Economic Globalization Sociology 2, Class 6 Copyright © 2014 by Evan Schofer Do not copy or distribute without permission

Announcements Announcements None! Agenda Today: Economic Globalization

States, Markets, Globalization Since around 1980 governments have shifted Keynesian / Welfare-state systems  free markets Why? Commanding Heights: Success of Hayek’s ideas; Elections (Reagan/Thatcher) Reich (Supercapitalism) New technologies & greater competition New/smaller companies could compete with the “giants”… challenged old regulations

Economic Globalization Simple definition: When economic activity that was formally local or national scale becomes organized on a global scale Spanning countries, rather than contained within them Examples: Globalization of… Trade / exchange Production Corporations Labor “Direct” Investment Capital I’ll define & discuss each.

Globalization: Trade Trade: The exchange of goods & services History: Historically, trade was local But, the word has become synonymous with “international trade”, which is global by definition History: Global trade was common in the late 19th century International trade amounted to 8% of GDP by 1913 But, trade collapsed during WWI, Depression, WWII Since World War II, trade has grown rapidly Trade surpassed 17% of world GDP in the 1990s NOTE: trade is concentrated among wealthy nations.

Global Trade 1950-2010

Trade: manufacturing vs agriculture Red indicates exports of manufactured goods

Globalization of Production Production: Creating products and services Example: Building a car Where do the raw materials come from? Where are parts made? Where is assembly done? In the past, auto production was primarily local Ex: raw materials were imported, but rest was local Now, it is common for auto production to span dozens of nations Parts made in various places, assembled in various places… Ex: Toyota’s globalized production system (on next slide).

Toyota’s Global Production System

Globalization of Production Global supply chains A “supply chain” refers to the steps through which raw materials are transformed into components and finally into a final product Cotton  woven cloth  shirt Because of decreased transportation costs, “The old [mass] production system could now be fragmented and parceled out around the world to wherever pieces could be done best or most cheaply.” Reich, ch 3 p 62.

Supply Chain: TV

Globalization of Production Reich “Supercapitalism” With globalization, America began to import much of what it consumes BUT: Aggregate trade statistics hide the fact that much of the trade occurs WITHIN American companies Part of supply chains… Implication: It is an oversimplification to say that foreign companies are ‘outcompeting’ US firms “Rather than American companies ‘losing their competitiveness’ … America started losing solely American companies.” The success of American companies no longer implies better wages & conditions for US workers.

Globalization of Production The globalization of production has limitations Issue: Economies of Agglomeration Geographical concentrations of knowledge, expertise, and production capacity create big benefits When you get lots of production concentrated in one place, companies can coordinate better 1. Detroit, Michigan (auto industry), 1950s-1970s Parts suppliers/factories/skilled workers all plentiful 2. Silicon Valley (computer industry) Stanford U (engineering expertise), venture capital, factories 3. Shenzen, China (electronics manufacturing) Engineering expertise, cheap labor, factories

Economies of Agglomeration Why are iphones made in China? NYT article: http://www.nytimes.com/2012/01/22/business/apple-america-and-a-squeezed-middle-class.html “In part, Asia was attractive because the semiskilled workers there were cheaper. But that wasn’t driving Apple. For technology companies, the cost of labor is minimal compared with the expense of buying parts and managing supply chains that bring together components and services from hundreds of companies. [It] “came down to two things,” said one former high-ranking Apple executive. Factories in Asia “can scale up and down faster and “Asian supply chains have surpassed what’s in the US” “The entire supply chain is in China now,” said another former high-ranking Apple executive. “You need a thousand rubber gaskets? That’s the factory next door. You need a million screws? That factory is a block away. You need that screw made a little bit different? It will take three hours.” “Another critical advantage for Apple was that China provided engineers at a scale the United States could not match. Apple’s executives had estimated that about 8,700 industrial engineers were needed to oversee and guide the 200,000 assembly-line workers eventually involved in manufacturing iPhones. The company’s analysts had forecast it would take as long as nine months to find that many qualified engineers in the United States.” In China, it took 15 days.

