Select Committee on Economic Affairs Minutes of Evidence

Memorandum submitted by Mr. Michael Kitson Judge Institute of Management Studies, Cambridge, and the Cambridge-MIT Institute


  1.  Much of the globalisation debate has been characterised by disputes between "pro-globalisers" who view it as a process generating economic growth and prosperity and "anti-globalisers" who view it as a force for injustice and exploitation (especially of labour and the environment). Many of the former derive their credibility from (allegedly) robust economic models whereas many of the latter see international capitalism as "putting profits before people".

  2.  Although both cases have their merits and weaknesses, an alternative perspective on globalisation is posited here. The key elements underpinning the analysis that follows are:

    —  Globalisation processes are complex.

    —  Globalisation processes are often exaggerated.

    —  Globalisation is often confused with regionalisation.

    —  Globalisation can result in multiple outcomes.

    —  Globalisation has not been accompanied by a reduction in national differentiation- varieties of capitalism exist and will persist.

    —  Globalisation makes economic, industrial and technology policy more important.


  3.  The concept pf globalisation has been applied to a wide variety of variables including social, political and cultural. Here I adopt a narrower focus, looking at the globalisation of economic and technological activities with a view to the implications for government policy.


  4.  Historically, the process of increased global integration has been erratic; punctured by periodic crises, the formation of regional trading blocs, and shifting world economic leadership.

  5.  The growth of world trade and world output can be evaluated in three historical epochs. First, the pre-First World War period, from 1870-1913, which was the era of the classical Gold Standard. Second, the interwar period, which saw the rise of a reformulated Gold Standard in the 1920s and its subsequent collapse in the 1930s leading to a series of discretionary and uncoordinated trade policies. And third, the post Second World War period which was dominated by the Bretton Woods system (the rules and institutions that regulated the international monetary and trading system in the postwar world) until its collapse in 1973 and which has been followed by a number of attempts at establishing stability in trade and foreign exchange.

Table 1


(Annual per cent Growth Rates, calculated peak to peak)



  Source: Kitson and Michie (2000), The Political Economy of Competitiveness, London and New York (Routledge).

  6.  As shown in Table 1, during 1870-1913, world trade increased by an average of 3.5 per cent a year whereas world output increased by an average of 2.7 per cent a year—in effect, the growing world economy was becoming more open and more dependent on international trade. A picture often presented of this period is that the classical Gold Standard facilitated world growth through creating the conditions for free trade and low inflation. This is a misnomer. In reality, the "stability" of the international system was founded on deflation in weaker countries and migration, and the adverse impacts of the system were limited by the resort to protectionism and the transfer of savings from the richer countries.

  7.  The period between the First and Second World Wars saw major discontinuities in growth and trade. The relative stability of the 1920s was followed by the turbulence of the 1930s. As shown in Table 1, during the 1913-37 period world trade grew at an average annual rate of 1.3 per cent, whereas output grew at an average annual rate of 1.8 per cent. During the 1930s, or more precisely from 1929, the world economy suffered severe disruptions; the disintegration of the world trading system was reflected in a movement towards a more closed world economy—a reversal of the 1920s trend towards increased openness.

  8.  During the post-Second World War period, world output and trade grew at a faster rate than in any previous period. The Bretton Woods period, from 1950 to 1973 witnessed a rapid growth of trade (average annual growth of 7.2 per cent) and output (average annual growth of 4.7 per cent), with a significant rise in the openness of the world economy. The Bretton Woods system did not function symmetrically; the burden of adjustment was borne by the weaker deficit countries, with the stronger countries accumulating increased reserves. Despite this asymmetry, the Bretton Woods system was relatively successful because it accommodated a number of adjustment mechanisms and was anchored by US monetary hegemony. Two of the adjustment mechanisms, which complemented each other, were firstly, the discretionary use of domestic monetary and fiscal policy and secondly, the use of capital controls.

  9.  The collapse of the Bretton Woods system ushered in a period of slower growth of world trade and output. From 1973 to 1990, world trade grew at an average annual rate of 3.9 per cent, around half that achieved in the Bretton Woods period, and output increased at an average annual rate of 2.8 per cent. Within this period there were major setbacks in the mid-1970s and the early 1980s; the former caused by the first OPEC shock and the latter by "OPEC 2" and the "monetarist" shock of deflationary policies being adopted in a number of the leading industrialised countries.

