Thursday, August 11, 2016

Towards a Post-Globalization World

Britain, Brexit, and a New Economic Direction

In a recent New York Times article, a reporter visited Wigan in the north of England to try to understand why Britain voted to leave the European Union. He spoke to a 61-year-old pro-Brexit voter, a worker at a canned food factory named Colin whose weekly income had fallen by 52% in the last three years, from $665 (£443) to $318 (£212). For Colin, that was painful. Still worse, he told the newspaper, was that the factory had moved from standard full-time contracts to “zero hour” contracts where the company decides each day how many hours Colin is needed. “It is basically slave labor,” Colin told the Times. This decline in wages and labor relations for semi-skilled and unskilled workers is partly due to increased competition from eastern European workers. The reporter interviewed a Pakistani and a Polish immigrant in Wigan, each of whom expressed strong views in favor of restricting immigration to benefit current residents’ access to jobs and social services. Another interesting report, a video in the Guardian made the same case, interviewing voters in seven different cities who attributed economic and social service problems to immigrants from eastern Europe. Another powerful story in the (London) Times visited the former coalmining village of Grimethorpe in Yorkshire to find voters angry about the local warehouse firm recruiting unskilled labor in Poland to work in Grimethorpe while turning down local residents who applied for jobs. One woman said that on polling day, she went around the village urging at least 50 friends and family to remember to vote and vote “Out”.  These are not “irrational” voters as London commentators, who lately like to call themselves the “cosmopolitan elite” suggest. Voters are acutely rational and aware when it comes to effects on their own livelihoods.

A small but growing number of economists are coming to realize that globalization is itself the key part of the problem causing economic stagnation in certain nations.  While globalization can in very broad terms be described as a process that makes the world economy more efficient by shifting production to low-cost nations, it’s by no means clear that such efficiency leads to higher growth rates for all nations.  In fact, looking at Figure 1, you can see that growth rates in the 21st century are lower than they were in the 1990-2000 period for every major nation in the table, with the exception of Switzerland. (The World Bank data is based on GDP per person adjusted for purchasing power parity, so as to make international comparisons fair.) Globalization as implemented since 2000 is highly advantageous to those economies that were properly prepared to exploit the opportunity, but highly disadvantageous to those economies that were not prepared, for two reasons: The high-wage losers face growing competition from low-wage competitors, and their economies were oriented towards meeting domestic demand rather than international demand. Those losers have become the turkeys at the globalization Christmas dinner. Three major economies fit that description well: the U.S., the U.K., and France.  To put it another way: you don’t join the Premier League without a strategy. Or: those who fail to plan are planning to fail.

Figure 1 shows that the U.S. lost 1.3 percentage points of annual growth in the 21st century as compared to the 1990-2000 period. In the U.K. the loss was 1 point and in France 1.2 points. Bearing in mind the power of compound growth, these are significant and substantial losses in national income that add up over time. They impact those in the lower portions of the income distribution far more than those in the upper. The critical challenge for those three economies is to restore growth to 20th century levels. I believe that’s achievable. One has simply to learn from the countries that have benefited from globalization.

Figure 1: Major Economy Growth Before & After Globalization Acceleration

World-Class and World-Scale Industries
In a globalized world, industries tend to concentrate in fewer countries with larger production facilities. We have seen this trend in automobiles for some 40 years. After its success in autos, Japan went on to achieve a large position in semiconductor manufacture. As a result, semiconductor production in the U.S. began to decline. (The present writer worked for the only U.S. company to build a new greenfield semiconductor fabrication facility in Silicon Valley in the 21st century, Infinera Corporation.) Globalization truly took off around the year 2000 in the wake of two developments: China’s accession to the World Trade Organization, and the series of events from the Maastricht Treaty of 1992, to the entry of low-income eastern European economies into the EU, and finally the creation of the Eurozone in 1999. Even though it did not join the euro, Britain was impacted by EU developments, through the free movement of EU citizens and from investment strategies based on a general belief that the European economy was headed for much tighter integration than ever before.

The result was an unprecedented migration of production, and lately services, to larger facilities in fewer countries. The smartphone is often described as the defining consumer product of the 21st century. In general, the smartphone in your pocket consists of chips built in Japan, Korea, and Taiwan, assembled onto a circuit card in China, and covered with a layer of hardened glass made in China. It may be true that the software running the smartphone was written in Cupertino, California, and one key chip was designed in Cambridge, England, but those functions involve far, far fewer jobs than the production jobs in Asia. Another example: the Internet is a defining institution of the 21st century. Half a century ago, we all had to make do with telephones. In Britain, those phones were manufactured in Britain and communicated over a network of switches designed and built in Britain by British workers. Today, the Internet in Britain consists of a network of switches, routers, and optical systems, largely designed in the U.S. but built in China, Malaysia, Thailand, and Singapore.  Increasingly, those network elements are not just manufactured, but designed in China too.