Foreign Direct Investment (FDI) Definition: Investing assets from one country into organizations, structures, and equipment in another Example: building (or buying) a factory in another country FDI does not include “intangible” investments, such as buying stock or currency in another country Recall: investment increases economic growth Countries like to attract FDI…

Capital Flows Capital Flows: Movement of assets (money) across national borders to purchase intangible investments Also called: Financial flows, globalization of capital markets, capital market integration Example: Buying stocks & bonds in another country Example: Buying other currencies for purposes of speculation (i.e., profit) Unlike FDI, capital investments can move quickly… flowing in and out of countries Elwood reading: “Pinball capital” Can precipitate or worsen economic crises

Labor (workers) Labor: people who work in the economy People can move across national borders: Immigration Historical perspective: Like trade, immigration was common in the late 19th century, but dropped in the mid 20th century Due to immigration laws, migration remains constrained Migrants represent a small fraction of the global population Moreover, labor flows tend to be regional Labor is an example of something that isn’t very globalized Mainly due to laws limiting immigration.

Multinational Corporations

Corporations Corporations can span national nations… Called: Multi-national corporations (MNCs); Multi-national Enterprises (MNEs); Trans-national corporations (TNCs) Firms can vary in extent they are global Sometimes only 1 or 2 factories overseas Or, they can be spread literally across the globe The majority of companies are still local But, multinationals have grow in number and size Some dwarf the economic capacity of entire countries…

What is most globalized? Some things are more globalized than others… How Global? Extremely Capital flows Very Trade Moderately Corporations, FDI, Production Not so much Labor (workers)

Video: Commanding Heights Episode 3, chapters 3-6 Time: 3:30 (or 6:15) to 28:00 Basic issues regarding trade, capital flows Global link: http://www.pbs.org/wgbh/commandingheights/lo/story/ch_menu_03.html Local link: Video\PBS.Commanding.Heights.Ep3.The.New.Rules.of.the.Game.DivX6.avi

Economic Globalization: Origins Basic requirements for global economy 1. Inexpensive transportation & communication 2. International financial (money) system 3. Countries that are willing to participate Absence of legal or regulatory “barriers” Shift from Keynesian policies  free markets.

Transportation Historically, people only traded lightweight, valuable items… spices, silk, ivory, etc… Things that could be easily carried long distances Global economic activity requires cost-effective transportation systems Otherwise most business activity remains localized Most changes are pretty obvious: increase in cars, trucks, planes, trains, ships… But, one change matters more than others: containerized shipping

Transportation Containerized shipping = a huge revolution in global transportation Started in the 1970’s Shipping containers: a standard 40ft box Easy to load and unload onto ships, trains, trucks Drastically reduced cost of shipping Huge ships can hold thousands of containers!

Containerized Shipping: Pics Ships can hold hundreds of containers!

Containerized Shipping: Pics Containers allow mechanical loading Pics: from Maersk Sealand Website

Containerized Shipping: Pics Containers can be transferred to trains, trucks

Containerized Shipping A 40 foot container can hold 10,000 pairs of shoes Cost to send a 40 foot shipping container with 10,000 pounds of cargo from Shanghai, China to the port at Long Beach Around $3,500 Taxes, insurance, etc. make it cost a bit more…

Containerized Shipping Consequence: Containerized shipping resulted in a dramatic increase in global trade Example: Container holds 10,000 pairs of shoes Container costs $3,500 to ship (including taxes) Total cost of shipping per pair: 35 cents! If cost of making a shoe in China is 36 cents less than in US, then there is an incentive to ship… Higher costs might come from: more expensive labor, costs of adhering to environmental laws, etc.