  10.  There were several reasons for the 1945-1973 era of relatively rapid growth coming to an end. The 1973 oil crisis is often cited. But this was more a symptom than a cause—there was a general rise in fuel and raw material prices caused on the one hand by the relatively rapid growth itself, combined on the other with no global system to manage the production of fuel and raw materials. The original ideas following the Second World War for developing some such international arrangements were quietly dropped when the leading capitalist countries found that they had ready access to such supplies at very low prices. This attitude was to prove short-sighted. On a global scale the balance of forces shifted gradually away from the industrialised countries towards the producers of energy and raw materials. And a similar shift in the balance of forces occurred domestically in the advanced economies as the era of full employment led to a strengthening of labour's bargaining power at the negotiating table and in the workplace.

  11.  Since 1990 there has been a significant increase in world trade and the world has become significantly more open; world output has also increased, but only marginally and recent growth rates are still significantly below those achieved during the Bretton Woods period. Furthermore, the degree of trade openness varies significantly between countries.

  12.  There are a number of lessons that can be drawn from the uneven and erratic path of trade integration. First, the process can be slowed (as in the 1970s) or reversed (as in the 1930s). The reversal of the 1930s reflected a major economic shock (or shocks)—an economic or a geopolitical shock today could have a similar impact. Second, the period of most rapid growth of output, trade and openness was a period (Bretton Woods) of global economic coordination and domestic economic intervention (a period often maligned as allowing excessive Keynesian intervention—although it is a moot point whether it was excessive and/or Keynesian).


  13.  Much of the globalisation (or the "hyper-globalisation") literature has characterised a "borderless world" dominated by footloose multinational companies (MNCs). Conversely, some globalisation sceptics argue that MNCs remain embedded in their national or regional economies.

  14.  Evidence on Foreign Direct Investment (FDI)—one measure of MNC activity—does show an increase since the 1970s (in volume, and as a share of total investment and of GDP) but there are significant variations across countries in both levels of dependence on FDI and increase over time, and the bulk of FDI flows are within the developed countries . To illustrate this: FDI inflows into Finland were 0.5 per cent of GDP in 1988 and 9.7 per cent of GDP in 1998 whereas outflows were 2.5 per cent in 1988 and 14.9 per cent in 1998 (OECD, 2000). For Japan—a much more closed economy—inflows were 0.0 per cent in 1988 and 0.1 per cent in 1998 and outflows were 1.2 per cent in 1988 and 0.6 per cent in 1998 (OECD 2000). In summary, there are large variations across time and space, and these variations do not simply correlate with economic performance.

  15.  Much of the FDI (up to 90 per cent of FDI in the OECD, according to some estimates), which does take place, involves mergers and acquisitions. While this may generate a number of technological and managerial spillovers, it does not add to the domestic capital stock.

  16.  Many globalisation sceptics point out that most MNCs remain "home" (country or region) based with respect to their sales and assets (especially R&D facilities). This is not surprising given the scale of the home base of some countries (especially the US). FDI, however, may be an effective vehicle for increasing the globalisation of technology (see below).Much will depend on the objectives of an MNC: is it seeking the lowest cost of production or is it seeking to utilise national or sub-national expertise and research? The latter is important given the potential benefits of local innovative clusters, hence—in management speak—"think global—act local".

  17.  The notion of a fully globalised economy dominated by truly global companies is a figment (be it the position posited by management gurus or their opposite number in the "anti" camp). But so is the sceptical view that MNCs are essentially home based. MNCs are becoming more global but this is a process that is uneven over time, space and activity.


  18.  A distinction can be made between the three processes that are often subsumed within the term "technological globalisation" (on which, see Archibugi and Michie, 1997 and Kitson and Michie, 2000). First, the international exploitation of national technological capabilities: firms try to exploit their innovations (often developed in local clusters) on global markets either by exporting products or by licensing the know-how—see the (uneven) spread of information communication technologies (ICT) and the activities of Microsoft. Second, collaboration across borders among both public and business institutions to exchange and develop know-how. Third, the generation of innovations across more than one country, which relates particularly to the activities of MNCs.

  19.  The first two of these dimensions to the globalisation of technology have increased in importance. Trade and patent flows and international technical agreements have increased dramatically over the past two decades or so. On the third category of the extent to which MNCs have increased their technological operations in host countries, the evidence is less clear. As noted above, many MNCs tend to be loyal to their own home-based country when they have to locate a strategic asset such as technology although others may be seeking out competitive clusters abroad.

