Select Committee on Treasury Written Evidence

Memorandum submitted by Stephen King, Group Chief Economist, HSBC


  Globalisation is as much associated with technology as with politics and markets, and has been a feature of the economic landscape for centuries. Globalisation occurs in waves with rapid advances interrupted by sometimes painful reverses. In its latest incarnation, globalisation has become more a story about the mobility of capital than about the mobility of labour. Although societies as a whole should, economically, benefit from globalisation, there are significant political obstacles, notably the creation of both winners and losers.

  UK wage growth has been unusually moderate in recent years, a reflection of both greater capital mobility and heightened immigration, notably from Central and Eastern Europe. Nevertheless, consumer spending has risen as a share of UK GDP. This reflects cheaper imports of consumer durables from low-cost production centres (a terms of trade effect), better access to credit and, perhaps, an improved ability, through the effects of globalisation, to fund the UK's current account deficit. Rising commodity prices suggest, though, that economic success elsewhere in the world may, eventually, eat into spending power in the UK.

  Data interpretation is particularly problematic during periods of rapid globalisation. Many of the current risks associated with, for example, protectionism are the result of potential misinterpretations of trade and capital account data. Cross-border activities by companies, differences in capital allocation skills between countries and changes in the ownership of capital across nations all have balance of payments implications but, at this stage, are poorly understood. There is a strong case for international institutions, notably the IMF, to play a bigger role in the measurement and understanding of global capital flows in order to avoid a nationalist backlash.


  1.  Economically, globalisation reflects the increased integration of markets. Barriers to integration—political, legal or technological—are removed. Individual, smaller, markets become a single common market.

  2.  Globalisation allows economies to transcend national borders. In some cases, this is a direct consequence of political change. The formation of the European Union is one example of this process, as was the unification of Germany in the 19th Century. In other cases, it is an indirect consequence of political change, or a side-effect of technological progress. The collapse of the Soviet Union led to a series of political realignments around the world that allowed capital and labour to migrate across hitherto impenetrable borders. The massive decline in telecommunications charges increased information flows across nations, again aiding the free flow of both labour and capital.

  3.  Globalisation also, of course, carries political overtones: it is not a purely economic event. Income and wealth may be redistributed. While it is easy to argue that integrated markets imply a more efficient allocation of the various factors of production, thereby raising outputs for a given set of inputs, this approach ignores three realities.

    —    First, there may be substantial adjustment costs as countries become more closely integrated with one another.

    —    Second, irrespective of adjustment costs, globalisation is likely, economically, to create winners and losers in relative terms and maybe also in absolute terms.

    —    Third, if globalisation raises output, it's also likely to raise social costs: damage to the environment is one obvious example. Put another way, the market benefits of globalisation may mask non-market costs.

  4.  In summary, globalisation is a shift to a global market place for goods, services and factors of production. It implies a more efficient use of resources—more output for given inputs—but it may also lead to income redistribution and ongoing social costs that may create political challenges. All these factors have to be considered in assessing an appropriate policy response to globalisation.


  5.  Globalisation has been a feature of the economic and political landscape for centuries, sometimes warmly embraced, sometimes feared. Human motives both for and against globalisation have been remarkably constant through time. In the 14th and 15th centuries, city walls became a useful barrier to entry behind which workers could form city guilds. Apart from ensuring professional integrity, these guilds were active in keeping out the products produced by cottage industries that operated beyond the city limits. Railways linked together economic communities that, previously, would have had only very limited contact: the economic success of 19th Century Britain—and the social costs—owe a lot to this extraordinary new piece of technology.

  6.  The latest period of globalisation does, however, have some uniquely defining characteristics.101[101] The most important of these is the mobility of capital both within countries and also across countries. Economics textbooks tend to assume that labour is mobile but that, at least in the short-term, capital is fixed. This no longer seems to be an appropriate assumption. Capital moves around the world with increasing ease: companies can locate capital in all sorts of different locations.

  Greater capital mobility reflects three main factors:

    —    First, the collapse of Soviet Communism and, pre-dating this, the new openness of Chinese leaders associated with the policies of Deng Xiaoping. Political rearrangements have been a crucial factor behind this latest phase of globalisation.

    —    Second, new information technologies have given rise to rapid declines in communication costs, primarily reflecting the huge changes in the telecommunications industry. These are the modern day incarnation of the railway revolution. Railways, though, connected towns within countries whereas today's lower communication costs are connecting countries across oceans.

    —    Third, the last thirty years have seen a major philosophical shift in favour of deregulation and open markets: capital controls have gradually been dismantled and, in response, countries have either shifted to purely floating exchange rate regimes or, in the euro's case, permanently fixed exchange rate regimes.