Why does this matter, some will protest. If British industry gives up on electronics, companies will surely be founded and jobs created in other industries.  Unfortunately, this archaic piece of homespun economic wisdom (sometimes called the theory of comparative advantage) does not apply to our 21st century world. As Michael Spence has written: “many job opportunities in the United States are shifting away from the sectors that are experiencing the most growth and to those that are experiencing less.” (1) This blog relies partly on the analysis of Professor Spence, who won the Nobel Prize for Economics in 2001. However I am applying it in this article to Britain, because I think Britain is today better placed than the U.S. to develop a post-globalization economic strategy.

Figure 2 shows the evolution of employment in three key sectors in Britain since 1998.  In the last 18 years, the manufacturing sector has lost 30% of its employment, while the health, social work, education and public administration sectors (let’s call it HSWEPA) have gained 42% or 2.75 million jobs. The problem for the economy is that manufacturing jobs are higher-paid than HSWEPA jobs, and manufacturing pay tends to grow at faster rates. Figure 3 shows the recent average weekly earnings of each sector. The differential between the two sectors is about £160 a week.  These are large numbers: in those 18 years, the British economy gained about 5 million new jobs, but more than half of them were in the relatively low-paid, low-pay-growth HSWEPA sectors. It lost 1.3 million jobs in the higher-paid, high-growth manufacturing sector. It’s also clear that the information & communication and finance & insurance sectors grew rapidly (by 24%), but those 482,000 new jobs are simply not enough to make a serious dent in the national trend towards lower-paid jobs.
Figure 2: Public sector jobs soar while manufacturing jobs decline

Figure 3: UK1998-2015: an economy moving strongly to relatively low-wage employment

Public commentators, including politicians, wave their flags for many issues which are secondary to the main issue, which is I believe this question of the industry and employment composition of the economy.  Much has been written about productivity and why Britain’s labor productivity growth has remained so low. It is a result of this massive shift of labor from high-productivity-growth employment (mainly manufacturing) to low-productivity-growth employment. And the shift continues.  Commentators also fret about the slow recovery from the 2008 financial crisis. In spite of recovery, manufacturing employment has been flat since 2008, an unprecedented phenomenon in an economic recovery. Manufacturing continues to move to those nations that have established themselves as leaders in the most important manufacturing sectors. How can Britain enjoy a strong economic recovery when the most valuable and the most pro-cyclical sector is in secular decline because it is packing its bags and heading to Asia?

Industrial Strategy
So what is to be done? First, three observations: first, to express such views is not racist or isolationist. Unlike presidential candidate Donald Trump, I am an internationalist. I believe the U.S. and the U.K. play vital roles in maintaining world peace, and must continue to do so. But I believe they can only continue to do so from a position of economic strength, not weakness. Secondly, within a national economy, economic growth is more important than redistribution. Redistribution is severely limited in an economy that is only growing by 1% a year. Voters will rebel against tax increases. The social services (a sore point with pro-Brexit voters) cannot be funded more aggressively than they already are, because the national income pot is not growing fast enough. On the other hand, more growth will make more redistribution possible. Thirdly, growth cannot be achieved simply by investing in infrastructure or education. These policies are valuable, but they will not by themselves produce the profitable industries and high-paying jobs that are essential to succeeding in a post-globalization world.

One glance at Figure 4 is sufficient to show that the outstanding economic success story of the last 40 years has been Singapore. Under Lee Kuan Yew’s leadership (1965-1990), Singapore rose to become the number one nation in the world in per capita living standards, as measured by the World Bank. This is a breathtaking achievement for a country so deprived of natural resources it needs to import water. Korea is also climbing steadily up the economic growth league table, from a position of abject poverty in the 1950s. With a population of 50 million, it recently surpassed Spain and Italy in per capita living standards. The so-called Asian Tigers (Singapore, Korea, Hong Kong, Taiwan) have recently been joined by China, and to a lesser extent other Asian countries. All are pursuing variations of the strategy of export-led growth that was invented after WWII by Japan.  The most successful European economies, such as Germany and Switzerland, have also pursued export-led growth strategies, not so much as a conscious strategic decision as in Asia, but as a reaction to the pressures of the competitive landscape they found in Europe when they first began to industrialize.

