destroy the economic rents of those who were lucky enough not to have been properly exposed to competition before.
In this sense, it’s not obvious that everyone benefits from free trade even if global output is raised.
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Ricardian assumptions worked better in the 1950s and 1960s, a world in which capital flows across borders were relatively limited and where trade flows took place between a group of economically ‘like-minded’ OECD countries.
The world has substantially changed since then.
Indeed, conditions have changed so much that it is no longer clear what the process of ‘exporting’ actually involves.
According to the Oxford English Dictionary, to export is ‘to send (goods or services) to another country for sale’.
An easy definition, admittedly, but it doesn’t entirely capture what is taking place economically.
Many exports these days take place within firms as part of global production platforms: any internal ‘sale’ is economically meaningless.

A good way to understand the problems associated with changing global trading patterns comes from Japan’s economic experience since the 1990s.
Japan’s economic miracle – a combination of exceptionally strong growth and generally low inflation – came to an abrupt end at the end of the 1980s.
Policymakers in the US and
Europe tend to argue that Japan’s failures stemmed from a disinclination to use macroeconomic policy to reflate Japan’s economy in the wake of the collapse in share and land prices in the early years of the 1990s, which, in turn, contributed to a world of deflation.
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Japanese policymakers hold a rather different view.
With the ticking clock of population ageing, Japan’s economic expansion was going to slow in any case.
In addition, policymakers rightly recognize the changes forced upon the Japanese economy and, in particular, on its industrial sector by China’s re-awakening.
These massive structural shifts are known as kudoka or ‘hollowing out’.

At first sight, it’s not obvious what was going on.
The share of Japanese exports going to China steadily increased from the beginning of the 1990s.
In 1990 itself, a mere 2.1 per cent of Japan’s exports went to China.
Five years later, the number had more than doubled to around 5 per cent.
By 2001, the share had risen to 7.7 per cent and, by 2008, it was up to 16 per cent.
On the face of it, then, China’s emergence has been great news for Japan: Japanese exports to the Middle Kingdom have soared in recent decades.

So why are Japanese policymakers so uneasy about this process?
Other than the mutual scars of history, the key concern is the composition of Japanese exports to China.
Since the early 1990s, Japan’s exports to China have been dominated by exports of capital goods – most obviously, machinery of one sort or another – and industrial materials.
Given low incomes per capita in China, this is perhaps not surprising: China needs all the capital goods it can get to drive the process of industrial catch-up that will take its people into the twenty-first century; Beijing’s subway system, for example, is tiny compared with the London Underground, even though Beijing’s population is somewhat larger.
In the process, China has become the emerging world’s single biggest recipient of foreign direct investment.

This development, though, has proved to be a major threat to Japan’s industrial structure.
Japanese multinationals used to depend
for their supplies of industrial components on the domestic so-called keiretsu firms, which were typically competing with each other for the attentions of the Japanese multinational ‘sole-buyer’.
As Japanese multinationals headed elsewhere for their supplies in the 1990s in a bid to lower costs, so China gained and the domestic Japanese keiretsu lost out.
Expensive Japanese workers were, in effect, replaced by cheaper Chinese workers who could perform similar tasks at a fraction of the price.
In this sense, the export of capital goods from Japan to China was synonymous with the export of jobs.
While this was good news for Japanese multinationals, able to reduce their dependency on Japanese suppliers alone and, therefore, to increase their profits, the impact on the Japanese industrial base was less encouraging.
‘Hollowing out’ contributed significantly to Japan’s stagnation in the 1990s and beyond.
For the average Japanese citizen, it’s not at all obvious that the opportunities presented by the emerging superpower across the way were entirely golden, no matter what the export data suggested.
Japan’s growth rate dropped from around 4 per cent a year in the 1980s to only 1 per cent a year thereafter.
Even if Japan’s multinationals – and their foreign shareholders – may have benefited from a new ‘global’ strategy, this has not necessarily brought many benefits for the Japanese people.
While many Japanese companies are well-established household names, the Japanese stock market, replete with companies vulnerable to the process of hollowing out, has delivered an abysmal performance since the beginning of the 1990s.
Meanwhile, wages have stagnated and, by Japanese standards, unemployment has remained painfully high.

Put another way, Japanese multinationals are no longer Japanese in the conventional sense.
They may be headquartered in Japan but, in many ways, they are no more beholden to their domestic economy than any foreign company that might choose to operate in Japan.
For multinationals, national borders are increasingly irrelevant.