  7.  Mobility of capital has helped raise living standards but, to date, the benefits have not been evenly distributed. Growth rates have varied enormously across the world from the non-existent (parts of Africa) to the very low (the eurozone and Japan), from the moderately robust (the US) to the very buoyant (China and, more recently, India). Moreover, within countries, there have been sizeable shifts in income and wealth distribution. China's income distribution, for example, is roughly the same as America's. Under globalisation, therefore, societies living under Communism and capitalism have seen the gap between rich and poor widen. Anyone familiar with Adam Smith would not be surprised: as he wrote in "The Wealth of Nations",

    "Wherever there is great property, there is great inequality... the affluence of the rich excites the indignation of the poor, who are often both driven by want, and prompted by envy, to invade his possessions... The acquisition of valuable and extensive property, therefore, necessarily requires the establishment of civil government".

  8.  From the UK's perspective—a perspective obviously shared by many other developed economies around the world—heightened capital mobility may result in a number of key changes.

  9.  Although unemployment is low, labour's relative share of the economy may eventually weaken and, by implication, capital's share may increase. Heightened capital mobility implies that labour has to be competitive not just for the UK to maintain its export share but, also, to keep capital within the UK. Wage increases in excess of productivity gains or wage levels in excess of those received by equivalent workers elsewhere can lead to an exodus of capital: to avoid this threat, wage claims have moderated, a process that, in turn, has left UK unemployment at low levels despite the fears often associated with globalisation. In this regard, the UK appears to have coped with globalisation more successfully than some of its European neighbours.

  10.  The labour market is not, though, affected only by the mobility of capital. Following the fall of the Soviet Union and the integration of Central and Eastern European countries into the European Union, the UK has experienced a huge increase in net immigration. This, in turn, has had a major effect on the UK labour market, a conclusion that is easily illustrated by a visit to any popular London restaurant. More formally, the Bank of England demonstrated in its February 2006 Inflation Report that the industries most dependent on migrant workers had been those experiencing the biggest declines in average pay in recent years.

  11.  Despite the wage constraint, British consumers have done very well: their share of GDP has risen over the last two decades, a theme commonplace in many parts of the industrialised world. Part of this is the result of domestic financial market liberalisation that, in turn, has given rise to better access to credit. Undoubtedly, though, another key factor has been the persistent deflation that has occurred in consumer goods prices: this price deflation is a direct, and beneficial, result of a better allocation of capital around the world. As consumers, we can buy more because the UK has experienced a steady improvement in the terms of trade associated with falling import prices. Globalisation may also have directly contributed to easier access to credit by allowing the UK to run a current account deficit in recent years without bumping into the funding difficulties of old.

  12.  While the decline in consumer goods prices is good news, there are limits to how far consumers are likely to benefit. Like other western developed countries, UK consumers are gaining from access to cheaper sources of production elsewhere in the world but, simultaneously, suffering from an ongoing increase in the price of raw materials. As the global production frontier shifts outwards—an inevitable result of Chinese and Indian economic success—so will the demand for the world's raw materials. Simple calculations suggest that, based on its current pace of development, China could be consuming the equivalent of all of today's global oil production in 25 years' time should energy prices remain at current levels. Rising energy prices—and other commodity prices—could, therefore, be a fact of life for many years to come. Again, issues of income redistribution are raised: it may be that globalisation leads to higher average incomes for the world as a whole, but more than all of the gains could, conceivably, accrue to those countries achieving the fastest growth rates: globalisation is a positive-sum game but there still may be both winners and losers.

  13.  As for capital, globalisation implies a growing distinction between brand and company. The Mini car is undoubtedly a British brand but it's owned by a German company, BMW. The Mini is assembled in Britain. The latest version of its engine comes from France and its earlier power plant came from Brazil as part of a joint venture with Chrysler (now Daimler-Chrysler). British investors are free to purchase BMW shares—on the Frankfurt, London and New York exchanges—and, therefore, enjoy the profits that stem from the success of the brand. Plenty of British workers are employed by BMW. When BMW's French-made engines are exported to the British assembly plant, they count as imports into the UK, but when the finished car is exported to the US, the engine, and the rest of the car, counts as a UK export.