International Financial System Another barrier to the global economy: Money Suppose I build and sell computers… What if someone from Japanwants to buy one? They only have Japanese money: Yen Problems: 1. Yen aren’t useful to me in the US 2. How much is my computer worth in Yen? Even if I would accept the money, I don’t know the value…

International Financial System In order to conduct trade, there must be an international system to handle currencies Example: The Gold Standard For every dollar the government prints, they hold a corresponding amount of gold in the bank Value of all currencies = tied to a common “standard” Example: US$1 = 1/35 ounce of gold Other currencies might have a different value: Example: Euro = 1/20 ounce, Yen 1/300 ounce

The Gold Standard The gold standard is one solution to trade in a world of multiple currencies If someone in Japan wants to buy my computer, they can convert Yen to gold International transactions paid in gold Then, I can convert gold to US$ Result: International trade is possible!

The Gold Standard The gold standard fell apart in the depression Governments wanted to boost their economies… Question: What are some ways the government can boost their economy? Governments increased spending The “New Deal” used stimulus to hire lots of workers & build infrastructure Goal was to boost the economy in the depression This required printing more money… even though gold supply didn’t expand Currencies were no longer tied to gold… Trade became difficult.

Bretton Woods Plan B: The Bretton Woods agreement helped to re-establish an international financial system New plan: U.S. Dollars would serve as the currency for international transactions US dollars would have a fixed value vs. gold Other currencies would have a fixed exchange rate versus the dollar Everybody was happy again… for a while…

Bretton Woods The Bretton Woods system also fell apart Basic Problem: The fixed exchange rates works only if trade and capital flows are small … compared to the size of the US economy Eventually, when global trade flows harmed the US economy, the US changed the system… The process is described by Herman Schwartz: “International Money, Capital Flows, and Domestic Politics.”

Floating Exchange Rates Plan C: The system of floating exchange rates Value of currencies is determined by market Like the price of commodities: oil, wheat, etc. Selling a computer to someone in Japan: Person in Japan goes to the currency market (bank) to buy US dollars Current exchange rate: 103 Yen per dollar Therefore, a US$ 1,000 computer costs 103,000 Yen

Currency Value Examples Country Currency Number per US$ Europe Euro 0.73 Canada Dollar .987 China Yuan/RMB 6.05 India Rupee 62.08 Japan Yen 103 Mexico Peso 13.4 South Korea Won 1077 Thailand Baht 32.8 United Kingdom Pound .60 As of Jan 23, 2014

Trade & Exchange Rates Currency values affect trade: Example: Suppose the Yen becomes more valuable relative to the dollar: From 103 yen per US$  10 yen per doller How much would a US$ 1,000 computer cost to a European? Answer: 10,000 Yen (as opposed to 103,000) When YOUR currency goes up relative to others, it is cheap to import If currency value drops, imports become expensive.

Trade & Exchange Rates Who benefits if Yen goes up relative to the US$? 1. Japanese consumers – they can buy American products cheaply 2. American exporters – they can sell lots more to Japan Who Loses? 1. American consumers – Japanese imports costs more 2. Japanese companies – can’t compete with cheap US imports

Floating Exchange Rates Why do currency values “float” (change)? What forces affect supply and demand? 1. Asymmetric trade If a country imports more than it exports, its currency drops Ex: US has a current accounts deficit with Japan (imports more than it exports) To purchase Japanese goods, Americans must sell dollars, buy Japanese Yen Demand drives up value of Yen relative to the dollar.

Floating Exchange Rates Example: The effects of asymmetric trade on currency values Suppose I sell 10,000,000 computers Japanese will sell 103 billion Yento banks in order to purchase 10 billion US$… If banks (currency markets) are flooded with Yen, supply increases, value drops… Currency markets don’t want more Yen Banks will give fewer US$ in exchange

Floating Exchange Rates What forces affect currency values? 2. Asymmetric capital flows If capital moves into a country, its currency goes up Ex: In early 1990s, global investors moved money into Thailand, Mexico… raising the value of currency If capital moves out of a country, its currency goes down Investors feared problems in Mexico, Thailand… pulled money out Thai Baht and Mexican Peso dropped in value

Floating Exchange Rates What causes asymmetric capital flows? 2. a. Interest rates If a country raises interest rates, its currency goes up Reason: Foreign investors prefer high rates The “electronic herd” is attracted to high rates… If a country cuts interest rates, its currency drops Investors would prefer moving money into countries where banks pay higher interest… Important issue: Globalization limits the ability of governments to control their own monetary policy Sometimes countries want to lower interest rates to boost the economy… But can’t because it would hurt their currency

Floating Exchange Rates What causes asymmetric capital flows? 2. b. Anything else that “scares” investors Government instability Concern that an economy isn’t going to do well Ex: Fears that Thailand was going “bust” Policy changes that investors don’t like Ex: big increase in taxes Shift away from free-market policies (“golden straightjacket”) All of these things can cause investors to pull their money out of a country quickly, harming currency values.