Figure 4: Singapore and Hong Kong overtake USA in real living standards (Source: World Bank)

Britain needs an industrial strategy that identifies and then targets sectors where it can build worldwide leadership. This needs to be a public-private partnership, but it must not involve the industries of the past (coal, steel, etc.) as have all industrial policies for the last 100 years. It must identify sectors where Britain is small today but has the potential to be a global player—based perhaps on mid-sized companies who have established a unique technology or other advantage. It should involve private businesspeople not from the world of the stock market but who have demonstrated long-term vision and persistence—people like Richard Branson and James Dyson. Their reputations should be hitched to the success of the strategy, because today their reputations are more important to them than money. It should be backed up with public investment funds to invest in technology and other potential competitive differentiators, while enabling private companies to invest and build a global position. The U.S. became the leader in designing the Internet, and China in building the Internet, through multi-billion-dollar government investment. Focus, persistence, and scale matter. Countries like Korea, Switzerland, Sweden, Singapore have shown that from a relatively modest size, one can build world-class positions. Through a form of the multiplier effect, these industries then have an outsize impact on the entire national economy.

But policymakers should be clear on the goal: it is not proliferating low-wage, “slave labor” jobs—voters told us on June 23rd that is not what they want. Nor is it creating high-profit companies like Apple that are incentivized to move the bulk of their jobs to Asia. The goal is to create high-wage, high-productivity-growth jobs within Britain. In his article on the U.S. situation, Professor Spence called for:  “an agreement that restoring rewarding employment opportunities for a full spectrum of Americans should be a fundamental goal.” Companies should be incentivized, i.e. rewarded, for how well they meet that goal.

They should also be disincentivized from undermining that goal. Part of increasing national income and high-wage jobs is avoiding the reduction of wages. An example: it was recently reported that IBM UK has a confidential goal of moving 80% of its UK jobs to India. (IBM has neither confirmed nor denied this report.) IBM’s logic is obvious—this will cut costs and raise profitability at the struggling computer company. Not only are Indian engineers less costly than British (or American) engineers; they are in general highly qualified. However, this policy is inimical to Britain’s economic growth. Incentives need to be put in place that favor companies employing British engineers for British work. Some will protest that EU rules and WTO rules forbid that. Well the EU is about to become history, and as for the WTO, Singapore and Korea have practiced such policies for decades and they are members in good standing of the WTO.  Henry Higgins’ dictum on Edwardian society applies well to international relations: it is not what you do that matters, but how well you pronounce it.

As industrial strategy identifies industries where Britain can achieve world leadership, controls and incentives need to be put in place to enable those industries to grow on the British Isles, until they achieve the necessary critical mass. I would not call this protectionism. I would call this post-globalization economic policy. Singapore loudly supports globalization—while ignoring the half-century of Singaporean economic policy that favors domestic companies. Britain should do the same. To quote Professor Spence once again: “Conditioning access to the domestic market on domestic production is a form of protectionism and a way to limit the movement out of the country of jobs and of value-added components in the supply chain. This is more common than might be supposed.”

The reason why these policies have not been pursued in the U.S. or the U.K. for the last 100 years is partly because so-called free trade was successful in the last century, but also because both countries have large, highly influential finance sectors that profit greatly from trade and cross-border investment and acquisition activity. In the U.S., I believe the situation is even worse. By pursuing an anti-employment strategy (i.e. exporting jobs to Asia), the U.S. tech industry has cut itself off from its most important source of support, its own employee base. The industry then had no choice but to invest heavily in lobbying, since voters have little interest in the goals of the tech industry. This is already backfiring, as voters turned this year to Donald Trump and Bernie Sanders, because they saw that the benefits of America’s much-vaunted technology revolution were accruing to a tiny sliver of the population.  

After a century of relative industrial decline, and 40 years of absolute decline in key manufacturing sectors, the British people are ready to embrace a new economic policy, to admit in effect that the policy of a highly diversified economy governed by the short-term incentives of the stock market is no longer suitable for a globalized world. Theresa May has already indicated that she is open to some of these ideas. Some will say Britain cannot do it, because free enterprise culture is too deeply embedded in the national psyche.  Yet a large and growing number of Asian nations have made that transition. China’s culture was for six centuries one of bureaucratic ossification and relative backwardness. Under Deng, China shamelessly stole ideas from Japan and Singapore. On current trends, it is set to become the world’s largest economy in ten years. Practical realities have a way of making us change what once seemed immutable. The question is how much more decline, how much more poverty, do we have to endure before we acknowledge that the solution was there all the time, staring us in the face from its perch on the shores of the Pacific?


(1) Spence, Michael, Globalization and Unemployment, The Downside of Integrating Markets, Foreign Affairs, July/August 2011.

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