Japan’s ‘hollowing out’ process has also increasingly been seen elsewhere.
The World Investment Report (WIR), published on an annual basis by the United Nations Conference on Trade and Development (UNCTAD), contains a wealth of useful information on multinational investments in foreign lands.
At the last count, 71,385 foreign companies had bases in the Czech Republic, while Romania had 89,911, Hungary 26,019 and Turkey 18,308.
The biggest of all, though, was China: 286,232 foreign companies were based there in 2007.

These trends are set to continue.
Surveys conducted by UNCTAD persistently show that favoured destinations for future foreign direct investment include China, India, the Russian Federation, Brazil and Vietnam, alongside the US.
Few European countries make it to the top ten: Germany and the UK are clinging on for dear life.

There is nothing new, of course, in the idea of companies operating at the regional or global level.
Companies often open plants in other parts of the world either to reduce the risks associated with protectionism (Japanese car companies to the US in the 1980s) or to produce goods to reflect local needs (US car companies to Europe in the 1950s and 1960s: the Pontiac Catalina would have struggled to find its way through the narrow streets of London, Rome or Paris).
Ranked by size of foreign assets, the top ten non-financial multinationals are what might reasonably be described as ‘the usual suspects’.
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What is new, however, is the increased motivation to invest in other parts of the world as a result of access to workers who are willing to work for much lower wages than those on offer in the developed world.

It’s worth spending a moment or two reflecting on how extreme the differences are.
In 1960 an average Chinese citizen’s per-capita income was 3 per cent of an American’s.
By 1970, following the Cultural Revolution, the ratio had dropped to just 1.5 per cent before rising to around 5 per cent in the first decade of the new century.
China’s living standards have thus risen quickly since the 1970s but, on average, Chinese incomes are still very low.
Brazil and Russia are doing little better, with incomes per capita around 12 to 15 per cent of those in the US in recent times; in relative terms, this still leaves them in the position last held by Japan in 1960.
India, meanwhile, remains extremely poor, with per-capita incomes less than 2 per cent of the US average.
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In previous centuries, workers in these countries had no access to global capital.
Now they do.
David Ricardo’s theory of comparative advantage no longer applies.
His arguments were based on the assumption that factors of production could not travel across borders.
The rapid growth of the emerging economies, however, depends critically on the ability of capital, in particular, to hop across borders with impunity.
And so it has proved to be.
The motivation for companies, domestic or multinational, to invest in these countries is not so much because their investments provide access to billions of new consumers who might buy their products (although there are plenty of eager emerging consumers keen to be seen with Gucci loafers, Louis Vuitton handbags or Cartier trinkets) but, rather, because factories can recruit cheap labour.
Economists often talk about the advantages of trade, but this is more a story about a major global redistribution of income, from those who have always enjoyed access to the best capital to those who, for the first time, have managed to place their feet on the rungs of the development ladder.

Japan’s ‘hollowing-out’ experience may be happening elsewhere.
US trade experience in recent years, for example, is certainly consistent with the Japanese story.
In 1988, the year before the Berlin Wall came down, China accounted for 1.6 per cent of US export of goods.
Ten years later, China accounted for 2.1 per cent of US exports.
By 2008,
that share had risen to 5.5 per cent, overtaking Japan (5.1 per cent), Germany (4.2 per cent) and the UK (4.1 per cent) in the process.

China is not the only emerging economy to become an important destination for US exports.
Also playing a crucial role in 2008 were Mexico (11.7 per cent), Brazil (2.5 per cent), an assortment of other Latin American economies and the United Arab Emirates (1.2 per cent).

At the margin, exports to emerging economies are beginning to dominate world trade.
For any given increase in US exports, for example, an expanding proportion is likely to be heading to the emerging world.
Some simple arithmetical manipulation can be used to calculate so-called ‘percentage-point contributions’ to overall export growth.
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These calculations can be used to explain what proportion of any given increase in exports is heading to any one country or region.
Not surprisingly, the main drivers of US export growth are Canada and Mexico (this was the case even before the signing of the North American Free Trade Agreement).
Elsewhere, however, there have been some major changes.
China didn’t make any sort of impression in 1988 but has rapidly moved up the rankings since then.
So has Brazil.
Japan, meanwhile, has headed in entirely the opposite direction: it may still account for over 5 per cent of US exports but its contribution to US export growth has been in rapid decline.
France and the UK have also fallen by the wayside.
The United States’ most important trading partners, those helping to shape the country’s economic future, now come from the poor South and West and not, as was true for many decades, from wealthy Europe.

The US is not the only country to have experienced huge changes in exports patterns in recent years.
As an export destination, the US itself is on the wane: although it still accounts for a large share of German, French, British and Japanese exports, it is less important than it once was.
The growth markets are to be found elsewhere: for
Europe, China, Russia, Poland, the Middle East and other countries in Asia all score increasingly highly.