Select Committee on Treasury Written Evidence


Memorandum submitted Dr Philip B Whyman, Lancashire Business School, University of Central Lancashire

EXECUTIVE SUMMARY

  This paper seeks to contribute in two ways towards the inquiry, made by the Treasury Select Committee, into Globalisation and its impact upon the real economy.

  Firstly, it provides a discussion of the variation in the definitions of globalisation (and internationalisation), and why these are important in terms of the development of national economic policy. Primarily, the paper claims that "strong" definitions of globalisation lead to claims of the impotence of national governments relative to Trans-National Corporations, and this results in a caution in the design and exercise of economic strategy which is not necessarily borne out by the evidence. Through a brief review of the data concerning trade and capital flows, the paper presents an argument that most of the evidence points towards an increasing internationalisation (not globalisation) of the world economy. Moreover, in so far as globalisation does in fact exist, it is little more advanced in many respects than during the Gold Standard era; the primary difference between the two periods relating to the composition of long-term capital flows—ie FDI in the contemporary period rather than portfolio investment in the early years of the last century.

  The second feature of the paper relates to the impact of globalisation upon national economic policy, and specifically it considers claims of the "death" or "retreat" of the nation state. The paper argues that, whilst increased internationalisation has increased certain of the constraints experienced by national governments, it has certainly not undermined the effectiveness of many of the main economic policy instruments. Moreover, the disappointing record of financial crises and resultant macroeconomic destabilisation throughout many different nations, together with the relatively poor record of the neo-liberal era, indicates that a more active economic policy strategy, based upon a proper appreciation of the role of aggregate demand management, would produce superior outcomes.

THE NATURE OF GLOBALISATION AND ITS OVERALL IMPACT ON THE UK ECONOMY

Globalisation and economic policy

The Meaning of globalisation

DEFINITION

  1.  Globalisation is quite possibly "the most contested concept in contemporary social science" (Grant, 2002:41), being "invariably over-used and under-specified" (Higgott and Payne, 2000:ix). Indeed, the imprecision that often accompanies debate surrounding globalisation prompted Wiseman (1998:1) to claim it to be "the most slippery, dangerous and important buzzword of the late 20th century".

  2.  The internationalisation of economic activity refers to the international expansion of trade, labour mobility, sourcing of components, product marketing and development, together with the dramatic increase in capital flows (Scholte, 2000:16). Nevertheless, according to this definition, production remains primarily national (or regional).

  3.  Globalisation, by contrast, concerns "macroeconomic unification" (Glyn and Sutcliffe, 1992:77; Amin and Thrift, 1994:4; Hirst and Thompson, 1996). Transformation of production occurs as trans-national corporations (TNCs) lose their former national identity, become truly footloose in terms of location of production and their international management owes no residual alegience to the interests of any individual nation state. Technological advances that have produced transaction cost reductions in transport and communications facilitate the development of a "weightless", information-knowledge-based, service-centred sector of the economy, together with a greater geographical diversification of corporate production and associated innovation in strategic, organisational and operational corporate behaviour (Katz, 1988; Carnoy et al, 1993). Hence, the OECD (1996:9) characterises globalisation "evolving [a] pattern of cross-border activities of firms involving international investment, trade and collaboration for purposes of product, development, production and sourcing and marketing".

THE EXTENT TO WHICH THE RECENT PHASE OF GLOBALISATION IS A NEW PHENOMENON FOR THE WORLD ECONOMY

Evidence for globalisation

  4.  The evidence for internationalisation is uncontested. Between 1970 and 1991, world GDP doubled, global exports nearly tripled in real terms and FDI quadrupled, with rates of real increase exceeding 25% per annum during the latter half of the 1980s (UNCTAD, 1993:17). In 1991, world exports of goods and services were valued at US$4 trillion, one-third of which was intra-firm trade, whilst exports represented approximately 19% of global GDP (Lazar, 1996:274-5).