  20.  The globalisation of technology is following an uneven path. As an example, the ICT revolution is often characterised as "global" but its impact varies between and within countries. To exploit its full potential will require adequate investment in infrastructure—telecommunications and computers—and education (to use it).


  21.  The rapidly increasing financial integration of the world economy has been apparent since the early 1970s. The collapse of Bretton Woods and the subsequent dismantling of capital controls ushered in a wave of financial liberalisation. This encouraged the growth of international banking and especially the growth of new financial instruments. The latter, initially devised to hedge against risk, were soon primarily used for speculative purposes and, through ICT developments, could be bought and sold very quickly (``hot money"). Foreign exchange dealings are now primarily used for speculative purposes: in the early 1970s the ratio of foreign exchange trading to world trade was around 2:1; by 1980 is was approximately 10:1; by 1995 it was approximately 70:1 and it is still increasing.

  22. The globalisation of capital markets could be a force for growth if such markets operated efficiently and if financial institutions could fail without major ramifications for the rest of the economy (domestic, regional or global). Unfortunately, neither of these conditions applies. Financial markets are increasingly dominated by "herding" behaviour so that prices do not reflect economic fundamentals—this leads to volatility and, occasionally, massive misalignments ("over" or "under" shooting). This can have major adverse effects on the real economy (production, jobs and capacity) which may persist in the long-term. Additionally, the failure of a financial institution can spread to other institutions (contagion) leading to "mania, panic . . . and crashes".

  23.  The rapid growth of "hot money flows" has led to volatility in exchange rates and asset prices and has deepened recent currency crises. Improved financial regulation is required and to be most effective it has to be through global institutions.


  24.  From the above it should be clear that while the world economy is indeed becoming more integrated, the notion that we have a fully globalised economy is a misleading simplification. Historically, the pace and extent of globalisation has varied during different international policy regimes and has been interrupted by intermediate developments, such as the formation of regional trading blocs.

  25.  Although there are those who believe that globalisation is almost a universal force for good, and there are those that believe it is universal force for harm, a more reasonable alternative is to consider that it can have multiple outcomes (some good, some bad), which will vary over time and space and it will lead to winners and losers (between countries and within countries).

  26.  An example: take an economic shock—say, a massive and rapid downturn in the US—which is rapidly transmitted through a "globalising" world economy. The impact of this shock will vary across countries and across sectors (it will depend on each country's trading and financial links with US and its trading partners). It will also depend upon the response of policy makers. If there is a significant impact and if policy makers have only limited success, individual economies will go into recession. The impact of this recession will have multiple impacts. Some firms may respond to a loss of markets by reducing capacity (capital stock and skills) which will be difficult to replace. Others may respond by innovating (``creative destruction") and uprooting complacent vested interests.

  27.  The conventional argument in favour of globalisation is that it improves the allocation of resources and improves specialisation and the exploitation of comparative advantage. Under certain assumptions and conditions it may do this—but under other conditions it will not. For instance, variations in trade performance in an increasingly integrated world economy may lead to persistent divergences in growth rates (winners and losers). Success in international trade becomes cumulative as increasing demand for net exports allows countries (or more specifically, the firms and industries within them) to exploit economies of scale and scope, improving their competitiveness and leading to further improvements in their trade performance. Conversely, weaker trading nations may fail to maintain balance of payments equilibrium at a high level of economic activity, with deflationary policies then pursued in an attempt to maintain external balance. The combined impact of poor trade performance and domestic deflation is likely to lead to a cumulative deterioration in relative economic growth as countries fail to exploit the increasing returns associated with a high level of economic activity. These twin processes of virtuous cycles of growth and vicious cycles of decline illustrate that the benefits of trade integration may not be evenly spread.

  28.  Similarly, there may be winners and losers within nations—an expanded global division of labour may reduce the demand for unskilled and semi-skilled labour in the industrialised countries. Without the appropriate policy response this could lead to increasing unemployment and job insecurity for those workers. At the same time, there may be increasing demand for skilled workers in the industrialised countries, leading to rising incomes. The resulting inequality could lead to social instability.

