Montrose Journal Winter 03
GLOBALISATION A LA CHINOISE - OR INDIAN STYLE -DAVID BLAKE, EXECUTIVE DIRECTOR, GOLDMAN SACHS
There's nothing new about the key feature of the new globalisation. A sudden discovery somewhere in the world breaks down the barriers of distance and customs. It happened in the 16th century when gold from the New World flooded through Spain. It happened at the beginning of the 19th century when machine-made cotton from Britain swept all before it. It happened again in the middle 19th century as the Great Plains of North America became the wheat fields of the world with the help of the steamship.
'This time the Great Discovery is people. And people make it different.'
No one should underestimate how much of the rise in living standards in the west has benefited from cheaper goods imported from the newly industrialised countries. In total, western economies are massive net beneficiaries from access to cheaper goods. The rise in living standards in the countries being drawn into the world system makes increasingly important markets as well. But the winners and losers in the advanced countries are not all the same, just as in the 19th century town dwellers in Britain welcomed the cheaper food from America which caused desolation to the agricultural economy.
There has been much focus of late on some of the macro-economic causes and consequences of China's large trade surplus with the old industrial countries. Is it caused by having too weak an exchange rate? Does the fact that the Renminbi is pegged to the dollar remove the Chinese authorities ability to control domestic monetary policy in China? Is the long-term build up of currency reserves as a side-effect of maintaining a stable currency either sustainable or desirable?
My own view is that a greater degree of flexibility for the Chinese currency would make sense for both China and the rest of the world. But there's no getting away from the fact that any plausible move in exchange rates would barely dent China's huge competitive advantage in the fields where it is strong. So macro policy, especially exchange rate policy, can only do so much.
And in any case it fails to understand that we are dealing here with a much bigger phenomenon. As is shown by the latest arrival on the scene. India.
In the western world, the emergence of China, like the rise of Japan before it, has often been seen in terms of its sectoral impact on the economy. Cars and TV's can be packed onto a ship and moved across the ocean; services can't. And so those who worked in services have had the benefits of cheaper goods, while those who work in manufacturing have seen their wages cut and their industries contract - or even close down altogether. We used to say that the US and Europe made up most of the "industrialised countries." But "industrialised" no longer properly defines economies where more than three in four now work in services.
According to the so-called Gini quotient, which measures income distribution and disparity in countries, the World Bank now indicates that China and the United States have reached about the same level, which is about 40. On the scale, a 1 is about where everyone in a country is economically equal, and 100 is where one person has all the money. Other countries, like Brazil, Guatemala, and South Africa are up at around 60. Most European countries are down in the 20-30 range. That is an interesting indicator of the growing income disparity in China. There is also data that urban disposable income grew in 2002 at about 14 percent, whereas rural disposable income only grew in 2002 at about four percent. The Chinese leadership understands that they are going to have to work on this income distribution problem in a way that avoids social instability.
Source: The Gini quotient
To understand what is happening now it is perhaps instructive to go back to the Alpine valleys of Switzerland nearly 150 years ago. Isolated and with bad transport links to everywhere, the inhabitants had already learned to seek high value per kilo in what they produced, building the Swiss watch industry to use the long winter. But that was only a solution for some of the people. Lush pasture fed the cows whose bells tinkled across the valley; and they produced copious quantities of lush milk. But Switzerland is a small country, milk is plentiful everywhere within a reasonable distance and it goes off quickly. One solution was to condense it and put it in tins as a Mr. Nestle did, but that required the product to be cheap enough to compete with fresh milk produced nearer the markets. So after much research they came up with a breakthrough and Presto! milk chocolate was invented.
That's not the only example of finding a way to export something in the guise of something else. Norway has enormous capacity for hydro power but little use for it in its remote areas. And so we have aluminium, the production of which eats up enormous amounts of electricity. So we come to the unexpected consequence of the electronic revolution of the past decade. For this has given India a way to export labour as services without any physical transportation of goods at all.
Hartford Connecticut used to call itself the insurance capital of the world and 50 years ago enormous amounts of paper used to make their way there to be processed as premium payments or as claims. Computerisation took its toll of many of the jobs there quite early, but for many there remained much work dealing with the outside world. This required a capacity to speak English well above that of any computer, a reliable postal system to communicate quickly and reasonably priced phone and data connections. All of these effectively limited sourcing to the US for US insurance companies.
Now along comes India, with a very large population with extremely high proficiency in English, an education system producing graduates of exceptionally high attainment levels in subjects which employers want and, the final piece in the jigsaw, access to an international phone system where costs of international calls have collapsed to levels little above those for a short distance call in the US.
Any service which can be delivered over the phone or internet can now operate in India as easily as Indiana for a US or UK consumer. The most often quoted example is the rise of call centres, themselves a new phenomenon which were hailed as the source of jobs for the future to replace those lost in manufacturing.
Like the production line jobs which have gone, these are not traditionally the sort of jobs which graduates would expect to take. But people in India with a degree will do them for far less than those they replace in the market they serve. They will even learn an American regional accent and avidly follow the fortunes of a baseball team to give a sense of familiarity to the clients.
As a growing number of large organisations are beginning to realise, there is no reason why this should only work for low-end jobs. India is the world's second software giant after the US. Many organisations have tried moving a part of their software work out of the UK, for example. In most cases the quality available in India is so much higher that they very soon want to move all of it.
So the old demarcation line between manufacturing exposed to newly-industrialising countries, and service sectors de facto protected, is breaking down. What new lines might be drawn?
An obvious one, and one which will hold is that if something MUST be done in a particular place then it WILL be done there. You can buy a computer on the internet, but someone has to deliver it physically to your home. You can only sweep the streets of Birmingham if you are in Birmingham.
But invention can change more of this than we think. Ten years ago, if you wanted new software for your computer you had to buy disks which were delivered by post or sold in a shop. Now you just download from the web.
Another demarcation line is what is provided by government. Most governments are more open to political pressure to keep jobs than most private companies are. But here is where the market comes into play. If governments do not use the much cheaper sourcing available to them, the relative price of the services they provide will rise. Voters will want to switch to cheaper private alternatives. And so the scope of things which are provided by the government will narrow.
Because all of this change is really about something very simple. Price. Over the past 15 years the supply of labour has increased dramatically in a huge step; the amount of capital available grows steadily but has not had that leap. Thus the relative prices at which these goods trade and the relative prices within the labour market have changed. It is not new that a change in the ratio of capital and labour changes the relative prices they can command. The Black Death killed people but left capital intact. And so for a long period after real wages were higher. For those who survived.
'Because all of this change is really about something very simple. Price.'
Consider a company with two employees, one a production line worker and one a manager making decisions about products, marketing and future action of all kinds. The company can sack the production worker and buy its product from overseas; but it can't sack the manager without ceasing to exist as an entity. Thus the relative power of the two is changed. Over time, either the company will move production to China or the manager will succeed in getting the production worker to take lower pay per unit of output.
But both of them have to reckon with the fact that the investors who put capital into the company can switch their capital out of it altogether to a company somewhere else in the world which takes advantage of the lower costs there. So the rate of return has to be higher.
Much of modern politics in the west is about how the political process interacts with this set of decisions. And we are only just beginning to see how big a set of changes we face.
David Blake is an executive director of Goldman Sachs and a former economics editor of The Times of London. He is writing in a personal capacity.