  5.  In terms of international capital flows, the ratio of foreign assets relative to world GDP from 17.7% in 1980 to 56.8% in 1995 (Crafts, 2000:27). Short term capital has increased substantially, with the daily volume of trading across the major foreign exchange markets rising from $18 billion in 1977 to US$2 trillion by 1999—a figure approaching one hundred times the equivalent value of international trade, easily exceeds the world's entire $1.5 trillion official gold and foreign exchange reserves and represents a value one third greater than the UK's annual GDP (Cotty, 2000:283; Eatwell, 2000:349). The vast majority of financial market transactions are speculative, and have no relation to the real economy—a reversal of the situation in 1971, when 90% of all financial transactions were made to facilitate international trade and long-term productive investment (Eatwell, 1995:277; Watson, 2002:205). The result is a dramatic reduction in the timescale over which financial transactions take place, with less than 1% of net global foreign exchange (FX) transactions have a maturity of longer than one year (Palley, 1998:178-9). Moreover, the acceleration in currency trading has increased instability in exchange rates, tripling the monthly volatility of G7 exchange rates and producing far greater increases in volatility for developing nations. Ironically, more money is traded on the world financial markets in six hours than has been lent by the World Bank during its entire history (Clark, 1999:1).

  6.  Evidence for globalisation is mixed. It is estimated that the largest 500 TNCs perform a majority of world trade, with the 40,000 corporations with headquarters in more than three countries accounting for two-thirds of world trade, and with half this amount occurring internally and therefore not being subject to external competitive market pressures (UNCTAD, 1995; Martin and Schumann, 1996:112; Lazar, 1996:274-5). The largest TNCs dominate many global industries, including consumer durables, air travel, recorded music, electronic components, steel, automobiles, aerospace, oil, personal computers, semiconductors, credit cards, visual media, insurance, chemicals, telecommunications, accountancy, and global merger and acquisitions. The aggregate stock of foreign direct investment (FDI), which facilitates the internationalisation of production, was estimated to be US$180 billion in 1991, with the largest one hundred TNCs controlling half of this amount (Dunning, 1993:15; UNDP, 1999:67; Scholte, 2000:129-130).

Globalisation or internationalisation?

  7.  The evidence for an increase in international economic inter-connectedness does not, by itself, prove the globalisation thesis, because much of the available data can arguably sustain distinct claims of internationalisation and/or regionalisation of economies, but where principal economic units remain essentially national (Petrella, 1996; Vandenbroucke, 1996:10). Indeed, whilst regional economic integration has been documented, with 109 regional agreements reported to GATT between 1948 and 1994 (for example EU, NAFTA, ASEAN), this points towards a "triadisation" of international economic development, not globalisation (Rugman, 2000, 2005).

  8.  It is therefore plausible to describe the process of internationalisation as a recurrent historical trend, complete with alternating phases of globalisation and fragmentation that has been repeated on a number of occasions in the history of the modern nation state (Clark, 1997). By contrast, other theorists propose the existence of a linear (not cyclical) trend towards increasing globalisation, but locate the emergence of the phenomenon anywhere from 100 to 500 years ago (Porter, 1986:42; Chase-Dunn, 1989:2). Moreover, caution should be exercised when responding to claims of globalisation, because seemingly permanent economic trends can be quite rapidly reversed, and therefore advocates of the globalisation thesis may suffer from a lack of historical perspective (Hirst and Thompson, 1996:37-8). It is naive to project the continuation of current trends as if this were an irreversible inevitability.

Is globalisation new?

