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Perspective: The heart of the new world economy
WEDNESDAY OCTOBER 1 1997Cross-border integration has now reached the levels of the 19th century - and this time companies play the central role, says Martin Wolf
Globalisation is a word that now leaps readily to every tongue. Like the idea or loathe it, few deny its existence or understate its significance. But how far has it progressed? And what role do companies play?
Behind the growing integration of the world economy lies the decline in the costs of transport and communication. Between 1930 and 1990 average revenue per mile in air transport fell from 68 US cents to 11 cents, in 1990 dollars. The cost of a three-minute telephone call between New York and London fell from $244.65 to $3.32. Between 1960 and 1990, the cost of a unit of computing power fell 99 per cent.
Technological change makes globalisation feasible. Liberalisation allows it to happen. Under the agreement reached at the end of the Uruguay round of multilateral trade negotiations, average advanced country tariffs on imports of manufactures will be reduced to under 4 per cent. Tariffs of developing countries are set to fall from 34 per cent between 1984 and 1987 to 14 per cent. Between 1970 and 1997, the number of countries that eliminated exchange controls affecting imports of goods and services jumped from 35 to 137.
Restrictions on investment have been reduced virtually everywhere. Around the world, there have been some 570 liberalising changes in regulations governing foreign direct investment since 1991. Some 1,330 bilateral investment treaties involving 162 countries are now in effect, a threefold increase in half a decade.
Technology and deregulation work together. The unit cost of sea freight, for example, fell 70 per cent in real terms between the beginning of the 1980s and 1996. Behind this sharp decline lay not just technical innovations, but increased competition generated by bigger, more liberal markets.
The extent of globalisation must not be exaggerated. At its pre-1914 peak, the UK's net capital outflow was 9 per cent of gross domestic product, twice as big a share of GDP as outflows from Germany and Japan in the 1980s. In the same period the number of workers moving across frontiers was greater than now.
Nevertheless, international economic integration has, on balance, probably gone further than ever before. According to Angus Maddison, an economic historian, ratios of exports to global output were 9 per cent in 1913, 7 per cent in 1950, 11 per cent in 1973 and 14 per cent in the early 1990s. Financial markets are ever more closely linked; and governments are increasingly bound by a web of multilateral agreements and institutions.
Such constraints are one difference between today and a century ago. More fundamental still is the role of companies. Where once integration tended to take the form of trade and capital movements at arm's length, it now occurs increasingly within companies.
In 1996, the global stock of foreign direct investment (FDI) was valued at $3,200bn. Its rate of growth over the previous decade was more than twice that of gross fixed capital formation. FDI flows grew at 12 per cent a year between 1991 and 1996, while global exports grew at 7 per cent. FDI is also widely spread: last year, 37 per cent of total FDI went to developing countries.
Investment leads to production. By 1995, 280,000 foreign affiliates generated $7,000bn in global sales, which exceeded global exports of goods and services by 20 per cent. According to the World Bank, the share in world output of multi-national affiliates jumped from 4.5 per cent in 1970 to 7.5 per cent in 1995. Their share in manufacturing output was 18 per cent in 1992, up from 12 per cent in 1977.
Multinational production generates further international transactions. In the US, intra-firm imports were more than 40 per cent of total imports by the early 1990s. Similarly, an estimated 70 per cent of global payments of royalties and fees are transactions between parent firms and their foreign affiliates.
Large companies have long dominated industries characterised by economies of scale and scope, by firm-specific skills in innovation, production or sales or by valuable trademarks or brands. Companies usually find it more profitable to exploit such assets in-house than sell or license them to other companies or engage in joint ventures.
As sophisticated and more differentiated goods and services become more important in demand, output and trade, so do companies with the capacity to supply these competitively. Inevitably, it is the most successful companies of the most advanced economies that do best beyond the borders of their country of origin.
The largest 100 multi-nationals, ranked on the basis of their foreign assets, own $1,700bn in their foreign affiliates, one fifth of global foreign assets. All but two of the companies are from advanced countries, 30 from the US alone. The top 25 US multinationals are responsible for half of the country's stock of foreign capital - a share that has remained almost unchanged over four decades.
The big change in recent years, however, is a shift in the reasons why companies move production overseas. Historically, companies have located production abroad in order to overcome natural or artificial barriers to trade. If production efficiency were the only criterion, it would have made sense for many companies to locate all their production at a single base, to maximise economies of scale. In practice, however, governments in consuming countries have pushed them to spread production more widely.
For example, much of the Japanese investment in the US and the European Union was a response to protection against its exports. The same is true of investment in many developing countries - in car and truck production, for example.
Other barriers to centralised production were inherent in the nature of the business. The provision of many services used to require face-to-face contact. Expansion of service firms therefore required the creation of elaborate overseas networks. Similarly, fear of fluctuations in real exchange rates encouraged the spread of production capacity across frontiers.
Many of these trends are now changing. Trade liberalisation makes traditional protection-jumping production unnecessary. Improvements in communications are eliminating natural barriers to long-distance commerce; services can now be produced in one country and exported to another, just like manufactured goods. And in Europe, at least, economic and monetary union will eliminate exchange rate fluctuations.
So, creating overseas production sites merely in order to meet local consumption looks an increasingly fragile basis for foreign investment. A much better one is the ability to make the best use of a company's competitive advantages by locating production wherever it is most efficient. Today's multi-nationals create widely spread networks of research, component production, assembly and distribution.
Evidence of this trend can be seen in the growing role of exports in multinational production. Between 1966 and 1993, exports from US- majority owned foreign affiliates rose from about 20 per cent of sales to 40 per cent. For affiliates in developing countries, exports rose from 10 per cent to close to 40 per cent.
This sort of internationalisation reflects - and augments - the economic liberalisation and technical change binding the world's economies closer together. To the extent that it reflects such forces, globalisation of companies is here to stay.
Part 1 Case study: DHL and International Telecom
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