Economic Globalization 2 Sociology 2, Class 7 Copyright © 2008 by Evan Schofer Do not copy or distribute without permission

Announcements Agenda Today: Lecture on Economic Globalization Midterm in 2 weeks: May 6 I will provide info about format soon – probably Thursday. I will provide a review sheet There will be a midterm review in section.

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

Econ Globalization: Production Production: The creation of 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 Or, it was a little bit global Ex: raw materials were imported, but all else was local Now, it is common for auto production to span dozens of nations Parts made in various places, assembled in various places… Ex: Picture in Knox/Agnew/McCarthy text (on next slide).

Toyota’s Global Production System

Econ Globalization: Production Extent to which production is global: Moderate Much more global than in the past… But, a lot of production remains within national borders.

Econ Globalization: Production/Trade Trade: The exchange of goods & services Historically, trade was local But, the word has become synonymous with “international trade”, which is global by definition Extent of globalization: High Global trade was fairly 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 BUT: trade is primarily concentrated among wealthy nations It isn’t global in the sense that all nations participate a lot…

Econ Globalization: Capital Capital Flows: Movement of assets (money) across national borders to purchase intangible investments Also called: Financial flows, globalization of capital markets 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 Causes much concern… Elwood mentions: “Pinball capital” Extent of globalization: Extremely high But, again, mainly concentrated among rich countries.

Econ Globalization: Labor Labor: people who work in the economy Like capital or goods, people can move across national borders: Immigration Extent of globalization: LOW, arguably decreasing 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 tiny fraction of the global population Moreover, labor flows tend to be regional, rarely global.

Econ Globalization: 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 They can have a main country, with 1 or 2 factories overseas Or, they can be spread literally across the globe Extent to which corporations are “global”: Moderate The vast majority of companies are still local And many multinationals are concentrated in a few countries But, multinationals have grow in number and size Some dwarf the economic capacity of entire countries… More on this later…

Econ Globalization: Direct Investment Foreign Direct Investment (FDI): Definition: Investing assets (i.e., money) from one country into organizations, structure, and equipment in another Example: building (or buying) a factory in another country Note: does not include “intangible” investments, such as buying stock in a company Extent of global FDI: Moderate Most investment is between wealthy, industrialized countries; Poor countries don’t participate much.

Economic Globalization: Origins Question: What are some basic things that are absolutely required in order to have a global economy? 1. Inexpensive transportation & communication 2. International financial (money) system 3. Countries that are willing to participate Removal of legal or regulatory “barriers”

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 long 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 (or 1000’s) of containers!

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

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

Containerized Shipping Question: Guess how much it costs to send a 40 foot shipping container with 10,000 pounds of cargo from Shanghai, China to Los Angeles? Answer: Less than $4,000 Taxes, tariffs, etc. make it cost a bit more… Question: How many pairs of Nike shoes fit in a container? Answer: over 10,000!

Containerized Shipping Consequence: Containerized shipping resulted in a dramatic increase in global trade Example: Container holds 10,000 pairs of shoes Container costs $5,000 to ship (including taxes) Total cost of shipping per pair: 50 cents! If cost of making a shoe in China is 51 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.

Containerized Shipping Containerized shipping has indirect consequences for the environment… Some examples: Companies can dump garbage in other countries Anything that is costly to dispose of in the US Hazardous waste; Old computers Mass shipping leads to spread of “invasive” non-native species Examples: Asian Tiger mosquito, Zebra mussel arrived in cargo ships.

International Financial System Another barrier to the global economy: Money Example: Suppose I build and sell computers… What if someone from Europe wants to buy one? They only have European money: Euros Problems: 1. I don’t want Euros – they are useless to me 2. How much is my computer worth in Euros money? 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.

The Gold Standard The gold standard is one solution to trade in a world of multiple currencies To sell a computer to someone in Europe, I can directly convert price US$ 1,000 computer = 35 ounces of gold = 700 Euros European gives 700 Euros to his bank… converts to gold Gold is given to US central bank; US$ 1,000 given to me Result: International trade is possible!

The Gold Standard Issue: If trade is one sided, gold drains from one country to another A “trade imbalance”, or a “current accounts deficit” Consequence European banks have less gold, issue fewer Euros Money supply shrinks European economy slows down, imports reduce… Result: System prevents asymmetric trade; system stays in equilibrium.

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 (e.g., hired people to build roads) to increase consumption 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 The process is described by Herman Schwartz: “International Money, Capital Flows, and Domestic Politics.” 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…

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. Ex: Selling a computer to someone in Europe European goes to the currency market (bank) to buy US dollars – to pay me for the computer Current exchange rate: .63 European pays .63 Euros to get each US$ Therefore, a US$ 1,000 computer costs 630 Euros…

Currency Value Examples Country Currency Number per US$ Europe Euro 0.77 Canada Dollar 1.18 China Yuan/RMB 7.76 India Rupee 43.95 Japan Yen 120.35 Mexico Peso 10.92 South Korea Won 932.95 Thailand Baht 41.29 United Kingdom Pound .507 As of February 6, 2007

Floating Exchange Rates Why do currencies “float”? Float = change values compared to each other Answer: Changing supply and demand affects value Example: Suppose I sell 10,000,000 computers Europeans will sell 6.3 billion Euros to banks in order to purchase 1 billion US$… If banks (currency markets) are flooded with Euros, supply increases, value drops… Currency markets don’t want more Euros Banks will give fewer US$ in exchange

Floating Exchange Rates Trading patterns are in an equilibrium with currency exchange rates If trade is balanced, currencies stay the same Balanced means Europeans buy US goods just as much as US citizens by European goods Both countries exchange an equal amount of currency If trade is imbalanced one side must sell more of their currency Ex: If Europeans import more, they sell currency and the Euro loses value Result: Low currency value makes imports “expensive”; Thus, imports slow down…

Trade & Exchange Rates As currency values change, trade is affected Example: Suppose the Euro becomes more valuable relative to the dollar: Value of dollar drops from .63 Euros to .10 Euros Euro worth 1.58 US$, goes up to 10 US$ How much would a US$ 1,000 computer cost to a European? Answer: Only 100 Euros! When a currency goes up relative to others, it is cheap to import If currency value drops, imports become expensive.

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

Trade & Exchange Rates Recent news article: WASHINGTON (AP) -- America's beleaguered manufacturing companies, chafing over the loss of 2.7 million jobs over the last three years, vowed Wednesday to press ahead harder to get China to stop manipulating its currency to gain trade advantages. (Associated Press) Issue: China keeps value of currency low Aids exporters, at expense of US companies

Trade & Exchange Rates Issue: Countries can strategically alter their currency values to gain an advantage in trade Example: High US imports should cause Chinese Yuan to rise relative to the US$ But: China floods market with Yuan, buys US$s Yuan value stays low compared to US$ Result: Chinese exports remain cheap for Americans Result: American manufacturing companies = Angry! Note: US did the same thing in the 1970s.

Exchange Rates & Volatility Capital flows and currency volatility can produce severe crises Example: Mexico in 1994 Companies bought lots of stock, investments in Mexico over several years… Panic selling in 1994 made stock market plummet Investors sold stocks, converted pesos to dollars Result: Value of pesos plummeted! Made the financial problems much worse.