  9.  There is a growing literature that indicates that, proportionally at least, levels of international trade, migration of labour and international flows of investment capital were higher in the late nineteenth century than the comparable situation at the end of the twentieth century (Zevin, 1992; Wade, 1996). For example, the UK's international trade accounted for 44.7% of GDP in 1913, and after a dramatic decline between 1914 and 1945, it had only risen to 40.5% by 1993. Similarly, France remains beneath its 1913 levels of openness (35.4%), with Germany only narrowly surpassing its 1913 figure of 35.1% by 3.2% in 1993, and with Japan recording a sharp fall from 31.4% in 1913 to 14.4% in 1993 (Hirst and Thompson, 1996:60; Bairoch, 1996:176). Western Europe exported 18.3% of its GDP in 1913, only slightly higher than the 21.7% recorded in 1992, whereas comparable figures for the USA were 6.4% and 7.5% of its GDP and Japan 12.5% to 8.8% of its GDP; the latter experiencing a decline in the importance of international trade (Bairoch and Kozul-Wright, 1996:6). Thus, although the volume of trade has increased substantially over the seventy years covered by these statistics, the international economy does not seem demonstrably more open today than during the gold standard era (Hirst and Thompson, 1996:37-8).

  10.  Capital mobility was a feature of the gold standard period, with one estimate calculating that the stock of FDI was around 9% of global output in 1913 (Bairoch and Kozul-Wright, 1996:10). Moreover, the growth in portfolio investment, particularly from France, Germany and the UK, exceeded expansion in output, and financed the industrial expansion of North America, Argentina, Australia, South Africa and Nordic European nations like Sweden. The UK exported an average 4% of its GDP between 1870 and 1914, with the absolute annual figure having risen to an incredible 9% of GDP by the end of the gold standard epoch (Hirst and Thompson, 1996:37-8). Capital movements were estimated to represent 5.3% of global GDP at the end of the gold standard epoch, whereas this figure only averaged 2.3% of world GNP between 1989 and 1994 (Taylor, 1996; Obstfeld and Taylor, 1997). Thus, when compared to relative GDP, capital flows are smaller today than they were seven decades ago, indicating that perhaps capital markets are not as tightly integrated as is typically perceived (Rodrik, 1996:4). One difference between the two time periods concerns the fact that most capital flows took the form of portfolio investment in 1913, rather than foreign direct investment (FDI), with the debt typically issued by governments and utilised to finance infrastructure investment, including railway construction, harbour development and telecommunications (O'Rourke and Williamson, 1999:211-2).

Why do definitions matter?

  11.  The importance arising from varying definitions of globalisation relates to their ability to condition perceptions of reality—particularly concerning the constraints globalisation imposes upon macroeconomic policy. For example, the hyper-globalisation thesis claims that an increasing integration of financial markets, the rising importance of TNCs in global manufacturing production, and their use of Foreign Direct Investment (FDI) to expand their control into an increasing number of national markets, has weakened the ability of the nation state to regulate capital and utilise traditional economic policy instruments to secure progressive policy goals (McGrew and Lewis, 1992:22; Held et al, 1999). It claims that his has caused a "crisis" and "retreat" of the nation state, where evasion of regulation and increased capital mobility has "hollowed out" state authority (Strange, 1996; Sassen, 1997).

  12.  Adherents to this theoretical position claim that Keynesian demand management policy is fatally constrained by capital mobility weakening the ability for government to tax mobile resources, therefore forcing down tax rates upon skilled labour and capital, and in the process undermining social policy and welfare state provision (Reich, 1992; Sachs and Warner, 1995; Veseth, 1998:137-8). Thus, Gray (1996:32) claims that globalisation makes the "distributional goals of social democracy unachievable, at least by traditional social democratic means". Furthermore, the assumption that TNCs possess credible exit threats and can use this leverage to force concessions from nation states to their advantage, may cause governments to pursue "international regime competition" to secure inward flows of capital investment, and in the process reduce the burden of taxation and regulation upon capital, with negative consequences for inequality and the financing of the welfare state (Cerny, 1990; Garrett, 2000:455).

  13.  This theoretical position is, however, contested. For example, a regionalist perspective holds that traditional economic programmes and policy instruments remain viable at the supernational level, whilst an intergovernmentalist perspective proposes that nation states retain considerable autonomy in economic policy-making and capital can still be regulated at national level (Hirst, 1999; Baker et al, 2002:411-414).