Floating Exchange Rates What forces affect currency values? 3. Countries can intervene strategically to alter their currency values Governments can sell their currency to lower its value They buy other currencies on global markets Governments can buy their own currency to raise its value They spend “reserves” of gold or other currencies on global markets This requires lots of money, so rich countries can do it more.

Trade & Exchange Rates Issue: Countries can strategically alter their currency values to gain an advantage in trade Asymmetric trade with China should cause Chinese Yuan to rise relative to the US$ The US imports much more than it exports But: China floods market with Yuan, buys US$ Yuan value stays low compared to US$ Result: Chinese exports remain cheap for Americans Result: American manufacturing companies = Angry! Note: Only big/wealthy countries can do this US did a similar thing in the 1970s Thailand tried, but ran out of money… it’s currency suddenly plummeted.

Financial Flows & Exchange Rates Issue: Trade & financial flows have same impact on currencies Asymmetrical flows cause currency values to change But remember: Investment flows are larger than trade flows, and they can happen much faster Elwood: “pinball capital” Result: global investors can cause currency values to change rapidly Called: market volatility (rapid change in value) If a currency value falls too low, serious economic problems arise.

Exchange Rates & Volatility Capital flows and resulting currency volatility can produce severe crises Example: Mexico in 1994 Global investors bought lots of stock, investments in Mexico over several years… This caused a slow rise in the peso. Not a problem. A minor political crisis led to panic selling in 1994 The stock market began to plummet Global investors rushed to sell stocks, converted pesos to dollars Result: Selling of pesos made the value of pesos plummet!

Video Commanding Heights, Ep 3, chapter 7 Time: 27:50 – 32:45.

Exchange Rates & Volatility Why was it bad for the value of pesos to drop severely, rapidly? 1. Suddenly, imports were very expensive Price of gas shot up Businesses dependent on imports couldn’t afford costs; potential for bankruptcies 2. Many Mexican companies had borrowed money from US banks US banks must paid in $, not pesos If pesos are worth little, suddenly can’t afford to pay loans Result: More bankruptcies, economic recession.

Exchange Rates & Volatility In the case of the 1994 peso crisis, the US government stepped in Provided emergency loans, etc., to prevent massive bankruptcy But, that was just a small crisis… It is clear that crises could occur that are too large to stop so easily.

Asian Financial Crisis Commanding Heights Video: In the 1990s, foreign investors moved capital into Asia And, foreign banks lent money to Asian companies at very low interest rates Consequence: Rapid economic growth Economies “heated up” But, capitalism is prone to boom-bust cycles… Companies built more factories and housing than needed The “boom” ended But – global dynamics made the “bust” much worse!

Asian Financial Crisis How did globalization prompt a crisis for Asian economies in the 1990s? 1. Investors pulled out quickly – affecting currencies Asian currency valued dropped… Imports became expensive Companies could no longer pay off loans to foreign banks Bankruptcies, unemployment…

Asian Financial Crisis How did globalization prompt a crisis for Asian economies in the 1990s? 2. Contagion Worries about Thailand spread to other Asian countries Self-fulfilling prophecy: fear of problems caused investors to pull out, creating real problems Also, many US companies were invested in Asia (or had made loans)… Now they were losing money Lesson: Integrated economies mean that crises tend to spread… Example: US financial crisis caused economic disruption around the globe.

More Video: Commanding Heights Topic: Asian financial crisis, spillover to other regions… Video: 40:48 to 48:10 Asian economic miracle Video: 48:10-1:14:30 Asian financial crisis and contagion