  29.  Globalisation can have multiple outcomes for the nation state. First, increased trade integration and technological globalisation can lead to virtuous cycles of growth or vicious cycles of decline. Second, increasing dependence on MNCs can improve employment and the technological base or it can lead to instability as footloose capital is increasingly mobile. The challenge for policy makers is to maximise the benefits and reduce the costs.

  30.  The one area of globalisation where the challenge is simply to reduce the cost is the growth of destabilising hot money flows.


  31.  Conventionally, it has been argued that "globalisation" makes it no longer feasible for individual countries to pursue independent economic policies in the face of globalised financial markets (the "powerless state" perspective). National economic policy objectives should be limited, it is argued, to seeking "stability" and "convergence". Stability and convergence are interpreted, perversely, as stability and convergence of policy instruments—interest rates, exchange rates, fiscal balances, and so on—despite the fact that stability in these may cause instability in real economic variables.

  31.  The alternative argued here is that globalisation increases the need for the active use of economic instruments to target real variables such as output and employment. With trade integration increasing the potential costs and benefits which will result from one nation's competitive advantage or disadvantage, increasing globalisation makes national institutions and policies more important rather than less. The costs of falling behind are exacerbated.


  32.  Trade performance has always been important for the UK economy and it is even more important if it is to prosper in a globalising world economy. The UK is a relatively open economy and although globalised capital markets allow balance of payment deficits to be financed in the medium-term, in the long-term they will have to corrected. A dynamic tradable sector will allow the UK to maintain a high rate of economic growth without encountering persistent balance of payments difficulties. This will require a more dynamic manufacturing sector; the UK cannot rely on trade in services to compensate for the long-term decline in manufacturing. In the three years, between 1997 and 2000 the UK trade balance in manufactured goods deteriorated by £18 billion, whereas during the same period the surplus on knowledge-based services increased by £10 billion (Rowthorn, 2001).


  33.  Industrial and technology policy also becoming more important in a globalising economy. National and local specific factors play an important role in the development of industrial innovation. There are a number of facets of national and local systems of innovation, although they usually embody education, innovation and R&D policies, as well as historical and cultural factors. The creation and development of effective systems of innovation are important to attract innovative activities including those associated with some MNCs. This may include investment in education, communications and university-industry partnerships. Such policies will create a modern, efficient and productive infrastructure and a well trained work force—which in turn will generate positive externalities.

  34.  Nations or local areas may also attempt to attract footloose capital through financial incentives. This creates the danger of a ``race to the bottom'', where areas compete for cost-sensitive and mobile capital which does not become embedded into the local or national economy.


  35.  Although globalisation reconfigures the scope for national and local action, it also requires the improved international regulation of financial institutions. The dangers of unfettered speculative activities have been illustrated by the financial crises in Asia and elsewhere. A new framework will require better information, tightening up the capital backing required by banks and security houses and greater international coordination of regulatory functions. The implementation of such changes would be undeniably difficult. First, the level of cooperation required would be significant, the "rules of the game" would be complex and the commitment to a large transfer of resources between countries (as opposed to within countries) would face political resistance. Second, there is no longer any one nation with the economic and political power to take centre stage: the lead must come from the dominant trading blocs. This itself presents additional difficulties as there is not only potential conflict between the blocs but those countries outside the main blocs may also be disadvantaged. Third, institutional reform would also be required to provide a more integrated and coherent structure that can develop with changing conditions. One important lesson of history is that regulation is best viewed as a process rather than a static state—and so the regulatory system needs to develop and change, sometimes quickly, to react to changes in the international financial system.


  36.  Active economic, industrial and technology policy are made more important rather than less by increased globalisation—a process which can mean that a loss of competitive advantage is translated rapidly into declining market share, output, employment and living standards. Policy may be more difficult to implement in face of more intense global pressures. But far from implying a need for less action, globalisation implies that policy action may need to be reconfigured and, in some areas, may be more interventionist than in the past.


  Archibugi, D. and Michie, J. (1997), Technology, Globalisation and Economic Performance, Cambridge: Cambridge University Press.

  Kitson, M, and Michie, J. (2000), The Political Economy of Competitiveness, London and New York (Routledge).

  OECD (2000) International Direct Investment Statistics, Paris: OECD.

  Rowthorn, R. (2001), "UK Competitiveness, Productivity and the Knowledge Economy", National Competitiveness Summit, 1 November 2001, Cambridge-MIT Institute, Cambridge, UK.

7 November 2001

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