THE IMPACT OF GLOBALISATION ON UK AND GLOBAL MACROECONOMIC STABILITY

The death of the nation state—has it been exaggerated?

  14.  One aspect of the postulated weakening of state power relates to financial deregulation providing additional exit options for private capital, leading to global tax competition, where corporations threaten to relocate (or FDI will not be attracted) unless governments reduce corporate tax burdens, and in any case, tax can be avoided through transfer pricing (Dicken, 1992:391). The implication is profound for progressive economic policy, since reducing taxation on mobile capital either requires it to be redirected onto less mobile labour, thereby increasing social inequality, or being forced to reduce public expenditure and with it prized welfare programmes. However, though broadening of the tax base, through closure of loopholes and greater reliance upon indirect taxation, tax revenue as a proportion of GDP has remained relatively constant. Indeed, studies have found a positive and statistically significant associated between capital mobility and the effective tax rate (Kopits, 1992; Swank, 1998). Furthermore, the evidence does not indicate an unequivocal convergence towards a neo-liberal, market-orientated model of capitalism (Perraton and Clift, 2004). Indeed, the resilience of these arrangements may indicate the existence of "institutional comparative advantage" (Garrett, 2000:457; Chang, 2003).

  15.  A second argument concerning the "retreat of the state", as governments bargain with TNCs over their conditions of operation rather than regulate their activities, neglects the fact that markets are not natural phenomena, but are always established in some form of legal and institutional context that defines the conditions under which transactions occur (Stopford and Strange, 1991). The power of the nation state therefore creates the conditions for markets to operate—ie legal and institutional framework. Indeed, if China can cause Google to self-censor their search engine and the UAE can frustrate the operation of Skype within its jurisdiction, national regulation remains effective—even for the supposedly "borderless" world of the internet. Hence, the World Bank (1997:41) disputes the "overloaded government" thesis and advocates states enlarging their role in protecting and correcting markets.

  16.  When discussing the net benefits to host economies from attracting inward FDI, it is important to realise that, for most industrialised economies, FDI flows represent only a small proportion of GDP and are exceeded by domestic investment by at least a factor of nine-to-one (Glyn, 1994; Weiss, 1998:174). The majority of FDI finances non-manufacturing assets such as golf courses, property (commercial and residential), hotels and shopping centres, whilst a large proportion of FDI occuring in the industrial sector is used to acquire existing assets rather than construct new productive facilities, and is therefore less effective in improving competition and providing additionality to the host economy (Fallows, 1994:481). Moreover, the fact that 81% of global FDI stock is located in high wage, high tax OECD nations, indicates that cost reduction is not the overwhelming factor causing the globalisation of production (Weiss, 1998:186). In addition, most TNCs concentrate 70-75% of value-adding activities in their home nation, indicating that they are more accurately national (or perhaps regional) firms which operate internationally (Wade, 1996:101; Hirst and Thompson, 1996:96). Thus, a study of the world's largest 100 TNCs reaches the conclusion that "not one of these can be dubbed truly `global', `footloose' or `borderless'" because no firm has overcome its dependence upon its home base (Ruigrok and van Tulder, 1995:168-9).

  17.  The integration of world financial markets is claimed to increase the cost of domestic stabilization policies (Kapstein, 1994). Financial markets typically prefer mildly deflationary policies as this preserves the value of financial assets (Palley, 1999:106). Fear of triggering capital flight and resulting currency crisis has resulted in governments seeking to appease financial markets—the Greenspan approach (Reich, 1992; Sachs and Warner, 1995). In the absence of a more active economic policy, nation states have indulged in "regulatory arbitrage", where domestic policy is re-orientated towards the interests of mobile capital—ie liberalisation of the labour and financial markets, lowering corporate taxation, resisting tougher environmental regulation (Cerny, 1990, 1997). The experience of the UK (1976), France (1981), Sweden (1991) and the ERM crisis (1992) are often used to justify this position—however this is a gross simplification (Callaghan, 2000:102-8; Schmidtke, 2002:8; Whyman, 2006). In all cases, policy mistakes led to the economic problems that precipitated speculative attack upon national currencies, whereas a combination of tougher financial regulation, "dirty" floating of the exchange rate and a reorientation of macroeconomic policy would have provided a superior solution.