Home Economy
Assets (US$
bn) Foreign
Sales %
% foreign

General Electric
Electrical and electronic equipment
Vodafone Group PLC
Ford Motor Company
Motor Vehicles
British Petroleum Company plc
Petroleum expl/ref/distr
General Motors
Motor Vehicles
Royal Dutch/Shell Group
Petroleum expl/ref/distr
Toyota Motor Corporation
Motor Vehicles
Total Fina Elf
Petroleum expl/ref/distr
France Telecom
Exxon Mobil Corporation
Petroleum expl/ref/distr

  Source: Unctad, World Investment report (2002).

  14.  Put another way, the globalisation of companies breaks down national borders and makes data on trade and capital flows between nations increasingly difficult to interpret. Companies no longer fit within national borders even if governments often regard them as national champions. The table above, which shows data from the United Nations listing the top ten non-financial companies ranked by the size of foreign assets, provides compelling evidence for this view. Modern sovereign borders are like the city states of old, vulnerable to the globalisation that stems from political and technological change and which leads to a more efficient allocation of resources.


  15.  China and India both play important roles in the globalisation process:

    —    They are growing very quickly and, hence, are seeing rapid reductions in the numbers living in poverty. In that sense, they highlight some of the key positives associated with globalisation.

    —    They are still very poor countries by UK standards in terms of per capita GDP and, hence, have lots of room to "catch-up".


GDP per capita (US$ 2004)


Source: World Bank.

    —    They have huge populations and, therefore, will place large demands on global raw materials in the years ahead. Other countries have experienced economic catch-up—Japan, South Korea and Ireland spring to mind—but these started from a higher per capita income in the first place and had small populations by Chinese and Indian standards.

    —    Unlike Japan's period of economic expansion in the 1960s and 1970s, China and India are actively taking part in the globalisation of capital markets: it's difficult to believe that China would have enjoyed the economic success of recent years without large inflows of foreign direct investment from the US, Japan and, to a lesser extent, Europe. China's future is, therefore, very much entwined with western interests.

    —    China and India may have low incomes per head, but they are producing large numbers of graduates who, so far, are prepared to work at wages significantly lower than those enjoyed in the UK, the US or elsewhere in the prosperous West. Skilled workers are attracting a wide range of capital: according to the UNCTAD, multinationals plan to invest heavily in research and development in both China and India in the years ahead, displacing investment that might have occurred in, for example, Europe in earlier times.

    —    As populations age in the west, Chinese and Indian workers will become more important sources of labour for western companies. Unless retirement ages rise in the west or, alternatively, western workers put in longer hours, western societies will become more dependent on the efforts of workers in China, India and many other parts of the developing world.

  16.  Of course, plenty of other developing markets are also playing a bigger role as a result of globalisation. The distinguishing features of China and India are, however, size, pace of growth and, in China's case, an economic and social model that differs substantially from the western model. Other countries keen to get on the development ladder will regard China as an alternative to the so-called "Washington consensus".

  17.  China's recent success also emphasises one of the key requirements of globalisation. China may have been one of the major global economic powers in the 13th and 14th Centuries but, for the next 600 years, China became an insular nation, its leaders deliberately cutting China off from the rest of the world. Society was very much based on agriculture and progress was limited. Only with Deng Xiaoping's willingness to embrace openness and engagement did China's economic performance change.

  18.  Further success depends critically on two factors. First, protectionism needs to be kept at bay: growing protectionist pressures in the US and Europe are, therefore, a major concern. Second, recognising that there are limits to an export-driven model, China in particular will have to find ways of shifting towards domestic consumption-led growth: this will depend on the evolution of domestic credit markets that will enable consumers to spend in advance of likely future income gains.


  19.  The inflation targeting framework can broadly be regarded as the perceived guarantor of macroeconomic stability both in the UK and, more broadly, across the world as a whole. Not all countries use a formal inflation target but the vast majority accept the conventional wisdom that price stability is a necessary condition of macroeconomic success. In that sense, there has been a globalisation of economic policy ideas: those countries whose policymakers depart from this conventional view may find themselves punished through higher interest rates, greater exchange rate volatility and, perhaps, greater volatility of output.

  20.  Yet price stability has its drawbacks. In a world where exchange rates are not completely flexible, relative price levels should be able to adjust: in other words, inflation rates should vary. A country benefiting from a global productivity shock may best experience the necessary improvement in the terms of trade through a fall in its price level. This leads to an increase in real incomes (prices falling relative to wages and profits) and to higher real interest rates (a reflection of faster productivity growth). A central bank that prevents this mechanism from working may leave monetary policy too loose, leading either to higher inflation or, possibly, to excessively high asset prices and over-leveraged households and companies. "Good" deflation occurred in the late 19th Century during an earlier period of rapid globalisation: its prevention today may eventually prove to be a source of macroeconomic instability.