National macroeconomic management—a viable alternative?

  18.  Passive adaptation to perceived dictates arising from globalisation is not a sustainable position. Globalisation has failed to produce a self-regulating world economy, characterised by high and more equally shared growth rates, as predicted by neo-classical economic theory, but is instead associated with rising inequality and increased instability. Financial integration and the increase in short-term liquidity, through financial capital flows, has increased the probability of contagion from financial crises elsewhere in the international community. Indeed, the world economy has experienced 69 banking and 87 currency crises between 1975 and 1996 (Kapstein, 1994; UNCTAD, 1997:65-6; Stiglitz, 2002). Solow (1997) is sufficiently concerned by these trends that he recommends that globalisation be slowed down "until we can be more vigilant in compensating the losers".

  19.  Fortunately, the state retains substantial capacities to govern global economic activities (Rodrik, 1996; Mann, 1997; Weiss, 1998). The vast bulk of a nation's resources are immobile, including physical and human capital, and therefore governments can invest in education, infrastructure, targeted industrial support and facilitation of the development of business networks in order to enhance the advantages of immobility and proximity for firms (Bleeke and Ernst, 1993; Wade, 1996:108; Diwan and Walton, 1997:2). The "embeddedness" of corporations in national institutions facilitates informational resources and co-ordination to secure common objectives, whilst the development of a cluster of skilled labour and a technical supply chain specialising in the specific activity of the firm reduces uncertainty arising from a dynamic business environment (Hirst and Thompson, 2000:306; Zysman, 2000:120-3). Thus, a "national system of innovation" can be extremely successful in developing international competitive advantage (Dunning, 1988; Porter, 1990). Indeed, business networks suggest that the advantages of the maintenance of a strong home base may be stronger than ever (Patel and Pavitt, 1991; Weiss, 1998:186).

  20.  Rodrik (1996) has demonstrated that, far from those economies that are the most integrated into the world economy suffering a convergence of economic policy and institutional arrangements resulting in a "shrinkage" of government, there is actually a positive correlation between openness and the share of government expenditure in GDP, due to the ability of government to act as an insulator against external shocks. Moreover, there is little convincing evidence to indicate that globalisation has undermined the efficiency of institutional frameworks within which economic policy operates (Garrett, 1995).

  21.  Review of the available evidence indicates that "strong" definitions of globalisation, and claims of the paralysis of the state, are overstated (Boyer and Drache, 1996; Berger and Dore, 1996; Watson, 1999a). However, propagation of the hyper-globalisation thesis may be "politically convenient" since it disciplines expectations and provides a "convenient post hoc rationalization" for a neo-liberal policy shift (Hay and Watson, 1999a:155; Watson, 1999b; Grant, 2002:49). Accordingly, the image of globalisation may be "so powerful that it has mesmerized analysts and captured political imaginations" (Hirst and Thompson, 1996; Hirst, 1999:88). Thus, the so-called crisis of social democracy is based upon a combination of "political fatalism", a "lack of confidence" and "a lack of political imagination" (Hay, 1998:529; Whyman, 2006).

  22.  This is not the forum to develop detailed policy design, however the management of aggregate demand is a necessary through not sufficient condition for the achievement and maintenance of full employment alongside a reasonable rate of economic growth. There is a large and growing literature suggesting that aggregate demand impacts directly upon the real economy through its impact upon the rate of investment, which in turn changes the stock of capital, thereby affecting productive capacity and employment (Bean, 1989; Rowthorn, 1995; Ball, 1999; Alexiou and Pitelis, 2003:628).

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May 2006





 
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