  21.  Ironically, the achievement of price stability has been met with concerns about instability in other areas. If price stability is desirable and, broadly, has been achieved, why have global imbalances widened in recent years? To what extent should the objective of price stability be relaxed to deal with global imbalances? Are global imbalances in some sense a result of the achievement of price stability?

  22.  Because the latest form of globalisation involves much higher capital flows, it's not surprising that imbalances are larger than in the past. Cross-border holdings of both assets and liabilities have increased dramatically, implying much larger savings flows from one country or region to others. These stock and flow effects are difficult to interpret.

    —    The US current account deficit, at 7% of US nominal GDP, is huge by past standards yet, to date, capital flows have been sufficiently large to fund the deficit without serious financial dislocations.

    —    The counterpart to the growing US current account deficit has increasingly come from emerging markets. The current account surpluses of China, Russia, the Middle East and Latin America have grown quickly in recent years.

    —    This flow of capital seems odd: economic theory suggests that capital should flow from countries with high per capita incomes and ageing populations to those with lower per capita incomes and youthful populations. In other words, the US should run a current account surplus as a counterpart to emerging market current account deficits.

  23.  A possible explanation lies with a variant of the comparative advantage theme. Rapidly expanding developing markets benefit from their comparative advantage in manufacturing but, at the same time, typically have poor domestic capital allocation skills: for example, many developing markets have poorly developed credit markets. Rapidly rising incomes tend to throw off excess savings which show up in ever-rising current account surpluses.

  24.  Meanwhile, the US has a comparative advantage in capital allocation not just in the US but globally. Should China, for example, choose to ask the US to look after its surplus savings, there's a good chance that some of those surplus savings will be re-invested back into China by US companies (by lowering the US cost of capital, Chinese purchases of Treasuries encourage higher levels of US investment globally). Put another way, the US operates as a bank to the developing world, taking deposits, charging a management fee (the trade deficit) and extracting a superior rate of return on its foreign investments in the light of its superior capital allocation skills.

  25.  Economically, this process could continue for quite some time. Politically, however, there may be limits. The difficulty lies with the varieties of foreign assets that developing markets are able to acquire. To date, investors from developing markets have primarily acquired liquid assets in the form of Treasuries, agencies and corporate bonds mostly denominated in US dollars. Should their current account surpluses continue to rise, however, they would surely be tempted to diversify out of pieces of paper into real assets: that, in turn, suggests that developing markets will increasingly have the economic power to increase their ownership over western capital. Put another way, globalisation is not just a story about western investors acquiring real assets in developing markets but of investors anywhere acquiring assets anywhere else.


  26.  Globalisation is, arguably, a function of politics, technologies and market liberalisation. Throughout history, globalisation has been a fact of economic life, whether it was the growth of cottage industries or the integration of China and India into the global economy.

  27.  Attempts to resist globalisation have typically failed, and the price of failure has often been high: nationalistic politics can lead to protectionism, lost opportunities and, at the limit, war.

  28.  The latest phase of globalisation has taken many millions of people out of poverty: China and India are potential economic beacons for other parts of the developing world, showing that openness and engagement can work to the advantage of the many rather than the few.

  29.  In my view, the biggest challenges facing the UK are not so much the risks associated with globalisation—arguably, with flexible goods and labour markets, the UK is better placed than others to cope—but, rather, policy mistakes that result from misunderstandings about the process of globalisation.

  30.  Of these, the most obvious are:

    —    A descent into protectionism. The US blames China for the large US current account deficit. This view, though, is based on a fallacious argument linking changes in bilateral trade positions with overall trade positions: because China has become the assembly hub for producers all over the world, the widening Chinese trade surplus with the US may be offset by narrowing trade surpluses of other countries with the US.

    —    A failure of international policy co-ordination. Globalisation strengthens the case for credible multilateral public institutions. Latest proposals to reform the IMF make sense but we're still a long way from having an international economic body that is properly able to represent the interests both of the rich, but slow-growing, industrialised world and the poor, but fast-growing, developing world.

    —    A misunderstanding of events taking place in the rest of the world. This is partly a problem with data provision. If the latest version of globalisation is a story about capital flows and changes in foreign asset and liability positions, our understanding of this process is necessarily poor, reflecting the paucity of data in this area. The IMF or other international bodies could, perhaps, play a bigger role in the assembly and dissemination of capital markets data to reduce the degree of misunderstanding that otherwise thwarts international economic relations.

May 2006

101   One defining feature is that this period of globalisation comes after an earlier period-starting roughly in 1914 with the outbreak of the First World War-of globalisation in reverse Back

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